Barbarians at the Gate and Private Equity’s Rule-Set Reset

With the stack of books on my desk that await my attention, I don’t know what propelled me to take the time to revisit Bryan Burrough and John Helyar’s outstanding Barbarians at the Gate. But given what is happening in China’s financial markets, I’m glad I did.

If you’re not familiar with the work, Barbarians at the Gate is an engrossing, deeply entertaining telling of the 1988 saga of how the wealthy, cosseted management team of RJR Nabisco tried to buy the company from its shareholders, only to watch the buy-out turn into a vicious battle to control the company. More than the story of a single company, the book is a case study of what happens when the predatory forces of what Thomas Friedman calls “the financial herd” encounter large corporations arguably awash in inefficiency and waste.

Despite this being a book written by two Wall Street Journal reporters, none of the players comes out of this looking particularly good. The book also calls attention to the political debate surrounding mergers, acquisitions, and private capital, and in the end underscores that both sides have a point. The financial tools that enable these transactions can be used for good or ill.

Used for good, they can unlock the assets and hidden profits of a moribund corporation to the benefit of employees, shareholders, and broader community.

Used for ill they can be used to perform the legalized equivalent of what wise guys in the Syndicate used to call a “bust-out,” or the systematic transfer of company assets into the pockets of a few individuals, followed by bankruptcy.

Nearly three decades after Michael Millken raised the much maligned junk bond to the level of high finance, launching a wave of mergers, acquisitions, buy-outs, spin-offs, and bust-outs that changed the face of capitalism. In that time, business in the United States (and to a lesser extent, Europe) have watched the systematic dismantling of the industrial conglomerates created in the wake of World War II.

As a result, people running public companies in America think a bit differently than they did three decades ago. Partly as a result of these financial machinations, American businesses are once again globally competitive, after a very long period of time in the late 1970s and throughout the 1980s when we were all questioning if they would ever be so again.

Which brings us to China.

Barbarians at the Jianguomen

Today, the people making the policies that affect China’s financial services industry are weighing the pros and cons of allowing just that sort of “creative destruction” to take place in China. There is a lot to argue for it – and a lot to argue against it.

On the pro side, the guys in Zhongnanhai understand that waste, inefficiency, graft, and corruption are rife in major Chinese enterprise, and they all profess a desire to end that and create a host of globally competitive Chinese enterprises. They see there is a role for government to play in that process, a role for the market, and a role for financial markets.

Yet in the face of the public history of the financial industry of the last 30 years, you understand why China’s leaders hesitate at the brink of unleashing such a wave of Schumpeterian mass destruction. Especially when in their eyes that effort carries the prospect of millions of downsized Chinese workers and a host of accompanying political and social problems, and especially when allowing The Herd to fill their pockets in the process implies some politically unsavory images in a land that remains at least nominally communist.

No senior official wants to preside over an industry where an RJR Nabisco-type fiasco is taking place. In fact, China’s leaders, bureaucrats, and cadres are mortally afraid of allowing any transaction that might generate the least significant public concern, media attention, or political outcry. Imagine for a minute being a Communist Party cadre reading Barbarians at the Gate one evening before bed, then the next day having to sit down with a group of foreign investors looking to buy a major Chinese business. How could you notbe concerned, if not terrified, especially as another major financial firm seems to set up shop in Beijing, Shanghai, or Hong Kong each week?

Kinder, Gentler Barbarians?

As a corporate communications specialist, a certified spin-doctor, you would expect me to say that any financial firm seeking to engage in creative destruction in China has got to make sure it positions its intentions in China correctly, delivering just the right messages to China’s alerted (if not alarmed) bureaucrats to assure them that you are looking out for their best interests.

I would – if it were that simple. It ain’t.

While I am a big fan of saying that business in China is fundamentally the same as doing business anywhere else, unless you understand what those fundamentals are, you’re lost in China.

One of the fundamentals that has enabled the immense success of the financial services industry in the U.S. is the understanding that while strategies remain constant, tactics – how you execute your purchase, integration, and sale of corporate assets – depends on the commercial and political environment and how it is evolving.

There are some extraordinarily bright people at private equity giant Carlyle, people who understand how messages need to be delivered. And yet Carlyle’s purchase of a controlling interest in heavy-equipment maker Xugong demonstrates that the financial services

China demands a different type of execution, one that addresses the concerns of regulators and does not incite – or carry the prospect of – significant political backlash. China’s regulators are looking for companies that understand the delicate line they walk between charting the nation’s future and taking care of the social and political issues they must deal with today.

In short, rather than waiting to hear messages, policy makers are looking for evidence that someone in the growing procession of private equity firms understands the political and social challenges of letting foreigners buy up China’s most promising business, and are willing to go out of their way to address them – in advance.

Because if they haven’t read Barbarians at the Gate, or something like it, they will soon.