Pe deals of the year

Introduction: Mission accomplished (mostly)   Terra Firma-EMI   3G-Burger King   BankUnited   Kinder Morgan   THL-Warner Music Group   Carlyle-China Pacific   Arcos Dorados   Sequoia-LinkedIn   Sun Capital-Bruegger's   Cerberus-Talecris   Court Square-FiberTech   Second best of the best

Carlyle Group has had its share of setbacks in China. Early on it attempted to buy a majority of Xugong Group Construction Machinery Co. Ltd., a state-run heavy-equipment maker, which turned into a long-drawn-out process attended by much media hoopla but in the end had to be dropped in 2008 amid political resistance. The firm shifted gears, opting for minority stakes instead, though a couple of portfolio companies have since landed in hot water amid allegations of accounting fraud.

But if there's one particular investment that illustrates how Carlyle's more nuanced stratagem of owning minority stakes can yield equally spectacular returns as a more traditional control investment, look no further than state-run insurer China Pacific Insurance (Group) Co. Ltd. The proof comes in $3.5 billion of proceeds that Carlyle's regional fund, Carlyle Asia Partners, pulled from two share sales in December and January after a 12-month lockup ended.

China Pacific launched an initial public offering on the Hong Kong Stock Exchange in 2009. Based on the $730 million total equity Carlyle injected in 2005 and 2007 for a 19.9% interest, the Washington firm, together with Prudential Financial Inc., booked a 3.6 times realized return on its initial investment. It stands to make much more from its remaining 8.05% stake.

By the time it went public, the group had become one of China's largest insurers, with 13% of the property and casualty market and 8% of the life market. "China Pacific is a classic example of how well private equity investment can work to solve balance sheet problems in China," says Neil Torpey, partner and chair of Paul, Hastings, Janofsky & Walker LLP's Hong Kong office.

When Carlyle and Prudential began to buy shares in the privately held company, it was severely undercapitalized and near collapse. But China's demographics -- a large aging population and underfunded pension obligations -- were working in its favor. "Carlyle was very much needed and welcomed in the restructuring," says Dorothy Lee, Carlyle's media director for Asia.

Between 2005 and 2007 the company recruited a new chief information officer, actuary officer and head of marketing. It invested in information technology and improved asset management strategies, adding alternative assets to the mix. It focused on higher-margin products, expanding distribution to cover substantially all of China's provinces. Carlyle's Xiangdong Yang and Junyuan Feng, who sit on the board, helped create a new compensation structure to better incentivize employees, Lee says.

China Pacific first listed in Shanghai and raised $4.2 billion in gross proceeds, though Carlyle was subject to a 36-month lockup. A subsequent listing planned for Hong Kong was delayed by the financial crisis but finally pushed through in December 2009 for $3 billion in proceeds. Again, Carlyle had a 12-month lockup. When that expired, Carlyle wasted no time completing an $860 million private placement to Allianz SE and Fairholme Capital Management LLC. A month later it unloaded 415.2 million more shares on the open market for $1.79 billion, reducing its stake to 8.05%.

Carlyle's work isn't done. China Pacific has been less successful in the life insurance segment. Product mix and productivity, both key areas, "were worse than its listed peers," says Patricia Cheng, an analyst with Hong Kong research and investment group CLSA Asia-Pacific Markets. The company gets more than half of its new sales "from thin-margin, single-premium products and distributes mainly through banks," she adds. Moreover, it hasn't totally penetrated China's major cities and remains dependent on third parties to sell its products.

Still, the analyst says, the company is well placed to participate in privatization programs ostensibly on China's drawing board to better manage pensions and create new products to offset pension liabilities.

Carlyle may well feel amply rewarded for having had a hand in China Pacific's transformation from an industry laggard into a public company with revenue of 141.3 billion renminbi ($21.7 billion) and operating profit of Rmb10.6 billion in 2010. But having skin in the game still would ensure an immense total return for Carlyle relative to its capital at risk -- if everything works out right.