Archive

Archive for September, 2009

Shenzhen’s New Growth Enterprise Market: Getting it Right, Right From the Start

September 30th, 2009 No comments

 

China First Capital blog post -- Ming Dynasty jade bowl

 

“Manage people’s expectations. Then, exceed them.” That’s not a bad rule to live by, or management principle to apply in regulating China’s fast-moving capital markets. This past week, China Regulatory Securities Commission, the nation’s stock market regulator, moved one step closer to opening trading in the new, Shenzhen-based, Growth Enterprise Market. It’s been ten years in the planning. The names were finally announced of the first companies that will list on the new market when trading begins later in October. All are private SME, and several had pre-IPO private equity funding.

The total amount of capital this first crop of IPOs will raise is well above most earlier estimates. The original stated plan was for smaller companies to list on the GEM, which, in turn, suggested the GEM market would be only a marginal contributor of growth capital for private SME. The minimum requirement was set at just $1.5mn in aggregate profits over the last two years. Even at high Chinese multiples, firms of that size would struggle to raise more than $10mn in an IPO.

But, in something of a surprise, CSRC chose larger companies to be in the first group to list. It now looks like that the ten companies will raise a total of over $400mn when their IPOs close, or an average of $40mn each. This, in turn, points to a cumulative market capitalization for this first group of around $2 billion. That bodes well for the market’s long-term future. A larger market capitalization means more liquidity and so less volatility in the share price. This will help attract more capital to the new Shenzhen market, and to subsequent future IPOs there.

Bravo, I say! The CSRC may well get the formula right, and so prove that these smaller-capitalization “growth stock markets” can work, both for companies and investors.

Elsewhere, these growth stock markets have mainly failed in their stated purpose to create an efficient platform for smaller companies to attract investors and raise capital. Germany’s Neuer Markt shut down soon after it was created. The small-cap markets in Singapore and Hong Kong have been disappointments. Small-cap companies stayed small-cap companies, which is entirely contrary to the purpose of a “growth board” like this. The granddaddy of them all, America’s OTC Bulletin Board, has become an all-purpose dumping ground for shady American firms, stock manipulators, and, sadly, several hundred once-strong Chinese SME who listed there after taking very bad advice from self-interested advisors and brokers looking to make a quick buck.

It’s anybody’s guess how many companies will list on Shenzhen’s GEM this year, or next. There is a backlog of at least 100 that have applied, and been provisionally accepted by CSRC. One thing we know: each IPO in China will get its final approval as part of an orderly process that takes into account the performance of companies already listed on GEM, and stock prices trends overall.

The Shenzhen GEM shows every sign of beginning to fill a very large, very important funding gap in China. Assuming, as I hope, that CSRC continues its preference for companies able to raise at least $30mn-$40mn in a public listing, these IPOs will channel capital to companies who would otherwise find it very hard to come by. Most of the private equity and venture firms that we work with don’t write checks that large. They generally invest around $10mn-$25mn in pre-IPO equity capital to own 20%-30% of a private Chinese SME. These investments are done at valuations of around eight times last year’s profits. So, a GEM listing could become the best source of growth capital for an SME that already has achieved some success, has profits of over $10mn-$20mn a year, but is still too small for a main board listing, in China or outside.

The public markets have two big advantages over private equity financing: they offer much higher price-earnings valuations, and give shareholders a liquid market to trade their shares. On the other hand, for Chinese SME, staging an IPO in China always has a level of deep unpredictability. The CSRC makes all the decisions about which companies can IPO and when. So, SME can wait two years or more to apply, get approval, and then put the IPO proceeds in the bank. If that SME is now growing quickly, has outsized opportunities near-to-hand with a high rate of return, but can’t finance its growth internally or with bank debt, a round of private equity will almost certainly be the best route to follow.

Done right (see my earlier blog post, on Foshan Saturday ‘s IPO) a company’s market capitalization, when it eventually completes its IPO, can be at least three times larger than it is at present. That means the laoban gets richer (nothing wrong with that), and investors are happier, too, because of the increased liquidity and stability from the higher market cap at IPO.

I’m extremely positive about the role the GEM will play in helping to build even stronger private Chinese SME. The CSRC and Chinese government have taken over ten years to plan this new stock market, and learn from the mistakes of others. All signs now are that they have done so, and the GEM will gradually create a group of publicly-traded private companies that will go on to achieve far more impressive results in the future.

From China, a Plan to Topple One of America’s Most Dominant Brands

September 24th, 2009 2 comments

China First Capital blog post -- China private equity

Every list of America’s most valuable brands includes the same parade of names, year after year – Coca-Cola, McDonalds, Disney, Google. Every year, these lists also ignore what could be the single most dominant brand of all. This brand is known by everyone in America, enjoys a higher market share than any of those on the list, and is able to charge a price premium as much as 300% above its competitors. The brand? Crayola Crayons

That’s right, that most humble and low-tech of children’s toys. No one outside the company knows Crayola’s exact market share. A good estimate is at least 80% of the US crayon market. Maybe higher. In other words, Crayola is dominant enough not just to warrant an anti-trust investigation, but to be broken up as a monopoly. 

Of course, I’m partly joking here – about the anti-trust part, not about the market share. Heaven forbid the US Department of Justice should ever decide to police kids toys. But, Crayola really is astoundingly powerful and dominant in its market. It enjoys, according to the company’s own research, 99% brand recognition in the US. Its name is not only synonymous with crayons, but has more or less shut down any lower-cost competitor from grabbing much of its market share. How it does this is also something of a miracle, since as far as I can tell, they do comparatively little advertising to sustain this. In other words, they are not only the most dominant brand, they are also the thriftiest, in terms of how much is spent each year sustaining that position in parents’ minds and kids’ playrooms. 

We don’t know exactly how big Crayola is, or any other fact about its financial performance, because it’s a private company. In fact, even more impenetrably, it’s a private company inside a private company. Binney & Smith, the original manufacturer, was sold to famously-secretive Hallmark in 1984. It’s all educated guesswork. 

But, I’m lucky to know a Chinese boss whose guesswork is far more educated than most. David Zhan is boss and majority shareholder of Wingart, a manufacturer of children’s art supplies based in Shenzhen. David is one of the smartest, savviest and most delightful businesspeople I know. Wingart is also one of my very favorite companies – though they are not a client, nor an especially large and fast-growing SME. But, Wingart is exceptionally well-run and focused, with well-made and well-designed products, as well as the most kaleidoscopically colorful assembly line I’ve ever seen. 

Wingart makes crayons. They are better than Crayola’s. That’s not David’s pride speaking, but the results of some side-by-side testing done by one of the larger American art supply companies. I personally have no doubt this is true. I’ve seen Wingart’s crayon production. Not only are they better, but they are much cheaper too. 

Still, it’s almost impossible for Wingart to gain any ground on Crayola. Wingart mainly sells under other companies’ brand names in the US, including Palmers, KrazyArt and Elmer’s. They have good distribution for many of their products at Wal-Mart and Target. But, not crayons. Wal-Mart would like to start selling Wingart’s crayons – not just, presumably, because they are better than Crayola. But, Wal-Mart, famously, does not like to be reliant on a single brand, a single supplier, for any of the products it carries. 

For the time being, Wingart’s factory is too small to produce crayons in the quantity Wal-Mart requires. This should change within a year or so, when Wingart moves to a new and larger factory about two hours from Shenzhen. Then, perhaps for the first time ever, Crayola will begin to face some real competition. I can’t wait. I think Wingart has a realistic chance to build a crayon business, worldwide, that will compete in size with Crayola, which is pretty much a US-dependent company. 

I have a lot of admiration for Crayola – not so much the crayons, but the fact that a 106 year-old brand could be so predominant in its market, and enjoy such unrivaled – and largely uncelebrated — supremacy for so long. But, I’d still like to see Wingart knock them down a few notches, or more. Crayola has it too good for too long.  American kids deserve the best crayons – as, for that matter,  do European, Chinese and other kids on the planet.

International Investors Miss The Boat in China – Because They’re Not Allowed Onboard

September 18th, 2009 No comments

China First Capital blog post Ming jar

Despite my fourteen years living in London,  I needed to fly all the way back to that city this week, from China, to finally get a look at Westminster Central Hall, a stately stone pile across the street from the even statelier, stonier pile that is Westminster Abbey. Central Hall does double duty, both as a main meeting place for British Methodists, and also as an impressive venue for conferences, including the first meeting of the United Nations in 1946. 

This week, it was site of the annual Boao Forum for Asia International Capital Conference. I flew in to attend, and participate in a panel discussion on private equity in China. The Boao Forum is something like the more renowned Davos Forum, but with a particular focus on Asia and China. This annual meeting focused on finance and capital, and drew a large contingent of about 120 Chinese officials and businesspeople, along with an equal number of Western commercial bankers, lawyers, accountants, investors, politicians, academics and a few other investment bankers besides me. 

Central Hall is crowned by a large domed ceiling, said to be the second-largest in the world. I enjoyed sending back a brief live video feed to my China First Capital colleagues in Shenzhen, whirling my laptop camera up towards the dome, and then down to show the conference. It was also the first time any of my colleagues had seen me in a suit. 

The weather was a perfect encapsulation of British autumn climate, with blustery and frigid winds, occasional radiant sunshine and torrential rain. It was my first trip back to London in over two years, and nothing much had changed. What a contrast to China, where in two years, most major cities seem to undergo a radical facelift. 

“How can a non-Chinese invest in Chinese private company?” It was a straightforward question, by a London-based money manager, for the panel I was on. Straightforward, even obvious, but it was actually one I’d never really considered before, to my embarrassment. In my talk (see Powerpoint here: http://www.chinafirstcapital.com/blog/wp-content/uploads/2009/08/trends-in-private-equity.pdf) , I made the case about why Chinese SME are among the world’s best investment opportunities for private equity firms.  It’s an argument I’m used to making to conference audiences in China. This is the first time I’ve done so anywhere else. The question, though, made me feel a bit like a guy telling his friends about the new Porsche Carrera for sale for $8,000, but then saying, “unfortunately, you’re not allowed to buy one.” 

The reality is that it’s effectively impossible for a non-Chinese investor, other than the PE firms we regularly work with,  to buy into a great private Chinese SME. For one thing, the investor would need renminbi to do so, and there’s no legal way to obtain it, for purposes like this. Even if you found a way around that problem, you’d face an even steeper one when you wanted to exit the investment and convert your profits back into dollars or sterling. 

The money manager came up to me later, and I could see the vexation in her eyes. I had persuaded her there were great ways for investors to make money investing in SME in China. Disappointingly, her clients aren’t allowed to do so. Cold comfort was all I could offer,  pointing out the same basic problem exists for any non-Chinese seeking to buy shares quoted on the Shenzhen and Shanghai stock markets. 

It’s a reasonable bet that China eventually will liberalize its exchange rate controls and ultimately allow freer convertibility of the renminbi. But, that doesn’t exist now. As a result, financial investment in renminbi in China is, for the most part, reserved exclusively for Chinese. Unfair? It must seem that way to the sophisticated, well-paid money managers in London, who these days have few, if any,  similarly “sure fire” investment options for their clients. 

China is, itself, awash in liquidity, and sitting on a hoard of over $2 trillion in foreign exchange reserves. So, there really is no shortage of capital domestically. Allowing foreign investors in, of course, would increase the capital available to finance the growth of great companies. But,  it will also add to the mountain of foreign reserves and put more upward pressure on the renminbi. That’s the last thing Chinese authorities need at the moment. So, most of the best investment opportunities in China are likely to remain, for quite a lot longer, open only to Chinese investors. 

Overall, this is a very good time to be Chinese. By my historical reckoning, it’s the best since at least the Tang Dynasty over 1,000 years ago. China has changed out of all recognition over the last 30 years, creating enormous material and social gains. That beneficial change, if anything, is accelerating. The fact Chinese also have some of the world’s best investment opportunities to themselves is just another dividend from all this positive change. 

If I were a money manager, I’d also be asking myself “how can I get some of this?” But, I’m not a money manager, and I formulate things very differently. I’m so happy and privileged to have a chance to help some of China’s great private entrepreneurs. Me and my team invest all our waking hours and all our collective passion in this. We are rewarded daily, by the trust put in us by these entrepreneurs, and by our very small contribution to their continued success. That’s more than adequate return for me.

I guess I’m not cut out for purely financial investing. 

 

Field Report from Guizhou – Where Cement Turns Into Gold

September 14th, 2009 No comments

Blue vase in China First Capital blog post

 

While writing this, I was more than a little the worse for drink. Over dinner, I drained the better part of a bottle-and-a-half of Maotai, China’s most celebrated rock-gut spirit, which sells for a price in China that French brandy would envy, upwards of $80 a bottle. It’s one of the more pleasant occupational hazards of life in China for a company boss. As far as I can tell, some Chinese seems to view it as a matter both of national pride and infernal curiosity to get a Western visitor plastered. By now, I know well the routine. I sit at a table surrounded by people generally drawn together with a common purpose – to treat me solicitously while proposing enough toasts to render me wobbly and insensate.  

As far as career liabilities go, this is one I can happily live with. I always try to eat my way to relative sobriety.  I’m in Guizhou Province. (I’ll wait five minutes while most readers consult an online atlas.) The food here is especially yummy – intense, concentrated flavors, whether it’s a chicken broth (I’m informed it’s so good because local chickens have harder bones than elsewhere in China), pig ear soup, a simple stir-fried cabbage, or a dizzily delicious dish of corn kernels from cobs gathered nearby. So, with each glass of Maotai (which started as thimble-sized and then were upgraded to proper shot-glasses) I tried as best as I could to wolf down enough solid material to hold at bay the nastier demons of drunkenness. 

Did I succeed? I believe so. At least in part. My Chinese didn’t sputter and seize up like a spent diesel engine, and my brain could just about keep up with the typhoon of sounds, smells and data points of the humongous cement factory I toured after dinner. 

If you can find a way to get to Eastern Guizhou, or Western Hunan, do. You’ll likely travel, as I did, along an otherwise empty but fantastically beautiful motorway, past the squat two-stored dwellings of the local Miao people, and the inspiringly eroded prongs that make up the local mountain-scape. If you are even luckier, and share my peculiar taste of what constitutes an ideal weekend, you might just end up, as I did, at the largest private cement company in Guizhou. It’s called Ketelin, and it’s to capitalism what a Titian portrait is to fine arts: drop-dead gorgeous. 

With Maotai bottles drained, and dinner inhaled, I went on a walking tour of the Ketelin factory, on a warm, breezy and clear summer night unlike any I’ve ever witnessed lately in smoldering Shenzhen and Shanghai. My host here is the company’s founder and owner, 宁总, aka Ning Zong. If I had to specify a single rule to determine how to discern a great entrepreneur, it might be “his favorite form of exercise is to walk 20 laps around his humming factory every night after dinner.” Such is the case with Ning Zong. Another great indicator, of course, is to have a business where customers are lined up outside your door, 24 hours a day, waiting to buy your product. That’s also true here. There is a queue of large trucks outside the front gate at all hours, waiting to be filled with Ketelin cement.  

Ning Zong is out here, in what is considered the Chinese “back-of-the-beyond”, and has built the largest private company in the province. And that’s just for starters. His only goal at this point is to build his company to a scale where it can serve all its potential customers, with the highest-quality cement in this part of China. This being China, that’s a very substantial, though achievable vision. He’s already built a state-of-the-art factory, on a scale that few can match anywhere else. And yet, there’s still so much unmet demand, not just in Guizhou, but in nearby provinces of Sichuan, Hunan and Hubei that Ning Zong’s burning desire, at this phase, is to expand his business by several-fold. 

That’s why I’m here, to work with him to find the best way to do so, by bringing in around $15 million in private equity. I have no doubt whatsoever that his plans and track record will prove a perfect match for one of the better PE firms investing in China. Whichever one of them gets to invest in Ketelin will be very fortunate. This facility, and this owner, are both pitchforks perfectly tuned to the key of making good money from the boom in China’s infrastructure development. Among other customers, Ketelin supplies cement to the big highway-construction projects underway in this area of China. 

 Is Ketelin an exception, here in Guizhou?  I don’t really have the capacity to answer that. Guizhou is generally considered by Chinese to be the also-ran in China’s economic derby, poorer, more hidebound and more geographically-disadvantaged than elsewhere in southern China. Water buffalo amble along the middle of local thoroughfares, and field work is still done largely without machines, backs stooping under the weight of newly-gathered kindling. While Guizhou is poor compared to neighboring Hunan and Sichuan, poor regions often produce some of the world’s best companies:  think of Wal-Mart and Tyson’s, both of which got started and are based in Arkansas, which is as close as the US has to a province like Guizhou.  

Guizhou, from what I’ve seen of it, is breath-takingly beautiful, with clean air and little of the ceaseless hubbub that marks the cadence in big cities like Shenzhen and Shanghai. This is China’s true hinterland, the part of this vast country that eminent outsiders have long said was impossibly backward and so beyond the reach of modern development.  

They are wrong, because what’s right here is the same thing that has already generated such stupendous growth in coastal China. It’s the nexus of vision and opportunity, of seeing how much money there is to be made and then doing something about it, to claim some of that opportunity and money as your own. Ning Zong has done so, on a scale that inspires awe in my otherwise Maotai-mangled mind. 

Come see for yourself.

 

Foshan Saturday’s Textbook Case of How to Grow, Prosper and Stage a Successful IPO in China

September 8th, 2009 No comments

Painting detail from China First Capital Blog Post

Though not in a ringside seat, I nonetheless had a privileged, up-close view of last week’s IPO for Foshan Saturday Shoes. That’s thanks to my friendship with Cao Yuhui, a partner at King & Wood law firm, and Foshan Saturday’s main corporate lawyer for the last several years.  It was a successful IPO by a very successful, well-run company. Foshan Saturday, a maker of high-end women’s shoes, raised over Rmb900mn in the IPO, selling about 20% of its equity. The share price closed up almost 20% on the first day of trading. The market cap is now closing in on Rmb5 billion. 

For Yuhui, it’s a great personal success. He first started advising the company when they were well along in their planning for what would have been a very ill-advised IPO in Singapore in 2006. Instead, Yuhui worked with the company to close a round of PE finance in 2007. Legend Capital, the venture capital arm of China’s largest computer manufacturer, invested Rmb 40 million in 2007. Over the following two years, sales and profits at Foshan Saturday more than doubled. It’s now the fourth-largest women’s shoe company in China, with a widely-known brand, and sales this year of over Rmb 1 billion. 

Legend is expected to liquidate its ownership in Foshan Saturday, and should earn a return of five times on its original investment – which is another way of saying that Foshan Saturday’s enterprise value increased five-fold during the time Legend was involved. So, while the VC firm did well, Foshan Saturday’s owner did even better. He is now sitting on a personal stake in the company worth over $350 million. He started the company just seven years ago. 

Foshan is a relatively small city by Chinese standards, with a population of about 5.5 million. It’s about two hours drive up the Guangdong coast from Shenzhen. It’s residents are known both for business acumen and personal modesty. 

Foshan Saturday is a textbook case of everything going right for a Chinese SME. The company was among the first to see the great potential for developing native Chinese fashion brands. They never bothered with OEM export manufacturing, but focused from the start on building a brand for young, Chinese urban females.

Even more crucial to its success, the company backed away from plans for that early IPO in 2006. The company then was a third of its current size. Many Chinese companies who chose to list in Singapore have since lived to regret it. The market has had few stellar performers among the Chinese SME listed there. Most have stumbled along with low earnings multiples, and as a result, quite a few have tried to delist in Singapore and try to float their shares on China’s domestic market. 

Foshan Saturday took the far better course of raising pre-IPO capital, from one of the better firms active in China. They raised only Rmb 40 million, but put it to use efficiently enough to accelerate growth by over 200%. In other words, as in all good investment opportunities among China’s SME, there was a very good place to put a reasonably small amount of capital to work, and earn significant returns. 

A lot of that growth came from an efficient strategy of opening retail counters inside shopping malls, where in lieu of rent, Foshan Saturday pays a share of revenue to the landlord. This limits the amount of capital needed to open new outlets. Foshan Saturday now has 1,200. About half the money raised in the IPO will go to opening still more retail outlets. 

A recent blog post by the Forbes bureau chief in China took a little swipe at me, saying Fuhrman “claims it is not too hard to pick winners that will quadruple your money in just a few years.” The Forbes writer (who I’ve never met) seems to think I’m daft. Yet, as the example of Foshan Saturday shows, it’s not all that hard to that well, or better.

From what I could gather, Legend Capital didn’t play a highly active role in the company. They knew a solid strategy when they saw one. So, they let the Foshan Saturday team execute, and then sat back and let the money start to roll in.  Result: profit to the VC firm of about $30 million on an investment of under $6 million. 

My friend Yuhui threw a big party at one of Shenzhen’s swankiest nightclubs to celebrate the IPO’s success. I wasn’t able to go, since I was traveling in Zhejiang. He told me later that there were about 60 guests, mainly mid and senior management from Foshan Saturday. They ran up a bar tab of around $1,500. 

I’m not big on drinking, but would have been happy to celebrate with them. Not just Foshan Saturday and Cao Yuhui did well from the IPO. It’s going to make it easier for other strong Chinese SME to achieve a similar success in years to come.

The roadmap is clear. It’s a three-step path to success for a successful IPO by a Chinese SME : (1) resist the lure of an early IPO; (2) bring in a good PE or VC investor to put more capital to work in ways that will earn a high return; and (3) stage an IPO several years later when the business has at least doubled its size. 


Investment Banking in China — New Report Published by China First Capital

September 2nd, 2009 No comments

China First Capital Report on Investment Banking

My CFC colleagues just completed our latest research report, on investment banking. It’s titled “投资银行的重要性”. A copy can be downloaded here: 

Download China First Capital Report on Investment Banking

The report examines the history, structure and central role of investment banks in raising capital for companies. Like other CFC reports, this one was meant to add meaningfully to the quality of information available in Chinese on financial topics relevant to SME owners and other private sector entrepreneurs. It’s a part of our work that I take special pleasure in. It can widen the circumference of our impact and contribution, beyond the relatively small group of CFC clients and the PE firms that finance them. 

We want the reports to be read widely, and to have some staying power. In choosing topics for these reports, we’re guided most strongly by our daily interactions with Chinese entrepreneurs, by the questions they raise, and problems they confront. So it is with the latest report. 

Investment banking isn’t well-understood in China, for the most part. There’s a lot of pigeonholing. Investment banks are primarily known for their IPO work, and not much else. The core function of investment banking – raising capital for companies —  is often missed.

This lapse speaks volumes about a larger, endemic problem in Chinese business: a shortage of growth capital among private businesses,  and an accompanying lack of knowledge how to raise it. 

Equity capital is used far less in China than the US to finance corporate activity. Bank loans could potentially fill the void somewhat, but they are very difficult for private Chinese companies to obtain from the country’s state-owned banks. The result: private companies under-invest and so grow far more slowly than market opportunities warrant. 

Of course, our new Chinese-language report on investment banking isn’t going to untangle this mess. Its aim is far more modest: to provide research and a rationale for investment banks’ central role in the capital-raising process.