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Interview with Prof. James Van Horne of Stanford University(1)
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The First China International Private Equity Forum just kicked off in Tianjin this month. The forum attracted more than 200 private equity funds from all over the world. Indeed, private equity managers today see opportunities in vast sectors of the PRC economy that have no dominant industry leader. Global private equity firms are rapidly opening offices in China and raising hundreds of millions of dollars to invest in the country.
What will be the challenges of private equity in China? Recently, Xing Zong, a 5th year Ph.D. student took an exclusive interview with Finance Prof. James Van Horne of Stanford University Graduate School of Business.
About Prof. James Van Horne
James Van Horne is the A.P. Giannini Professor of Finance, having come to Stanford in 1965. He teaches MBA courses in corporate finance, mergers and acquisitions, corporate restructuring, fixed-income securities, and government and nonprofit debt financing. He was the first recipient of the distinguished teaching award by MBA students, and recipient again in 1997. He is the past president of the American Finance Association and of the Western Finance Association, and has been an active member of the Financial Economists Roundtable. He also has served as Associate Editor of several leading finance journals.
Professor Van Horne has focused his research on issues in corporate finance, valuation, and on the term structure of interest rates. His some 60 articles in finance, economic, and management journals often involve empirical inquiry. He is the author of five books, three of which - Financial Management and Policy, 12th edition; Financial Market Rates and Flows, 6th edition; and Fundamentals of Financial Management, 12th edition, (coauthor) - have been widely used as texts in the U.S.A. and abroad. In addition, he has written 24 cases used in MBA courses in the school.
Xing Zong: Prof. Van Horne, it is my honor to throw a few questions at you, who is known as the most fabled inquisitor in Stanford Business School. First of all, since private equity is a relatively new concept in China, many readers are not familiar with it. Could you please tell us the difference between private equity and investment firms/investment banks, and especially venture capital? What are the major advantages of private equity over VC?
Van Horne: Private equity embraces several activities which are loosely classified under the heading "PE". Venture capital funds new enterprises and subsequent rounds of equity financing prior to sale of the start-up to a strategic buyer or the sale of common stock. Another aspect involves buyouts typically of a publicly traded company, where such company is taken private. Usually the transaction involves a significant amount of debt, hence the name leveraged buyouts (LBOs). A final set of activities sometimes placed under the general heading of private equity are hedge funds. In turn, hedge funds embrace a wide variety of endeavors -- the most common being long/short positions in common stocks.
Xing Zong: Despite the importance of the small business sector, China’s financial markets are poorly equipped to fund its growth. Therefore people have high expectations on private equity. Could you please tell us what kind of roles does private equity play in the economic boom in United States?
Van Horne: The first category of private equity, venture capital, has been around for over 50 years. It fueled start ups in a number of industries, but the largest endeavors have been in technology and in bio-tech. Venture capital has allowed many new ideas to come to fruition, and has contributed to innovation and GDP growth. Buyouts allow for ownership restructuring and, sometimes, more efficient utilization of resources. Hedge funds may make financial markets more efficient through arbitrage transactions.
Xing Zong: Many people have a certain perception towards private equity. They tend to consider private equity will cause many listed company exit stock markets, as a result, it might cause damage to the capital market, what do you think?
Van Horne: With buyouts, public companies are taken private and this reduces the number of publicly traded companies, all other things the same. However, buyout firms will exit after a holding period where they try to create value by making the firm more efficient. One exit is an initial public offering in which the company again becomes a publicly traded company.
Xing Zong: A big challenge for private equity in China is: there is no standard methodology for valuing a company in China. It is very common that Chinese entrepreneurs base their firms’ value on the similar U.S. firms. Do you think that’s reasonable?
Van Horne: The standard metrics for valuation are: price-to-earnings ratios; price-to-book ratios; enterprise value-to-sales; enterprise value-to-earnings before interest, taxes, depreciation and amortization (EBITDA); and discounted cash flow analysis of future free cash flows. Most of these metrics can be applied in China today. I think that it makes sense to do so, because these metrics are common not only to the United States, but to Europe and to other parts of the world.
The First China International Private Equity Forum just kicked off in Tianjin this month. The forum attracted more than 200 private equity funds from all over the world. Indeed, private equity managers today see opportunities in vast sectors of the PRC economy that have no dominant industry leader. Global private equity firms are rapidly opening offices in China and raising hundreds of millions of dollars to invest in the country.
What will be the challenges of private equity in China? Recently, Xing Zong, a 5th year Ph.D. student took an exclusive interview with Finance Prof. James Van Horne of Stanford University Graduate School of Business.
About Prof. James Van Horne
James Van Horne is the A.P. Giannini Professor of Finance, having come to Stanford in 1965. He teaches MBA courses in corporate finance, mergers and acquisitions, corporate restructuring, fixed-income securities, and government and nonprofit debt financing. He was the first recipient of the distinguished teaching award by MBA students, and recipient again in 1997. He is the past president of the American Finance Association and of the Western Finance Association, and has been an active member of the Financial Economists Roundtable. He also has served as Associate Editor of several leading finance journals.
Professor Van Horne has focused his research on issues in corporate finance, valuation, and on the term structure of interest rates. His some 60 articles in finance, economic, and management journals often involve empirical inquiry. He is the author of five books, three of which - Financial Management and Policy, 12th edition; Financial Market Rates and Flows, 6th edition; and Fundamentals of Financial Management, 12th edition, (coauthor) - have been widely used as texts in the U.S.A. and abroad. In addition, he has written 24 cases used in MBA courses in the school.
Xing Zong: Prof. Van Horne, it is my honor to throw a few questions at you, who is known as the most fabled inquisitor in Stanford Business School. First of all, since private equity is a relatively new concept in China, many readers are not familiar with it. Could you please tell us the difference between private equity and investment firms/investment banks, and especially venture capital? What are the major advantages of private equity over VC?
Van Horne: Private equity embraces several activities which are loosely classified under the heading "PE". Venture capital funds new enterprises and subsequent rounds of equity financing prior to sale of the start-up to a strategic buyer or the sale of common stock. Another aspect involves buyouts typically of a publicly traded company, where such company is taken private. Usually the transaction involves a significant amount of debt, hence the name leveraged buyouts (LBOs). A final set of activities sometimes placed under the general heading of private equity are hedge funds. In turn, hedge funds embrace a wide variety of endeavors -- the most common being long/short positions in common stocks.
Xing Zong: Despite the importance of the small business sector, China’s financial markets are poorly equipped to fund its growth. Therefore people have high expectations on private equity. Could you please tell us what kind of roles does private equity play in the economic boom in United States?
Van Horne: The first category of private equity, venture capital, has been around for over 50 years. It fueled start ups in a number of industries, but the largest endeavors have been in technology and in bio-tech. Venture capital has allowed many new ideas to come to fruition, and has contributed to innovation and GDP growth. Buyouts allow for ownership restructuring and, sometimes, more efficient utilization of resources. Hedge funds may make financial markets more efficient through arbitrage transactions.
Xing Zong: Many people have a certain perception towards private equity. They tend to consider private equity will cause many listed company exit stock markets, as a result, it might cause damage to the capital market, what do you think?
Van Horne: With buyouts, public companies are taken private and this reduces the number of publicly traded companies, all other things the same. However, buyout firms will exit after a holding period where they try to create value by making the firm more efficient. One exit is an initial public offering in which the company again becomes a publicly traded company.
Xing Zong: A big challenge for private equity in China is: there is no standard methodology for valuing a company in China. It is very common that Chinese entrepreneurs base their firms’ value on the similar U.S. firms. Do you think that’s reasonable?
Van Horne: The standard metrics for valuation are: price-to-earnings ratios; price-to-book ratios; enterprise value-to-sales; enterprise value-to-earnings before interest, taxes, depreciation and amortization (EBITDA); and discounted cash flow analysis of future free cash flows. Most of these metrics can be applied in China today. I think that it makes sense to do so, because these metrics are common not only to the United States, but to Europe and to other parts of the world.
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