Tuesday, April 29, 20086:30 AM - 7:45 AM

Investing in China Workshop

Speakers:Jim Lavelle, Managing Director and Group Head of Industrial and

Environmental Technologies, Houlihan LokeyMitchell Nussbaum, Partner and Chair, Corporate Securities Practice

Group, Loeb & Loeb LLPDavid Tang, Managing Partner, Asia, Kirkpatrick & Lockhart PrestonGates Ellis LLP; Chairman, Federal Reserve Bank of San Francisco

Moderator:Nicholas Sandler, Senior Vice President, Crestwood Pacific Group; Head

of Business Development, Crestwood China Hydro LLC

Considering investment in China

• Foreign investments into China are restricted.

• Foreign Investment Industrial Catalogue (the

latest version revised on October 31st, 2007 and effective fromDecember 1st, 2007).

• Foreign investment in businesses arecategorized as:

– Encouraged;

– Permitted;

– Restricted; or

– Prohibited.

Source: K&L Gates.

Encouraged industries

• Typically involve industries using advanced ornew technologies.

• Examples include mining, oil & gas, food andbeverage manufacturing, high and newtechnology development centers, and scientificresearch, technical services and geologicalexploration.

• Foreign investments are generally permittedthrough WFOEs.

Source: K&L Gates.

Restricted industries

• Typically involve old technology or sectors that are inthe process of gradually opening up.

• Examples include telecommunications, legal services,printing of publications, construction and operation ofoil refineries with an annual output of 8 million tons orbelow, repair, design and manufacturing of vessels;production & supply of electricity, gas and water.

• Investments in restricted industries are often subjectto higher-level government approvals.

• Often limited to joint ventures and, in some cases,with the Chinese partner as the major partner.

Source: K&L Gates.

• Typically involve projects of public interest,national security or that may causeenvironmental pollution.

• Examples include construction and operationof nature reserves and wetlands ofinternational importance; publication,distribution and import of books, newspapersand magazines.

• Prohibited industries are closed to foreigninvestment

Prohibited industries

Source: K&L Gates.

Permitted industries

• Projects not listed in the Catalogue aregenerally considered permitted and do notrequire special approval, unless specificallybarred in other PRC regulations

Source: K&L Gates.

Types of entities in China

• Domestic Companies

– Limited Liability Company

– Joint Stock Limited Company

• Foreign Invested Enterprises

– Wholly Foreign Owned Enterprise

– Equity Joint Venture

– Contractual Joint Venture

– Representative Office

Source: K&L Gates.

Joint ventures (JVs)

• A new business entity (Equity Joint Venture)or contractual relationship (Contractual JointVenture or Cooperative Joint Venture)

• Share investment and operation expenses,management responsibilities, and profits andlosses.

• Two types: Equity Joint Venture orContractual (Cooperative) Joint Venture.

Source: K&L Gates.

JVs (continued)

• Pros:

– Access local market expertise and preferentialmarket treatment.

– Use Chinese partner’s manufacturing capacity,relationships with the local governmentcombined with foreign party’s technology,know-how and marketing experience.

– Exit opportunities (can do China domesticlisting).

Source: K&L Gates.

JVs (continued)

• Cons:

– Need to manage relationship with JV partner;and JV partner’s relationship with localgovernments.

– Shared ownership, control and management.

– Loss of technology.

– Exit opportunity not attractive for foreign listing.

Source: K&L Gates.

Wholly foreign owned enterprises(WFOE)

• Independent legal entity entirely owned by foreigninvestor(s).

• Pros:

– No issue on ownership, management, control or culture.

– Secure ownership of IP

• Cons:

– On your own, no local partner.

– Not permitted to carry on certain businesses - Examplesinclude mining, tobacco, restaurants, bars, building andconstruction, car production, airplane production, etc.

Source: K&L Gates.

Representative office

• Not an independent legal entity.

• Cannot carry on direct profit-making businessactivity.

• Perform liaison on market research for parentcompany only.

Source: K&L Gates.

Recent SAFE and MOFCOM issues

• China has currency exchange controls.

• RMB trades within a band pegged to currency basket.

• Upward pressure on (and inflows and exchange to)RMB continues.

• On May 29, 2007, the State Administration of ForeignExchange of China (SAFE) issued new OperatingProcedures which clarify Circular No. 75

• Circular 75 imposes foreign exchange control onfinancing and “round-trip” investments by domesticresidents through offshore SPVs.

Source: K&L Gates.

Recent SAFE and MOFCOM issues

• Operating Procedures impose new burdens oninvestors in transactions with Chinese “round-trip”.

• “SPV” refers to an offshore vehicle established orcontrolled by a PRC domestic resident individual orlegal person for the purpose of overseas equityfinancing of domestic assets or interests.

• "Round-trip investment" refers to investment fromoffshore SPVs invested in or controlled by a PRCresident individual or legal person.

• PRC resident individual can be foreigner (US)

Source: K&L Gates.

Recent SAFE and MOFCOM issues

• Regulation on M&A of Domestic Enterprise byForeign Investors issued by MOFCOM, SAFE,CSRC, SASAC and Tax Bureau releasedSeptember 2006.

• Share or assets swaps between PRC residentsand foreign companies require MOFCOMapproval.

• No approvals given to date.

• Blocks foreign listings for PRC businesses whichdid not have foreign ownership before September’06.

Source: K&L Gates.

Sina model

• Offshore holding company sets up WFOE.

• WFOE and offshore company contract with aChinese company and its shareholders.

• Chinese company operates the restricted business

• Economics flow to WFOE and Offshore companythrough contracts.

• Used by Chinese Internet-related company listedon the NASDAQ as well as other companies inrestricted businesses.

Source: K&L Gates.

Sina model

Offshore Co

Hong Kong Co

WFOEPRC Co

PRCNationals

Loan

Pledge interestsIn PRC Co

Grant control

Services, license, etc

FeesSource: K&L Gates.

Loans to PRC companies

• Offshore investor of FIE (EJV, CJV and WFOE)may make loan to the FIE and the amount of suchloan can be limited up to the difference betweenthe total investment and the registered capital forthe FIE.

Source: K&L Gates.

Using JVs for flexibility inA share listing

• Foreign invested company limited by sharestechnically allowed to list on A-share markets.

• In practice, only JVs granted approval for listing

• No WFOE granted approval.

• JV can have additional exit option in A-ShareListing.

• A-Share listing can only access RMB market.

Source: K&L Gates.

New Enterprise Income Tax

• Effective January 1, 2008

• Imposes standard enterprise income tax (“EIT”)rate at 25%.

• Reduced EIT rate of 20% for small-scale and thin-profit enterprises.

• Preferential EIT rate of 15% available to approvedhigh / new technology enterprises.

Source: K&L Gates.

Chinese New Enterprise Income Tax

• Imposes 10% withholding tax on dividends,interest and other passive income paid tonon-Chinese entities.

• Tax treaties and arrangements reducewithholding tax to 5%. For payments tosome jurisdictions (eg. Hong Kong)

Source: K&L Gates.

Enforcement of contracts: mutualenforcement arrangement betweenChina and Hong Kong

• Arrangement between the Mainland and HongKong for mutual recognition and enforcement ofcivil and commercial judgments as agreed.

• Arrangement for mutual enforcement of arbitralawards between the Mainland and Hong Kong.

• Facilitated enforcement of contracts entered intobetween parties in Mainland and Hong Kong.

Source: K&L Gates.

• Feasible exit strategies include listing on the domestic and/or international markets; sell topotential China financial investors

• Be aware of restrictions on repatriation of investment and dissolution of JVs• Possible trade sale to Chinese or non-Chinese groups

Exit Considerations

• Take the appropriate route to channel investment into China• Understand State Administration of Foreign Exchange (SAFE) regulations on repatriation of funds

Exchange Controlsand Repatriations

• Understand Chinese national tax regime and use effective investment structures such as BVIs tominimize taxes

• Take advantage of local tax treatment regime for foreign investments, e.g.. “three-year exemptionand two-year 50% reduction”

• Changes in taxation post WTO, e.g. Elimination of preferential tax treatment

Taxation

• Availability of local currency financing opens alternative options in raising capital• Ability to borrow domestically• Equity financing feasibility in the domestic market: foreign-invested enterprises (FIEs) are

allowed to list in the A share market• Hedging is another issue for consideration in the foreign vs. local currency decision• Cash flow management across different legal entities

Financing

• Restructuring needs for business, operations, balance sheet, and additional SOE considerationsRestructuring

• Increasing legal protection of intellectual property rights through new laws and regulationsIntellectual Property

• Understand the existing corporate governance / management structure – change if necessary• Alignment of management’s interests with investor’s interests• Establish new and effective corporate culture, organizational structure, employee incentive plan• Effective operational / management control

CorporateGovernance/Management

• Holding company vs. discrete entities• Onshore vs. offshore• Minority / strategic investment vs. controlling stake

Investment Structure

Key structure related issues for investors

Source: Houlihan Lokey.

Case study:Fushi acquires 100% of Copperweld

Fushi International, Inc.

has acquired

Copperweld Bimetallics, LLC

We served as

exclusive financial advisor and

structured and negotiated the transaction

on behalf of Fushi International, Inc.• Completed on October 29, 2007, the transaction

expanded Fushi’s base of products and customers andestablished the Company as a worldwide industryleader

• Houlihan Lokey acted as sole financial advisor to Fushion all aspects of the transaction and was responsiblefor negotiating and structuring the deal

Transactionsnapshot

• Copperweld Bimetallics, LLC is a leading U.S.manufacturer of copper-clad steel and CCA wire

• Copperweld produces a range of products for use incommunications, utility, transportation, and industrialapplications in both the U.S. and international markets

• A second manufacturing location in Telford, Englandprincipally services the growing European market

Targetprofile

• Fushi International, Inc. is a China-based wiremanufacturer with a market capitalization of USD 345million

• Fushi is a leading Chinese manufacturer of bimetalliccomposite wire products, principally copper cladaluminium wires, which is used in a wide variety ofapplications

Client profile

Source: Houlihan Lokey.

Industrial technology joint venture case study

Project Diana transaction highlights the complexity of JV transactionsin China, the impact of the current Chinese financial markets as wellas developing nature of Chinese M&A and IPO law

• Obtain premium valuationupfront

• Preserve control overoperations

• Preserve flexibility to take JVpublic at a later point

Target’s objectives

• IPO regulations

• Corporate law requirements

• Shareholder agreements

• Accounting/consolidation offinancials

Issues addressed

• Access to China market

• Low-cost production

• Securing low-end product line toenter a rapidly growing segment

• Protecting market positions

Acquiror’sobjectives

• A North American industrial technology company (“Acquiror”) sought to form a partnership withthe leading Chinese company in its segment through either a JV or full control acquisition. Theultimate transaction structure negotiated needed to allow both parties to meet their respectivestrategic objectives and fiduciary obligations

Overview

Flexibility to take JV public

Bridging valuation expectations

Managing governance/operational control

Shareholder impacts of future capital investment

Receive endorsement of the leading global player

Access to technology

Increase in scale/size (to make a more attractive IPOcandidate)

Protecting IP

Creating value for shareholders

Cultural fit

Source: Houlihan Lokey.

Case Study

Corona Shenzhen Juchang Fashion Co. Ltd.

Company overview

• Corona Shenzhen Juchang Fashion Co. Ltd.(“Corona” or the “Company”) is a leading women’sfashion company in the People’s Republic of China

• Currently has 412 franchises and 42 owned stores in28 provinces and autonomous cities in china –management is forecasting 1473 stores by 2010

• 2007 Revenue over US$60 million; Net Income ofUS$11 million

– Head quarters are in Shenzhen, in the province ofGuangdong – population 80 million

Source: Crestwood Pacific Group.

Projected growth

The company is forecasting revenue and net income ofover US$ 328 million and US$70 million respectively forthe fiscal year ending 2010

Projected revenue 2008 - 2010

$0

$50

$100

$150

$200

$250

$300

$350

2008 2009 2010Year

Revenue, US$ millions

Projected stores 2008 - 2010

156265 313

612

860

1,070

-

200

400

600

800

1,000

1,200

1,400

1,600

2008 2009 2010

Year

Franchised Stores

Owned Stores

Number of stores

Source: Crestwood Pacific Group.

• China’s clothing market: US$40 billion industry

• Foreign companies are rapidly entering the 1st and 2nd

tier Chinese city market, as the average income ishigher – between US$776 and US$1,034

• Chinese brands have more recognition in 3rd and 4th

Tier cities, as foreign brands face challenges such asinfrastructure, which is less developed in these cities

• Department stores sales: 40% of the market

• Franchise chains and individual clothing outlets: 60%of the Market

• Profit margins: 50 to 70% due to the lower cost ofmanufacturing

Outlook

Source: Crestwood Pacific Group.

Company facts

• Corporate HQ is in Futian Central District ofShenzhen

• Currently has over 169 employees reporting tothe various heads of departments

• Mr Chen is seen as a strategic leader, whoadopts a hands on approach to managementand is actively involved both management anddesign

Source: Crestwood Pacific Group.

Growth strategy

Franchises

• Currently 412, which represents 60% coronas sales -long term plan for franchises to represent 50% ofstores

• 1145 total stores by 2010

Owned stores

• Currently 42

• Forecasting 328 owned stores by 2010.

Source: Crestwood Pacific Group.

Use of proceeds

• The proceeds will be used for the following:

Uses of financing

SAP and enhanced ERP implementation $1.5 million

Additional company owned stores $11.0 million

Total $12.5 Million

Source: Crestwood Pacific Group.

Investment highlights

Extensive retail network well positioned throughout the PRC

Multiple distribution channels

Vertical business model: Own branding, research, design,manufacturing and sourcing, distribution and retail capabilities

Technology investment SAP implementation and enhanced ERPsystem in 2008 results in

Marketing strategy intensify Corona brand building throughout thePRC, targeting customers and future franchisees

Committed management team

Expansion opportunities

Source: Crestwood Pacific Group.

Corona WFOE Structure

PRC

Offshore

Chen Yuzhen

Corona Shenzhen(WOFE)

Juchang

100%

100%

82.9%

SBI E2

Crestpac

8.55%

8.55%

70m RMB registeredcapital (US $10 M)

Corona Int’l (BVI)

Where the Corona’sassets are held inChina

Where Crestpac & SBI moneyflow in (US $10 M)

Source: Crestwood Pacific Group.

Thank You