One of the world’s great discount retailing entrepreneurs, Theo Albrecht, died recently. He and his brother built Aldi into one of the world’s largest discount supermarket chains, with consolidated sales likely of over $50 billion. Along the way,  Theo also managed to buy what was then a small food store in Southern California, Trader Joe’s,  and then build it into one of the best and fastest-growing food retailing companies anywhere. 

Where is the Theo Albrecht of China? The question is not an idle one. No country can now match in absolute numbers or recent financial success the entrepreneurs of China. There are great home-grown Chinese companies everywhere, in just about every industry. But, not in food retailing. 

This is surprising. Food, of course, is the main thread, along with family, that weaves together Chinese civilization.  As nowhere else, people’s lives are organized around shopping, preparing and consuming of food. While it’s no longer a primary form of greeting as it was until about a century ago, the phrase “吃饭了吗？”, or “Have you eaten?” is still spoken or written by SMS more times each day in China than any other. 

The most successful retailers in China are, for the most part, all Western companies: Wal-Mart, Ikea, Carrefour, Zara. The most successful fast food chains: McDonalds and Kentucky Fried Chicken. There are Chinese competitors, some of which are quite good. But, in food retailing, the picture is bleak. There are lots of supermarkets in China, modeled on the American style, but none I’ve been to does anything special.  Certainly, there is no Chinese food store that can compare with the two chains Theo Albrecht built. 

I’ve yet to find a Chinese food chain that even attempts to be a source for quality discounted products, the formula Albrecht’s stores do so well. One result: supermarket food prices in China tend to high, considering income levels. There is no real low-end competition. 

Chinese love bargains at least as much as Germans and Americans. The Chinese market couldn’t be bigger, or more primed for a great discount food retailer to enter. The fact none has yet to surface in China is a source of real bewilderment to me – in part, because I’d likely be a frequent customer. 

A Chinese version of Aldi would be a great place to start. For those who’ve never been, Aldi stores tend to be much smaller than a typical supermarket. Everything about an Aldi store is bare bones – the merchandise is mainly stacked in corrugated cardboard shipping cartons, placed in pallets on the floor.

Aldi stores have a narrow range of mainly brand-name food products, things like cereal, detergent, beer, processed meats. Prices are low, probably around 25%-40% below prices in full-range supermarkets. Customer service is all but non-existent. Everything about the store screams at you: “come here to buy stuff cheap, not for the ambiance”. 

Aldi’s retail model, with its small stores and efficient use of floor space,  would work well in Chinese cities, where real estate prices are high. A limited range of only the most-commonly bought products is also suited to China. The Chinese market is simpler. People haven’t yet developed a preference, as many Americans have, for stores stocking 200 different permutations of potato chip. Margins at a Chinese Aldi would grow consistently over time. As the number of stores grows, the company would have more buying power and greater leverage with the brand-name manufacturers. 

If anything, a Chinese Trader Joe’s might do even better. Again, the store size is smaller than a typical supermarket. But, where Aldi focuses on selling mainly well-known global brands, almost everything sold at Trader Joe’s is the store’s “own brand”.

The Trader Joe’s products are all high-quality, as good or better than national brands. But, the prices can be much lower than branded products, since Trader Joe’s isn’t spending/wasting anything on marketing or advertising. That’s the retail proposition Trader Joe’s makes to its customers: “If you don’t mind buying our brand, we’ll sell you better stuff at lower prices than you can buy anywhere else”. 

If going to Aldi is like a trip to a supermarket stock room, a visit to Trader Joe’s is far more pleasant. The stores are always in nice areas, with helpful and friendly staff, free samples, wide and well-organized aisles. The customers seem overwhelmingly affluent and educated. They shop at Trader Joe’s because they like and care about good food, but don’t want to pay an unnecessary premium for a big brand. 

Trader Joe’s sells both staples like coffee, pasta, cooking oil, bread, milk, and also prepared foods, including fresh salads and soups. Non-food items include detergent,  vitamins, pet food, plants, and flowers. Every Trader Joe’s I’ve been to is crowded at all hours of the day. According to Businessweek, the company has the highest sales per square foot of any food retailer in the US. 

High quality “own brand” food items at lower prices sold in a nice environment is a retail idea I think would work very well in China’s major cities like Shanghai, Beijing, Shenzhen. There’s a big market for higher-quality food products. What’s more, big brands have only been around in China for about a decade. So, it should be comparatively easier in China than in the US to get people to support a single brand that offers top quality across a range of products. 

The Chinese market is ready. The big mystery is why no Chinese entrepreneurs have attacked it.  

Making things in China is cheap. Buying things in China is not.

People living elsewhere, or ones like me who move here, will be rather surprised  to find out how expensive prices are for many of the more familiar brand-name products on sale in China. At current exchange rate of 6.78 renminbi to the dollar, many goods and services in China are sold at prices similar to the US.

Years ago, the Economist came up with their “Big Mac Index” as a way to measure real exchange rates. In their most recent survey, the renminbi looks 48% undervalued, because a Big Mac costs $1.95 in China, compared to $3.73 in the USA.

Source: The Economist

Of course, those prices tell only part of the story. Chinese wages are about 1/15^th America’s. So, while it takes an average working American about ten minutes to earn the money to buy a Big Mac, in China, a reasonably well-paid office worker would need to toil about about four times as long to earn the Rmb 13 needed to buy a Big Mac. By this measure, the price of a Big Mac in China, to truly equal the price in the US, should be about 33 cents, and therefore the exchange rate should be over Rmb35 to the dollar.

Of course, the renminbi is never going to get that low. In fact, the overwhelming likelihood is that renminbi will get much stronger than the current rate of 6.78 to the dollar. Upward pressure comes from China’s $2 trillion in foreign exchange reserves and large balance of trade surplus with the US. As the renminbi rises in value, the prices of many goods in China will become even higher, when translated into dollars, than those in the US.

How expensive are things in China? To find out, I did a little comparison shopping at the Wal-Mart closest to my office in Shenzhen. As in the US, Wal-Mart in China is highly successful, and got that way by offering “low everyday prices”. Considering the big gap in income levels between US and China, it would be a fair assumption that prices at Wal-Mart in China would be appreciably lower than those at Wal-Mart in the US.

But, that assumption would be wrong, for the most part. Here’s a rundown of prices on some popular branded products at my local Shenzhen Wal-Mart — prices below are in renminbi and current dollar equivalent at prevailing exchange rate. Quite a few are Procter & Gamble products. P&G are very strong in China, and its products are often market leaders. As in the US, P&G enjoys a close relationship with Wal-Mart.

Source: Peter’s Shopping

A few days after my visit to Wal-Mart in Shenzhen I flew to New York on business. In between meetings, I did some comparison shopping. 

Wal-Mart is the largest retailer in the US, but does not have any stores in New York. One reason is New York City’s unfriendly labor laws that would make it hard for Wal-Mart to operate in New York without unionized workers. Instead, I checked prices at local Food Emporium supermarket, Walgreens and CVS. 

While there are some pretty good deals in China, for example Heinz Ketchup and Coke, most things on the list are in line with prices in the US.  In other words, they do not reflect the vast differences in average earnings and therefore purchasing power.

Chinese workers manufacture wholesale, but buy retail.

Prices in China are high, in part, because there is a VAT of 13% on most things. More important, retailing in China is not nearly as efficient as it is in the US. While Wal-Mart is successful in China, it doesn’t enjoy anything like the market share it does in the US. Smaller, but my guess is, far more profitable. Wal-Mart faces very limited low-price competition in China. Most stores are of the Mom-and-Pop variety, which keeps overall prices high. Urban real estate is also expensive, and that also has an underlying impact on consumer prices.

In China, it’s easier to make money selling than manufacturing. Retail margins are higher and less squeezed than they are in the US. This will likely be true for many years to come. For Chinese consumers, especially the +40% who live in cities, they will likely continue to pay prices on par with those in the US, while earning appreciably less.

Two factors are paramount in explaining the phenomenal economic success of China over the last thirty years: smart government policies and the abundant ingenuity, hard work, talent and entrepreneurial drive of the Chinese people.

A day doesn’t go by without me seeing at first hand that entrepreneurial genius at work in China. The inner workings of government, however, are generally invisible to me as an outsider.

During a recent trip to Shandong, however, I had the privilege of seeing part of China’s government up close, doing what it often does best – constructing and carrying out policies that allow businesses to thrive in China.

In all countries, governments makes the rules and sets the conditions under which business succeed and fail. China is no different. One obvious difference: China’s government clearly must be doing a lot right for the country to deliver the greatest sustained period of economic growth ever recorded.  How was this achieved? The simple answer is that China’s government began 30 years ago to scrap a rigid socialist system for a free market economy.

“Socialism with Chinese characteristics” is the official phrase. It’s no set doctrine, but mainly a pragmatic pursuit of policies to foster global competitiveness, employment and rising living standards in China. China government invites its citizens to evaluate it on this basis, using statistics, to judge how well it manages the economy.

Most would agree, including me,  the government is doing an outstanding job. How it does so,  however, is very much of a mystery.

Over the course of four days, I met with the mayors and Communist Party Secretaries of three of Shandong’s larger and more prosperous cities: Weifang, Laiwu and Linyi. These were working meetings, not diplomatic meet-and-greets. I was the only non-Chinese in these meetings. I was traveling at the invitation of the chairman of one of our clients. This client already has extensive and highly-successful operations in Shandong, with revenues there in the last two years of over Rmb 1 billion.

“We are here to serve you”. This is the statement I heard repeated in each city by the Party Secretary and the Mayor.  This is neither an idle boast nor an empty promise. In every instance where I’ve been in meetings with senior figures in the Chinese government, I’ve been deeply impressed by their competence, directness and sense of purpose in offering to do whatever it takes to help improve the conditions for investment and so raise local living standards.

The meetings with Shandong political leadership had an overlapping two-way purpose: to facilitate my client’s expansion plans in Shandong, and to allow the Party Secretary and Mayor of each city to lay out in plain language the economic development agenda for the next few years. They did this confidently, effectively, forcefully.

I’ve never before heard political leaders speak with such a single-minded focus, as well as evident sincerity,  on their priorities to improve the life, work and leisure of their citizens. There was no self-aggrandizement, no insincere black-slapping, no empty platitudes, indeed nothing that could be construed as expressions of naked self-interest, or the exclusive interest of the party they represent.

There is a good reason for this: political careers in China are made and lost in part on how well the local economy performs, as measured by objective statistics. The metrics include not just local gdp growth, but also the growth in living and recreation space per person, the completion of large local infrastructure projects on time and on budget, urban beautification programs like planting trees and cleaning up local waterways.

Political success in China must be tangible, measureable. And the improvements must come quickly enough – generally within 2-3 years – to boost an official’s chance to continue to climb the rungs.

Arguably, most political careers, including in the US, are determined by how well political leaders deliver for their citizens.  The clear difference in China, from what I can see,  is that it’s a much more data-driven process, more like how management are rewarded or penalized inside a big company. As Peter Drucker, perhaps the wisest thinker about management famously said, “You can only manage what you can measure.”

China is often run by the Communist Party  like one large centralized corporation. The command-and-control methods of management appear similar. While a vastly oversimplifies things, the meetings I attended with political leaders in Shandong were very familiar in many respects to business meetings I’ve attended. The local leaders articulated the goal, which in each case is to keep local gdp growing at well above China’s national average. All three cities are now doing so.

The infrastructure would need to be continuously upgraded to achieve this. As each city gets richer, of course, it gets correspondingly harder to generate such large annual leaps in output. So, projects grow in scale to the truly monumental. In Weifang, for example, the Party Secretary outlines plans to build a new greenfield port and industrial center outside the city that would one day house over one million people in spacious new apartment buildings.

In each city, the planning goals were uniformly ambitious. The political leaders left no doubt that private business should and must play a big part in the process.  They pledged not just help removing any administrative obstacles, but also to make land available at concessionary prices for private sector projects that would create large number of jobs.

The three cities I visited – Weifang, Laiwu and Linyi – are all thriving, not just economically, but also in these more human terms. The cities are for the most part clean, pretty, with newly-built urban infrastructure of roads, housing, parks.

Many outside China have likely never heard of these places. But, Linyi and Weifang, with populations of 11 million and 8 million respectively,  are both larger than any city in the US and Europe.

Laiwu, is smaller, with a population of just over 1 million. However, it does like to do things in a big way. At lunch with the Party Secretary and Mayor, I sat at the largest round dining table I’ve ever seen. Sixteen of us ate at a table that was over four meters in diameter – so large that each person was served lunch individually, one small helping at a time, by a large team of waiters. 

Corruption and political chicanery exist in China, of course, as they do in US, Europe, Japan and everywhere else political officials with control over valuable resources interact with businessmen. But, in my experience during my three days meeting officials in Shandong, the local government is far more intent on lending a helping hand, rather than looking for back-handers.

China’s one-party political system is not to the taste of many Americans or Europeans.  But, if judged by standards of effectiveness, rather than electoral accountability, local governments in China routinely outperform their counterparts in the US.  For all the pretentions to public service, accountability and incorruptibility, US politics, especially at the local level, is infested by influence-peddling and political bribery in form of campaign contributions.

As I saw living for many years in Los Angeles, the second biggest city in the US, local officials act mainly in ways that favor a select few, and deliver only scant benefits to the society as a whole. LA is now teetering on the edge of bankruptcy, with degraded infrastructure, failing schools, punishingly high taxes. LA, like China, is also run as a one-party system, with a Democratic machine that pushed through election rules that make it all but impossible for the opposition Republic Party to gain control, no matter how badly the Democratic Party politicians mess up.

Given a choice, I’d take Shandong’s local bosses anytime. They are held to a higher, more transparent standard. Over the course of a four-to-five year term in office, they will often preside over real material improvements in citizens’ lives that few American politicians will deliver over the course of a career.

Xinjiang is a big place, with a land mass the size of Western Europe. It occupies 1/6^th of China’s territory, yet contributes only 1.5% of its population. I think I now know why it’s so empty. All that space must be devoted to growing Hami Melons.

This fruit is Xinjiang’s most popular export to the rest of China. It’s high season now. Even here in Shenzhen, as far as one can travel from the melon-growing precints near the Gobi Desert in Xinjiang, the large Hami melons are pervasive – in fruit stores, supermarkets, pushcarts. You can also find them piled high on many streets all over the city, with each Hami hoard minded by a guy from Xinjiang with a long sharp knife and a small scale.

The melons are generally oval-shaped and weigh about 10 pounds each. I’ve bought segments of ones weighing twice that. The most popular way to eat the melon is as a snack on the street. A tall thin slice on a wooden skewer sells for Rmb 1.

For those who haven’t had the pleasure, a Hami tastes a lot like cantaloupe, but the flesh is much crunchier, almost like an apple’s.

This time of year, across China, Hami crowds every other fruit out of the marketplace. I can’t find any statistics on Xinjiang’s total production, but my guess would be it runs to the millions of tons. Imagine the logistics: a market of 1.4 billion all simultaneously ravenous for your perishable product, grown on the fringe of a desert in one of the most distant, infrastructure-starved corners of the country.

Just to supply the Chinese market must occupy the full-time summertime efforts of tens of thousands of farmers, packers, and shippers. The melons are grown, boxed and then shipped by road and rail to every corner of China. It seems like for every 100 melons exported from Xinjiang, one local Uighur must accompany the shipment, to run the impromptu sidewalk stalls selling the fruit.

If other parts of China also grow the melon, I’m not aware of it. To find buyers, they would probably have to falsely label their melons as coming from Xinjiang. In China, Hami belongs to Xinjiang the way champagne belongs to the Champagne region of northern France.

Shenzhen probably has a larger market for Hami, on average, than many other parts of China. It’s a rich city, and Hami melon is not cheap. Bought by the kilo, the price runs to around Rmb8 to Rmb 12, or about 70-90 cents a pound. I’m buying around 10 kilos a week.

You can also find Hami this time of year in Los Angeles, usually at Persian grocery stores. Parts of Southern California’s desert are similar to Xinjiang’s Hami growing region. But, the fruit is very much a minority taste in the US. It’s likely to remain that way. As big as it is, Xinjiang will never be able produce enough Hami to satisfy fully Chinese tastes, let alone an export market.

CFC has just published its latest Chinese-language research report. The title is 《私募基金如何创造价值》, which I’d translate as “How PE Firms Add Value ”.

You can download a copy here:  How PE Firms Add Value — CFC Report. 

China is awash, as nowhere else in the world is,  in private equity capital. New funds are launched weekly, and older successful ones top up their bank balance. Just this week, CDH, generally considered the leading China-focused PE firm in the world, closed its fourth fund with $1.46 billion of new capital. Over $50 billion has been raised over the last four years for PE investment in China. 

In other words, money is not in short supply. Equity investment experience, know-how and savvy are. There’s a saying in the US venture capital industry, “all money spends the same”. The implication is that for a company, investment capital is of equal value regardless of the source. In the US, there may be some truth to this. In China, most definitely not. 

In Chinese business, there is no more perilous transition than the one from a fully-private, entrepreneur-founded and led company to one that can IPO successfully, either on China’s stock markets, or abroad. The reason: many private companies, especially the most successful ones, are growing explosively, often doubling in size every year.

They can barely catch their breath, let alone put in place the management and financial systems needed to manage a larger, more complex business. This is inevitable consequence of operating in a market growing as fast as China’s, and generating so many new opportunities for expansion. 

A basic management principle, also for many good private companies, is: “grab the money today, and worry about the consequences tomorrow”. This means that running a company in China often requires more improvising than long-term planning. I know this, personally, from running a small but fast-growing company. Improvisation can be great. It means a business can respond quickly to new opportunities, with a minimum of bureaucracy. 

But, as a business grows, and particularly once it brings in outside investors, the improvisation, and the success it creates, can cause problems. Is company cash being managed properly and most efficiently? Are customers receiving the same degree of attention and follow-up they did when the business was smaller? Does the production department know what the sales department is doing and promising customers? What steps are competitors taking to try to steal business away? 

These are, of course, the best kind of problems any company can have. They are the problems caused by success, rather than impending bankruptcy.

These problems are a core aspect of the private equity process in China. It’s good companies that get PE finance, not failed ones. Once the PE capital enters a company, the PE firm is going to take steps to protect its investment. This inevitably means making sure systems are put in place that can improve the daily management and long-term planning at the company. 

It’s often a monumental adjustment for an entrepreneur-led company. Accountability supplants improvisation. Up to the moment PE finance arrives, the boss has never had to answer to anyone, or to justify and defend his decisions to any outsider. PE firms, at a minimum, will create a Board of Directors and insist, contractually, that the Board then meet at least four times a year to review quarterly financials, discuss strategy and approve any significant investments. 

Whether this change helps or hurts the company will depend, often, on the experience and knowledge of the PE firm involved.  The good PE firms will offer real help wherever the entrepreneur needs it – strengthening marketing, financial team, international expansion and strategic alliances. They are, in the jargon of our industry, “value-add investors”.

Lesser quality PE firms will transfer the money, attend a quarterly banquet and wait for word that the company is staging an IPO. This is dumb money that too often becomes lost money, as the entrepreneur loses discipline, focus and even an interest in his business once he has a big pile of someone else’s money in his bank account.   

Our new report focuses on this disparity, between good and bad PE investment, between value-add and valueless. Our intended audience is Chinese entrepreneurs. We hope, aptly enough, that they determine our report is value-add, not valueless. The key graphic in the report is this one, which illustrates the specific ways in which a PE firm can add value to a business.  In this case, the PE investment helps achieve a four-fold increase. That’s outstanding. But, we’ve seen examples in our work of even larger increases after a PE round.

The second part of the report takes on a related topic, with particular relevance for Chinese companies: the way PE firms can help navigate the minefield of getting approval for an IPO in China.  It’s an eleven-step process. Many companies try, but only a small percentage will succeed. The odds are improved exponentially when a company has a PE firm alongside, as both an investor and guide.

While taking PE investment is not technically a prerequisite, in practice, it operates like one. The most recent data I’ve seen show that 90% of companies going public on the new Chinext exchange have had pre-IPO PE investment. 

In part, this is because Chinese firms with PE investment tend to have better corporate governance and more reliable financial reporting. Both these factors are weighed by the CSRC in deciding which companies are allowed to IPO. 

At their best, PE firms can serve as indispensible partners for a great entrepreneur. At their worst, they do far more harm than good by lavishing money without lavishing attention. 

The report is illustrated with details from imperial blue-and-white porcelains from the time of the Xuande Emperor, in the Ming Dynasty.

“Five years ago, all I had to worry about was producing enough to earn a small profit. Now I spend time dealing with employment issues, environmental regulations, tax policies, trying to increase market share and staying ahead of competitors. The pressure is much worse. ”

Welcome to the suddenly changed and increasingly pressured world of Chinese corporate management. 

This comment comes from the boss of a large, integrated chemical factory in Shandong. He and I were talking recently. He is still a relatively young guy of around 40. But, in his 15 year career as first an engineer, then a manager and finally as factory boss, he has seen the purpose, methods, scope, goals and responsibilities of Chinese management change from top to bottom. 

Like much else in China, company management has undergone a lifetime’s worth of change in a matter of a few years. It’s a byproduct of larger forces at work in China’s economy – the withdrawal of direct state planning and control, the ascendancy of the private sector, China’s entry to the WTO and the opening of China’s markets to imports, the rise of a vibrant consumer market. All of these have made planning and decision-making far more intricate and the stakes far higher for Chinese corporate managers, both in state-owned and private companies. 

In the case of my friend in Shandong, he is working for a company majority owned by the state. In theory, that should make his management tasks far easier. In most cases, the Chinese government – whether at national, provincial or local level – is a very lenient shareholder. In fact, they would appear to the ideal owner for any manager who is looking for easy ride. 

In China as elsewhere, when the state is the owner, no one is really in charge. The Chinese government is not looking for dividends. Most profits stay inside the company.  

Here’s the paradox that Chinese managers all live with: as undemanding as the Chinese government is as a shareholder, they are increasingly demanding as a regulator and law-maker. That is a big reason why corporate management has gotten so much more complex in China. In a short space of time, China has gone from a more laissez-faire stance to one with strict environmental, tax and labor laws that rival those of the US and Western Europe. 

True, these tougher regulations are not yet universally applied or enforced. But, any Chinese manager who chooses to act in total disregard of these rules will eventually find himself in deep, deep trouble. Take labor laws. China continues to introduce new forms of workplace protection that give important new rights to hired staff and restrict the prerogatives of management. Any Chinese with a complaint over pay or conditions can complain directly to the Laodong Ju, or Labor Bureau, a quasi-state body that enforces labor laws. 

The process is not without its hiccups. Management can still intimidate and threaten workers who seek redress. But, the system does work. 

Example: a friend of mine worked for several years as a salesperson for an electronics company based in Shenzhen. She was paid part in commission. She did her job well. For months, then years, the boss held back the commission payments, claiming cash flow problems. This is old style China management: don’t pay, offer excuses. This boss assumed he could continue indefinitely with this trickery, in part because the general view is that female workers in China are more easily cowed or mollified. 

Instead, my friend quit without warning,  went right to the Labor Bureau, which made one call to her ex-boss. No investigation. Just a phone call and a stern warning from the Labor Bureau. My friend got her money – about $20,000 in total – within a week. The boss will now have a much harder time doing what he’s always done – pad his own take-home by cheating workers out of what they are entitled to. Tyrannizing workers is no longer a workable HR strategy for a Chinese management team. 

New environmental rules are, if anything,  even more disruptive of old lax ways of managing business in China. Managers who choose to improve margins by ignoring pollution standards are risking an early unpaid retirement. Example: a client of ours is the leading environmentally-friendly paper manufacturer in Shandong. Two years ago, he had 29 competitors in Shandong. Today, he has only three. 

The other 26 were shut down, virtually overnight, for violating environmental standards. The managers at those factories, most of which were around for many years, now likely understand better than most how much the craft of management has changed in China.  

Elsewhere in Shandong, my friend the chemical company boss, is now making another decision that was unimaginable when he began his career: he is working on a plan for a management buyout of the factory. The business is now 65%-owned by a large local coal mine, which in turn, is owned by the provincial government. 

The buy-out plan is still in its early stages. To succeed, he’ll need to persuade several levels of government – no one is quite sure how many – and also take over some significant liabilities, including debts of about $15mn.  It’s not clear if the current management will need to put up cash to buy the government’s controlling stake, or if, as preferred, they can pay in installments, using cash from the business. 

Servicing debt and having most of one’s wealth tied up in illiquid shares of one’s company are other adaptations now being learned by Chinese management. Each year, their working lives grow harder, more pressured and, for the more talented and nimble ones, far more financially rewarding.  Stride-for-stride with the modernization of China’s economy, Chinese corporate managers have gotten better faster than anywhere else, ever.

Shenzhen’s Stock Exchange was the world’s busiest and largest IPO market during the first half of 2010. Through the end of June, 161 firms raised $22.6 billion in IPOs on Shenzhen Stock Exchange. The Shanghai Stock Exchange ranked No.4, with 11 firms raising $8.2 billion.

Take a minute to let that sink in. The Shenzhen Stock Exchange, which two years ago wasn’t even among the five largest in Asia, is now host to more new capital-raising transactions than any other stock market, including Nasdaq and NYSE. Even amid the weekly torrent of positive economic statistics from China, this one does stand out. For one thing, Shenzhen’s Stock Exchange is effectively closed to all investors from outside China. So, all those IPO deals, and the capital raised so far in 2010, were done for domestic Chinese companies using money from domestic Chinese investors.

The same goes for IPOs done on Shenzhen’s larger domestic competitor, the Shanghai Stock Exchange. In the first half of 2010, the Shanghai bourse had eleven IPOs, and raised $8.2 billion. That brings the total during the first half of 2010 in China to 172 IPOs, raising $31 billion in capital.

The total for the second half of 2010 is certain to be larger, and Shenzhen will likely lose pole position to Shanghai. The Agricultural Bank of China just completed its IPO and raised $19.2 billion in a dual listing on Shanghai and Hong Kong exchanges. Over $8.5 billion was raised from the Shanghai portion.

One reason for the sudden surge of IPOs in Shenzhen was the opening in October 2009 of a new subsidiary board, the 创业板, or Chinext market. Its purpose is to allow smaller, mainly private companies to access capital markets. Before Chinext, about the only Chinese companies that could IPO in China were ones with some degree of state ownership. Chinext changed that. There is a significant backlog of several hundred companies waiting for approval to go public on Chinext.

So far this year, 57 companies have had IPOs on Chinext. The total market value of all 93 companies listed on Chinext is about Rmb 300 billion, or 5.5% of total market capitalization of the Shenzhen Stock Exchange. On Shenzhen’s two other boards for larger-cap companies, 197 companies had IPOs during the first half of 2010.

The surge in IPO activity in China during the first half of 2010 coincided with the dismal performance overall of shares traded on the Shanghai and Shenzhen stock exchanges. Both markets are down during the first half of the year: Shanghai by over 25%  and Shenzhen by 15%. 

The IPO process in China, both on Shanghai and Shenzhen markets, is very tightly controlled by China’s securities regulator, the CSRC (证监会). It’s the CSRC that decides the number and timing of IPOs in China, not market demand. One factor the CSRC gives significant weight to is the overall performance of China’s stock market. They want to control the supply of new shares, by limiting IPO transactions, to avoid additional downward pressure on share prices overall.

So, presumably, if the Chinese stock markets performed better in the first half of 2010, the number of IPOs would have been even higher. Make no mistake: the locus of the world’s IPO activity is shifting to China.

Two years back, I met the boss and toured the factory of a Shenzhen-based company called TMK Power Industries. They make rechargeable nickel-metal hydride, or Ni-MH,  batteries, the kind used in a lot of household appliances like electric toothbrushes and razors, portable “Dustbuster” vacuum cleaners, and portable entertainment devices like MP3 players. 

At the time, it seemed to me a good business, not great. Lithium rechargeable batteries are where most of the excitement and investment is these days. But, TMK had built up a nice little pocket of the market for the lower-priced and lower-powered NI-MH variety. 

I just read his company went public earlier this year in the US, through a reverse merger and OTCBB listing. I wish this boss lots of luck. He’ll probably need it.

Things may all work out for TMK. But, at first glance, it looks like the company has spent the last two years committing a form of slow-motion suicide. 

Back when I met the company, we had a quick discussion about how they could raise money to expand. I went through the benefits of raising private equity capital, but it mainly fell on deaf ears. The boss let me know soon after that he’d decided to list his company in the US.

He made it seem like a transaction was imminent, since I know he was in need of equity capital. Two years elapsed, but he eventually got his US listing, on the OTCBB, with a ticket symbol of DFEL. 

Here is a chart of share price performance from date of listing in February. It’s a steep fall, but not an unusual trajectory for Chinese companies listed on the OTCBB. 

From the beginning, I guessed his idea was to do some kind of reverse merger and OTCBB transaction. I knew he was working then with a financial advisor in China whose forte was arranging these OTCBB deals. I never met this advisor, but knew him by reputation. He had previously worked with a company that later became a client of mine. 

The advisor had arranged an OTCBB deal for this client whose main features were to first raise $8 million from a US OTCBB stock broker as “expansion capital” for the client. The advisor made sure there wouldn’t be much expanding, except of his own bank account and that of the stock broker that planned to put up the $8mn. 

Here’s how the deal was meant to work: the advisor would keep 17% of the capital raised as his fee, or $1.35mn.  The plan was for the broker to then rush this company through an expensive “Form 10” OTCBB listing where at least another $1.5 mn of the original $8mn money would go to pay fees to advisors, the broker,  lawyers and others. The IPO would raise no money for the company, but instead all proceeds from share sale would go to the advisor and broker. The final piece was a huge grant of warrants to this advisor and the stock broker that would leave them in control of at least 15% of the post-IPO equity. 

If the plan had gone down, it’s possible that the advisor and broker would have made 2-3 times the money they put up, in about six months. The Chinese company, meanwhile, would be left to twist in the wind after the IPO. 

Fortunately for the company, this IPO deal never took place. Instead, I helped the company raise $10mn in private equity from a first class PE firm. The company used the money to build a new factory. It has gone from strength to strength. Its profits this year will likely hit $20mn, four times the level of three years ago when I first met them. They are looking at an IPO next year at an expected market cap of over $500mn, more than 10 times higher than when I raised them PE finance in 2008. 

TMK was not quite so lucky. I’m not sure if this advisor stayed around long enough to work on the IPO. His name is not mentioned in the prospectus. It does look like his kind of deal, though. 

TMK should be ruing the day they agreed to this IPO. The shares briefly hit a high of $2.75, then fell off a cliff. They are now down below $1.50. It’s hard to say the exact price, because the shares barely trade. There is no liquidity.

As the phrase goes, the shares “trade by appointment”. This is a common feature of OTCBB listed companies. Also typical for OTCBB companies, the bid-ask spread is also very wide: $1.10 bid, and $1.30 asked. 

Looking at the company’s underlying performance, however, there is some good news. Revenues have about doubled in last two years to around $50mn. In most recent quarter, revenues rose 50% over the previous quarter. That kind of growth should be a boost to the share price. Instead, it’s been one long slide. One obvious reason: while revenues have been booming, profits have collapsed. Net margin shrunk from 13% in final quarter of 2009 to 0.2% in first quarter of 2010. 

How could this happen? The main culprit seems to be the fact that General and Administrative costs rose six-fold in the quarter from $269,000 to over $1.8mn. There’s no mention of the company hiring Jack Welch as its new CEO, at a salary of $6mn a year. So, it’s hard to fathom why G&A costs hit such a high level. I certainly wouldn’t be very pleased if I were a shareholder. 

TMK filed its first 10Q quarterly report late. That’s not just a bad signal. It’s also yet another unneeded expense. The company likely had to pay a lawyer to file the NT-10Q to the SEC to report it would not file on time. When the 10Q did finally appear, it also sucked money out of the company for lawyers and accountants. 

TMK did not have an IPO, as such. Instead, there was a private placement to raise $6.9mn, and in parallel a sale of over 6 million of the company’s shares by a variety of existing shareholders. The broker who raised the money is called Hudson Securities, an outfit I’ve never heard of. TMK paid Hudson $545,000 in fees for the private placement, and also issued to Hudson for free a packet of shares, and a large chunk of warrants.

Hudson was among the shareholders looking to sell, according to the registration statement filed when the company completed its reverse merger in February. It’s hard to know precisely, but it seems a fair guess that TMK paid out to Hudson in cash and kind over $1mn on this deal. 

The reverse merger itself, not including cost of acquiring the shell, cost another $112,000 in fees. At the end of its most recent quarter, the company had all of $289,000 in the bank. 

These reverse merger and OTCBB deals involving Chinese companies happen all the time. Over the last four years, there’s been an average of about six such deals a month.

This is the first time – and with luck it will be the only time – I actually met a company before they went through the process. Most of these reverse merger deals leave the companies worse off. Not so brokers and advisors. 

Given the dismal record of these deals, the phrase 美国反向收购 or “US reverse merger” , should be the most feared in the Chinese financial lexicon. Sadly, that’s not the case.

I don’t know the direction of the dollar-renmibi exchange rate. But, I do know most of the American press, led by the

The immediate media reaction – and that of the Obama administration – was one of hosannas and smug approval. The tone of most coverage was along the lines, “the Chinese have finally seen the error in their mercantilist ways and will now allow their currency to appreciate strongly against the dollar, leading to a new golden age of manufacturing employment in the US.”

A week has gone by and the renminbi has appreciated by exactly 0.5%.  So, a $100 item made in China that previously cost Rmb682 will now cost an importer Rmb685, or $100.50. Factory managers in the US may be waiting for awhile yet before the flood of orders arrives from China.  The President’s union buddies will also not soon see much of an uptick in their membership rolls.

For those without short-term memory impairment, this is, of course, the second time in two months that US press and the Obama administration loudly predicted the imminent upward revaluation of the renminbi. In April, a flurry of reporting, loudest and strongest from the New York Times,  announced the Chinese government was at last ready to accede to US demands and let the renminbi rise.

That time, the press articles were timed to coincide with a visit by the US Secretary of Treasury, Timothy Geithner, to Beijing. He was there, if the Administration and its media allies were to be believed, to talk tough and get the Chinese to fall in line with American wishes. Discernible results? Zero.

This time around, the reporting coincides with the G-20 Summit meeting in Toronto, where we are told, President Obama will use his intelligence and oratorical brilliance to persuade Chinese leader Hu Jintao to do his part for the sagging US economy. Likely results? We’ll see, but the signs are that China will continue to make policy decisions with its own interests to the fore.

There is much both wrong and economically illiterate about all this US pressure to revalue the renminbi. Start with the fact the Chinese currency is not significantly undervalued. Yes, it is tied to the dollar. So are many other currencies with which the US trades, including Mexico, Taiwan, Russia, Singapore, Thailand, Saudi Arabia. The renminbi’s formal peg with the dollar ended in July 2005. It is true that the renminbi, if it were fully convertible and freely floating, would likely appreciate against the dollar. But, by enough to really make an impact on US manufacturing employment? Hardly.

The biggest benefit to China of letting the renminbi rise against the dollar would be to lower the renminbi cost of China’s huge imports of oil, iron ore and other core dollar-denominated raw materials. Weighing against this would be falling margins at many of China’s exporters, which would ultimately have an impact on manufacturing employment.

Creating and maintaining jobs is a paramount concern for a country whose labor force grows by millions every year, and where there is no “social safety net” as in the US.  Fact: every year, six million more Chinese join the migrant labor force, according to recent report by China’s National Population and Family Planning Commission.

It’s a mistake shared by many Americans that at the current exchange rate, China is some kind of low-cost paradise for people with dollars. I live here. Prices here are not low. In fact, most things in China, with exception of fresh vegetables and public transportation, are either on par with US prices or higher.

Most fruit is generally more expensive here, even at the proletarian outdoor market where I do a lot of my shopping. Same goes for beef, chicken and most everything else you fill up a supermarket cart with. Gas, automobiles, computers, TVs, brand-name products are all higher in China than in the US.

I’m writing this in my local Starbucks in Shenzhen. And while this is hardly a perfect bellwether, the cheapest cup of regular brewed coffee here costs Rmb 15, or $2.20. A cappuccino? Rmb 25, or $3.65.  The place is jammed, as it always is, from noon to midnight. Not a seat in the house. Starbucks has over 350 stores in China and growing fast.

Not that long ago, the renminbi was pegged at 8.2 to the dollar. Has this 17% appreciation done anything to impact the decline of manufacturing employment in the US, a decline that began over 30 years ago? No. Will another 17% appreciation of the dollar reverse this trend? I very much doubt it.  Instead, what will likely happen is prices for many products in the US will rise sharply, since so much of what America likes buying is made here.  This will lead to higher unemployment, lower growth and hit hardest the poorer Americans President Obama claims to champion.

Make no mistake: if Chinese prices rise, this will not create huge new opportunities either for US manufacturers to reconquer the domestic market or allow lower wage countries like Bangladesh, Nigeria, India, the Dominican Republic or Peru to increase dramatically their exports to the US. Those countries can’t now, nor will they ever in my view, manufacture products to match the quality at the same price of those made in China, even if the cost of Chinese made products rises 15%-20% or more.

True, an economics professor’s models would argue otherwise, and President Obama is surrounded by economics professors. The models are plain wrong. Some textile imports from places other than China will rise. Not much else.

So, the real world result of the “strong renminbi” policy: greater economic hardship in the US.  But, won’t ordinary Chinese benefit from lower import prices? Perhaps a little, but not in any way that will create the desired outcome of much higher manufacturing employment and exports in the US. Maybe the Washington state apples and cherries in my supermarket will become a little cheaper, and become only twice as expensive as they are in the US. Again, not overly likely.

China’s current currency policy has its benefits and drawbacks. The benefit is mainly greater predictability for exporters, which has been somewhat helpful during the economic crisis of the last two years in China’s largest export markets of the US and Europe. Even with the stable exchange rate, a lot of exporters in China went bankrupt over this period, because of a collapse in orders from the US and Europe.

The biggest drawback of current exchange rate policy: $3 trillion in foreign exchange reserves accumulated to soak up all the dollars still pouring into the country. This money is not being put to any direct productive use to improve China’s economy. A higher renminbi will not alter that calculus much, if at all.

I’m troubled in many ways by the direction of American international financial policy. The Obama Administration finds it far easier to scapegoat China’s exchange rate than put their focus on the deepest source of American economic malaise: runaway spending and budget deficits in Washington, with the inevitability of large tax increases to follow.

It’s not likely to happen, but here’s what I’d most like to see is the next time the US media starts braying for a higher renminbi. Chinese newspapers respond with articles, quoting unnamed Chinese government officials,  pleading with the Obama Administration to cut spending, deficits and taxes, and so put more money in the pockets of American consumers. They will certainly choose to spend some of this cash on Chinese-made products and so help boost employment, wages and living standards across China.

As panaceas go, this one would be a lot more effective and all-around helpful than anything the American government and its media allies are peddling.

Anyone who has enjoyed Chinese food in China will discover, by aroma as well as by taste, that garlic is the most widely-used flavoring agent of all, after salt. It’s detectable – in fact visible – in just about every stir-fried or stewed dish, in such large quantities to leave most outsiders breathless. Which, of course, is just as well. 

A simple stir-fried dish will often have 3-4 whole cloves of chopped or sliced garlic. Many dishes have far more. One of my favorites, Lazi Jiding, is a Sichuan dish of small chunks of chicken, chili peppers, and often several heads’ worth of garlic cloves all deep-fried together.

Garlic turns up everywhere, at all times of the day. This morning at the breakfast buffet of the hotel where I was staying in Fujian, there was a dish of simple stir-fried cabbage that had at least 25 cloves of garlic in it. I stopped counting long enough to spoon some onto my plate, and move onto the next garlic-laced Chinese breakfast treat.  

I lived a lot in Italy,  the other country famed for its use of garlic. There, adding more than one clove to a dish is usually considered excessive, even uncouth. You will likely eat more garlic in a day in China than a month spent eating in Italy. 

In the US, garlic has become a far more common part of the diet than when I was a child.  I began noticing several years ago that all the garlic I bought in LA was imported from China. That always struck me as odd, since very little fresh food is imported from China, and California has a town, Gilroy, that’s famed as one of the world’s largest producers of garlic. 

The Made-in-China garlic I’ve bought is always fresh, crisp and cheap – usually no more than a dollar a pound. I never figured out how anyone could make any money shipping it from so far and selling it for so cheap. 

I assumed that the US’s ever-increasing appetite for garlic was emptying China of its favorite flavoring. Since moving to China, however, I’ve seen that wasn’t the case, that there was more than enough to satisfy China’s far larger appetite. So, then my question became: where is all this garlic being produced? From all the garlic in circulation, you’d think half of China’s arable land must be used to cultivate it. Yet, I’ve never seen any in the ground. I’ve asked friends, farmers, chefs, but never got a clear answer to where all this garlic was coming from. 

Now I know at least one place. Jinxiang County in Shandong Province is the largest garlic-producing area in China. This little-known area in Shandong’s southwest corner is not far from Qufu, Confucius’s birthplace. Jinxiang  is also now one of the centers of worldwide commodity speculation. The price of Jinxiang-grown garlic has spiked recently, rising more than fifty-fold from its low a year ago. As the China Daily reports, “Garlic trading has created a handful of new millionaires overnight in Jinxiang county.” 

I couldn’t find a figure for Jinxiang’s total garlic output. But, last year Jinxiang produced 70% of China’s garlic for export, over one million tons last year. That means that Jinxiang produced half all the garlic eaten outside China. At current pace and current export price of around $1,000 a ton, Shandong will export over $1 billion of garlic in next 12 months. 

China has no strong natural advantage in garlic-production. It’s not particularly labor-intensive, nor does it grow best in climate like China’s. Garlic, after all, is a member of the onion family, and so grows pretty well all over the world. Jinxiang must be the world’s leading garlic producer for other reasons that highlight a part of China’s economic strength that is often not emphasized: regions with intensive focus on particular industries (in this case, growing garlic for home and export market)  and a developed infrastructure to move goods quickly and efficiently to market. 

China has one other advantage that helps explain its dominance in global garlic-production. The whole plant can be sold for good money, not just the bulb. Chinese also eat prodigious quantities of the green garlic shoots that grow above ground. This vegetable, called jiu cai （韭菜）in Chinese, is served on its own, as a stir-fried dish, or added to many other staples, including dumplings. Like a skilful butcher carving a hog,  garlic farmers in Jinxiang know how to extract every morsel of profit, and leave nothing to waste. 

I’m determined now to go to Jinxiang. Partly, it’s because I love garlic. But, I also want to see (and smell) this region for myself, how farms are organized, what else is grown or manufactured there. I want to find out more how one place became so big and so successful selling one agricultural product that (unlike, say, tobacco or ginseng) grows just about anywhere. 

My company is lucky enough to have two clients in Shandong. I’ve already worked out how far these companies are from Jinxiang, and will go there at first opportunity.  I’m pretty certain over the last 20 years, to satiate my love of garlic, more of my money has ended up in Jinxiang than just about anywhere else in China.