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“If You Are Going to Do Something, Do It Big”

March 27th, 2012 No comments

The first thing that strikes you is complete geographic implausibility of it all. In a rural corner of China’s barren, sparsely-populated and dusty Loess Plateau, sits an enormous complex of factories, dormitories, roads, and train tracks occupying an area of 38 square kilometers (14.6 square miles, almost 19 million square feet). That’s over half the size of Manhattan, 58 times larger than LA’s Disneyland, three times larger than the world’s busiest international airport, Heathrow in London.

The site belongs to a single Chinese company. It’s private, been in business less than a decade, has come from nowhere to become the world’s largest manufacturer of a critical component used in steel production, with likely revenues this year of over USD$1.5 billion (Rmb10 billion), profits of over USD$130 million , and assets of over USD$2.4 billion (Rmb 15 billion).  It’s 99% owned by its founder and chairman, with the other 1% held by his wife and daughter. By any measures, it is among the largest private industrial companies in the world, and certainly among the fastest ever to get to $1 billion in sales.

Not only have you never heard of it, neither has virtually everyone in China. It’s never listed among the biggest private companies in China. Its owner is never included among the ranks of the country’s private sector billionaires. Just how unknown is this remarkably successful entrepreneur? Here’s one measure. Believe me, I’m a big nobody in China. But, a Baidu search turns up more articles and references to me and my company than to this company boss and his.  In terms of orders of magnitude, his company employs about 2,000 times more people than mine, and occupies a premises that’s about, well, 190,000 times larger.

I’m not going to disclose the company or the boss’s name. We’re in discussions with them, and it would be unprofessional to do so. None of my competitors, as well as virtually no credible PE firms,  have visited the company.

My purpose here is two-fold: to shed a little light on a remarkable individual entrepreneurial achievement and also to give some sense of the scale of entrepreneurial greatness in China. I find myself, more often than I’d like, drawn into discussions – occasionally arguments – with people in the US and Europe about how entrepreneurship in China is in a class by itself, compared to everywhere else in the world, excepting perhaps the US and Israel.

Entrepreneurs are more numerous here (over 70 million private companies) and the best ones, numbering at least in the thousands, have created more wealth and spawned more positive societal progress in the last ten years than any other single group of people on the planet. I live in a perpetual state of wonder, doing what I do for a living in China, having occasion to meet entrepreneurs of the caliber of this particular boss.

A little more about him. He is, by my eye, about as modest an individual as you would likely ever run across. The only obvious concession to his enormous wealth is a rose gold watch he wears along with standard-issue baggy Chinese suit. If he sat next to you on a plane, my guess is you’d pin him as the owner of a small hardware store, not the owner of the world’s largest manufacturing business for a component used in a lot of what’s for sale there.

His office is hardly palatial, and sits just above the oldest section of his giant factory complex. He never went to college, and has no engineering or technical background, despite founding and now running one of the more complicated large-scale engineering and manufacturing businesses you’d ever hope to see.

Everything about the man, except his ego, is huge. “If you are going to do something,” he tells me, “do it big.” This applies not only to the huge area his business occupies, but the size of the investments he is making in its future. He is taking his business downstream and building, simultaneously, at least four huge new production sites, with total planned investment of over $3 billion. The local government is busy decapitating the top half of a silt mountain to create a level 500 acre site (about one square mile) for one of these new production areas. He begins building on it this year.

As I drove away from the factory area, I remarked to my colleague that the whole complex must be a source of intense interest at the CIA and National Security Agency in Washington, DC. Satellite photos will show the vast scale of this enterprise, as well as all the construction taking place. One recently-completed building is four stories tall and a mile long, all indoors.

My guess is the two spy agencies aren’t all that sure what exactly is being produced or planned here. I drove through it. Within a year, it will start producing steel products for the auto and home appliance industry.

How did this one entrepreneur build such a huge business is such a short time? Obviously, good timing, luck, some support from his local government and banks played a part. But, one key factor was a gamble he made in 2008 that paid off big time. When the financial crisis hit, his state-owned competitors (there were once three within a few hundred miles of him) cut way back on raw material purchases. This boss did the opposite. He exploited a steep drop in commodity prices, bought big and so locked in very large profits when customer demand began to pick up in 2009. Of course, had prices kept falling, he would have likely been bankrupt. His state-owned competitors? Now, all out of business.

Just about every “yuan” of profit he earns is poured back into expanding production. His bank loans are moderate –  about 10% of total assets. He’s only drawn down 70% of the credit lines provided by local banks. Measured by scale (factory size, employees, revenues) his company is similar to many larger SOEs in China. Asked to make a comparison, he explains that SOEs target only top line growth — girth for its own sake. He is far more focused on making money. The projected annual rate of return on newer projects is well above 25%.

He’s thinking about an IPO within two to three years. At a guess, his business could have a market capitalization at that point in excess of USD$8 billion. An IPO on that scale will bring him a lot of unwanted notoriety. He would likely instantly be vaulted into the ranks of the five hundred richest people on the planet. Billionaires in China rarely have it easy. Quite a few seem to end up in prison, or targeted by waves of bad publicity. For him, the real appeal of going public is the potential to raise an additional $1.5 billion to $3 billion to invest in further downstream expansion.

Whether or not my company works with his, it was one of the signal delights of my 35-year professional career to meet this entrepreneur, tour his factories and eat in his dining room.  At this moment in history, China is the entrepreneurial center of the world.

Why I Love What I DO

March 15th, 2012 1 comment

My love story began 25 years ago on a bus barreling down the Mass Pike highway in Western Massachusetts. It continues to this day, stronger and more captivating than ever. It has provided the joy, the passion, the inspiration, the endless study and purpose of my life. I’m talking about my love affair with entrepreneurs and entrepreneurship. 

Twenty-five years ago I was a newly-hatched baby reporter at Forbes Magazine in New York, on my first proper reporting assignment. An editor asked me to look into what was then still a small New England bus company with the unlikely name of Peter Pan Bus Lines. Against the odds, little Peter Pan was competing, and somehow winning, against America’s giant intercity bus company, Greyhound. I took one of their busses from New York’s dreary Port Authority station to the company headquarters in Springfield, Massachusetts. 

I sat down with the company’s CEO, Peter Picknelly. He gave me my first lesson in what it’s like to be an entrepreneur, the challenge and the delight of taking on – and eventually taking down – a big rival. To my surprise, as well as my editors, I was able to turn the conversation into an article that made it into Forbes, under my byline. My first. I was hooked– not so much with reporting and journalism. That was purely a means to an end. My life’s direction became meeting and learning from entrepreneurs.

At that time, I knew and cared little about small business and entrepreneurs. Both my grandfathers were founders of successful companies. But, growing up under their noses, I never quite appreciated just how special they — and their fellow entrepreneurs – really were. Only when I landed at Forbes, after years of studying Chinese history, then spending time in China and Hong Kong as a grad student, did it first begin to dawn on me how much I had to learn, and how deeply I should admire, the people who take the limitless risk to start businesses, find and please customers and, not all that infrequently, end up changing the world for the better. 

Fast forward to today, and I’m living a life that is the culmination of this 25 years of meeting, talking with, learning from some of the best entrepreneurs in the US, Europe and now China. In the four years since starting CFC, I’ve met in China more great entrepreneurs than in the previous 21. That is no small accomplishment, since among the entrepreneurs I met previously are Bill Gates, Miuccia Prada, Ken Olson and dozens more, less famous, but in many senses, no less remarkable and successful.

Entrepreneurs in China share much the same profit-making and opportunity-seeking DNA of entrepreneurs elsewhere. What makes them more remarkable, though, is fact that almost all got their start at a time when entrepreneurship, when starting your own company, was new, untried, often hazardous in China. They not only had to overcome the obstacles familiar to entrepreneurs everywhere (where do I find the money? How do I make a profit, feed my family and reinvest? What about my larger competitors?) but a raft of others that would daunt just about any other sane individual. 

Until comparatively recently, China’s economy was a near-perfect socialist vacuum in which entrepreneurship could not survive.  The economy was almost entirely in state hands. Licenses were not granted to private businesspeople. Banks would not lend. This was the world today’s successful Chinese entrepreneur was born into. There were no role models. The previous generation of private entrepreneurs had, in large part, been expropriated and excoriated or fled the country in 1949. 

Laws giving equal treatment to private companies were only introduced in 2005. Even then, private companies have had it very tough, in many cases. It remains a challenge. Taxes are numerous and high. Regulations can be as stifling as anywhere else in the world. Laws change frequently. Worker salaries are now growing by 25% a year or more. Every good business idea, almost within minutes, attracts hundreds, if not thousands, of competitors. Success or failure can be conferred at the whim of a local bureaucrat. 

And still, the great entrepreneurs of China keep marching forward, in ever greater numbers. A week doesn’t go by when I don’t meet or hear about a successful and accomplished entrepreneur. I’m just back from a five day trip to cold and barren Northwestern China. For me, it was far more enjoyable than a long weekend on the beach at Bali. 

During my trip, I met back-to-back with the founders of nine different companies, sharing hours of discussion with each, and a delicious meal with most. Each of the nine is successful, in industries ranging from cooking oil to laser components, from high-tech fiberglass threads to the world’s largest producer of a refined mineral used by steel mills all over the world. 

In my next blog post, I will tell the story of this mineral company and its remarkable founder. In eight years, since starting his business with little capital and no relevant experience or higher education, he has built a business worth, conservatively, $2 billion. He owns 99% of it. His wife and daughter the remaining 1%. 

Each of these entrepreneurs, like so many others in China and elsewhere, will achieve more in their lives than most, and likely leave a lasting imprint on generations to come. This was true for my grandfathers, whose success (one as the owner of a department store, the other as the founder of a button-making company) in the middle part of the 20th century created the wealth to send their children to college, get advanced degrees, and so ultimately provide a very affluent upbringing and even more possibilities in life for me and my brothers and cousins. 

The roots of so much of my own happiness are opportunities and experiences made possible by the business success of my two entrepreneurial grandfathers. It is the greatest of privileges for me to now work helping in a small way some outstanding entrepreneurs here in China.

The “OTCBB-ization” of the Hong Kong Stock Exchange

March 6th, 2012 No comments

From the world’s leading IPO stock market to a grubby financial backwater with the sordid practices of America’s notorious OTCBB. Is this what’s to become of the Hong Kong Stock Exchange ?

I see some rather disturbing signs of this happening. Underwriters, with the pipeline of viable IPO deals drying up, are fanning out across China searching for mandates and making promises every bit as mendacious and self-serving as the rogues who steered so many Chinese companies to their doom on the US OTCBB.

The Hong Kong Stock Exchange (“HKSE”) may be going wrong because so much, until recently, was going right.  Thanks largely to a flood of IPO offerings by large Chinese companies, the HKSE overtook New York in 2009 to become the top capital market for new flotations. While the IPO markets turned sharply downward last year, and the amount of IPO capital raised in Hong Kong fell by half, the HKSE held onto the top spot in 2011. US IPO activity remains subdued, in part due to regulatory burdens and compliance costs heaped onto the IPO process in the US over the last decade.

During the boom years beginning around 2007, all underwriting firms bulked up by adding expensive staff in expensive Hong Kong. This includes global giants like Goldman Sachs, Citibank and Morgan Stanley, smaller Asian and European firms like DBS, Nomura, BNP Paribas and Deutsche Bank and the broking arms of giant Chinese financial firms CITIC, ICBC, CIIC, and Bank of China. The assumption among many market players was that the HKSE’s growth would continue to surge, thanks largely to Chinese listings, for years to come. With the US, Europe and Japan all in the economic and capital market doldrums, the investment banking flotilla came sailing into Hong Kong. Champagne corks popped. High-end Hong Kong property prices, already crazily out of synch with local buying power,  climbed still higher.

The underwriting business relies rather heavily on hype and boundless optimism to sell new securities. It’s little surprise, then, that IPO investment bankers should be prone to some irrational exuberance when it comes to evaluating their own career prospects. The grimmer reality was always starkly clear. For fundamental reasons visible to all but ignored by many, the flood of quality Chinese IPOs in Hong Kong was always certain to dry up. It has already begun to do so.

In 2006, the Chinese government closed the legal loophole that allowed many PRC companies to redomicile in Hong Kong, BVI or Cayman Islands. This, in turn, let them pursue IPOs outside China, principally in the US and Hong Kong. Every year, the number of PRC companies with this “offshore structure” and the scale and growth to qualify for an IPO in Hong Kong continues to decline. A domestic Chinese company cannot, in broad terms, have an IPO outside China.

Some clever lawyers came up with some legal fixes, including a legally-dubious structure called “Variable Interest Entity”, or VIE, to allow domestic Chinese companies to list abroad. But, last year, the Chinese Ministry of Commerce began moving to shut these down. The efficient, high-priced IPO machine for listing Chinese companies in Hong Kong is slowly, but surely, being starved of its fuel: good Chinese private companies, attractive to investors.

Yes, there still are non-Chinese companies like Italy’s Prada, Russia’s Rusal or Mongolia’s Erdenes Tavan Tolgoi still eager to list in Hong Kong. There is still a lot of capital, while listing and compliance costs are well below those in the US. But, the Hong Kong underwriting industry is staffed-up mainly to do Chinese IPOs. These guys don’t speak Russian or Mongolian.

So, the sorry situation today is that Hong Kong underwriters are overstuffed with overhead for a “coming boom” of Chinese IPOs that will almost certainly never arrive. China-focused Hong Kong investment bankers are beginning to show signs of growing desperation. Their jobs depend on winning mandates, as well as closing IPOs. To get business, the underwriters are resorting, at least in some cases, to behaviors that seem not that different from the corrupt world of OTCBB listing. This means making some patently false promises to Chinese companies about valuation levels they could achieve in an Hong Kong IPO.

The reality now is that valuation levels for most of the Chinese companies legally structured for IPO in Hong Kong are pathetically low. Valuations keep getting slashed to attract investors who still aren’t showing much interest. Underwriters are finding it hard to solicit buy offers for good Chinese companies at prices of six to eight times this year’s earnings. Some other deals now in the market and nowhere near close are being priced below four times this year’s net income. At those kind of prices, a HK IPO becomes some of the most expensive equity capital around.

In their pursuit of new mandates, however, these Hong Kong underwriters will rarely share this information with Chinese bosses. Instead, they bring with them handsomely-bound bilingual IPO prospectuses for past deals and suggest that valuation levels will go back into double digits in the second half of this year. In other words, the pitch is, “don’t look at today’s reality, focus instead at yesterday’s outcomes and my rosy forecast about tomorrow’s”.

This is the same script used by the advisors who peddled the OTCBB listings that damaged or destroyed so many Chinese companies over the last five years. Another similar tactic used both by OTCBB rogues and HK underwriters is to pray on fear. They suggest to Chinese bosses that they should protect their fortune by listing their company offshore, at whatever price possible and using whatever legally dubious method is available. They also play up the fact a Chinese company theoretically can go public in Hong Kong whenever it likes, rather than wait in an IPO queue of uncertain length and duration, as is true in China.

In other words, the discussion concerns just about everything of importance except the fact that valuation levels in Hong Kong are awful, and there is a decent probability a Chinese company’s HK IPO will fail. This is particularly the case for Chinese companies with less than USD$25 million in net income. The cost to a Chinese company of a failed IPO is a lot of wasted time, at least a million dollars in legal and accounting bills as well as a stained reputation.

There is, increasingly, a negative selection bias. Investors rightly wonder about the quality of Chinese companies, particularly smaller ones, being brought to market by underwriters in Hong Kong.

“No one has a crystal ball”, is how one Hong Kong underwriter, a managing director who spends most of his time in China scouring for mandates, explains the big gap between promises made to Chinese bosses, and the sad reality that many then encounter. In a real sense, this is on par with him saying “I’ve got to do whatever I’ve got to do to earn a living”. He can hold onto his job for now by bringing in new mandates, then hope markets will turn around at some point, the valuation tide will rise, and these boats will lift. This too is a business strategy used for many years by the OTCBB advisor crowd.

The OTCBB racket is now basically shut down. Those who profited from it are now looking for work or looking elsewhere for victims, er mandates. Tiny cleantech deals are apparently now hot.

My prediction is a similar retrenchment is on the way in Hong Kong, only this time those being retrenched won’t be fast-buck types from law firms and tiny OTCBB investment banks no one has heard of. Instead, it’ll be bankers with big salaries working at well-known brokerage companies. The pool of IPO fees isn’t big enough to feed them all now. And, that pool is likely going to evaporate further, as fewer Chinese companies sign on for Hong Kong listings and successfully close deals.