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The New York Times on China – Often Wrong, Seldom in Doubt

November 30th, 2010 3 comments

crops111

The impetus for writing the last blog post was reading this in a New York Times article on China:  “Most people in China can only dream of being able to afford an expensive phone. But millions of Chinese are developing a taste for luxury goods, and Apple products have joined Louis Vuitton bags as totems of wealth.”

The comment was vintage NYT reportage: managing to be both condescending and ill-informed. The reality is otherwise: personal wealth in China is widespread and growing quickly. While not yet at levels seen in Taiwan or Hong Kong, more people in China can afford “an expensive phone” than in the US. The New York Times, however, prefers more often to characterize China today much as it has for the last 30 years – as a largely poor country, with a few selfish and wealthy autocrats lording over a teeming mass of mistreated peasants subsisting on starvation wages.

Back when I was a reporter, I once heard someone describe another journalist as,  “Often wrong, but never in doubt”. The same, writ large, can be said of The New York Times Its primary activity is one of substantiation, not investigation. It seeks out, or partly imagines, stories that will support its rather simple, binary world view: Democrats good, conservatives bad; UN good, US military action bad; tolerance for its favored groups and causes, good; tolerance for the groups and causes it loathes, bad.

I don’t get my business news from The New York Times, a habit I first cultivated over 20 years ago when I went to work at Forbes. The times I do read business stories in the NYT they seem to be written by reporters with a disdain and distrust for business. I’ve met a few NYT business reporters over the years. If I had to sum up their basic belief system, it would be “property is theft”.

As far as China goes, the NYT’s reporting mainly has two dominant flavors: “we don’t like it”, or “we don’t understand it”. Human rights, pollution, Tibet and defective manufactured products figure prominently. China’s remarkable positive transformation, and the huge increases in personal, political and economic freedom, all get short shrift inside the pages of the NYT.

Of course, there are many and better sources of information about China. The Wall Street Journal, for example, is consistently good. The NYT’s circulation is shrinking year-by-year, as is its influence. But, for a certain group of Americans, particularly on the left and in the more elite precincts of academia and the media, the NYT remains the primary source of information about the world.  So, its reporting about China has outsized consequences,  helping to shape (or deform) elite opinion in the US.

It will come as news to many of the NYT’s readers that China is on the whole a stable and contented nation. This is, arguably, the most important story of my lifetime, China’s return, after at least a 500-yeaar hiatus, to a place of central importance in the world, as a confident and prosperous nation. The New York Times too often seems the last to know.


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The Middle Kingdom’s Mighty Middle Class

November 18th, 2010 No comments

Ming Jiajing from China First Capital blog post

China recently overtook Japan to become the world’s second-largest economy. China’s population, of course,  is ten times larger than Japan’s. So, per capita, China is still one-tenth as affluent as its Asian neighbor.

A far more important, if little noticed, economic trend is that China’s middle class is now far larger than Japan’s. Indeed, the Chinese middle class will soon surpass, if it hasn’t already,  America’s, and so become the largest middle class country in the world.

There is no standard definition of “middle class”. So, measuring the number of people falling within this category is an imprecise science. It generally refers to people whose household income allows them to enjoy all the comforts of life well-above pure subsistence: these include vacations, air-conditioned homes, the full assortment of labor-saving home appliances, personal transport, and sufficient savings to cope with shorter-term economic problems like unemployment or a health emergency.

In China, by my estimate, there are at least 250-300 million people who now fall into this category. This is an economic achievement of almost unimaginable scale. Thirty years ago, there was no “middle class” in China, and but for a tiny group of top or well-connected party officials, virtually no one in the country of 1.4 billion could be described as living above basic subsistence.

Today, China has more internet and mobile phone users than anywhere on the planet. It is the world’s largest market for new cars. Housing prices across the country, in most of the major cities, are at or above the average levels in the US.

These housing prices are a big reason for the swift rise in the middle class in China. With few exceptions, anyone who owns a home in a Chinese city can now be considered middle class. That’s because most urban housing now is worth at least $50,000-$70,000. In major cities like Shanghai, Beijing or Shenzhen, housing prices are now among the highest in the world, and so just about every property-owner is sitting on an asset worth well in excess of $100,000.

Most Chinese either own their homes outright, or have mortgages that represent less than 50% of the home’s current value. Even in more rural parts of China, there are tens of millions of home-owners who have equity of at least $20,000 in their home.

Unlike in the US, Chinese can’t easily tap into the wealth locked up in their homes by taking out second mortgages. But, the wealth effects are still very real in China. People know how much their home is worth, have confidence the price will likely continue to appreciate. So, spending habits can reflect this.

In fact, most Chinese have a better idea of the current value of their homes than anyone in the US or Europe. That’s because property is sold based on price per-square-meter, and everyone in China seems to know that current value of the square meters they own. The Chinese government has been trying for the last sixth months, with limited success, to moderate the fast rise in property prices across the country.  Most housing has appreciated by at least 15% this year.

Housing is the main bedrock of middle class status in China. But, salaries are also rising sharply across the board in the professional class (as well as those working in factories), putting more cash in people’s pockets. The stock market has also become a major additional source and store of wealth.

It’s a common characteristic of the middle class everywhere to feel a little dissatisfied, and a little anxious about one’s economic future and ability to remain among the more better-off. This is very noticeable in China as well. Many of China’s middle class don’t consider themselves that comfortable.

The pace of social and economic change is so swift, and prices for many middle-class staples like cars, foreign vacations and housing are so high,  that people don’t have a real sense of “having made it’.  They also fret about their retirement, about saving enough to put their kids through the best schools, about job security. In other words, they’re very much like the middle class in the US.

Middle class spending is the single most important source of economic activity in the US. This isn’t yet true of China, but each year, it will become more important. This reality should be at the top of the agenda for boardroom planning at companies in China and much of the rest of the world. China’s middle class will become a market not only larger in size, but in purchasing power, than America’s.

China’s very rich (it now has more billionaires than any other country except the US) and poor tend to be the focus on most of the reporting by the world’s financial press. They are generally blind to the most significant development of all, the emergence over the last ten years of an enormous middle class in China. Without a doubt, more Chinese join the middle class each year than in the US, Europe and Japan combined.

Remember, many of the most successful global businesses in the US over the last 50 years – Ford, McDonalds, Disney, Coca-Cola, P&G, Wal-Mart to name just a few – got that way by focusing originally on selling to America’s middle class. China’s middle class is fast becoming an even richer target.

Anyone selling services or products for the middle class ought to find a way to do so in China. Quickly.

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China’s National Social Security Fund: the World’s Largest Investor in PE Firms

November 9th, 2010 1 comment

17th c jade  perfumer from China First Capital blog post


Soon to be the world’s largest pool of investment capital for the private equity industry, China’s National Social Security Fund will be responsible for paying the pensions of hundreds of millions of workers in China. It will eventually need trillions of dollars to do so. The good news for workers in China, the NSSF is professionally, carefully and competently run. China’s huge pool of pension cash is in safe hands.

I recently talked to the partner at a Chinese PE fund that is soon to receive some of the NSSF money. The report: the NSSF, though new to the world of private equity investment, has a process for choosing PE firms that is as rigorous as many of the world’s most sophisticated and investment managers. There are multiple levels of due diligence, including outside lawyers, accountants, and consultants who assess the investment performance and strategy of a PE firm, interview PE partners at length, and then provide the NSSF with recommendations.

The NSSF has used Singapore’s much-smaller but very well-managed Central Provident Fund as a model. Workers contribute part of their pay, and the money is then managed and invested by the government fund to achieve a solid rate of return that will provide for a reasonable monthly pay-out at retirement.

In contrast, the public pension systems in the US and much of Europe are thinly-disguised forms of taxation. The government collects money with each paycheck, promising to pay workers a monthly allowance when they retire. Cash from current workers is used to pay the pensions of those who have already retired. The system works fine when pensions are kept to a modest level and there are always many more people working then retired. Neither of these are true in Europe and the US. These pension plans have enormous unfunded liabilities that can be met only through cutting pension payments in the future, raising taxes on current workers or both. It’s grim.

China, wisely, chose a much sounder method of funding public pensions, when it began introducing state pensions over the last decade. Cash is invested for the future, not spent as soon as it arrives. A 35 year-old Chinese worker has a far better chance of collecting a decent state pension in 30 years than an American one. The US system is technically insolvent. The Chinese one is rolling in cash.

The NSSF had Rmb 777 billion ($120 billion) in assets at the end of 2009.  The assets are growing swiftly. More Chinese each year join the urban workforce, and so have a percentage of their salary handed over to the NSSF. Salaries are also rising fast, which sends more money into the pension system each year. Either by the end of this year, or certainly by next, the NSSF’s assets should surpass those of CALPERS , and become the world’s largest pension fund and largest Private Equity Limited Partner (“LP”), as investors in PE firms are called.

Though a government agency, the NSSF is managed like a private pension fund. It invests its capital in a mix of assets, to earn a reasonable, safe, risk-adjusted return to meet pension obligations in the future. Depending on NSSF’s investment performance, its assets should be approaching $500 billion within five years.

Most of the NSSF capital is invested in low-risk and low-yielding bonds. The NSSF’s target is an investment return of at least 3.5% a year. As part of the asset mix, the NSSF is also planning to invest about 10% of its capital in “alternative assets”,  mainly with private equity firms investing in China. It has already begun placing capital with PE firms, including CDH, SAIF Partners, New Horizon Fund.

The NSSF will likely commit over Rmb20 billion ($3 billion) a year in new capital to private equity in China. That dwarfs the activity of all other LPs in the world, including pension funds, insurance companies, university endowments.

As long as the NSSF maintains its professional approach to choosing PE firms to invest with, I’m confident it will earn a good rate of return on its PE investments. The better PE firms are earning returns of over 33% a year from their investments in China. Looking out twenty to thirty years in the future, state pensions in China will be more secure and more generous because of the investment in PE funds.

There is no better risk-adjusted asset class in the world today than investing in private Chinese companies. This is precisely what Chinese PE firms do. They provide growth capital to companies that are usually already large, profitable and successful.  The only constraint is capital. PE firms provide it, generally at modest valuations of around ten times current year’s profits.

In two to three years, these same companies will IPO in China at valuations of at least forty times past year’s profits. It’s an investment formula that can reliably produce returns of 500%-800% over two to three years.  Nowhere else in the world can match China, both on the number of attractive private companies to invest in, and the returns from doing so.

China’s private companies, and their millions of customers and employees,  will benefit from the capital provided to PE firms by the NSSF. China’s entire working population will eventually benefit as well, as these companies grow larger, more successful, and become valuable public companies. Profits from the successful PE investments will flow back to the NSSF, to support the retirement of millions.

Of course, a PE firm needs to know what it’s doing, how to select good companies, and also how to assist them in making a successful transition to publicly-traded businesses. The good ones do. The NSSF’s screening process is designed to determine which firms are the best, and then place money with them.

The main coin of the realm in China, as everyone knows, is “guanxi”, or the personal relations that tie people together and form the basis for most business deals. Fortunately for China’s working population, the NSSF, from what I’m told,  is guided by fiduciary principles and best practices, not personal ties, in assessing where to put the nation’s savings.  Along with the interviews and legal scrutiny, the NSSF also hires FOF firms (“Fund of Funds”) to evaluate PEs on its behalf. It’s another smart move. FOF firms have the most detailed knowledge and experience choosing good PE firms, and monitoring their performance.

The NSSF is responsible for the long-term financial security of hundreds of millions of people. It’s an awesome responsibility. By all evidence, they are doing important work, and doing it well.


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ChiNext: One Year Later, Celebrating a Success

November 1st, 2010 1 comment

Zhou dynasty from China First Capital blog post

This past Saturday, October 30,  marked the one year anniversary of the founding of the ChiNext (创业板) stock market. In my view, the ChiNext has been a complete and unqualified success, and should be a source of pride and satisfaction to everyone involved in China’s financial industry. And yet, there’s quite a lot of complaining and grumbling going on, about high share prices, high p/e multiples,  “underperformance” by ChiNext companies, and the potentially destabilizing effect of insiders’ share sales when their 12-month lockup period ends.

Let’s look at the record. Over the last year, the board has grown from the original 28 companies to 134, and raised a total of 94.8 billion yuan ($14bn). For those 134 companies, as well as hundreds more now queuing up for their ChiNext IPO, this new stock market is the most important thing to ever happen in China’s capital markets.

Make no mistake, without the ChiNext, those 134 companies would be struggling to overcome a chronic shortage of growth capital. That Rmb 94.8 billion in funding has supported the creation of thousands of new jobs,  more indigenous R&D in China, and provided a new and powerful incentive system for entrepreneurs to improve their internal controls and accounting as a prelude to a planned ChiNext IPO.

China’s retail investors have responded with enthusiasm to the launch of ChiNext, and support those high p/e multiples of +50X at IPO. It is investors, after all, who bid up the price of ChiNext shares, and by doing so, allow private companies to raise more capital with less dilution. Again, that is a wholly positive development for entrepreneurship in China.

Will some investors lose money on their investments in ChiNext companies? Of course. That’s the way all stock markets work. The purpose of a stock market is not to give investors a “one way bet”. It is to allocate capital.

I was asked by a Bloomberg reporter this past week for my views on ChiNext. Here, according to his transcript,  is some of what I told him.

“For the first time ever, the flow of capital in China is beginning to more accurately mirror where the best growth opportunities are. ChiNext is an acknowledgement by the government of the vital importance of entrepreneurial business to China’s continued economic prosperity. ChiNext allocates growth capital to businesses that most need and deserve it, and helps address a long-standing problem in China’s economy: capital being mainly allocated to state-owned companies. The ChiNext is helping spur a huge increase of private equity capital now flowing to China’s private companies. Within a year my guess is the number of private equity firms and the capital they have to invest in China will both double.”

A market economy functions best when capital can flow to the companies that can earn the highest risk-adjusted return. This is what the ChiNext now makes possible.

Yes, financial theory would argue that ChiNext prices are “too high”, on a p/e basis. Sometimes share prices are “too high”, sometimes they are “too low”, as with many Chinese companies quoted on the Singapore stock market. A company’s share price does not always have a hard-wired correlation to the actual value and performance of the company. That’s why most good laoban seldom look at their share price. It has little, if anything, to do with the day-to-day issues of building a successful company.

Some of the large shareholders in ChiNext companies will likely begin selling their shares as soon as their lock-up period ends. For PE firms, the lock-up ends 12 months after an IPO. If a PE firm sells its shares, however, it doesn’t mean the company itself is going sour. PE firms exist to invest, wait for IPO, then sell and use that money to repay their investors, as well as invest in more companies. It’s the natural cycle of risk capital, and again, promotes overall capital efficiency.

There are people in China arguing that IPO rules should be tightened, to make sure all companies going public on ChiNext will continue to thrive after their IPO. That view is misplaced. For one thing, no one can predict the future performance of any business. But, in general, China’s capital market don’t need more regulations to govern the IPO process. China already has more onerous IPO regulations than any other major stock market in the world.

The objective of a stock market is to let  investors, not regulators, decide how much capital a company should be given.  If a company uses the capital well, its value will increase. If not, then its shares will certainly sink. This is a powerful incentive for ChiNext company management to work hard for their shareholders. The other reason: current rules prohibit the controlling shareholders of ChiNext companies from selling shares within the first three years of an IPO.

The ChiNext is not a path to quick riches for entrepreneurs in China. It is, instead, the most efficient way to raise the most capital at the lowest price to finance future growth. In the end, everyone in China benefits from this. The ChiNext is, quite simply,  a Chinese financial triumph.


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