One of China’s Best State Enterprises Shows Need for Reform — Financial Times

October 6th, 2015 No comments

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Financial Times article Peter Fuhrman

China’s ruling State Council last month released a much-anticipated plan meant to kick the country’s huge state-owned enterprise (SOE) sector into shape. No small amount of kicking is required. Not all but many of China’s 155,000 SOEs are inefficient and often loss-making. Where SOEs do make money, it’s usually because of markets and lending rules rigged by the government in their favor.

Finding a truly good SOE, one that can take on and outcompete private sector rivals in a fair fight is hard. Gong He Chun is one. Customers throng daily to buy its high-quality products, often forming long queues. The employees, unlike at so many SOEs in China, are helpful and enthusiastic and take evident pride in what they are doing. Though local private sector competitors number in their hundreds, Gong He Chun has them all beat.

Gong He Chun is a small restaurant chain, with just four shops in the ancient and Grand Canal city of Yangzhou, about 300km up the Yangtze river from Shanghai. It specializes in preparing and serving meticulously-prepared versions of dishes that have for over 1,000 years made Yangzhou synonymous with fine eating in China.

It’s a rather long and mouth-watering list, including crab and pork-stuffed xiaolongbao dumplings (below centre), potstickers (below right), steamed shrimp dumplings, shredded tofu and of course Yangzhou’s most famous culinary export, Yangzhou fried rice.

Gong Hechun

Gong He Chun was founded in 1933 as a private concern, but was then, like almost all other private businesses, expropriated in 1949. It’s been an SOE ever since, its shares owned by the Yangzhou government branch of SASAC, the government agency now responsible for holding shares and guiding the management of all SOEs. Gong He Chun somehow held on through the long dark years during Mao Zedong’s rule when most restaurants in China were shuttered, and investment in the SOE sector was directed toward Stalinist heavy industry – steel mills, coal mines, power plants, railroad rolling stock and the like.

Yangzhou, Yangzhou cuisine and places like Gong He Chun represented just about everything that Chairman Mao Zedong most detested. Since at least the Tang Dynasty (618-907), the town has had a reputation for its mercantile traditions, beautiful women and traditional culture. To eradicate such bourgeois roots, Mao and his planners crammed the city in the 1950s and 1960s with ugly sooty chemical factories and smelters.

I remember first visiting Yangzhou in 1981 and being shocked by the sight of once-splendid Ming Dynasty temples and courtyard homes converted to makeshift factories and communal dwellings. In those days, finding anything to eat, even at the few hotels where foreigners were allowed to stay, was no simple matter. All food, including dumplings, was available only with ration coupons.

Things have improved over the last twenty-five years. One not-unimportant reason for this is that Jiang Zemin, who ran China from 1989-2002 is a native son of Yangzhou while his successor, Hu Jintao, was raised in the next door town of Taizhou. Jiang still visits Yangzhou at least once a year, usually during Qingming Festival when filial Chinese return to their home to sweep the graves of their ancestors. Yangzhou this year is celebrating with pomp the 2,500th anniversary of its founding.

Gong He Chun (see photo) still hews closely to the recipes and cooking methods perfected in the 1930s by the founder Wang Xuecheng. This means cutting thin soup noodles by hand, preparing the dumplin skins in such a way as to create tiny pores and air pockets that allow flavor to seep in.

Ever wonder exactly how a properly prepared potsticker should look?

At Gong He Chun, as all its many cooks are taught, they must fulfill Wang’s precise prescription: the overall outward appearance of a sparrow’s head, with its slender sides resembling a lotus leaf and its bottom fried to the color of a gold coin. If only the management and workers at China’s huge substandard SOE oil refineries took as much care, China’s polluted skies would surely improve.

While the quality of what comes out of the kitchen is world class, there are places where the dead hand of state ownership can be detected. The toilets are primitive, plastic plates and bowls are old and chipped, and the overall décor looks like a 1950s US high school lunchroom.

Though its brand-name and reputation are known nationally, Gong He Chun has no apparent intention to expand outside Yangzhou. The three-tiered system of SOE management in China, with ownership spread among national, provincial and local branches of SASAC, makes it both rare and difficult for any local SOE like Gong He Chun to expand outside its home base.

Meantime, a Taiwan company, Din Tai Fung, has taken Yangzhou cuisine, especially the crab xiaolongbao, and built a high-end chain of global renown, with Michelin-starred restaurants across East and Southeast Asia as well as the US, Australia and Dubai. Its China outlets sell dumplings at three times the price of Gong He Chun.

I’m lucky to know the China chairman of Din Tai Fung, and have spent time with him inside Din Tai Fung restaurants. Every detail is sweated over by the chairman, from the starched white tablecloths to the polish on the bamboo steamers to the precise number of times a xiaolongbao dumpling should be pinched closed. Gong He Chun’s state owners are utterly devoid of the drive, vision and hunger for profits and expansion that only a private proprietor can bring.

A newly-announced government policy on SOE restructuring has already come in for criticism in China. Xi Jinping and his State Council – once keen to expose SOEs to more market rigor and competition – have opted for a more “softly-softly” approach, with no specific targets for improving the woeful performance of many SOEs. One reason is that a fair chunk of China’s SOE system is in chaos, thanks to a more high-priority policy of the Xi government. Every week brings new reports about bosses and senior management at China’s largest SOEs being investigated or arrested for corruption.

If there was ever an economic rationale for a small chain of traditional dumpling shops to be owned by the state, no one seems able to recall it. What profit Gong He Chun makes is not being reinvested in this rare SOE jewel, but is used instead to prop up SOE losers in Yangzhou. As China’s new SOE reform policy now begins its tentative roll-out, it looks certain Gong He Chun will for years to come remain a rare bright spot in a blighted SOE landscape.

Peter Fuhrman is Chairman & CEO China First Capital. He has no business relationship with Gong He Chun.

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“A lot hasn’t gone to plan”: SuperReturn Interview

September 15th, 2015 No comments


Does [China’s] shift from a manufacturing-driven economy to a service-driven one make macroeconomic shocks like those seen this summer inevitable?

Peter Fuhrman: China has enjoyed something of a worldwide monopoly on hair-raising economic news of late: a stock market collapse followed by a klutzy bail-out, then a devaluation followed by a catastrophic explosion and finally near-hourly reports of sinking economic indicators. As someone who first set foot in China 34 years ago, my view is we’re in an unprecedented time of economic and financial uncertainty . Consumers and corporates are noticeably wobbling. For a Chinese government long used to ordering “Jump!” and the economy shouting back “How high?” this is not the China they thought they were commanding.  Everyone is looking for a bannister to grab.

And yet, China still has some powerful fundamentals working in its favour. Urbanization is a big one. It alone should add at least 3-4% to annual GDP a year for many years to come. The shift towards services and domestic growth as opposed to exports are two others. For now, these forces are strong enough to keep China propelling forward even as it tows heavy anchors like an ageing population, and a cohort of monopolistic state-owned enterprises (SOEs) that suck up too much of China’s capital and often achieve appalling results with it.

Look, the Chinese stock market had no business in the first place almost tripling from June last year to June of this. The correction was long, long overdue. It’s often overlooked that China’s domestic stock market has a pronounced negative selection bias. Heavily represented among the 3,000 listed companies are quite a number of China’s very worst companies, with the balance made up of lethargic, low-growth, often loss-making SOEs. The good companies, like Tencent or Baidu, predominantly expatriate themselves when it comes time to IPO. To my way of thinking, China’s domestic market still seems overpriced. The dead cats are, for now, still bouncing.


Given this overall picture, do you expect to see greater or fewer opportunities [in China] for alternative investments and why? 

Peter Fuhrman: The environment in China has been challenging, to say the least, for alternative investment firms not just in the last year, but for the better part of the last decade. A lot hasn’t gone to plan. China’s growth and opportunities proved alluring to both GPs and LPs. And yet too often, almost systematically, the big money has slipped between their fingers. Partly it’s because of too much competition, and with it ballooning valuations, from over 500 newly-launched domestic Chinese PE and VC firms. The fault also sits with home-grown mistakes, with errors by private equity firms in investment approach. This includes an excessive reliance on a single source of deal exit, the IPO, all but unheard-of in other major alternative investment environments.

Overall PE returns have been lacklustre in China, especially distributions, before the economy began to slip off the rails. In the current environment, challenges multiply. A certain rare set of investing skills should prove well-adapted: firms that can do control deals, including industry consolidating roll-ups. In other words, a whole different set of prey than China PE investors have up to now mainly stalked. These are not pre-IPO deals, not ones predicated on valuation arbitrage or the predilections of Chinese young online shoppers. There’s money to be made in China’s own Rust Belt, backing solid well-managed manufacturers, a la Berkshire Hathaway. There’s too much fragmentation across the industrial board. China will remain the manufacturing locus for the world, as well as for its own gigantic domestic market.

Another anomaly that needs correcting: Global alternative investing has been overwhelmingly skewed in China towards equity not debt. The ratio could be as high as 99:1. This imbalance looks even more freakish when you consider real lending rates to credit-worthy corporates in China are probably the highest anywhere in the advanced world, even a lot higher than in less developed places like India and Indonesia. Regulation is one reason why global capital hasn’t poured in in search of these fat yields. Another is the fact PE firms on the ground in China have few if any team members with the requisite background and experience to source, qualify, diligence and execute China securitized debt deals. There’s a bit of action in the China NPL and distress world. But, straight up direct collateralized lending to China’s AA-and-up corporates and municipalities remains an opportunity global capital has yet to seize. Meanwhile, China’s shadow banking sector has exploded in size, with over $2.5 trillion in credit outstanding, almost all of which is current. There’s big money being made in China’s securitized high-yield debt, just not by dollar investors.


What’s the overall story of alternative investors engaging with central planning? How would you characterise the regulatory environment?

Peter Fuhrman: China has had a state regulatory and administrative apparatus since Europeans were running around in pelts and throwing spears at one another. So, yes, there is a large regulatory system in China overseen by a powerful government that is very deeply involved in economic and financial planning and rule-making. One must tread carefully here. Rules are numerous, occasionally contradictory, oft-time opaque and liable to sudden change.

Less observed, however, and less harrowing for foreign investors is the core fact that the planning and regulatory system in China has a strong inbuilt bias towards the goal of lifting GDP growth and employment. Other governments talk this talk. But it’s actually China that walks the walk. The days of anything-goes, rip-roaring, pollute-as-you-go development are about done with. But, still the compass needle remains fixed in the direction of encouraging strong rates of growth.

The Chinese government has also gotten more and more comfortable with the fact that most of the growth is now coming from the highly-competitive, generally lightly-regulated private sector. Along with a fair degree of deregulation lately in industries like banking and transport, China also often pursues a policy of benign neglect, of letting entrepreneurs duke it out, and only imposing rules-of-the-game where it looks like a lot of innocents’ money may be lost or conned. To be sure, foreign investors in most cases cannot and should not operate in these more free-form areas of China’s economy. They often seem to be the first as well as the fattest targets when the clamps come down. Just ask some larger Western pharmaceutical companies about this.


In the long view, how long can the parallel USD-RMB system run? Do you expect to see the experiments in Shanghai’s Pilot Free Trade Zone (FTZ) replicated and extended? 

Peter Fuhrman: Unravelling China’s rigged exchange rate system will not happen quickly. Every baby step — and the steps are coming more fast of late — is one in the direction of a more open capital account, of greater liberalization. But, big change will all unfold with a kind of stately sluggishness in my view. Not because policy-makers are particularly wed to the notion of an unconvertible currency. There’s the deadweight problem of nearly $4 trillion in foreign exchange reserves. What’s the market equilibrium rate of the Dollar-Renminbi? Ask someone facing competition from a Chinese exporter and they’re likely to say three-to-one, or an almost 100% appreciation. Ask 1.4 billion Chinese consumers and they will, with eminent good reason, say it should be more like 12-to-one. Prices of just about everything sold to consumers in China is higher, often markedly higher, than in the US where I’m from. This runs from fruit, to supermarket staples, to housing, brand-name clothing up to ladder to cars and the fuel that powers them.

I think the irrational exuberance about Shanghai’s FTZ has slammed into the wall of actual central government policy of late.  It will not, cannot, act like a free market pathogen.


Reform of China’s state-owned enterprises has been piecemeal, and private equity has had patchy success with SOEs. Do you expect this to change, and why?

Peter Fuhrman: For those keeping score, reform of SOEs has yet to really put any points on the board. The SOE economy-within-an-economy remains substantially the same today as it was three years ago. Senior managers continue to be appointed not by competence, vision and experience, but by rotation. The major shareholder of all these SOEs, both at centrally-administered level as for well as those at provincial and local level, act like indifferent absentee proprietors, demanding little by way of dividends and showing scant concern as margins and return-on-investment droop year-by-year at the companies they own.

There are good deals to be done for PE firms in the SOE patch. The dirty little secret is that the government uses a net asset value system for state-owned assets that is often out-of-kilter with market valuations. Choose right and there’s scope to make money from this. But, if you’re a junior partner behind a state owner who cares more about jobs-for-the-boys than maximizing (or even earning) profits then no asset however cheaply bought will ever really be in the money.


TPP has been described as ‘a club with China left out’. If it comes to pass, how do you expect China to respond?

Peter Fuhrman: China has responded. Along with its rather clumsy-sounding “One Belt, One Road” initiative it also has its Asia Infrastructure Investment Bank. The logic isn’t alien to me. When American Jews were barred from joining WASP country clubs, they tried to build better clubs of their own. When Chase Manhattan, JP Morgan and America’s largest commercial banks wouldn’t hire Jews, they went instead into investment banking, where there was more money to be made anyway.

But, China may not so easily and successfully shrug off their exclusion from TPP. It increases their aggrieved sense of being ganged-up upon. The US understands this and now frets more about China’s military power. The partners China are turning to instead – especially the countries transected by the “One Belt, One Road” – look more like a cast of economic misfits, not dynamic free traders like the TPP nations and China itself. I don’t think anyone in Beijing seriously believes that increased trading with the Central Asian -stans is a credible substitute. Even so, China will not soon be invited to join the TPP. China has hardly acted like a cozy neighbour of late to the countries with the markets and with the money. Being feared may have its strategic dividends. But the neighbourhood bully rarely if ever gets invited to the block party.


Peter Fuhrman will be speaking at SuperReturn Asia 2015, 21-24 September 2015, JW Marriott, Hong Kong.

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The Economist Survey on China Business

September 11th, 2015 No comments


Econ survey2

With a timing that can only be described as exquisite, the Economist today publishes their in-depth survey of business in China. It appears at a time when the media is brimming with stories, often in my view overblown,  about China’s economic problems and challenges. The Economist survey provides light where there’s been way too much heat of late. I couldn’t recommend more highly taking the time to read it in full.

Please click here to go direct to the survey on the Economist website. It includes nine separate articles, each offering a banquet of analysis, ideas and insights on where China’s economy, both private sector and SOE, is heading.

The author of the survey is Vijay Vaitheeswaran, the China business and finance editor. This is the first Economist China business survey in many years. It was certainly no small undertaking. China’s size, complexity and ever-morphing business environment make a comprehensive future-looking summary of this kind difficult in the extreme to do well.

I got to meet Vijay during his research phase. I took him for Tibetan food in Shenzhen. He ended up quoting me briefly in one of the articles in the survey.

Vijay paid particular attention to accelerating innovation cycles in China’s hardware industry. He spent a few days in Shenzhen including attending a kind of hacker forum for hardware geeks. He calls Shenzhen “the world’s best place to start a hardware firm” and visited my favorite exemplar of this, 18-month-old mobile phone brand OnePlus.

Quick aside, since the launch of its new model, the OnePlus 2 six weeks ago, the waiting list to buy one has grown to over five million people. If OnePlus’s factories can keep pace with the exploding demand, the company is on track to sell over $2 billion of phones in coming twelve months.

While overall highly positive about China’s economic prospects and the ambitions of its vast pool of private sector entrepreneurs, the survey sounds a note of caution. It argues that the less efficient state-owned sector appears more and more like an unevolved creature from a foregone era.  They are, the survey warns, sucking up too much of China’s capital and achieving too little with it, all the while fighting to maintain the cozy monopolies that keep the far more dynamic and efficient private sector shut out.

How much market? How much government control and ownership? All countries struggle to find a balance. China stands out because the private sector has come so far so fast. Thirty years ago when I first set foot in China there was no private sector to speak of. Now, in all but the so-called “commanding heights” of China’s economy, entrepreneurs run rampant. 1.4 billion Chinese benefit from this fact every day.


China Adjusts to a New Economic Normal — Toronto Globe And Mail

September 11th, 2015 No comments

Globe and Mail

China adjusts to a new economic normal

Nathan VanderKlippe


No one at the California River Town golf course saw the axe coming. Ever since 2007, when its sprawling fairways began to take over rural fields that once grew beans and pears, California River Town had been a thriving staple of the local economy. It picked up awards, employed more than 500 and welcomed more than 300 golfers a day. Local celebrities and comedians walked its greens.

Golf was sweeping across China, with hundreds of courses being opened to a rising upper-middle class with money to spend – and the benefits spread widely.

More than 60 of the employees at California River Town came from the nearby village of Gongyi Zhuangcun, whose residents were put to work cleaning bathrooms and cutting grass.

It made for good work.

“I was quite happy there. There are so many flowers and green grass,” said Ms. Liu, a woman who worked at the course for seven years and declined to provide her full name for fear of reprisals.

Then on June 10, her boss came to tell her not to come back the following day. Instead of an advance dismissal notice, she was given a week’s pay and asked to sign papers saying her departure was voluntary. It was not. The golf course suggested the 51-year-old woman retire (in China, female factory workers can stop work at 50; public sector workers can retire at 55).

Five days later, another cohort was let go. She figures at least a third of the employees are now gone.

“They said business was bad,” Ms. Liu said. She was shocked. For most of the past four decades, China has known nothing but growth, a world where wages gained 10 per cent a year, employment was plentiful and tomorrow was practically guaranteed to be more prosperous than today.

“Now the economy is suddenly falling,” Ms. Liu said. She can’t understand it. “Golf used to be very popular. Why has it suddenly gone bad?” she asked.

It’s an increasingly common question across China, which is grappling with an economic slowdown that has shocked exporters, property developers and stock investors, and is now hitting something perhaps more important: public confidence. Economic weakness is suddenly taking centre stage, as the toll of shrinking gross domestic product figures – China is on track to post its slowest growth in 25 years, and economists increasingly question the official numbers – begins to grow apparent.

“Companies are suffering acutely from shrinking revenues and profits. This is a first, arguably since reform began,” said Peter Fuhrman, chairman of China First Capital, a boutique mainland China-based investment bank.

The collapse of the stock market may have simply been air rushing out of a giant bubble. But to many in China, it was a signal that things have changed, that there is now “a whole new world within China,” Mr. Fuhrman said.

“From what we understand, from companies out selling stuff in China, pretty much everybody has just has been sitting on their wallets since July. It’s been the sharpest drop that anyone has not only seen, but could imagine, in such a short period of time.”

It’s apparent not just in golf courses, but in hotels, restaurants and delivery services, along with factories and construction sites.

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Traditional Chinese Medicine — regulated cures or regulated quackery?

August 24th, 2015 No comments

medical diagnosisChina has the world’s second largest drug market and it’s growing fast. Estimates are that by 2020 prescription pharmaceutical sales will top $300 billion a year, second only to the US. Drug sales are regulated by the Chinese FDA, which on the surface, has been modeled after the US FDA.

In fact, though, China’s drug industry and regulation is like nowhere else in the world. The reason: one third of all drug sales in China are of approved traditional Chinese medicines (“TCM”) made from dried leaves, roots, stems, fungi, flowers, and seeds, along with a variety of animal, insect and lizard skins and secretions.

The same Chinese FDA regulatory system that tests and approves Western medicines also approves TCM ingredients and potions. China’s healthcare industry thus stands with one foot planted in 21st century science and one foot in its opposite, a world of age-old popular folklore and folk cures.

Chinese medicine has been around in China for at least 2,000 years. Western drugs and teaching hospitals arrived about a century ago. The two regard one another with almost mutual incomprehension. Pharmaceutical executives will tell you that TCM has utterly failed to prove its efficacy in clinical tests, while many of China’s 400,000 traditional Chinese doctors and practitioners consider most “Xi Yao” (西药), or Western medicine, to be disruptive or toxic to the natural yin-yang balance. At most larger general hospitals in China, one can find doctors separately practicing each type of medicine. On the ground floor, two separate pharmacies dispense prescriptions.

Chinese navigate between the two worlds. When feeling unwell, they will self-diagnose and decide to seek either Western drugs or TCM. Visiting the doctor is one China’s more popular indoor activities. Each year, Chinese make over four billion visits to a clinic, with about one-fifth of those being to see a TCM practitioner.  No surprise, TCM is more popular among older folks in China.

China’s pharmaceutical industry, and the regulations that govern it, are a nice allegory for the state of China’s national genome — part relentlessly modern, part three-thousand year-old archive of analects, customs, superstitions. The two coexist, but the results can sometimes be less than the best-of-both-worlds. Such is the case with drug regulation.

For all Western-style pharmaceuticals now seeking approval in China, there are well-established standards, based on multi-phase clinical trials and double-blind studies. With TCM, such standards that do exist are not so much the product of rigorous evidence-based medical science. If it doesn’t poison your system and the ingredients have been used for centuries in China then it’s likely going to get approved.

The result is, as one CEO of a Chinese pharmaceutical company explained to me recently, “down the hall at the China FDA from scientists with PhDs in biology and chemistry are a bunch of guys giving the green light to TCM substances that have not been proved by accepted scientific standards to have any medical benefit whatsoever. How can these things be regulated, sold and labeled as medicines? ”

This CEO then makes a larger point. The Chinese FDA’s split personality, of administering both a clinical drug approval regime for Western drugs and one for TCM that doesn’t demand any proof of efficacy is likely part of the reason China’s pharmaceutical industry has yet to come up with any genuine breakthroughs.

In his mind, TCM should be only sold and regulated as foods.  A government agency, in other words, shouldn’t be telling people something is a medicine on the basis of nothing more than a history of people believing it to be.

One famous case in point: Yunnan Baiyao. It is among the most famous and widely-sold TCM formulations. It’s also big business. The eponymous publicly-traded company has a nearly $12 billion market cap. It is sold as a medicine, but its ingredients are a state-secret. No one, perhaps not even the regulators, knows what’s in it. Could any of its ingredients be bad for you or harvested and processed in less-than-sanitary conditions? No one knows and yet Chinese keep relying on it.

Among the best-selling TCM cold cures is a packaged potion called 999 made in Shenzhen. Many Chinese swear by it. The US FDA says its recent on-site inspection of the facility where it’s made revealed “significant violations of current good manufacturing practice (CGMP) regulations for finished pharmaceuticals.”

The official correspondence is quite damning. The makers of 999, according to the US FDA inspectors, “failed to establish laboratory controls that include scientifically sound and appropriate specifications, standards, sampling plans, and test procedures designed to assure that components, drug product containers, closures, in-process materials, labeling, and drug products conform to appropriate standards of identity, strength, quality, and purity.“ But, as far as can be determined, China’s own FDA has never visited the factory or never found any problems with the way 999 is being made.

Over the last five years, China’s ruling Communist Party has moved decisively to create and manage a large First World-scale regulatory apparatus. Transportation, hiring and firing, air and water quality, foods and medicines are all now subject to very clear-cut rules, often as tight as those as in the US. Enforcement grows more strict every year.

At the apex of this new regulatory system is China’s FDA. It was remade from top-to-bottom, beginning seven years ago when its one-time chief was arrested and then executed for corruption and approving tainted products for sale in China. In 2013, standards were toughened up again, the old agency disbanded and the newly-constituted CFDA was created and elevated to ministerial level.

The Chinese public is being told this new agency will be a fierce, powerful and incorruptible guardian of the national health. But, the tough cop seems to have a big blind spot when it comes to TCM.


China Evening News Report

August 2nd, 2015 1 comment

CCTV logo


It is the world’s most watched nightly news report, China’s CCTV 7pm evening news program, “Xinwen Lianbo” (新闻联播). Simultaneously broadcast on most terrestrial tv stations in China, it has a nightly audience estimated at over 100 million.

This past week, the level of broadcast Chinese on this news program took a brief, steep dive. The reason: a short clip of me speaking Chinese led off a news report about recent economic reforms in Guangdong Province and the introduction of pilot free trade zones in Guangdong‘s three largest cities, Shenzhen, Guangzhou and Zhuhai.

You can watch the video by clicking here. (You may need to sit through a pre-roll advertisement.) My contribution is mentioning how comparatively easy it is to register a business in Shenzhen Qianhai,  the most ambitious of Guangdong’s free trade zones.

I was out of the country in Europe when the broadcast was aired, so didn’t get to watch it live. But, I knew instantly something was going on. As I sat in a lunch meeting in Switzerland at 1:15pm (7:15pm China time), calls and messages started flooding in from friends and acquaintances watching the report in China.


Trials and tribulations: China’s shifting business landscape highlighted in new report — Financier Worldwide

July 23rd, 2015 No comments


Trials and tribulations: China’s shifting business landscape highlighted in new report

BY Fraser Tennant

The deeper trends reshaping the business and investment environment in China today are the focus of a new report – ‘China 2015: China’s shifting landscape’ – by the boutique investment bank and advisory firm, China First Capital.

As well as highlighting slowing growth and a gyrating stock market as the two most obvious sources of turbulence in China at the midway point of 2015, the report also delves into the deeper trends radically reshaping the country’s overall business environment.

Chief among these trends is the steady erosion in margins and competitiveness among many, if not most, companies operating in China’s industrial and service economy. As the report makes abundantly clear, there are few sectors and few companies enjoying growth and profit expansion to match that seen in previous years.

The China First Capital report, quite simply, paints a none too rosy picture of China’s long-term development prospects.

“China’s consumer market, while healthy overall, is also becoming a more difficult place for businesses to earn decent returns,” explains Peter Fuhrman, China First Capital’s chairman and chief executive. “Relentless competition is one part, as are problematic rising costs and inefficient poorly-evolved management systems.”

To read complete article, click here.

China 2015 — China’s Shifting Landscape — China First Capital new research report published

July 20th, 2015 No comments

China First Capital research report


Slowing growth and a gyrating stock market are the two most obvious sources of turbulence in China at the midway point of 2015. Less noticed, perhaps, but certainly no less important for China’s long-term development are deeper trends radically reshaping the overall business environment. Among these are a steady erosion in margins and competitiveness in many, if not most, of China’s industrial and service economy. There are few sectors and few companies that are enjoying growth and profit expansion to match last year and the years before.

China’s consumer market, while healthy overall, is also becoming a more difficult place for businesses to earn decent returns. Relentless competition is one part. As problematic are rising costs and inefficient poorly-evolved management systems.  From a producer economy dominated by large SOEs, China is shifting fast to one where consumers enjoy vastly more choice, more pricing leverage and more opportunities to buy better and buy cheaper. Online shopping is one helpful factor, since it allows Chinese to escape from the poor service and high prices that characterize so much of the traditional bricks-and-mortar retail sector. It’s hard to find anything positive to say about either the current state or future prospects for China’s “offline economy”.

Meanwhile, more Chinese are taking their spending money elsewhere, traveling and buying abroad in record numbers. They have the money to buy premium products, both at home and abroad. But, too much of what’s made and sold within China, belongs to an earlier age. Too many domestic Chinese companies are left manufacturing products no longer quite meet current demands. Adapting and changing is difficult because so many companies gorged themselves previously on bank loans. Declining margins mean that debt service every year swallows up more and more available cash flow. When the economy was still purring along, it was easier for companies and their banks to pretend debt levels were manageable. In 2015, across much of the industrial economy, the strained position of many corporate borrowers has become brutally obvious.

These are a few of the broad themes discussed in our latest research report, “China 2015 — China’s Shifting Landscape”. To download a copy click here.

Inside, you will not find much discussion of GDP growth or the stock market. Instead, we try here to illuminate some less-seen, but relevant, aspects of China’s changing business and investment environment.

For those interested in the stock market’s current woes, I can recommend this article (click here) published in The New York Times, with a good summary of how and why the Chinese stock market arrived at its current difficult state. I’m quoted about the preference among many of China’s better, bigger and more dynamic private sector companies to IPO outside China.

In our new report, I can point to a few articles that may be of special interest, for the signals they provide about future opportunities for growth and profit in China:

  1. China’s most successful cross-border M&A ever, General Mills of the USA acquisition and development of dumpling brand Wanchai Ferry (湾仔码头), using a strategy also favored by Nestle in China
  2. China’s new rules and rationale for domestic M&A – “buy first and pay later”
  3. China’s most successful, if little known, recent start-up, mobile phone brand OnePlus – in its first full year of operations, 2015 worldwide revenues should reach $1 billion, while redefining positively the way Chinese brand manufacturers are viewed in the US and Europe
  4. Shale gas – by shutting out most private sector investment, will China fail to create conditions to exploit the vast reserves, larger than America’s, buried under its soil?
  5. Nanjing – left behind during the early years of Chinese economic reform and development, it is emerging as a core of China’s “inland economy”, linking prosperous Jiangsu and Shanghai with less developed heavily-populated Hubei, Anhui, Sichuan

We’re at a fascinating moment in China’s story of 35 years of rapid and remarkable economic transformation. The report’s conclusion: for businesses and investors both global and China-based, it will take ever more insight, guts and focus to outsmart the competition and succeed.


The Shenzhen Unicorn — Week in China Magazine

July 17th, 2015 No comments



OnePlus Two

A sizeable quotient of the techno-hip crowd in the US and Europe is counting down the days to the launch next week of the newest Android mobile phone by China’s OnePlus. It’s called the OnePlus Two and follows a little more than a year after the 18-month-old company’s first phone, the OnePlue One, went on sale in the US and Europe. With barely a nickel to spend on marketing and promotion, OnePlus insouciantly dubbed its OnePlus One a “flagship killer” claiming it delivered similar or better performance than Samsung, LG and HTC Android phones costing twice as much.

The tech media swooned, and buyers formed long online queues to buy one from the OnePlus website,, the only place the phones are sold. In little more than six months last year, OnePlus sold over one million phones.

The new OnePlus model is rumored to be built around a new top-of-the-line Qualcomm processor, and features a larger screen, an upgraded in-house version of Android software, fingerprint recognition. Price? Around $300. It will be available, as was the OnePlus One for most of the last year, on an “invitation-only cash-upfront” basis to prospective buyers. How to get a coveted invitation remains something of a dark art. New OnePlus owners are given a certain number of invitations to send to whoever they please.

The July 27th launch will be an online event broadcast in virtual reality. OnePlus manufactured and is giving away a cardboard virtual reality viewer said to be as good or better than the ones sold by Google for $20. The viewers have been flying out the door for the last month.

To read complete article, click here.


China’s Incendiary Market Is Fanned by Borrowers and Manipulation — The New York Times

July 13th, 2015 No comments


China’s Incendiary Market Is Fanned by Borrowers and Manipulation

Can Mass Smuggling Help China’s Sagging Economy?

July 7th, 2015 No comments

Futian Kouan

As it struggles with a weakening economy and now a bearish stock market, China has recently taken two giant steps to stimulate the transition to a consumer-led economy. One is official policy and the other is a more spontaneous, chaotic, possibly illegal but ultimately perhaps more effective.

In May, China announced it would slash tariffs on a range of goods from imported shoes to cosmetics to lower prices and boost spending at home. The other step may do more in the short-term for lowering high consumer prices in China and narrowing the gap with goods sold in neighboring Hong Kong.

Quietly but rather systematically, Chinese Customs has begun permitting, at least at one border crossing, smuggling on a truly gargantuan scale. Thousands of Chinese are passing through Shenzhen’s Futian Kouan (also sometimes known as Futian Port) crossing every hour, with most pulling huge wheelie suitcases or hand-trucks laden with the products sold in Hong Kong that are most in demand here in China — milk powder, electronics, diapers, food, candy, even luxury products like designer bags and watches.

At a guess, several tons of merchandise is being moved every hour from noon until 10pm into China this way. What was once one of the most fiercely policed Customs posts in the world has become at various times an open channel through which anyone with the cash and energy can bring goods in without a risk of confiscation or payment of the high official Chinese Customs duties.

There was always smuggling between Hong Kong and Shenzhen. But, until recently, those doing the smuggling tried to hide the fact they were evading the rules. The whole idea of smuggling, after all, is to try to pass unnoticed through Customs. Not any longer, not some days at Futian Kouan.

The Futian Kouan border has become the key link in what is probably the world’s largest free-form wholesale network in the world — cross the border into Hong Kong the morning, head right for the shops, haul the goods across the border at Futian Kouan in the afternoon, then sell through shops back in China that evening.

There’s plenty of money to be made. Prices in Hong Kong are often one-third to one-half lower than in the PRC. If you remove the worry of being stopped at Customs, well, then it’s harder to think of many easier ways to turn a quick profit.

Why Chinese Customs is turning a blind eye is not certain. Is it an effort to encourage more consumer spending in China by allowing in more low-priced stuff from Hong Kong? Or is it a way to torpedo the effects of new visa rules in Hong Kong to limit the number of Chinese on shopping trips? Hong Kong caused further aggravation in Beijing by voting down China’s plans for electing Hong Kong’s next leader.

Whatever the reason, the overall impact of the crowd smuggling is not insignificant. Shops have bloomed in Shenzhen and further afield selling the goods pulled across the border. The only downside is that the Futian Kouan border crossing, once rather sleepy, has become inundated by the foot traffic of entrepreneurial Chinese going to and from Hong Kong to buy in bulk. Lines at immigration are at least four to five times longer than previously.

There’s been no official announcement that Customs is now occasionally taking a relaxed attitude at Futian Kouan. But, word has clearly spread.

The border separating Shenzhen and Hong Kong is the busiest in the world, with at least ten million people crossing every month. There are four main border stations. Two connect directly between the Shenzhen and Hong Kong metro systems. The other two are for cars and buses.

The busiest crossing of the four, at least until recently, Lo Wu. Here, there’s no sign of any new tolerance for big-time smuggling. Uniformed Chinese Customs officials stand just outside the immigration channel. Most anyone pulling even a single suitcase is directed to one of the nearby x-ray machines, where each bad is inspected. Fines and confiscation remain routine. No one would dare try to walk into China at Lo Wu crossing, as they do now at Futian Kouan, pulling a hand-truck piled with crates of stuff bought in Hong Kong.

As at Lo Wu, it is also possible at Futian Kouan to connect on foot, once you’ve passed through both Hong Kong and Chinese immigration and Customs, from the Hong Kong to the Shenzhen Metro systems. But, Futian Kouan is not a main stop on the Hong Kong Metro. There are three to four to fives times more trains every hour to Lo Wu. The Lo Wu trains used to be packed at all hours of the day. These days, far less so. Now, Chinese queue up at Hong Kong Metro platforms specifically to catch the less-frequent trains terminating at Futian Kouan.

With such large crowds and long lines, I stopped using Futian Kouan when I cross back from Hong Kong. But, I still feel the splashback from the tide of bodies and merchandise moving across the border. Most who cross at Futian Kouan then get on the Shenzhen Metro. Technically, anyone carrying even one large suitcase is supposed to buy a special ticket, and those with lots of bags are meant to use other means of transport. These rules seem to be no more strictly enforced than those at Futian Kouan Customs. Result is, most days on my rush-hour ride home, Chinese bulk shoppers fresh in from Hong Kong will try to squeeze in, with their 200-300 pounds of loaded boxes and bags. (See photo above.)

In Hong Kong, over the last nine months, there’ve been anti-PRC demonstrations, as well as some unfriendly chatter, from people complaining about the crowds of Chinese bargain-hunters arriving each day. Hong Kongers, not affectionately, refer to the Chinese as “locus shoppers”.  New rules then came in limiting Shenzhen residents to one trip a week to Hong Kong. Fewer Shenzhen residents now cross every day, but those that do, are making up for it by bringing far more back with them on each trip, while Chinese Customs officials silently oblige.

If headstong people in Hong Kong needed any reminding, it’s China that calls the shots.



Focus Media Reaches $7.4 Billion Deal to List in Shenzhen — New York Times

June 4th, 2015 No comments




HONG KONG — Years after delisting in the United States after a short-selling attack, one of China’s biggest advertising companies is hoping to cash in on a market rally on its home turf.

Focus Media, a company based in Shanghai that was privatized and delisted from the Nasdaq two years ago after being targeted by short-sellers, on Wednesday reached a 45.7 billion renminbi, or about $7.4 billion, deal for a listing on the Shenzhen Stock Exchange. The transaction values Focus at about twice the $3.7 billion that its management and private equity backers — led by the Carlyle Group — paid to take the company private in 2013.

Focus and its investors, which also include the Chinese companies FountainVest Partners, Citic Capital Partners, CDH Investments and China Everbright, are trying to tap into China’s surging domestic stock markets. The main Shanghai share index has risen 51 percent this year, while the Shenzhen index, where Focus will be listed, has more than doubled, increasing by 114 percent.

Other Chinese companies that retreated from American markets, as well as their private equity backers, are likely to be watching the Focus deal closely. If it goes through and the new shares rise sharply, it could offer an incentive for others to follow suit — and give private equity firms an easier way to sell their stakes.

Some other big Chinese companies that delisted from the United States market in recent years include Shanda Interactive Entertainment, which was valued at $2.3 billion when it was privatized by its main shareholders in 2012; and Giant Interactive, which was privatized last year in a $3 billion deal.

Focus is coming back to the market through a so-called backdoor listing, in which its main assets are sold to a company already listed in exchange for a controlling stake in the listed firm. Such an approach can offer a more direct path to the market than an initial public offering — especially in mainland China, where hundreds of companies are waiting for regulatory approval for their I.P.O.s.

But such deals can also be complex. In mainland China, they often subject shareholders to lengthy periods during which they are prohibited from selling or transferring shares. Also, unlike an I.P.O., the moves tend not to help the companies involved raise cash.

“All backdoor listings are convoluted exercises, not capital-raising events,” said Peter Fuhrman, the chairman of China First Capital, an investment bank based in Shenzhen, which is in southern China. “When you do them domestically in China, they become even more hair-raising.”

Dozens of Chinese companies retreated from American exchanges in the last five years after a wave of accounting scandals and attacks by short-sellers. Some of those companies were forcibly delisted by the Securities and Exchange Commission; others were taken private by management after their share prices slumped.

Focus was the biggest of those privatizations. In November 2011, the company was targeted by Muddy Waters Research, a short-selling firm founded by Carson C. Block. Muddy Waters accused Focus of overstating the number of digital advertising display screens it operated in China, and of overpaying for acquisitions.

Focus rejected the accusations, but its shares fell 40 percent on publication of the initial report by Muddy Waters. In summer 2012, the company’s chairman, Jason Jiang, and a group of Chinese and foreign private equity firms announced plans to delist Focus and take it private, a deal that was completed in early 2013.

On Wednesday, Jiangsu Hongda New Material, a Shenzhen-listed manufacturer of silicone rubber products, said it would pay 45.7 billion renminbi, mostly by issuing new stock, to acquire control of Focus. Shares in Jiangsu Hongda have been suspended from trading since December, when it first announced plans for a restructuring that did not mention Focus. The shares remain suspended pending further approvals of the Focus deal, including from shareholders and regulators in China.

If completed, the deal would leave Mr. Jiang, the Focus chairman, as the biggest single shareholder of Jiangsu Hongda, with a 25 percent stake.

The mainland China brokerages Huatai United Securities and Southwest Securities are acting as financial advisers on the deal.

Just a few of the Chinese companies delisted from stock exchanges in the United States in recent years have attempted a new listing elsewhere.

Last year, China Metal Resources Utilization, a small metal recycling company, successfully listed in Hong Kong. It had been listed on the New York Stock Exchange, under the name Gushan Environmental Energy.

The Hidden Unicorn: China Venture Capital Fails to Spot OnePlus

June 3rd, 2015 No comments


Missed investment opportunities are rarely this glaring. Despite having hundreds of firms managing billions of dollars and employing thousands of people all supposedly out scouring China for the next big thing, China’s venture capital industry not only failed to invest in the single-most successful startup in recent Chinese history, mobile phone manufacturer OnePlus, most failed even to take note of the company’s existence. Meantime, a fair chunk of the tech savvy population of Europe and the US was enduring long waits and by-invitation-only rationing system to buy one of its prized mobile phones.

Since its founding less than a year-and-a-half ago, OnePlus went from bootstrap startup to likely “unicorn” (a billion-dollar-plus valuation) faster than any company in Chinese history. Unlike China’s other unicorns — Xiaomi, Meituan, newly-merged Kuaidi and Didi Dache and drone maker DJI Innovations — OnePlus hasn’t yet raised a penny of VC or private equity money.

With its first phones going on sale just one year ago, OnePlus has racked up a rate of growth as well as a level of brand awareness in Europe and the US never seen before from a new Chinese electronics manufacturer. OnePlus is the real deal. Revenues last year from May through December were $300mn. This year, OnePlus is on track to surpass $1 billion in sales, mainly in the highly-competitive US and European mobile phone market.

Over roughly that same period, China PE and VC firms invested over $15 billion in 1,300 Chinese firms, many also operating in the mobile industry, either as manufacturers or service providers. Needless to say, not a single one of these VC-backed startups has performed as well over the last year as OnePlus, nor created half as much buzz.

If China venture capital has a big fat blind spot it’s for companies like OnePlus. That’s because China venture capital —  which now trails only the US in the number of firms and capital raised —  is most comfortable backing Chinese companies that copy a US online business model and then tweak it around the edges to make it more suitable to the China market.

OnePlus couldn’t be more dissimilar. It is disruptive, not imitative. It takes a special kind of venture investor to recognize and then throw money behind this kind of business. OnePlus’s bold idea was to compete globally, but especially in the US and European markets, against very large and very rich incumbents —Samsung, Google, LG, Motorola, HTC — by building a phone that targets their perceived weak spots. As OnePlus sees it, those competitors’ phones were too expensive, too slow, of middling quality and the Android software they run too difficult to customize. At the same time, OnePlus sought to turn the sales model in the US and Europe on its head: no retail, no carrier subsidy, phones built-to-order after the customer had paid. Until a month ago, only those with an invitation were allowed to buy.

Nothing quite like it had ever been attempted. Will OnePlus continue its ascent or eventually crash-and-burn along with other once high-flying mobile brands like Blackberry and Nokia? Whichever happens, it’s already achieved more with less than any Chinese company competing for market share in the US and Europe. That augurs well.

From my discussions with OnePlus’s 25 year-old co-founder Carl Pei, it seems few China-based venture firms sought out the company and those that did failed to make much of an impact. The company instead opted to run on a shoestring, by cutting the need for working capital by building phones only after the customer paid. They also economized on marketing and advertising, typically where much venture money gets burnt.

OnePlus spent a total of about USD$10,000 on advertising. Instead, it poured its effort and ingenuity into building a mass following on the three major US social media platforms, Youtube, Twitter and Facebook. There’s no better, cheaper or more difficult way now to establish a brand and build revenues than getting lots of praise on these social networks. OnePlus’s success at this dwarves anything previously achieved by other Chinese companies. Compared to Xiaomi, OnePlus has double the Facebook likes, four times the Twitter followers and five times more Youtube subscribers. All three, of course, remain blocked inside China itself.

Sales of OnePlus phones also got an immeasurable boost from a string of flattering reviews in some of the most influential newspapers and tech blogs in the US and Europe.

Having reached a likely billion-dollar-plus valuation and billion-dollar revenue run-rate as a very lean company, OnePlus is now near closing on its first round of venture finance. But, it is planning to raise money in Silicon Valley, not from a VC firm in China. DJI just opted for a similar strategy, raising $75 million from Accel Partners of Palo Alto at an $8 billion valuation to expand its sales and production of consumer and commercial drones. DJI, like OnePlus, is based in China’s high-tech hub, Shenzhen.

One can see a pattern here. Many of China’s more successful and globalized companies prefer to raise money outside China, either by listing shares abroad, as Alibaba did last year, or raising money direct from US venture firms. US-based venture firms were early investors in Baidu, New Oriental Education and Ctrip , all of which later went on to become multi-billion-dollar market cap companies listed in New York.

Why do so many of China’s best companies choose to raise money outside China, despite the fact there’s now so much money available here and valuations are often much higher in China than outside? I have my theories. One thing is indisputable: being local hasn’t conferred much if any advantage to China’s venture capital industry.

Being China’s hidden unicorn hasn’t evidently done OnePlus much harm. It has revealed, though, some blinkered vision at China’s venture capital firms.


China Debt Investing, Simplified

May 26th, 2015 No comments


Yield ladder

China’s Most Successful Startup?

May 14th, 2015 No comments



OnePlus Never Settle

China’s most successful startup?


Ask people in China to name the country’s most successful and innovative new mobile phone brand and most will immediately declare Xiaomi. Ask tech-savvy Americans and Europeans and they will just as quickly suggest OnePlus. Though largely still unknown in China, Shenzhen-headquartered OnePlus, established less than 18 months ago, has achieved more success more quickly in US and European markets than any other Chinese mobile phone company. It is also possibly the China’s most successful startup since Xiaomi was established five years ago.

OnePlus, by my estimate, has now joined the most exclusive club in the technology world, a “unicorn”, meaning technology startups with a valuation of over $1 billion. Other Chinese unicorns besides Xiaomi are China’s Uber, Kuaidi Dache and group buying site Meituan. Unlike those other Chinese companies, OnePlus has not yet raised any money from venture capitalists.   OnePlus is also the only truly international Chinese unicorn, since most of its sales and growth are outside China.

With just a tiny amount of seed capital,  the company began selling its phones little more than a year ago in late April 2014. Its 2014 full-year revenues were $300mn, well behind Xiaomi’s $12 billion.  But, unlike Xiaomi, OnePlus chose to focus its efforts on the US, Western Europe and India. In these places, OnePlus is doing far better than Xiaomi, and is now considered a legitimate competitor to major international Android phone brands like Korea’s Samsung, Taiwan’s HTC, Japan’s Sony and America’s Google Nexus. OnePlus is cheaper than these others, but that doesn’t seem to be the main reason its winning customers as well as enthusiastic reviews from experts. It’s mainly because of the quality of both OnePlus’s hardware and Android software.

According to the Wall Street Journal, the One Plus phone is “exceptional” and it “beats Apple iPhone 6 and Samsung Galaxy S5 in many ways.” The New York Times has called the OnePlus phone “fantastic, about the fastest Android phone you can buy, and its screen is stunning “.  Time Magazine chimed in with OnePlus is “exactly how a smartphone should be.” Engadget, the widely-read US technology blog, recently rated the best phones to buy in the US. Oneplus came out on top. That’s certainly a first for a Chinese brand.

Engadget smartphone rankingIn my seven years as an investment banker in China and before that as CEO of a California venture capital firm, I’ve never met quite such a mold-breaking company. OnePlus set out to achieve what no other Chinese company has ever done, to excel not just at making low-cost fast-to-market products but making ones of the highest quality, in engineering and design, hardware and software.

They next did something else no Chinese, and few American companies have done successfully: use social media sites Twitter, Facebook and Youtube to market its products at almost zero cost, and build a brand with a high reputation and a growing band of loyal customers and followers in the US and European markets.

Both Xiaomi and OnePlus say they plan to make most of their money from selling services and software, not from selling phones. Xiaomi has the advantage of much larger scale, with far more users. But, OnePlus may actually do better with this strategy and make more money for the simple reason that in the US and Europe, compared to China, a lot of people are accustomed to paying for mobile software and services.

OnePlus sold over one million phones last year between May and December, mainly in the US and Europe. It spent a total of about $10,000 on advertising worldwide. Samsung, by contrast, spends over $350mn a year in the US advertising its mobile phones. Worldwide, Samsung is spending over $14bn in advertising and its mobile phone market share has been declining since 2013.

On many fundamental levels, OnePlus thinks and acts differently than any other successful startup in China. Start with its two founders, Pete Lau and Carl Pei. They met while working at a Chinese domestic mobile phone and Blu-ray player manufacturer called Oppo. Lau is responsible for OnePlus’s manufacturing and product engineering, including overseeing a network of outsourced suppliers and manufacturers in and around Shenzhen. “We want to tell the world: Chinese products are great,” Lau says.

Pei’s background is more unusual. He is responsible for the company’s international growth and unique marketing strategy.  Everything about Pei – his background, his way of thinking and his approach to selling mobile phones successfully in the US and Europe – sets him well apart from all other Chinese tech entrepreneurs I’ve met. He is ethnically Chinese, but before coming to Shenzhen three years ago, had never lived or worked in China and his Chinese language ability, by his own admission, is so-so. Now 25, Pei was raised mainly in Sweden.

To understand Pei’s approach to business, it’s useful to understand something about business and culture in Sweden. It’s a small country, with less than 10 million people and fewer than 17,000 Chinese. Yet, it has arguably produced more innovative, world-changing companies, per capita, than any other country in the world. There’s a long list of them. My five favorites are furniture retailer IKEA, milk packaging company Tetra-Pak, bearing manufacturer SKF, fashion retailer H&M and music streaming company Spotify. In each case, these companies now dominate entire industries, with high-quality products and fair prices. Sweden has no real luxury brands. Instead it has a lot of great companies that have changed the ways a huge mass of people across the world live their lives, from the milk they drink to the beds they sleep on, the clothes they wear and now even the music they pay to listen to.

Sweden’s last attempt at success in mobile phones ended up badly. Ericsson once had a decent business selling basic phones, but the birth of smartphones was the death of Ericsson’s mobile business. OnePlus stands a better chance, in part because it’s a mix of Swedish focus on targeting a mass customer market together with Chinese speed and adaptability. I expect to see more of these “mixed blood” companies emerging in China, as China becomes more globalized and more welcoming to non-natives immigrating to start new businesses.

By basing itself in Shenzhen, OnePlus sits inside the world’s most densely-packed ecosystem of component, chip and contract manufacturing companies. It’s hard to imagine OnePlus could have been built as successfully anywhere else in the world. Foxconn, manufacturer of iPhones, is among the companies with its China base in Shenzhen.  Intel has also moved in in force to win business from these small, nimble Chinese electronics companies.

Manufacturing smartphones in Shenzhen is comparatively easy. Far harder is convincing Americans to buy a mobile phone without a subsidy and a service contract from a network provider like Verizon or AT&T. Yet, OnePlus is so far succeeding.  One reason: other companies that tried ended up spending millions of dollars on advertising to try to explain to Americans why they should buy a phone directly. It was mainly burned money. OnePlus spent nothing on advertising but used Twitter, Facebook, Google Plus and Youtube to build up a group of early adopters, who then went out and evangelized their friends.

OnePlus has 1.1mn “likes” on Facebook, double Xiaomi’s, along with four times as many followers on Twitter. On Youtube, the Oneplus channel has five times more subscribers than Xiaomi. Keep in mind Youtube, Twitter and Facebook are banned in China, where all of OnePlus’s employees are. OnePlus has become an expert at selling and brand-building using websites OnePlus’s own team aren’t supposed to even be looking at.

Ask Carl how he figured out how to do things in the US market that American companies, including hundreds with millions of dollars in VC money, weren’t able to do and he just shrugs, like it was all pretty easy. OnePlus still has no office in the US, no staff there, no repair centers, nothing. In the beginning you could only buy a OnePlus in the US and Europe with an invitation. Even with one, OnePlus only accepted orders from new customers one day a week, on Tuesdays.  As OnePlus’s reputation grew, the invitations became themselves valuable commodities. They still sell on eBay for $10-$20 each. OnePlus is now gradually loosening up and letting those without an invitation buy its phones, but again, only one-day-a-week, on Tuesdays.

Selling by invitation only may seem counterproductive. But, it’s proved vital to OnePlus’s success up to now. The reason: making mobile phones is generally a very cash-intensive business, since you need to have huge amounts of working capital to buy parts, build phones, supply to retail channels, and then wait for cash to return. OnePlus had no access to a big pot of working capital. So they have basically built phones to order, after the customer has paid.

One-third of the OnePlus’s 400 staff, including about 50 non-Chinese, are dedicated to customer service, which mainly means answering emails and responding to comments and questions on the company’s website and forums. This is another core thing OnePlus does better than any company I’ve seen in China. It’s establishing a new idea in the US and Europe about what a Chinese company is and does. Not just a source of cheap manufactured goods, but a company with a clear and powerful brand identity, one knows how to communicate well and sell things to college-educated 20-30 year-olds who live in San Francisco, Berlin and London.

Success has come quickly, but Pei, from my discussion over dinner with him, is certainly not complacent. He sees risks everywhere, not only from the obvious examples of Nokia and Blackberry, two once world-conquering mobile phone companies that have all but disappeared from the market. Apple remains very powerful. It and Google also own a lot of the key intellectual property patents for mobile phone signal processing, software and chip design. If either chooses to sue OnePlus, they have far more money to fight a patent lawsuit in a US court. Legal fees could easily top $20mn, money OnePlus does not now have. The US patent law system has been abused before, a big company sues a small but fast-growing one, not because it has a good legal case, but knowing that fighting the lawsuit, paying the legal bills, can put this new competitor out of business.

Pei’s three burning concerns are the OnePlus fails to attract enough talented global executives to join the company, loses its edge in designing hardware and software, or grows too large to maintain its quirky brand image and identity. OnePlus is in the process of opening new offices and moving key people from Shenzhen to Bangalore and Berlin because Pei believes it will be easier to find talented staff there.

Another worry, surprisingly, is how and when to bring in venture capital investors. OnePlus will likely try to raise money from one of the world’s famous Silicon Valley VCs. They have the most experience investing in disruptive businesses, helping startups like OnePlus to grow, especially in the US market, and they also can provide lots of help finding top executives and distribution partners. But, these Silicon Valley VCs have also not seen anything exactly like OnePlus before, a Chinese startup, likely with some core operations in India, and a magical ability to sell to Americans without having any Americans involved.  If successful, OnePlus could have one of the largest Series A VC rounds in history, raising perhaps $100mn-$200mn. Will money spoil the company or improve it?

OnePlus’s revenues are on track to more than triple this year to over $1 billion. But, there are lots of places where OnePlus could stumble and fall. Its new model launches and software upgrades could get delayed. Cost pressures could force them to raise prices in the US as they recently had to do in Europe, because of steep fall in the Euro. Also, US and European early-adopters are a fickle bunch. They could start throwing bricks at OnePlus instead of kisses. Case in point, in less than two years, Taiwanese mobile phone company HTC went from the most talked-about and fastest-growing company in the industry to an also-ran.

China’s mobile phone industry, as well as much of the TMT sector, have a reputation for being not much more than a bunch of knock-off artists, with no real innovation worthy of the name. OnePlus and Xiaomi both point the way towards a different and better future for China industry. Yes, OnePlus is good at assembling components cheaply. But, its core strengths as a company are too rarely found in China: an obsessive focus on product design, product quality, branding and customer engagement. These are what determine a company’s value as well as competitive strength. OnePlus is the first Chinese company to gain a large number of buyers and fans in the US and Europe by being simultaneously good at all these.

China’s long-term economic competiveness requires that more companies like OnePlus emerge. But, until it came along, China didn’t have a single one. It’s the most concrete sign that China may transition away from being a source of copy-cat products sold cheap and begin to play in the global big leagues, generating buzz while competing and taking market share from large, rich incumbents like Google and Samsung.