The exit of HSBC Private Equity (Asia) last week from its nearly six-year investment in the restructured Tong Lung Metal Industry Co was one of the few successful corporate turnaround cases in Taiwan, although its efforts in overhauling Tong Lung, making the world's third-largest locksmith profitable again and keeping its promises to eventually take the firm public in March this year were unthinkable to many.
The private equity firm rescued Tong Lung in 2000 when the family-run locksmith was on the brink of bankruptcy. Following years of effort to improve the locksmith's cash flow and business operations, HSBC Private Equity on Wednesday sold its 68 percent stake in Tong Lung to Test Rite International Co for NT$2.18 billion (US$66.3 million).
HSBC Private Equity's return of 36 percent from its original investment of some NT$1.6 billion was considered much higher than the average annual return on private equity deals, which has only topped 13 percent over the past two decades, according to data provided by Thomson Financial.
Despite HSBC Private Equity's smart investment as well as its graceful exit, private equity firms -- often called vulture funds or corporate raiders -- are still an unlikely partner of old-school businesses, due to their voracious hunt for underperforming companies. Typically, they purchase companies cheaply, harshly overhaul their operations, dress them up for maximum profit and leave.
For better or for worse, such funds have entered Taiwan in droves in recent years, looking for new opportunities in the financial, media and telecom sectors. Last month, for instance, MBK Partners announced it would buy 60 percent of China Network Systems Co, the nation's biggest cable company, for NT$30.9 billion, following in the footsteps of Carlyle Group, which bought a stake in No. 2 cable TV operator Eastern Multimedia Co, and Macquarie Bank, which bought a stake in No. 3 Taiwan Broadband Communications.
Other noteworthy examples of such deals include Temasek Holdings' purchase of a 15 percent stake in E.Sun Financial Holding Co for NT$13.13 billion in March, as well as Newbridge Capital and Nomura Group's combined bid for a 27 percent stake in Taishin Financial Holding Co for NT$31 billion in February.
Despite being flush with cash, private equity firms have been criticized for taking advantage of easily available debt financing to close deals. In other words, they tend to use little of their own cash while borrowing most of the purchase cost from banks.
What makes this borrowed money worrisome is that the debt can pile up so much it becomes difficult for the companies to handle. Worse, some of these firms have been found to use the cash flows -- generated from both the loans and the improved business -- to enrich themselves rather than pay down the companies' debts.
Last week, Britain's Financial Services Authority said in a 102-page report that private equity firms may risk the stability of UK financial markets by taking on excessive levels of debt. A recent report by Standard & Poors also warned that record levels of debt have been racked up by companies acquired by private equity firms through leveraged transactions.
Extreme cases may only be one small part of this emerging sector, but the Financial Supervisory Commission should have banks reconsider how their lending to private equity firms would fare in a recession. Apart from concerns over the industry's impact on capital markets, the regulator should also examine how this industry's issues with transparency, disclosure and financial misconduct would affect the stakeholders of companies: employees, shareholders and the communities that depend on them.