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China’s Bold “One Belt One Road” Move To Dramatically Extend Its Power and Commerce in the Indian Ocean — The Financial Times

September 27th, 2017 No comments

 

 

Much has been said — but far less is understood — about the One Belt One Road initiative, the centerpiece of Xi Jinping’s expansive foreign policy. That Mr. Xi has ambitions to extend across Eurasia China’s commercial, political and military power is not in doubt. But, the precise details on OBOR remain just about as unclear now as they did four years ago when the policy was unveiled — which countries are included, how much cash China will invest or lend, where are the first-order priority projects, will any of the trillions of dollars of proposed spending achieve commercial rates of return? Questions multiply. Answers are few.

There is one remote corner of the planet, however, where the full weight of OBOR’s grand strategy and profit-making potential are coming into view. It’s in a small village called Hambantota along the southern fringe of Indian Ocean beachfront in Sri Lanka.

One of China’s largest and most powerful state-owned companies, China Merchants Group, with total assets of $855 billion, is in the final stages of completing the purchase for $1.1 billion of a 99-year lease for a majority stake in a seven-year-old loss-making deep-water container port. It was built for over $1 billion on a turnkey basis by Chinese state-owned contractors. It is owned and operated by the Sri Lankan government’s Port Authority.

I’m just back in China from a rare guided visit inside Hambantota port. Like other bankers and investors, we’ve felt the pinch as much of Chinese outbound investment has been cancelled or throttled back this year. Hambantota, though, is full steam ahead.

Hambantota’s future appears now about as bright as its present is dreary. On the day I visited, there was virtually no activity in the port, save the rhythmic wobbling of a Chinese cargo ship stuck in Hambantota for three weeks. Due to choppy seas and also perhaps inexperienced Sri Lankan port staff, the Chinese ship has been sitting at anchor, unable to unload the huge Chinese-made heavy-duty cranes meant to operate on the quayside.

Though the Chinese ambassador to Sri Lanka has pledged that Hambantota will one day resemble Shanghai, as of today, elephants in the nearby jungle are about as numerous as dockworkers or pedestrians. Tragically, the region was ravaged, and partly depopulated, by the Tsunami of 2004. China Merchants will take over management of the port within the next month or so. There is much to do — as well as undo. The Hambantota port, under Sri Lankan government management, has been a bust, a half-finished commercial Xanadu where few ships now call. The port has lost over $300 million since it opened.

China Merchants’ plan to turn things around will rest on two prongs. Its port operations subsidiary, Hong Kong-listed China Merchants Port Holdings, will take over management of Hambantota. It is the largest port owner and operator in China. Almost 30% of all containers shipped into and out of China are handled in China Merchants’ ports. The ports business earned a profit of $850 million last year. China Merchants has what the Sri Lankan government’s Hambantota port operator could never muster: the operational skill, clout, capital and commercial relationships with shippers inside China and out to attract significant traffic to Hambantota. China’s state-owned shipping lines deliver more containers than those from any other country.

In addition, China Merchants will enlist other large China SOEs to invest and set up shop in an 11 square-kilometer special economic zone abutting the Hambantota port. The SEZ was created at the request of the Chinese government, with the promise of $5 billion of Chinese investment and 100,000 new jobs to follow. China Merchants is now drawing up the master plan.

A who’s who of Chinese SOE national champions are planning to move in, beginning with a huge oil bunkering and refining facility to be operated by Sinopec as well as a large cement factory, and later, Chinese manufacturing and logistics companies. This “Team China” approach – having a group of Chinese SOEs invest and operate alongside one another — is a component of other OBOR projects. But, the scale of what’s planned in Hambantota is shaping up to be far larger. The flag of Chinese state capitalism is being firmly planted on this Sri Lankan beachfront.

Hambantota is only ten to twelve nautical miles from the main Indian Ocean sea lane linking the Suez Canal and the Malacca Straits. Most of China’s exports and imports sail right past. An average of ten large container ships and oil tankers pass by every hour of every day. From the Hambantota port office building, one can see the parade of huge ships dotted across the horizon. Along with transshipping to India and the subcontinent, Hambantota will provide maintenance, oil storage and refueling for shipping companies.

Sri Lanka is the smallest of the four Subcontinental countries, with a population of 20 million compared to a total of 1.7 billion in India, Pakistan and Bangladesh. It has one geographic attribute its neighbors lack — a deep-water coastline close to Indian Ocean shipping lanes and conducive to building large deep-water ports able to handle the world’s largest container ships and supertankers. This should make Sri Lanka the ideal transshipment point for goods and natural resources going into and out of the Subcontinent.

The Port of Singapore is now the region’s main transshipment center. It is three to four times as distant from India’s major ports as Hambantota. Singapore is now the world’s second-busiest port in terms of total shipping tonnage. It transships about a fifth of the world’s shipping containers, as well as half of the world’s annual supply of crude oil.

Even before President Xi first articulated the OBOR policy, Sri Lanka was already seen as a key strategic and commercial beachhead for China’s future trade growth in the 40 countries bordering the Indian Ocean. China and Sri Lanka have had close and friendly diplomatic ties since the early 1950s. Both style themselves democratic socialist republics.

Sri Lanka is the one country in the region that enjoys cordial relations not only with China but also the US, and the three other Subcontinental nations. Sri Lanka’s GPD is $80 billion, less than one-tenth the total assets of China Merchants Group. Sri Lankan per capita GDP and literacy rate are both about double its Subcontinental neighbors. While a hardly a business nirvana, it is often easier to get things done there than elsewhere in region.

The first port was established in Hambantota around 250 AD. It was for centuries, until Chinese emperors sought to prohibit Chinese junks from sailing the open seas, a stopping point for Chinese ships trading with Arabia.

China Merchants has been trying for four years to close the deal there. China Merchants Port Holdings is a powerful presence in Sri Lanka. It already built and operates under a 35-year BOT contract a smaller, highly successful container port in the capital Colombo. It opened in 2013. It’s one of the few large-scale foreign direct investment success stories in Sri Lanka. The future plan is for the China Merchants’ Colombo port to mainly handle cargo for Sri Lanka’s domestic market, while Hambantota will become the main Chinese-operated transshipment hub in the Indian Ocean.

Chinese SOEs are also in the throes of building a port along the Pakistani coast at Gwadar and upgrading the main ports in Kenya. The direction of Beijing’s long-term planning grows clearer with each move. If not exactly a Chinese inner lake, the Indian Ocean will become an area where Chinese shipping and commercial interests will more predominate.

During the Hambantota negotiations, the Sri Lankan government blew hot and cold. The country needs foreign investment and Chinese are lining up to provide it, as well as additional infrastructure grants and loans. Chinese building crews swarm across a dozen high-rise building sites in Colombo. Chinese tourist arrivals are set to overtake India’s. The main section of the unfinished highway linking Colombo and Hambantota was just completed by the Chinese.

The new coalition government that came to power in Sri Lanka in early 2015 has sometimes showed qualms about the scale and pace of Chinese investment. India has already signaled unease with the Chinese plans to take over and enlarge the port in Hambantota. Prior to signing the contract with China Merchants, the Sri Lanka government provided India with assurances the Chinese will be forbidden to use the port for military purposes.

China Merchants will effectively pay off the construction loans granted by the state-owned Export-Import Bank of China to the Sri Lankan government in return for the 99-year operating lease. China Merchants plans to invest at least another $1 billion, but perhaps as much as $3 billion, to complete Hambantota port and turn it into the key Indian Ocean deep-water port for ships plying the route between Suez and East Asia. Rarely if ever in my experience do OBOR projects have the crisp commercial logic of Hambantota. Assuming ships do start to call there, Hambantota should prove quite profitable, as well as a major source of employment and tax revenue for Sri Lanka.

As of now, there is almost no housing and no infrastructure in Hambantota, only the port facility, a largely-empty international airport and a newly-opened Shangri-La hotel and golf course. The airport and port were pet projects of a local Hambantota boy made good, Mahinda Rajapaksa. He was Sri Lanka’s president from 2005 to 2015, when he was voted out of office. In December last year, the port was taken over by a mob of workers loyal to the Rajapaksa. They took several ships hostage before the Sri Lankan navy sailed in to end the chaos.

The port will be able to handle dry cargo, Ro-ro ships transporting trucks and autos, oil tankers as well as the world’s largest 400-meter container ships. Hambantota should lower prices and improve supply chains across the entire region, and so drive enormous growth in trade volumes — assuming power politics don’t intrude.

China and India have prickly relations, most recently feuding over Chinese road-building in the disputed region of Doklam. India has balked at direct participation in OBOR, and complains loudly about its mammoth trade deficit with China, now running about $5 billion a month. Chinese exports to India have quadrupled over the past decade, in spite of India’s extensive tariffs and protectionist measures. Hambantota should allow India’s manufacturing sector to be more closely intertwined with Chinese component manufacturers and supply chains. That is consistent with India’s goal to increase the share of gdp coming from manufacturing, and manufactured exports, both still far smaller than China’s. But, India will almost certainly push back, hard, if Hambantota leads to a big jump in its trade deficit with China.

China’s exports may be able to come in via the Sri Lankan backdoor. India and Sri Lanka have a free trade agreement that in theory lets Sri Lankan goods enter the vast market duty-free. Chinese manufacturers could turn the Hambantota free trade zone into a giant Maquiladora and export finished products to India. This would flood India with lower-priced consumer goods, autos, chemicals, clothing. Bangladesh, Pakistan and Burma — smaller economies but friendlier with China — would likewise absorb large increases in exported Chinese goods, either transshipped from Hambantota or assembled there.

No area within OBOR is of greater long-term significance to Chinese commerce. Fifty years from now, if UN estimates prove correct, the population of India, Pakistan and Bangladesh will be about 2.3 billion, or about double where China’s population will be by then.

Some China Merchants executives are dreaming aloud the Thai and Chinese governments will close a deal to build a canal across Southern Thailand. This would shave 1,200 miles off the sea route from Suez to China. The preferred canal route across the isthmus of Southern Thailand is actually shorter than the length of the Panama Canal. The canal would re-route business away from Singapore and the Malacca Straits. The likely cost, at around $25 billion, could be borne by China without difficulty. Hambantota would grow still larger in importance, commercially and strategically.

For now, though, the Thai canal is not under active bilateral discussion. Not only does the ruling Thai junta worry about its landmass being cleaved in two, the governments of the US, Japan, Singapore would likely have serious reservations about altering Asian geography to enhance China’s sea power and naval maneuverability.

By itself, a Chinese-owned and operated Hambantota will almost certainly reconfigure large trade flows across much of Asia, Africa and Europe, benefitting China primarily, but others in the region as well. It is a disruptive occurrence. While much of China’s OBOR policy remains nebulous and progress uncertain, Chinese control of Hambantota seems more than likely to become a world-altering fact.

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As published in The Financial Times

 

 

 

 

Venture Fundraising in Yuan Soars as Investors Target Chinese Tech Firms — The New York Times

September 23rd, 2017 No comments

 

HONG KONG (Reuters) – China-focused venture capital funds are increasing their bets on local technology companies and a further opening of Chinese domestic capital markets, raising money in the yuan at the fastest pace in five years.

Fund managers have raised 95.8 billion yuan ($14.54 billion) this year through late September in funds denominated in the Chinese currency, which is also known as the renminbi, compared with 56.7 billion yuan in all of 2016. That puts 2017 on pace to be the biggest year since 2012, when 145.8 billion yuan was raised, according to data provider Preqin.

There are currently 78 funds looking to raise as much as another 1.15 trillion yuan over the next couple of years, Preqin said, most of it coming from mammoth-sized state-owned entities and so-called government guidance funds, which seek to foster domestic innovation in different industries from advanced engineering and robotics to biotechnology and clean energy.

 Those include the 350 billion yuan sought by the China Structural Reform Fund, 200 billion yuan targeted by the China State-Owned Capital Venture Investment Fund and a proposed 150 billion yuan for the state-owned Enterprise National Innovation Fund.

The enormous size of the fundraising ambitions of the Chinese state-backed funds means it may take some time before they reach their final goals. The China Structural Reform Fund, which was launched in 2016, has raised 20 percent of its registered capital and its president said in an interview with Caixin Global that funding will be completed by the end of 2018.

“We’re at the all-time highest of capital-raising high water marks, with a tsunami of government-backed entities seeding incubators, VC funds, locally, provincially, nationally,” said Peter Fuhrman, CEO of China-focused investment bank China First Capital. “China has a lot of money in its government apparatus. It wants to seed innovation and entrepreneurship and this is how it’s doing it.”

The surge contrasts with the slowdown in seed financing for start ups in the United States, which is down for the past two years. It also compares with flat growth expected for U.S. venture capital fundraising in 2017, according to estimates from the National Venture Capital Association (NVCA).

CATCHING ENTREPRENEURS

Firms such as Lightspeed China Partners, Morningside Venture Capital, GGV Capital and investment and merchant bank Ion Pacific that previously only had U.S. dollar funds are launching their first funds in yuan. Others like Hillhouse Capital, Sequoia Capital China and China Renaissance that have raised funds in both currencies are adding to their yuan cash pile with new funds.

Key to those firms is to not lose potential investment opportunities in sectors closed to foreign investors or miss out on investing with the Chinese entrepreneurs who now want to list their companies locally instead of in the United States.

“Catching the right entrepreneurs in the ecosystem is our number one priority, so currencies to us are just tools, those are the tools that I need to catch these entrepreneurs,” said Harry Man, partner at Matrix Partners China, which has funds in both currencies. “That’s why if you don’t have RMB in your hand, ultimately you’ll be missing 50 percent of the deals. Then you’ll be forced to raise an RMB fund and that’s why everybody is doing it.”

Sequoia Capital China, which backed top Chinese technology firms such as Alibaba Group (BABA.N), is looking to raise at least 10 billion yuan for a new fund, while Hillhouse Capital, an early investor in companies including Tencent Holdings Ltd (0700.HK), Baidu Inc (BIDU.O) and JD.com Inc (JD.O), is targeting about 8 billion yuan for its fund, sources told Reuters.

The investment management arm of securities firm China Renaissance is also adding to its yuan reserves with a new fund worth about 6 billion yuan, according to a person familiar with the plans who couldn’t be named because details of the fundraising aren’t yet public. Ion Pacific is raising 1 billion yuan for its debut fund in the Chinese currency, while GGV Capital is about to close fundraising for its first yuan-denominated fund.

“Some sectors don’t allow foreign investors, so for example, in the culture and media industry you need to apply for certain licenses like video licenses and you need to be a local investor,” said Helen Wong, a partner at Qiming Venture Partners.

“Now the IPO window is open for the local stock market, so that encourages a lot of companies to go for a local listing,” she added, in reference to the increase in IPO approvals by regulators in 2017 that is prompting more companies to start preparations to go public. Previously, a slow approval process and long line of companies waiting for clearance dissuaded many from those plans.

The shift would give an added boost to the Shenzhen and Shanghai bourses. China has had 322 new listings this year, raising a combined $22.9 billion, Thomson Reuters data showed. This already surpasses the 252 for all of 2016, even after the country’s securities regulator slowed the number of weekly IPO approvals in May.

It could also reduce the influence of the Nasdaq and New York stock exchanges, where many Chinese technology companies previously flocked when they went public.

“For the RMB side, you see more companies in restricted sectors like healthcare and media and certain parts of cleantech that needs government support to get started,” said Hans Tung, managing partner at GGV Capital. “You also see companies in the fintech space and a lot of them need a license to operate a business in the financial services industry, so they tend to want to list in China.”

 

As published in The New York Times.

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Why Has China’s GDP So Outpaced IRR?

September 22nd, 2017 No comments

It’s the paradox at the core of China investing: why has such a phenomenal economy proved such a disappointing investment destination for so many global institutional investors, PE firms and Fortune 500s.

Financial theory provides a conceptual explanation. Investment returns are not absolutely correlated to GDP growth. China will likely go down in history as the best proof of this theorem. China as certainly delivered exceptional GDP growth. In per capita PPP terms, China is 43 times larger than in 1981, when I first set foot in China as a grad student. No other country has ever grown so fast, for so long and lifted so many people out of poverty and into the consumer middle class.

Commensurate investment returns, however, have been far harder to lock in. Harvard Business School’s global alumni organization invited me to give an hour-long talk on this topic this week. It required a quick gallop through some recent and not always happy history to arrive at the key question — does the future hold m0re promise for global institutional investors looking to deploy capital in China.

 For more detailed look at some reasons for the big disconnect between China’s national GPD growth and investment IRR, and some suggestions how to improve matters, please have a look by clicking here at the HBS talk slide deck.

Publicly-quoted shares in Chinese companies have failed by far and away to keep pace with the growth in overall national income. In the alternative investment arena, global PE and VC firms enjoyed some huge early success in late 1990s and first part of the 2000s. Since then, the situation has worsened, as measured in cash returns paid out to Limited Partners. One major reason — the explosion within China of Renminbi investment funds, now numbering at least 1,000. They’ve bid up valuations, gotten first access to better opportunities, and left the major global PE and VC firms often sitting on the sidelines. With tens of billions in dry powder, these global firms look more and more like deposed financial royalty — rich, nostalgic, melancholy and idle.

China this year will add approximately $1 trillion of new gdp this year – that’s not a lot less than the entire gdp of Russia. Indeed, China gdp growth in 2017 is larger than the entire gdp of all but 15 countries. Who is making all this money? Are all the spoils reserved for local investors and entrepreneurs? Can global investors find a way at last to get a bigger piece of all this new wealth?

Overall, I’m moderately sanguine that lessons have been learned, especially about the large risks of following the Renminbi fund herd into what are meant to be sure-thing “Pre-Ipo” minority deals. Active investment strategies have generally done better. With China’s economy well along in its high-speed transition away from smokestack industries and OEM exports to one powered by consumer spending, there are new, larger and ripe opportunities for global investors. In virtually all major, growing categories of consumer spending, Western brands are doing well, and will likely do better, as Chinese consumers preferences move upmarket to embrace high-quality, well-established global household brand names.

Harvard, its alumni and benefactors have a two hundred year history of investing and operating in China. So, there’s some deep institutional memory and fascination, not least with the risks and moral quandaries that come with the territory. The Cabot family, at one time among America’s richest, provided huge grants to Harvard funded in part by profits made opium running into China.

Harvard Management Company, the university’s $35 billion endowment, was an early and enthusiastic LP investor in China as well as large investor in Chinese quoted companies including Sinopec. Their enthusiasm seems to be waning. Harvard Management is apparently considering selling off many of its LP positions, including those in PE and VC funds investing in China.

This looks to be an acknowledgment that the GP/LP model of China investing has not regularly delivered the kind of risk-adjusted cash-on-cash returns sophisticated, diversified institutional investors demand. While China’s economy is doing great, it’s never been harder to achieve a successful private equity or venture capital investment exit. True, the number of Chinese IPOs has ratcheted up this year, but there are still thousands of unexited deals, especially inside upstart Renminbi funds.

While decent returns on committed capital have been scarce, the Chinese government continues to pour billions of Renminbi into establishing new funds in China. There’s hardly a government department, at local, provincial or national level that isn’t now in the fund creation business. Diversification isn’t a priority. Instead, two investment themes all but monopolize the Chinese government’s time and money — one is to stimulate startups and high-tech industry (with a special focus on voguish sectors like Big Data, robotics, artificial intelligence, biotech) the other is to support the country’s major geostrategic initiative, the One Belt One Road policy.

One would need to be visionary, reckless or brave to add one’s own money to this cash tsunami. Never before has so much government money poured into private equity and venture capital, mainly not in search of returns, but to further policy and employment aims. It’s a first in financial history. The distortions are profound. Valuations and deal activity are high, while returns in the aggregate from China investing will likely plummet, from already rather low levels.

Where should a disciplined investor seek opportunity in China? First, as always, one should follow the money — not all the government capital, but the even larger pools of cash being spent by Chinese consumers.

In China, every major consumer market is in play, and growing fast. This plays to the strengths of foreign capital and foreign operating companies. There are almost unlimited opportunities to bring new and better consumer products and services to China. Let the Chinese government focus on investing in China’s future. High-tech companies in China, ones with globally competitive technology, market share and margins are still extraordinarily rare, as are cash gains from investing here.

Meantime, as I reminded the HBS alumni, plenty of foreign companies and investors are doing well today in China’s consumer market. Not just the well-known ones like Apple and Starbucks. Smaller ventures helping Chinese spend money while traveling globally, or obtain better-quality health care and education options, are building defendable, high-margin niches in China. One company started by an HBS alumnus, a native New Yorker like me, is among the leading non-bank small lending companies in China. It provides small loans to small-scale entrepreneurs, mainly in the consumer market. Few in China know much about Zhongan Credit, and fewer still that it’s started and run by a Caucasian American HBS grad. But, it’s among the most impressive success stories of foreign investment in China.

Of course, such success investing in China is far from guaranteed. Consumer markets in China are tricky, fast-changing, and sometimes skewed to disadvantage foreign investors. For over two hundred years, most foreign investors have seen their fond dreams of a big China payday crash on the rocks of Chinese reality.

The rewards from China’s 35 years of remarkable economic growth has mainly — and rightly — gone to the hard-working people of China. But, there’s reason to believe that in the future, more of the new wealth created each year in China will be captured by smart, pragmatic investors from HBS and elsewhere.

 

As published by China Money Network

As published by SuperReturn

YouTube video of the full lecture to Harvard Business School alumni organization