I’m flying back from China as I write this, and bringing with me something of great value to me personally — even if I can’t claim to recognize every character. It’s the Chinese-language report prepared by my China First Capital colleagues on how a Chinese SME can avoid the quicksand and plan a successful IPO. Built on a first draft in English of mine, it’s written specifically for Chinese SME bosses. The report is called “如何选择上市的时机和地点”. 

Download Here: 如何选择上市的时机和地点 “When & Where to IPO for Chinese SME”

We prepared the report with the explicit goal to help SME bosses make more informed decisions in capital-raising and IPO. There’s been an acute lack of reliable, well-researched information in Chinese on this topic. We hope the report will improve this “information deficit”. 

For me personally, this is the most important report we’ve prepared thus far for SME bosses. As this blog has discussed at length recently,  Chinese SMEs have been victimized disproportionately by every form of IPO indignity, from US OTCBB listings, to reverse mergers, Malaysian IPOs, SPACs and other schemes promoted by the predatory bankers, lawyers and advisors that swarm around China. 

Indeed, there are few bigger risks to a successful Chinese SME than making the wrong decision and heeding the wrong advice on where and when to IPO. 

I’d welcome feedback on the report. You can email me at ceo@chinafirstcapital.com

For those who can’t read the report in Chinese, it provides a comprehensive summary of pluses and minuses for Chinese SME of listing on the US, Hong Kong and Chinese stock markets. It also discusses at length, with several case studies,  the damage done to good Chinese SME by OTCBB listings and reverse mergers in the US. The bad examples abound. 

Even if you can’t read the Chinese, I hope you’ll consider sending it on to those active in China’s capital markets, as well as to any Chinese businessmen contemplating a public offering.  Better Chinese-language information is the strongest antiseptic to kill off the bad deals and bad dealmakers in China. So, I hope all those with a genuine interest in promoting entrepreneurship in China will help spread the word.

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Market capitalization plays a very important part in the success and stability of a Chinese SME’s shares after IPO. In general, the higher the market capitalization, the less volatility, the more liquidity. All are important if the shares are to perform well for investors after IPO.

There is no simple rule for all companies. But, broadly speaking, especially for a successful IPO in the US or Hong Kong, market capitalization at IPO should be at least $250 million. That will require profits, in the previous year, of around $15mn or more, based on the sort of multiples that usually prevail at IPO.

Companies with smaller market capitalizations at IPO often have a number of problems. Many of the larger institutional investors (like banks, insurance companies, asset management companies) are prohibited to buy shares in companies with smaller market capitalizations. This means there are fewer buyers for the shares, and in any market, whether it’s stock market or the market for apples, the more potential buyers you have, the higher the price will likely climb.

Another problem: many stock markets have minimum market capitalizations in order to stay listed on the exchange. So, for example, if a company IPOs on AMEX market in the US with $5mn in last year’s profits, it will probably qualify for AMEX’s minimum market capitalization of $75 million. But, if the shares begin to fall after IPO, the market capitalization will go below the minimum and AMEX will “de-list” the company, and shares will stop trading, or end up on the OTCBB or Pink Sheets. Once this happens, it can be very hard for a company’s share price to ever recover.

In general, the stock markets that accept companies with lower profits and lower market capitalizations, are either stock markets that specialize in small-cap companies (like Hong Kong’s GEM market, or the new second market in Shenzhen), or stock markets with lower liquidity, like OTCBB or London AIM.

Occasionally, there are companies that IPO with relatively low market capitalization of around RMB300,000,000 and then after IPO grow fast enough to qualify to move to a larger stock market, like NASDAQ or NYSE. But, this doesn’t happen often. Most low market capitalization companies stay low market capitalization companies forever.

Another consideration in choosing where to IPO is “lock up” rules. These are the regulations that determine how long company “insiders”, including the SME ownerand his family, must wait before they can sell their shares after IPO. Often, the lock up can be one year or more.

This can lead to a particularly damaging situation. At the IPO, many investment advisors sell their shares on the first day, because they are often not controlled by a lock up and aren’t concerned with the long-term, post-IPO success of the SME client.  They head for the exit at the first opportunity.

These sales send a bad signal to other investors: “if the company’s own investment advisors don’t want to own the shares, why should we?” The closer it gets to this time when the lock up ends, the further the share price falls. This is because other investors anticipate the insiders will sell their shares as soon as it becomes possible to do so.

There are examples of SME bosses who on day of IPO owned shares in their company worth on paper over $50 million, at the IPO price. But, by the time the lock up ends, a year later, those same shares are worth less than $5mn. If it’s a company with a lot market capitalization, there is probably very little liquidity. So, even when the SME bosshas the chance to sell, there are no buyers except for small quantities.

The smaller the market capitalization at IPO, the more risky the lock-in is for the SME boss. It’s one more reason why it’s so important to IPO at the right time. The higher an SME’s profits, the higher the price it gets for its shares at IPO. The more money it raises from the IPO, the easier it is to increase profits after IPO and keep the share price above the IPO level.   This way, even when the lock up ends, the SME boss can personally benefit when he sells his shares.

Of all the reasons to IPO, this one is often overlooked: the SME boss should earn enough from the sale of his shares to diversify his wealth. Usually, an SME boss has all his wealth tied up in his company. That’s not healthy for either the boss or his shareholders. Done right, the SME boss can sell a moderate portion of his shares after lock in, without impacting the share price, and so often for the first time, put a  decent chunk of change in his own bank account.

We give this aspect lot of thought in planning the right time and place for an SME’s IPO. We want our clients’ owners and managers to do well, and have some liquid wealth. Too often up to now, the entrepreneurs who build successful Chinese SMEs do not benefit financially to anything like the extent of the cabal of advisors who push them towards IPO. 

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The timing of IPO is the most important question for all Chinese SME preparing for a public listing. Unfortunately, the correct answer is often the one most rarely heard. Instead, many investment bankers and advisors in China tell the SME boss that an IPO should be scheduled “as soon as possible”.

This is often music to the bosses untrained ears, since they’re wrongly assuming that the proceeds of an IPO will go directly into their pockets – a misconception these same investment bankers and advisors can literally cash in on. They’ll tell the SME boss the “bad” news — that the IPO proceeds must go to the company not to his personal bank account, and that the boss won’t be able to sell any of his own shares for a year or more after the IPO – towards the end of the expensive pre-IPO planning process, when it’s usually too late to pull out, without losing a huge amount of money.

This is if they bother to mention it at all. I’ve heard of instances where the Chinese boss is never told directly by his investment bankers, lawyers and advisors, but only finds out if his staff prepares a Chinese translation of the SB-2 prospectus used in OTCBB listings.

So, if not “right away”, what is the correct answer to the question: “when should a Chinese SME IPO”? Of course, circumstances will differ for each company. But, as a general principle, an IPO should come at the apex of an SME’s growth curve, when the company is achieving its historical highest return on equity and return on investment. This way, the SME will get a fuller value for its shares when it does list them publicly.

This also explains why pre-IPO private equity can have such a key role to play in the process. The purpose: put more capital to work than the company can generate internally, or can borrow from banks. This equity capital is then invested where it will earn the highest return over a two to three year period – for example, increasing production and improving economies of scale, or accelerating the pace of opening new distribution outlets.

The PE firm will also help improve efficiencies – in their role as risk-sharing partner with the SME boss – that can lead to significant improvement in net margins. In most cases, the pre-IPO PE capital can result in a doubling of profits. Done right, the pre-IPO capital will result in only modest level of dilution for existing owners – usually no more than 25%. It’s like switching on the after-burners: the SME can speed up its growth, improve its margins, seize large available market opportunities, and so position itself for a far more successful IPO in two to three years’ time.

An IPO has one great value above everything else: it will be the cheapest and most efficient way for an SME to raise the capital it needs to expand its business. The shares will likely be valued at multiples two times higher than a pre-IPO PE investor will pay. Since the amount of capital raised will be a multiple of profits, the higher the profits at IPO the better.

To illustrate this, let’s imagine a company with profits last year of RMB75 million. It has its IPO now, at a PE of 15 and its market capitalization at IPO is RMB 1,125,000,000. The company sells 25% of its shares in the IPO, and so it raises RMB 281,250,000. If instead the company waits another year, it raises a RMB50 million of pre-IPO private equity to help push its profit growth. A year later, profits have reached RMB120 million. If the company now has its IPO, at the same PE of 15, and sells 25% of the shares, it will raise RMB450,000,000 or 60% more.

Let’s  assume  the company continues to maintain a high return-on-investment, after IPO. If so, the more money raised at IPO, the higher profits should be able grow in the future. This is perhaps the most important predictor of overall share performance after IPO. By waiting to IPO, so that its size and profits would be larger, this company will be able to raise much more at IPO and so continue generate higher profits for many years into the future.

A company can IPO only once. So, it is important to raise the optimal amount during this one IPO. If a company IPOs too early, it will sacrifice its ability to finance its growth in the future. Many of the most successful IPOs in China were for private SME companies that had pre-IPO investment from private equity companies: Baidu, Alibaba, Suntech, Belle. That isn’t a coincidence. It’s the result of the sort of smart IPO-planning that is too rare in China.

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My last post dealt with the often-unprincipled conduct of the advisors, bankers and lawyers who created many of the disaster stories among Chinese SME companies seeking a stock-market listing. It’s not a topic that will win me a lot of friends and admirers among the many advisors, lawyers, and investment banker-types still active, sadly, sponsoring OTCBB and reverse merger deals in China. In my experience, they tend to put the blame elsewhere, most often on Chinese bosses who (in their view) were blinded by the prospect of quick riches and so readily agreed to these often-horrible transactions. 

There’s some truth to this, of course. But, it’s a little like a burglar blaming his victim for leaving a second-story window unlocked. Culpability – legal and moral – rests with those who are profiting most from these bad IPO deals. That’s the advisers, bankers and lawyers.  They are the ones getting rich on these deals that, too often, leave the Chinese company broken beyond repair. 

The bad IPO deals are numerous, and depressingly similar. I don’t make any effort to keep tabs on this activity. I usually only learn specifics if I happen to meet a Chinese SME boss who has had his company crippled by doing an OTCBB listing or reverse merger, or an SME that is in the process of doing a deal like this. 

Here are a few “case studies” from among the companies I’ve met. They make for depressing reading. I’m omitting the names of the companies and their advisers.  The investment bankers on these deals deserve to be publicly shamed (if not flogged) for what they’ve done. But, the stories here are typical of  many more involving crooked investment bankers and advisers working with Chinese SME. The story lines are sadly, very familiar. 

COMPANY 1

A Guangdong electrical appliance company, with 1,500 employees, had 2008 revenues of $52mn, and net profit of $4mn, did a “reverse merger” in 2007 and then listed its shares on the OTCBB. Despite the company’s good performance (revenues and profits grew following the IPO), the share price fell by 90% from $4.75 to under 5 cents. At the IPO, the “investment advisors” sold their shares. The company also raised some cash, about $8mn in all.  But, quickly, the share price started to fall, and the market capitalization fell from high of $300mn to under $4mn. The company’s management didn’t have a clue how to manage a US publicly-traded company (none spoke English, for one thing), and so started making regulatory mistakes and had other problems with filing SEC documents. The company’s management, still with much of the $8mn raised in the IPO in its corporate bank account,  then started selling personal assets at wildly inflated prices to the company, and so used these related party transactions to take most of the remaining cash from the business into their pockets. No surprise, the company’s auditors discovered problems during its annual SEC audit, and then resigned.

The company’s share price is so low it triggered the “penny stock” rules in the US, which limit the number of investors who are allowed to buy the shares.

COMPANY 2

An agricultural products company with $73 million in 2008 revenues chose to do a “reverse merger” in the US, to complete a fast IPO early in 2009. The company got the idea for this reverse merge from an investment adviser in China who promised to raise $10 million of new capital as part of the reverse merger. The agricultural products company believed the promise, and spent over $1 million to buy the listed US shell company, including high fees to US lawyers, accountants and advisers.   

After buying the shell and spending the money, the company learned that the advisor had failed to raise any new capital. The company now has the worst possible situation: a listing on the OTCBB, with no new capital to expand its business, a steadily falling share price, and annual costs of being listed on the OTCBB of over $500,000 a year. At this point, no new investor is likely to invest in the company, because it already has a public listing, and a very low share price.

Because of this reverse merger, the company’s financial situation is now much worse than it was in 2008, and the company’s founder effectively now has no options to finance the expansion of his business which, up until the time of this reverse merger, was thriving.

 COMPANY 3

In 2008, an outstanding Guangdong SME manufacturing company signed an agreement with a Guangdong  “investment advisor” and a small US securities company that specializes in doing “Form 10 Listings” of Chinese SME on the OTCBB. They told the company’s boss they were a “Private Equity firm”. The investment advisor and the US securities company were working in concert to take as much money from this company as possible. Their contract with the company gave them payments of over $1.5 million in cash for raising $6mn for the company, a fee of 17%, and warrants equal to over 20% of the company’s shares. The $6mn would come from the securities company itself, so it could claw back a decent chunk of that in capital-raising fees, and also grab a huge slug of the equity through warrants. 

The securities company quickly scheduled a “Form 10” IPO for summer of 2008, and arranged it so the shares to be sold would be the warrants owned by this securities company and the Chinese investment advisor. So, according to this scheme, the Chinese SME would have received no money from the IPO, and all the money (approximately $10 million) would have gone direct to the securities company and the advisor.

The securities company deliberately misled the SME founder into thinking his shares would IPO on NASDAQ. Further, they gave the founder false information about the post-IPO performance of the other Chinese SME they had listed through “Form 10 Listings” on the OTCBB. Most had immediately tanked after IPO. 

In this case, the worst did not happen. I had met the boss a few months earlier, through a local bank in Shenzhen, and liked him immediately.  Before the IPO process got underway, I offered him my help to get out of this potentially terrible transaction. This was before I’d set up China First Capital, so the offer really was one of friendship, not to earn a buck. I promised him if he could get out of the IPO plan, I’d raise him money at a much higher valuation from one of the best PE firms in China. 

The boss was able to cancel the IPO plan, and I started China First Capital with the first goal of fulfilling my promise to this boss.  CFC quickly raised the company $10mn in private equity from one of the top PE companies , and the valuation was over twice the planned IPO valuation from the “investment advisor” and the securities company. This SME used the $10mn in pre-IPO capital to build a new factory to fill customer orders. 2009 profits will double from 2008. The company is on path to an IPO in 2011, and at that time, the valuation of the company will likely be over $300mn, +7X higher than at the time of PE investment.

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Back again in Shenzhen, with plenty of food for thought, as well as food for the belly. I go through the same “immersion program” whenever I arrive back here: it involves stopping for a plate of dumplings or bowl of noodles once every 30 paces. Or anyway, it certainly seems that way. 

The food for thought, as always, centers on ways to deliver enhanced value and service to clients and business partners. We have a set of core principles, that we build our business on, and that collectively represent our main differentiators. They are disarmingly simple – to work with integrity and honesty,  and always put the success of our clients’ first. We know that if we do this, our own success will follow. 

Simple, but not nearly as universal as they should be in our business. A lot of investment banking, IPO and advisory work in China has bordered on the criminal. Hundreds of SME companies were damaged, if not destroyed, by advisors, lawyers and others who neglected entirely to put their clients’ interests first. Instead, they pushed for companies to take various fast routes to IPO in the US, typically reverse mergers, OTCBB Listings, Form 10, SPAC deals. The reason: the advisors, lawyers, bankers all made a pile of money, quickly, through these kinds of deals. When things turned sour, as they often did, the advisers, bankers and lawyers were generally nowhere to be found, and the Chinese companies were left in dire straits.

Obviously, the bosses of the Chinese companies were complicit, since they agreed to these kinds of schemes to achieve a fast IPO. But, in my experience, the bosses main sin was that of ignorance. They simply didn’t understand all the workings of these kinds of deals, or even the fee-structure that would disproportionately reward the advisers, lawyers and bankers. In other words, the Chinese bosses didn’t do their DD, didn’t check the dismal track record of the many Chinese companies that already opted for OTCBB listings or reverse mergers.

I sometimes think the Chinese term for IPO, “上市” ( “shang shi”) has magical, intoxicating effect on some Chinese bosses. They hear it and suspend all their normal caution and suspicion. Soon, they end up agreeing to what are often truly disastrous transactions that don’t even deserve the name IPO.

There are, by some estimates, several hundred Chinese companies now listed on the OTCBB that are somewhere between “on life support” and “clinically dead”. Their share prices fell steeply immediately after listing (by which time the advisers, bankers and lawyers all pocketed their fees and lined up their next victims) and are below $1. There is little to no liquidity. They often trade at PE multiples of 1-2x. The costs of retaining the OTCBB listing are bleeding the companies of badly-needed money. They have no chance to raise additional capital, nor to do much of anything (except waste money on Investor Relations firms) to lift their share price.

I get angry just thinking about this. I’m offended that people in my field of work would be involved in such self-serving, greed-ridden transactions. Secondly, it’s also brought a lot of harm, and sometimes complete failure, to what were very good Chinese SME companies that once had bright futures, until they had the misfortune of putting their financial futures in the hands of these advisors.

Of course, the guiding principle behind all investment decisions must be “caveat emptor”. Chinese bosses clearly didn’t “caveat” enough. That’s regrettable. But, the gains made by the advisors, lawyers and bankers were so enormous, and so ill-gotten. That’s the heart of the matter: Chinese companies were ruined so that a bunch of ethically-challenged finance people could get rich.  For me, this is contemptible.  How these people sleep at night I don’t know.

I do know this: we try to do everything we can to make it less likely that a good Chinese SME goes the same route, and ends up in the same sad condition. One way is through information. We’re producing Chinese-language materials meant to explain the hazards of transactions like OTCBB listings and reverse mergers. Our plan is to distribute the materials as widely as possible, both online and off. It may not put the bad guys out of business, but at least it will make it easier for Chinese SME bosses to know which questions to ask, what kind of track record to look for or, more often,  run away from.

I’ll be sharing soon on this blog  the English version of some of this information.

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In an interesting discussion this week in Shenzhen with a very smart and capable lawyer (Ke Luo of Fangda Partners), I learned about a small, but growing backlash against the Top Tier private equity firms working China. Evidently there have been some articles in the Chinese press voicing criticisms of their approach and methods, and comparing them unfavorably with Chinese domestic investment companies. 

Upfront disclosure: we choose to work only with the 70 or so Top Tier private equity firms active in China, as we believe they are the best investors for companies with the greatest potential, adding more value, beyond just capital, than any other source of investment. 

A main point of contention: the ratchet and performance provisions of most of the top private equity investment deals in China (and everywhere else in the world). These are the provisions, incorporated into the final closing share purchase agreement, through which the PE firm gains greater ownership in a company they’ve invested in if the company fails to meet previously agreed revenue, profit or margin targets.   

It’s a penalty for underperformance. And a very effective and focusing one. It’s not uncommon for these ratchets provisions to specify that the PE firm can gain an additional 10-15% ownership, at no additional cost,  in a company that fails to meet the annual targets. 

In good economic times and in solidly-run companies, ratchet provisions are very rarely put into effect. So, they are a generally just a ghoulish contingent presence in every PE investment contract, the stick that compliments the carrot of a PE firm investing in your business. I know from personal experience that the concept can seem very off-putting – even frightening – to some Chinese bosses: that the PE firm will, for example, go from owning 25% of his company to 40% of his company if the owner has one year that falls below the projected levels of profit and revenue. 

We’re not in good economic times at the moment, so it’s a certainty that more ratchet provisions will be triggered this year. This is what is behind some of the complaining in the Chinese press about international PE firms. Chinese investment firms apparently don’t often include ratchet provisions. The implication of the articles is that a Chinese company is better off taking money from a Chinese investment company, and so free itself from the possibility of a sort of “takeover by stealth”, as the PE firm’s ownership ratchets upward with each year of under-target performance. 

On the surface, ratchet provisions are a very fat, very easy target. So, no surprise some in the Chinese press are attacking them. But, it’s a very incomplete, unfair – and even financially illiterate – criticism to say that because of performance ratchet provisions, a Chinese company is better off taking money from a Chinese investment company. 

Chinese investment firms may not use performance ratchets, but they have a variety of other serious weaknesses. Believe me, I’m no fan of ratchets of any kind, and work hard in negotiations with PE firms to eliminate their potential for causing harm to our clients’ businesses.  But, I still think, in almost all cases, a good Chinese private company is far better off taking money from a reputable PE firm than from a more loosely-run Chinese investment business. 

The reasons are many. But, the most deep-seated are based on an appreciation of what an outside investor can and should provide a strong Chinese SME company besides just capital. Money, famously, all spends the same. So, taking $10mn from a rich uncle or from a leading private equity firm is no different, in terms of what the money can buy – a new factory perhaps, or expanded marketing and sales, or an acquisition. 

The key difference is that the best PE firms are going to do a lot more than just write a check and then wait for the riches to flow three years later at IPO. They are going to get deeply involved assisting the company to improve all areas of its operations, implementing best practices in areas like financial accounting and corporate governance, as well as providing real expertise on hard core sales and operational issues. They also know, from past successful experience, how best to guide a private company towards a successful IPO, whether on China’s domestic stock market, or abroad.

A Chinese investment company, from what I can gather, does not have the experience, the management talent – or even the inclination – to be involved in such a detailed fashion with the companies it invests in. 

I believe, based on my own practical experience,  that the good PE firms often really do make a significant difference inside a company, enabling it to get further faster than it otherwise would. Of course, PE firms can be a pain to work with. This goes way beyond the potential for a ratchet provision to be triggered. The good PE firms act as fiduciaries for their Limited Partners, and so require a massive amount of due diligence before investing, and no less enormous information flows (generally on financial performance) after an investment is made. They want quarterly board meetings, and often hold veto rights on any spending above $500,000 or so. 

But, in return, the PE firm will go to the furthest limits of its collective abilities to make sure the Chinese company succeeds above and beyond even what the boss of that company could expect. A domestic Chinese investment company? Most likely, they have had little experience with leading good companies toward successful IPOs, little operational knowledge, little desire to commit so thoroughly to adding value inside a company. 

So, yes, performance ratchet provisions are nasty. However, they should never come into effect – if the company and the PE firm are doing everything in their power to keep the business growing. The PE firms, contrary to the way it may appear, do not  want performance ratchets triggered any more than the company’s owner does. It’s also going to reflect badly on the PE firm’s judgment and abilities, and so make it harder for them to continue to raise money for future investment.

In other words, every time a performance ratchet is triggered, it gets harder for that PE firm to continue to thrive. They would rather own a smaller share of a solid company that’s meeting its targets, than a bigger share of one that isn’t.

Following on from the publication of the China First Capital report, “2009 Private Equity and Strategic M&A Transactions in China — A Preview“ , the Chinese version is now completed. It’s more than just a change in language.

It incorporates a different but complimentary perspective to the English report, one enriched by the deep knowledge, insights and experience of my China First Capital colleague, Amy Bai. 谢谢白海鹰。

Here’s the first section. 

概  览

危机创造机遇

2008 年对于中国是不平凡的一年。2008年带给我们骄傲和欢乐，也带给我们挫折和悲伤。北京奥运会使我们感到前所未有的骄傲和自豪。刚刚战胜了冰冻灾害的我们又遭遇了汶川大地震。

从经济领域来看，2008年同样也是不平凡的一年。在年初，上海、深圳和香港的股市都出现了长势良好的喜人景象。IPO形势大好。然而，在2008年夏，股市开始暴跌 ，IPO也开始枯竭。到年底，上海、深圳和香港的股市均下跌了60%左右。 

中国的私募股权投资和风险投资出现了与股市涨跌相应的波动变化。在年初，投资活动非常活跃。上半年，私募股权投资和风险投资在中国的投资总额超过了100多亿美元。随着金融风暴的影响，私募股权投资和风险投资也放缓了在中国的投资步伐。到去年底的时候，基本上已经停止了所有投资活动。 

中国，美国和全球其他国家均以前所未有的方式采取了一系列干预措施，以期稳定经济。然而， 

当我们跨入2009年时，全球经济进入衰退期已成为不争的事实。 

大家所关心的问题是，经济复苏期何时来临？何时开始新一轮的投资比较合适？我公司愿与您们分享就上述问题的一些观点和想法。 

作为中国首创投资的董事长，凭借在资本市场，私募股权投资和商业领域20余年的经验，我经历过数次商业周期，并且成功地带领我的企业幸存了下来。例如，我曾经担任美国加州一家风险投资公司的首席执行官，目睹了网络泡沫的破灭， 当时的情形和现在类似，所有的私募股权投资活动几乎都停止了。 但是，仅仅两年以后，交易活动和企业估值又呈现回升趋势。 

所以，我们认为，就整体投资环境而言，2008年的金融风暴将会继续影响中国经济的发展，中国目前仍旧会经受各种考验。但是，对于私募股权投资、风险投资和兼并收购而言，2009年是个充满着无限机会的一年。机会与风险并存。只要你抓住了机会，成功就近在咫尺。 

2009年，企业所有人和私募股权投资公司可以期待商业主题中的下列几点。 

行业整合与“质的飞跃”

在2009年新年伊始，我们就感受到了中国经济所面临的严峻局面。经济增长速度减慢，成千的工厂倒闭和数以万计的人失业。中国许多经济领域已经出现了一种所谓“超饱和”状态，也就是很多企业在一个经济领域竞争，但是每个企业的市场份额都很小。这种情况下，中国企业进行合并的时机已经成熟。

在市场经济的自由竞争规律下，缺乏竞争力的企业会逐渐被淘汰。然而，具有竞争力的企业会不断赢取市场份额。并且，在良性循环下会不断发展壮大。产量不断提高，成本继续降低，从而，提高利润。企业将所赚取的盈余再度投到生产中以降低成本，进而形成一个良性循环。 

从消费者的角度来说，一个优秀的企业，由于其管理完善、生产效率高和销售策略适当，吸引着无数消费者。除此之外，强有力的主导品牌将会适时并购其他品牌。在这种状况下，企业间的合并已经成为不可避免的趋势。 

在中国，这种合并的势头刚刚开始。中国拥有仅次于美国的巨大的国内市场。在中国的许多纵向市场（包括金融服务，消费品，分销和物流，零售，时尚等），只要多争取一分的市场份额，销售收入就能增加上千万美元。 

通常，相对于企业所处行业，中国企业的规模都相对较小。在一些国营企业和半国营企业不占主导地位的区域，优秀民营企业抢先出击，兼并和收购其他区域内的竞争者，进而成为国内行业的领军企业。

对于投资者来说，这种帮助企业进行并购活动的机会将是空前的。企业在并购后的兴盛是投资者和企业共同期待的。即使在经济衰退期，并购案中 的优胜企业也会呈现销售收入和利润长期持续增长的现象。 

利润增长为IPO的

重现提供了平台

在过去的五年里，对于投资中国市场的私募股权投资者和风险投资者来说，IPO无疑是最可靠的退出途径。 

下面的图显示，IPO交易量在2007年达到了高峰。在2008年初，IPO交易量继续呈现高增长趋势。然而，到2008年的下半年，IPO交易量急转直下，直到2009 年年初。

众所周知， IPO市场与股票市场紧密相连。当股票市场整体表现不好时，企业发行新股票的欲望也会相应减弱。所以，只要中国股票市场和香港股票市场继续呈现薄弱趋势，IPO活动就不会呈现上升趋势。 

对于私募股权投资者和风险投资者来说，这意味着他们需要做出巨大的改变。 

为适应当前形势，私募股权投资公司和风险投资公司需要改变他们的投资方向。较之前而言，企业IPO前的短期投资机会已大大减少。换言之，私募股权投资公司或风险投资公司以18倍的估值投资于中国企业， 18个月后，再以20倍的价值发行上市的简单套利的机会已经一去不复返了。 

取而代之的是，在中国进行投资活动的私募股权投资公司应该从价值投资者的角度考虑他们在中国的投资，而不是从套利的角度去衡量他们在中国的投资。这说明了，私募股权投资公司在中国寻找目标企业时，应以企业的长远高回报为目标注入投资基金。 

企业的利润增长为中国市场的IPO重现提供了平台。具体而言，私募股权投资的重点应该集中在帮助企业提高运作效率和利润率上。 

这是一个值得强调的财务理念，尤其是在现今中国。企业估值归根结底是一个与公司盈利能力相关的函数，而不是一个投资者愿意为公司盈利能力而支付的价格函数。在市盈率倍数的公式中，“收益”部分是关键，而不是“价格”部分。在过去的五年时间里，IPO股票价格市盈率可谓差距巨大。IPO股票价格市盈率高至超过100， 低至少于5。 

对于中国市场来讲，情况可以瞬息万变。IPO股票价格市盈率很有可能出现回升趋势。什么时候会发生？我们无法给您一个准确的答案。但是我们可以确定的是，一个优秀的私募股权投资者想要投资于有明确目标和有能力实现目标的中国优秀企业。

 换言之，企业有计划和具体步骤去提升利润和利润率。那么，选择正确的中国企业进行投资，选择适当的额度进行投资和帮助企业提升整体价值，是私募股权投资公司和风险投资公司在未来几年内成功的关键所在。

 私募股权投资公司和风险投资公司提升企业价值的方式有很多。可以通过向企业提供市场营销，业务发展，金融工程，运营效率，企业治理，审计，战略兼并和收购等方面专业人才，来帮助企业迅速提高企业价值。

无论通过上述哪种方式，企业的收益都有可能被大大提高。关键点是，帮助企业保持强劲的利润增长态势。这样，在股市复苏的时候，IPO的时机再一次到来时，我们的客户企业会从中脱颖而出，赢得最高收益。 

2009年，一个有着投资重点和帮助企业成长的私募股权投资公司会脱颖而出。

AltAssets is among the world’s leading sources for news and analysis on the global private equity industry. They just published a summary of my firm‘s report, “2009 Private Equity and Strategic M&A Transactions in China — A Preview“. 

AltAssets is based in London, and provides news and research to more than 1,000 institutional investors and 2,000 private equity and venture capital firms worldwide.

Here is what they wrote about the China First Capital report:

“CHINA THE MOST ROBUST EMERGING MARKET FOR PRIVATE EQUITY AND VENTURE CAPITAL SAYS REPORT”

China continues to be the world’s most robust emerging market for private equity and venture capital finance, even in a difficult global economic environment, according to the Private Equity and Strategic M&A Transactions in China 2009 report just released by China First Capital, a boutique investment bank with offices in China, Hong Kong and the USA.

Peter Fuhrman, China First Capital’s chairman and the report’s author, said, “While the overall investment environment remains challenging and the effects of 2008’s turbulence are still being felt, 2009 will be a year of unique opportunity for private equity, venture capital and M&As in China.” 

China’s economy continues to grow, powered largely by successful small and medium private businesses, many of which are among the fastest-growing companies in the world. Private equity and venture capital investment in China will likely reach record levels in 2009, the report projects, with over $1bn in new investment into high-growth Chinese SMEs with strong focus on China’s booming domestic market. 

“In 2009, China should rightly be among the most attractive and active private equity investment markets in the world,” the China First Capital report predicts. “Many of the international private equity firms we work with are expecting to invest more in Chinese SMEs in 2009 than in 2008. Chinese companies raising capital this year will enjoy significant financial advantages over competitors, improving market share and profitability.” 

The report identifies five central trends that will drive the growth in private equity and venture capital investment in China’s SMEs in 2009. They are: the drive for industrial consolidation; profit growth helping to reignite the IPO markets for Chinese companies in China, Hong Kong and the USA; increased importance of convertible debt and other hybrid financings; opportunities for strategic M&As; well-financed businesses with strong balance sheets will enjoy sustainable competitive advantage in China’s domestic market. 

“The pathways to success in China are fewer and narrower than in recent years. But, for the entrepreneurs and private equity investors that can navigate their way in 2009, this will be a year of abundant opportunity,” Fuhrman added. 

Copyright © 2009 AltAssets

As the Chinese National Congress meets this week in Beijing to plot the course of the Chinese economy in 2009 and beyond, it’s worth reflecting what an exceptional, juddering year 2008 was. Sure, the Olympics stole most of the headlines, and provided the lasting images of Chinese progress and triumph. But, those images also dulled, in many respects, our perceptions of the brunt force of the economic blows China sustained during 2008. Make no mistake, 2008 was a year of challenge, disruption and dislocation not seen in China for a generation or more. 

The year started with the worst winder storms in decades. This was followed, just months later, by the cataclysmic Wenchuan Earthquake in Sichuan. Beyond the colossal loss of life and destruction, the earthquake had a much broader, unprecedented social impact across China. There was an enormous outpouring of national compassion and grief. While wholly positive as an expression of China’s rightful growing self-confidence, this vast prolonged period of national mourning also had a very direct and negative impact on economic activity. For weeks if not months, as I saw firsthand, there was a tangible unwillingness to spend as freely, to enjoy life as unabashedly as in the years previously. It was as if much of China received some intimation of their own mortality in the wake of the Sichuan Earthquake. 

Next came an accelerated fall in property values across much of China. Alongside this, the stock market fell sharply. These two, the property and stock markets, are the main stores of wealth for many middle class Chinese. People felt poorer because they were poorer. The fall of both property and share prices wiped away billions of dollars in national household wealth. People in their hundreds of millions were suddenly poorer, as household net worth plummeted, and Chinese pulled back even more strongly from their spending. Then, in late summer, came the financial tsunami in the USA, with the credit crisis, the collapse of Lehman Brothers, and the intensifying recession. 

Any basic college economics textbook – to say nothing of common sense — could foretell the next step: a fall in overall confidence levels among Chinese consumers. This further muffled already depressed levels of personal spending. 

We’re now well into the first quarter of 2009, and my own sense, after spending these last three weeks in China, is that the cumulative impact of all of 2008’s bad news is still being felt, acutely. However, my sense is that the worst may indeed be over, and that 2009 will be a year of rebuilding and reasserted economic confidence in China. 

Of course, when talking about general economic trends in the world’s third largest economy, a lot of the clarifying detail gets lost. But, we have a real sense, in our day-to-day work, of just what an extraordinarily difficult year 2008 was for even the best Chinese businesses. Our firm, China First Capital,  has focused on serving China’s middle market private Small and Medium Enterprises (SMEs), assisting them with capital-raising strategic M&A and other financial transactions.

Unlike traditional investment banks reliant mainly on short-term transactions, China First Capital’s role as financial and strategic advisor to Chinese SMEs often begins at early stages of corporate development and continues through the capital raising process from private equity to a successful IPO and beyond to global leadership. 

Even our strongest clients had a tough time in 2008. In one example, a business that is one of China’s leading consumer fashion brand, maintained outstanding growth last year in overall revenue, with domestic sales rising by 30%.  That’s mainly testament to the company’s no less outstanding management and brand-positioning. But, the bottom line was less stellar. Profit margins were squeezed, and the company earned half as much in 2008 as it expected to as late as July 2008. That represents a shortfall against plan of almost $6mn. That equates, of course, to having less money to invest in building on that growth rate in 2009.  

They remain a great company, and there’s little doubt 2009 will be a better year. But, when we met with them recently, the company’s financial management are still reeling from the brutal effects of 2008. If nothing else, it drives home as little else can the importance of fortifying the company’s balance sheet, which has been overly-reliant on retained earnings and short-term bank loans to finance growth. This client, like the Chinese economy, has weathered the once-in-a-generation turmoil of 2008. Better days lie ahead — my bet is sooner, rather than later.  

My firm, China First Capital, just completed our annual report on Private Equity, Venture Capital and Strategic Mergers and Acquisitions in China. I had the biggest hand in writing it, so the opinions expressed are my own. My view, overall, is one of realistic optimism. China will continue to be the world’s most robust emerging market for private equity and venture capital finance, even in a very difficult global economic environment. A big reason for this is the continuing strong performance of many private SME companies in China, especially those focused on the domestic market, rather than exports. 

China First Capital has a special affinity for these strong private SMEs. They are the only companies we choose to work with. There a few reasons for this. A big one is my personal conviction that the most important predictor of a success in private equity investing is putting money into a company with a truly outstanding boss. Ideally, the boss will also be the entrepreneur who founded the company. 

You can do all the spreadsheet modeling and projections you want, but nothing else matters quite as much as the quality and drive of the leadership at the top. In many of the good Chinese SMEs, the boss is a first-class business strategist and opportunity-seeker. Give him a dollar and he’ll bring you back five. In many of China’s larger state-owned, or partially state-owned companies in China, the boss is often more a political animal, appointed to the job as much for skills as a bureaucratic infighter as for talents at managing a business. Give him a dollar and he’ll come back in a while and ask you to lend him another three. 

SMEs, no surprise, usually run circles around their state-owned competitors in China. That’s a big reason we choose to work exclusively for SMEs. Another reason: we prefer long-term partnerships with our clients rather than one-off deal-making of larger investment banks. We act as a financial and strategic advisor to Chinese SMEs in a long-term process that often begins at early stages of corporate development and continues through the capital raising process from private equity to a successful IPO and beyond to global leadership. 

Thanks to these Chinese SMEs,  China should be among the most attractive – and active – private equity investment markets in the world in 2009. Many of the international private equity firms we work with are expecting to invest more in Chinese SMEs in 2009 than in 2008. Indeed, private equity and venture capital investment in China will likely reach record levels in 2009, the report projects, with over $1 billion in new investment into high-growth Chinese SMEs with strong focus on China’s booming domestic market.

Chinese companies raising capital this year will enjoy significant financial advantages over competitors, improving market share and profitability.

The report, titled “Private Equity and Strategic M&A Transactions in China 2009”, identifies five central trends that will drive the growth in private equity and venture capital investment in China’s SMEs in 2009. They are:

1. the drive for industrial consolidation;
2. profit growth helping to reignite the IPO markets for Chinese companies in China, Hong Kong and the USA;
3. increased importance of Convertible Debt and other hybrid financings;
4. opportunities for strategic mergers and acquisitions;
5. well-financed businesses with strong balance sheets will enjoy sustainable competitive advantage in China’s domestic market.

Here’s the report’s first section. I’ll add more of it in later posts.

 Overview  

Turbulence creates opportunity

2008 was a year of extremes in China. Extremes of joy and pride, during the Beijing Olympics. Extremes of sadness and shock following the Sichuan earthquake. Even the climate reached extremes, during China’s crippling winter storms early in 2008. 

Financially, 2008 was also a year of extremes. The stock markets in Hong Kong, Shanghai and Shenzhen rose strongly in the first months of the year, and IPOs were plentiful. By mid-year, the markets began plunging, and IPOs dried up. By year-end, Shenzhen, Shanghai and Hong Kong were all down 60% for the year. 

China’s private equity and venture capital investments followed a similar turbulent course, beginning strongly, with over $10 billion invested in Chinese companies in the first half of the years, and then the pace of new investments slowed to a crawl.   

Governments in China, the USA and around the world intervened in an unprecedented fashion to stabilize the economy and the credit markets. As we enter 2009, there is no longer any doubt that the world economy is in recession. 

The question now is when will the recovery begin and when will be a good time to begin investing again? I want to offer a personal perspective to our valued relationships, both clients and the private equity firms we work with. As Chairman of China First Capital,  Ltd, with over 20 years of experience in the capital markets, private equity and business analytics, I’ve survived my share of business cycles. One example, I was CEO of a California venture capital company during the Dot-Bust years, the last time private equity investing came to a similar standstill. Within two years, deal activity and valuations resumed their upward momentum. 

My view: the overall investment environment in China remains challenging and the effects of 2008’s turbulence are still being felt. But, 2009 will be a year of unique opportunity for private equity, venture capital and mergers and acquisitions in China. Tough times can be the best time to make money. 

The Chinese economy is under significant strain as 2009 begins, with growth decelerating, factories closing by the thousands and unemployment rising. Many areas of China’s domestic economy are “over-saturated”, with too many companies competing with small market shares. China is ripe for consolidation. 

In the freely competitive markets, the weakest companies will perish. The stronger competitors will be able to add market share and enjoy the virtuous cycle of increasing volumes lowering unit costs, thus boosting profits that can be re-invested to lower still further costs of production.

Chinese consumers will respond as well, and reward with more of their money the better managed companies with the most efficient manufacturing and distribution. Out of this, stronger dominant brands will emerge, and this too will push for greater consolidation.

This process is just beginning in China. China’s domestic market is huge, second only to the US. In many vertical markets (including financial services, consumer goods, distribution and logistics, retailing, fashion), each point of additional market share in China can equate to tens of millions of dollars in additional revenue.

Chinese companies are still, most often, small-in-scale relative to the size of the industries they serve, particularly in areas where private companies, rather than those with partial or complete state-ownership, predominate Strong regional companies will acquire competitors elsewhere in China to become national powerhouses.   

For investors, the opportunities will be unparalleled to back the Chinese companies that will thrive during this process of consolidation.  The winners will be able to increase revenues and profits strongly and sustainably, even in a weak economy.

Not quite “a staircase to hell”, but the graphic below shows the steep fall in IPO activity in China in 2008. It looks pretty scary, doesn’t it? Chinese IPO activity in 2008 was at its lowest level since 2004. IPO activity basically came to a halt towards the end of last year. 

No one looking at the table will see much room for optimism. But, it’s worth remembering that though down by almost 80% from the year earlier, IPOs of Chinese companies in 2008 still did manage to raise $20 billion of new capital. The key thing now is that this money is used well and wisely, to build profits and market share at these now-publicly-traded Chinese companies. By doing so, these companies will provide an impetus for companies and investors to get back into the IPO market. 

In other words, the IPO market in China is most attractive vibrant not when a company sees a big price jump in its first days of trading. This does little for company, and benefits mainly those who claimed an allocation of shares ahead of the IPO. The key driver for the IPO market should be that the capital raised in an IPO is used wisely, to put companies on a higher growth path. 

Higher profits will boost company valuation, and also allow newly-listed companies to more easily raise additional equity capital in the future. As I sometimes remind the Chinese laoban we work with, “an IPO should not be just a goal in itself, but also the cheapest way to raise additional capital to build your business even faster.” 

Take the money from a public listing to make more money: that’s the quickest way in which Chinese companies can do their part for reviving the IPO market and start building again the “staircase to heaven”, with annual gains every year in the amount of money raised through IPOs. 

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Even as IPO activity all but came to a standstill in 2008, China’s M&A market reached an all-time high in 2008, with almost USD$160 billion in deals completed, according to Thomson Reuters. This makes China the biggest M&A market in Asia, for the first time ever. 

This is an important development, and I expect China’s role as Asia’s largest M&A market will continue into the future, despite the current economic slowdown. The reasons: M&A deals in China will continue to make business and financial sense. China’s M&A activity in 2008 was almost equally split between purely domestic deals – where one Chinese company buys or merges with another – and the cross-border acquisitions where Chinese and foreign firms join together – either with the Chinese firm buying into the overseas business, or the foreign firm taking a stake in a Chinese one.  

I see huge scope for growth in both areas. China’s economy, though growing more slowly now than in recent years, is still expanding. Despite its vase size (China is now the world’s third-largest economy, trailing only Japan and the US) Chinese companies are still, most often, small-in-scale relative to the size of the industries they serve, particularly in areas where private companies, rather than those with partial or complete state-ownership, predominate. China’s private sector is filled with minnows, not whales. 

The result: there is ample room for consolidation in virtually every industry. Smaller firms will continue to merge, to gain both market share and scale economies. Strong regional companies will acquire competitors elsewhere in China to become national powerhouses. 

The M&A market, more than IPO activity, tends to holds up well even during sour economic times, or when stock markets fall. As share prices drop, the lower valuations make it cheaper for acquirers to act. We had evidence of this recently in the US, where one of the biggest M&A deals of all-time was recently announced: Pfizer’s planned acquisition of Wyeth Labs. 

In China, valuations for both quoted and private companies are lower than they were a year ago. That lowers the cost of acquiring a competitor. The cheapest way to build market share, at this point in China, will often be to buy it. 

All M&A transactions have risk. Very often, the planned-for gains in efficiency never materialize from combining two similar businesses. In China, the complexities go above and beyond this. There is due diligence risk – the difficulty of getting accurate financial information about an acquisition target – and management risk as well.  Good Chinese companies are  usually owned and run by a single strong Chairman, with scarce management talent around him. In a merger, the boss of the acquired company will often step aside, leaving a big hole in that company’s management, and so making it harder for the acquiring company to integrate its new acquisition. 

How to do M&A right in China? Good deal-structure and good advice are crucial. Structure can anticipate and resolve some of the larger post-acquisition headaches. Advice is important to make sure that the price and strategic fit are right. Just as China’s SMB’s need specialized merchant banks to serve their needs in raising capital, these SMBs, as they grow, will also need competent M&A advisors to identify target companies, manage the DD, do the valuation work, help negotiate the price, and assist with post-acquisition integration. 

Last year was a strong one for M&A in China. But, the future should be even brighter, once current economic uncertainty begins to abate.  Looking ahead, I see a real possibility that China’s M&A market will overtake America’s as the world’s largest. I’m planning for my company to play a part in this. 

Looking purely at the economic news from China of late, this has not been the happiest of Chinese New Years. The Chinese government is estimating that 16% of the huge migrant labor force of 200 million will have no job to return to after the New Year.  Factories are continuing to close, or cut employment, across the country. Guangdong province, where China First Capital has its base in China, is particularly hard hit, because it’s still the primary production base for much of China’s better private factories. While factories are being moved out of Guangdong to less expensive, inland locations like Jiangxi, overall industrial employment in factories in Guangdong is still huge, and hugely reliant on migrant labor. There’s no solid date, but ten million or more workers may have lost their jobs in Guangdong over the last six months. 

The picture is no less bleak in terms of projections for corporate profits in China in 2009. Larger companies are reporting profit falls of over 50% in 2008, and forecasting even worse results this year. This matters crucially in China. Over 40% of total economic output is generated by business investment. This, in turn,  is intimately tied to corporate profits, since most of that business investment is financed out of retained profits. According to a recent report in the Wall Street Journal, “official statistics show that 63% of investment in China last year was financed by what are called “internally generated” funds, which include retained profits. That’s up from just below 50% a decade ago.” 

In other words, as corporate profits decline, they take Chinese GDP growth with them. This falling economic output, in turn, influences consumer sentiment, and so takes personal spending down with it. 

Good economic news is a scarce commodity this Chinese New Year. But, I see one bright glimmer of hope here. Chinese companies have been excessively reliant on retained earnings and expensive bank debt to finance their growth, rather than equity capital. The difficult economic environment, in China and indeed worldwide, provides a good opportunity for better Chinese companies to reorient their method of financing capital investment and growth. It’s the right time to take on equity capital, and use it as a platform to continue to invest and grow, even if corporate profits are in cyclical decline. 

The Chinese companies that can raise equity finance will enjoy a significant financial advantage over competitors, and so be able to gain market share. Adding equity finance lets a company both lower its overall cost of capital, and also increase the amount of capital it can put to work in its business. Both of these factors equate to a very real competitive advantage. 

Equity investors, principally PE firms, will need to change their orientation as well. The opportunities to do shorter-term “pre-IPO” financing are far fewer than they were, because stock market valuations are way down and IPO activity has slowed to a crawl. So, the simple arbitrage of a PE firm buying into a Chinese company at a valuation, say, of 10x and selling out 18 months later in an IPO at 20x are gone. 

Instead, PE investors in China need to think more like value investors, and less like arbitrageurs. This means looking for opportunities to deploy capital into good businesses offering high rates of return on that invested capital. Equity investment is then used to expand output, lower unit costs, gain market share, and so expand both profits and profit margins. Build profits and valuation will take care of itself. If a Chinese company can put equity capital to work well, and accelerate profits in 2009 and beyond, that business will be worth a lot more money when the IPO market revives than if it simply cut back on investing to ride out the bad times. 

This year is going to be difficult, challenging, but also potentially highly rewarding for all of us participating in the financing of private companies in China. It’s a year when good companies should be able to get even better. And smart-money PE firms will make far more, over the medium-term, than fast-money valuation arbitrageurs ever did. 

Looking for confirmation of how much more vibrant China’s IPO market — and therefore private equity market — is than the US? Well, the numbers are in. China’s IPO market has stumbled. America’s is in a coma.  

As reported in the Shanghai Daily, the number of IPOs in 2008 on China’s domestic stock exchanges fell, both in number and amount of capital raised. The totals were 76 IPOs, compared to 118 in 2007. The total capital raised was US$15 billion (RMB 103.4 billion) on the Shanghai and Shenzhen stock exchanges, down 77% from a year earlier.

While hardly a banner year for IPOs in China, the situation in the IPO market in the US was nothing short of cataclysmic. IPO activity was basically at a standstill, touching lows not seen for a generation. The last two quarters of the year, there wasn’t a single IPO by a venture capital or private equity-backed business. The IPO window in China may have closed somewhat. In the US, it seems welded shut.

What does this mean? Well, for one thing, it’s not a predictor of future activity. The US markets are highly cyclical. IPO activity ceased, in large part, because of more general weakness in the stock market, which was down over 33% in 2008. As the stock market begins to recover, so will IPO activity. Meantime, however, many venture capital and private equity firms in the US are going to suffer. Badly. 

In China, stock markets fell more steeply than in the US, but that didn’t entirely undermine the public appetite for new issues. There are a lot of cultural factors at work here. But, one fact that’s often overlooked is that most shares in China are owned by individuals. In the US, over two-thirds (by valuation) are owned by institutions. Individuals tend to have a higher appetite for risk than institutions, whose managers are constrained by fiduciary responsibilities and a competitive need to outperform their peers.

So, when it comes to the IPO market, China enjoys a structural advantage over the US, at this point in history. Equally important, China’s continued high economic growth of over 8% underpins corporate profit growth that is among the fastest in the world. 

Each $1 of profit in China can still be sold for $15 or more at IPO. That’s why China looks even more attractive, comparatively, than it did before for many of the world’s private equity firms. 

In the global competition for capital, China now ranks as a genuine superpower. 

It was President Richard Nixon who somewhat infamously remarked, “We’re all Keynesians now” in 1971, just about the time he launched a series of disastrous economic policies, including wage and price controls. This was right before Nixon’s fabled trip to China. 

Nixon is, of course, long gone, and a lot of Keynesianism theory has been discredited. But, China recently introduced its own brand of Keynesian-style economic stimulus package, totaling almost $600 billion. The purpose is to shore up the slowing Chinese economy, by increasing government spending by something like 15% of current annual gdp. That’s a very big chunk of change. 

Most of the money is meant to go towards infrastructure and poverty alleviation programs. It should help shield China’s economy from some of the ill effects likely to come from a recession in the US and Europe  – which for China, will mean slowing growth, if not an actual decline,  in exports and direct investment. 

The $600 billion stimulus package is an important sign of a larger change now underway in China’s economy. The huge domestic market, rather than exports, will be the main engine of growth from here on. This, in turn, bolsters the most compelling investment case for private equity investors in China.

The best investment opportunities will be those companies that have the products, services and potential to dominate in China’s domestic market. How to find these companies? The ideal businesses are those that already established themselves as high-quality producers for export markets, and are now turning their primary focus to the home market.  These companies already built manufacturing expertise and scale through exports. Ideally, they also continued to upgrade their OEM production to serve good global brands with higher-priced products, rather than as simply a low-cost, low-value producer.

An interesting comparison: this is the opposite of the strategy many of the best Japanese companies followed: they first achieved dominance in the very-competitive Japanese domestic market, then, battle-hardened, set out to conquer the world. Great examples of this are Toyota, Honda, Sony, Matsushita, Takeda Chemicals, Canon, Kao.

The Chinese approach is different, but no less powerful. Good Chinese companies have already mastered, through their OEM business, short product cycles and the importance of anticipating changing consumer taste.  Both are central to success in China’s domestic market as well.

At China First Capital, we’re fortunate to work with one client, Harson, that exhibits all the best characteristics of a Chinese business now building a dominant position in China’s domestic market. Harson began as an OEM manufacturer, and continually upgraded its manufacturing and product design to serve some of the best international brand names in its industry. Under its very able and far-sighted chairman, Harson then began, almost five years ago, to use that foundation to build its own domestic brand business in China.  That domestic business is now thriving, and moving forward, should account for over 60% of Harson’s projected $300mn in total revenues within two years.  

There will be no faster-growing large market in the world than China’s domestic market. The Chinese government will play a role, by spending on improving education and infrastructure. But, the great entrepreneurs, like Harson’s, will do even more to remake China over the next two decades and beyond by selling Chinese more of what they want and crave.