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China Merchants Steams in to Compete with SoftBank’s Vision Fund — Financial Times

July 10th, 2018 No comments

 

China Merchants Group has been adopting new technology to resist foreign competitors for nearly 150 years. Founded in the 19th century, the company brought steam shipping to China so it could compete with western traders.

Now an arm of the Chinese state, CMG has been enlisted once again to buy up technology at a time when global private equity is vying for a share of China’s burgeoning tech market.

The country’s largest and oldest state-owned enterprise, CMG said this month it would partner with a London-based firm to raise a Rmb100bn ($15bn) fund mainly focused on investing in Chinese start-ups.

The China New Era Technology Fund will be launched into direct competition with the likes of SoftBank’s $100bn Vision Fund, as well as other huge investment vehicles raised by top global private equity houses such as Sequoia Capital, Carlyle, KKR and Hillhouse Capital Management.

“They have been very important to China in the past, especially in reform,” said Li Wei, a professor of economics at Cheung Kong Graduate School of Business in Beijing. “But you haven’t heard much about them in technology . . . It’s not too surprising to see them moving into this area, upgrading themselves once again.”

CMG is already one of the world’s largest investors. Since the start of 2015 its investment arm China Merchants Capital, which will oversee the New Era fund, has launched 31 funds aiming to raise a combined total of at least $52bn, according to publicly disclosed information.

But experts say little is known about the returns of those funds, most of which have been launched in co-operation with other local governments or state companies.

Before New Era, China Merchants Capital’s largest fund was a Rmb60bn vehicle launched with China Construction Bank in 2016. While almost no information is available on its investment activity, the fund said it would focus on high-tech, manufacturing and medical tech.

CMG’s experience investing directly into Chinese tech groups is limited, although it has taken part in the fundraising of several high-profile companies. In 2015 China Merchants Bank joined Apple, Tencent and Ant Financial to invest a combined $2.5bn into ride-hailing service Didi Chuxing, a company that now touts an $80bn valuation. It also invested in ecommerce logistics provider SF Express in 2013.

Success in Chinese tech investing is set to become increasingly difficult as more capital pours into the sector.

“Fifteen billion dollars can seem like a droplet in China,” said Peter Fuhrman, chairman and chief executive of tech-focused investment banking group China First Capital, based in Shenzhen. “We’re all bobbing in an ocean of risk capital. Still, one can’t but wonder, given the quite so-so cash returns from China high-tech investing, if all this money will find investable opportunities, and if there weren’t more productive uses for at least some of all this bounty.”

CMG, however, has always set itself apart from the rest of the country’s state groups. It is unlike any other company under the control of the Chinese government as it was founded before the Chinese Communist party and is based in Hong Kong, outside mainland China. Recommended Banks China Merchants Bank accused of US discrimination

The business was launched in 1872 as China Merchants Steam Navigation Company, a logistics and shipping joint-stock company formed between Chinese merchants based in China’s bustling port cities and the Qing dynasty court.

Mirroring its New Era fund today, it was designed to compete for technology with foreign rivals. At that time it was focused on obtaining steam transport technology to “counter the inroads of western steam shipping in Chinese coastal trade”, according to research by University of Queensland professor Chi-Kong Lai.

Nearly a century later, after falling under the control of the Chinese government, CMG became the single most important company in the early development of the city of Shenzhen, China’s so-called “window to the world” as it opened to the west.

Then led by former intelligence officer and guerrilla soldier Yuan Geng, the company used its base in Hong Kong to attract some of the first investors from the British-controlled city into the small Chinese town of Shenzhen, which has since grown into one of the world’s largest manufacturing hubs.

Its work in opening China to global investment gained CMG and Yuan, who led the company until the early 1990s, status as leading figures in the country’s reform era.

Today the company is a sprawling state conglomerate with $1.1tn in assets and holdings in real estate, ports, shipping, banking, asset management, toll roads and even healthcare. The company has 46 ports in 18 countries, according to the state-run People’s Daily, with deals last year in the sector including the controversial takeover of the Hambantota terminal in Sri Lanka and the $924m acquisition of Brazilian operator TCP Participações.

CMG did not respond to requests for comment. But one person who has advised it on overseas investments said the Chinese government was using it in the same way the company opened up Shenzhen to the outside world, helping “unlock foreign markets”.

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In Today’s China, Paradoxes Still Abound. But So Do Opportunities — Site Selection Magazine

November 21st, 2017 No comments

 

In September, China First Capital Chairman and CEO Peter Fuhrman, familiar to attendees at the World Forum for FDI in Shanghai last year, delivered a talk from China to Harvard Business School alumni. Here, with Mr. Fuhrman’s permission, we present excerpts from his remarks.

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GDP growth has never and will never absolutely correlate with investment returns.

Any questions? No? Great. Thanks for your time.

Of course I’m joking. But that key reality of successful investing is all too often overlooked, and China has provided all of us over these last 30-some-odd years with a vivid reminder that IRR and GDP are by no means the same animal.

China is, was and will likely long remain a phenomenal economy. The growth that’s taken place here since I first set foot in China in 1981 has been something almost beyond human reckoning. Since I first came to China as a postgrad in 1981, per-capita GDP (PPP) has risen 43X, from $352 to $15,417. China achieved so much more than anyone dare hope, a billion people lifted out of poverty, freed to pursue their dreams, to make and spend a bundle.

China this year will add about $1 trillion of new GDP. Just to put that in context, $1 trillion is not a lot less than the entire GDP of Russia. So who is making all this newly minted money? And how can any of us hope to get a piece of it? Another question: Why, if China is such a great economy, has it proved such a disaster area for so many of the world’s largest, most sophisticated global institutional investors, private equity firms and Fortune 500s?

Turning Inward

Let’s start with the fact that China is a part of the World Trade Organization, but not entirely of it — not fully subscribed in any way to the notion that reciprocity, openness, free trade, level playing fields and equal treatment are positive ends unto themselves. As China has gotten richer it has seen even less and less need to attract foreign capital and foreign investment. That’s a tendency we see in other countries, including obviously some of the rhetoric we now hear in the U.S. — that more of the gains of the national economy should belong to its citizens. But China’s way is different.

The renminbi is a closed non-tradable currency, so getting US dollars into and out of China has always been difficult. China now has the world’s second-largest stock and bond markets, but those markets are largely closed to any investors other than Chinese domestic ones. But China also continues to provide companies going public with by far the highest multiples anywhere in the world.

When I first came to China 36 years ago China was a 100-percent state-owned economy. Twenty years ago the first rules were put in place to allow a private sector to function. Today, according to anyone’s best estimate, it’s about 70 percent private and 30 percent state, and most of the value creation is being provided by that private-sector economy. So in theory there should be very interesting M&A opportunities. But it’s been exceedingly difficult to get successful transactions done. One of the core reasons is that by and large all private-sector companies in China, large and small, are family-owned.

The other thing important to consider is a Mandarin term: guifan. It’s the Chinese way of explaining the extent to which a company in China is abiding by all the rules of the road — the taxes you should pay, the environmental and labor laws you should follow. It’s not at all uncommon that successful private-sector companies in China are successful by virtue of having negotiated to pay little or no corporate tax on profits.

For foreign-owned companies in China it’s an entirely different story. They are by and large 100-percent compliant with the written rules. This has an enormous impact on the operating performance of any company, so you can imagine how potentially skewed the competitive environment becomes. And keep in mind that corporate taxation in China in the aggregate is, if not the highest in the developed world, then among the highest, and the environmental and labor laws are every bit as difficult, rigorous, tough and expensive to implement as they are in the U.S.

China is a country where local government officials are scored on the measurable success of their time in office, and success is overwhelmingly attributed to GDP growth. So it should be no surprise if what they’re trying to do is optimize GDP growth, the percentage of a company’s income that goes back to the government in taxation can have an adverse effect on that. Instead the government will continue to urge its local companies to take the money and, rather than pay tax, continue to invest, expand and therefore build local GDP.

The Hum of Consumerism

The reasons to stay engaged and find a viable investment angle include GDP growth. China’s GDP is likely to continue to grow by at least 6 percent a year. Second, across my 25 years of involvement in China, every one of the predictions of imminent collapse — financial catastrophe, local government debt, bad bank loans, real estate bubbles — have proved to be false. It appears China has some resiliency, and it’s certainly the case that the government has the tools and financial resources to ride out most challenges.

Third has been how effortlessly it’s made the transition that still bedevils lots of Europe, from a smokestack economy to a consumer-spending paradise. At this moment every major consumer market in China is booming both online and offline. Alibaba, Baidu and Tencent are now operating as three of the most profitable companies in the world.

How does China have a robust, booming consumer economy and an enormous appetite for luxury brands, yet on average salary levels that are still one-fifth or one-sixth the levels in the US? The simple answer is that almost all the Chinese now living in urban China — about half the population, compared to about 15 percent when I first got here — owns at least a single apartment if not multiple, which is more and more common. The single best-performing asset in history has probably been Chinese urban real estate over the last 30 years. It’s fair to say the average appreciation over the last 10 years is at least 300 percent.

Though China has a population whose incomes on paper look like those of people flipping burgers at McDonald’s, they seem to have the spending power and love of luxury goods like the people summering in East Hampton. Even Apple itself has no idea how big its market is here in China. It’s likely that at least 100 million iPhone 8s will be sold to Chinese over the next year. The retail price here in China is at least 30 to 40 percent higher than in the US, with most phones bought for cash, without a carrier subsidy.

‘You’ll Be Older Too’

So where is it possible to make money in China? One message above all: Active investing beats passive investing every time. What you need to do is either be the owner-operator or be a close strategic partner with one, and stay actively engaged.

There are four major areas of opportunity: Tech, health-care services, leisure and education (see graphic below). The potential for building out a chronic care business in China is enormous. Looking ahead 25 to 30 years, sadly China will likely suffer a demographic disaster. This country will become a very old society very quickly. That’s the inevitable product of 30 years of a one-child-per-family policy. By 2040 or 2050, 25 percent of China will be over the age of 65.

The overall rate of GDP growth is unlikely to ever rival that of a few years ago at 10 to 12 percent a year, but overall what we have is higher-quality growth. People in China are living well. Things should continue to motor along very smoothly at least for one more generation — a generation whose members are better educated, more skilled, ambitious and globalized than their parents.

There’s no denying the reality of what a better, happier, freer, richer country China has become since I first set foot here. I marvel every day at the China that I now live in, even while I occasionally curse some of the unwanted byproducts like heavy pollution in most parts of the country, overcrowding at tourist attractions, bad traffic, and a pushy culture that’s lost touch with some of China’s ancient glories.

China will continue to amaze, inspire and stupefy the world. The Chinese have done very well and will do better. At the same time, those of us investing in China may do a little better in years to come than we have up to now. More of the newly minted trillions in China just may end up sticking to our palms.

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China Investing, The Pain and the Perks — Harvard Business School Global Alumni Lecture

October 10th, 2017 No comments

 

It was a delight and a privilege to give a talk on China investing to Harvard Business School’s global alumni organization. If you’d like to see the slide deck, please click here. The audio version of the lecture, done by worldwide webcast,  is also up on YouTube.

The topic was a big one — why have China investment returns so often failed to keep pace with the phenomenal growth in the country’s economy, and can investors do anything to improve the odds of success? Given an hour to discuss, I could only really scratch the surface.

A key takeaway: the past needn’t be prologue. Investing in China may prove less vexatious in the future. In part, that’s because of the growth of a mass affluent consumer market in China, a shift that plays to the strengths of many US, European and East Asian companies and institutional investors. Second, of course, everyone now can learn from past mistakes and misperceptions.

As I said in closing, “China will continue to amaze, inspire and stupefy the world. Chinese have done very well and will do better. At same time, those of us investing in China may do a little better here in years to come than we have up to now. More of the newly minted trillions in China just may end up sticking to our palms.”

 

 

 

Why Has China’s GDP So Outpaced IRR?

September 22nd, 2017 No comments

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

 

As published by China Money Network

As published by SuperReturn

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

 

 

 

China’s Wanda Group, Where to From Here — CNBC Interview

August 24th, 2017 No comments

 

 

 

 

 

 

 

 

 

Interviewed this morning on CNBC’s Squawk Box about Wanda and its new “asset light strategy”.

My conclusion: “Wanda just underwent the corporate version of emergency bariatric surgery. It’s suddenly become a much slimmed-down company. What Wanda is today, what it will become, we don’t yet know. But, it looking clear Wanda is no longer one of the heavyweights of China’s private sector. “

 

China’s New Plan for Silicon Valley Partnerships — Global Times

August 16th, 2017 No comments

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The once-sizzling romance between China and Silicon Valley has cooled rather dramatically. This has some potentially serious consequences for both sides, but especially for China, which desires to invest in and gain access to some of the hottest new ideas from this cradle of innovation. A new strategy is needed.

Until recently, Chinese investment funds and companies were investing hundreds of millions of dollars every year into promising Silicon Valley start-ups, as part of a strategy to forge closer ties between the US high-technology sector and the large Chinese market. But the flow of funds has largely dried up.

There are two main reasons. First, Chinese regulators imposed new restrictions on large overseas investments. Second, the US government began to take a less friendly attitude toward Chinese technology investment in the US, killing several proposed deals and holding up approval on many others.

There is every sign that things in the US are going to get more restrictive rather than less. As someone convinced of mutual benefits from Chinese investment in US technology, it all seems highly counterproductive. The world needs more deep and extensive ties between the Chinese and the US high-technology world, not just in start-up investing but also in university research and scientific conferences, shared research and development (R&D) labs, and partnerships among large companies working in hot fields like semiconductors, robotics, artificial intelligence and clean energy.

What can China do? Rather than sending money out, it can encourage more US high-technology start-ups to relocate to China. There is a huge amount to be gained, both for China’s continuing industrial upgrading and for innovative US technology companies looking to grow into giants.

China has in abundance the most vital ingredients for technology start-up success:  capital, a market and talented managers and engineers. In many industries, for example advanced manufacturing, robotics and new battery technologies, China often has more to offer technology companies than the US.

China already has lured a lot of Chinese-born scientists and technologists back from Silicon Valley to open start-ups. The next step is to lure some of the best early-stage US technology companies to China. This addresses a big weakness in the US high-technology scene: companies there tend to view the China market as an after-thought. In reality, it is often the market most worth prioritizing.

I’m seeing how well all this can work on the ground. We’re helping a promising US robotics company build its future in China. It is establishing a Chinese company as its main asset and moving some of its core team to China. It expects to add many more staff in China. The breakthrough product it’s now perfecting has a huge potential market in China’s manufacturing industry.

Originally, this company was aiming to find investors in China to help it grow in Ohio. We helped explain why bringing the company to China would make a lot more sense. The company is applying for R&D grants as well as venture capital in China. Within a 100-kilometer radius of its future base in Shenzhen, South China’s Guangdong Province is the largest concentration of potential customers and partners in the world.

We foresee big mutual gains if China can attract many more exciting early-stage technology companies. They  will create jobs, pay taxes and invest in local R&D. The benefits to China should be far larger than just buying some shares in a technology company based in Silicon Valley.

The objective isn’t to evade US rules but to bring start-ups early in their growth stage to the market where the demand is greatest. Technology companies do best when they sit close to the biggest concentration of customers.

The Chinese government has already said it wants to make the country more of a magnet for global technology talent. Shenzhen is a great city for US start-ups to grow big.

The steep drop in Chinese investment in Silicon Valley may actually prove a blessing in disguise. It’s smart to keep more of that capital at home to invest in great technology companies in China. Many US technology start-ups will achieve far more, and far more quickly, if they make China their future home.

The author is Chairman and CEO of China First Capital.

 

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http://www.globaltimes.cn/content/1061519.shtml

 

After Wanda Deal, Chinese Property Developer Faces Debt Risk — The New York Times

July 17th, 2017 No comments

A Dalian Wanda property in Nanchang, China.

BEIJING — The Chinese property developer Sunac China Holdings has turned into one of the country’s biggest white knights, swooping in to help troubled companies with too much debt. The risk: Sunac is amassing its own large pile of debt in the process.

Sunac has more than doubled its debt load in a year to $38 billion. Its deal this week to buy a portfolio of theme parks and hotels from the Dalian Wanda Group, the heavily indebted Chinese conglomerate, will add to the tab. At $9.3 billion, the acquisition is larger than the market value of Sunac.

“The problem for Sunac is twofold,” said Peter Fuhrman, chairman of China First Capital, an investment bank. “They themselves are already rather overleveraged and they are not paying distressed prices.”

Sunac is offering a much-needed lifeline.

For years, China fueled growth by providing easy credit. Chinese companies borrowed heavily, using the money to fund aggressive expansions.

As the economy now slows, companies are increasingly running into financial trouble, with some having to borrow even more to pay their debts. Policy makers are worried that the country’s Passover level of corporate debt could threaten the broader financial system.

Sunac, China’s seventh-largest property developer in terms of sales, has been able to tap into its financial strength to help companies under pressure. Since 2012, Sunac’s property sales have grown at double-digit rates nearly every year, giving it the firepower to scoop up assets and land plots.

Before the Wanda deal, Sunac in January pumped $2.2 billion into LeEco, a tech firm struggling to pay off its creditors. This May, it paid $1.5 billion for an 80 percent stake in Tianjin Xingyao, a property firm known for leaving its projects uncompleted.

In 2015, Sunac made a play to rescue Kaisa, pledging $1.2 billion to take over the troubled property company; it later pulled out after Kaisa did not meet certain conditions for the deal. That same year, it announced a partnership with the cash-poor Yurun Holding Group, which ran a business empire ranging from sausage making to property and finance.

It is a remarkable turnabout for the company’s founder, Sun Hongbin.

Mr. Sun started his career at the Lenovo Group, where he was promoted to run enterprise development. But he had a falling out with Liu Chuanzhi, the founder of Lenovo, over a business dispute. Related to the dispute, Mr. Sun was sentenced in 1992 to five years in jail for misappropriation of public funds.

After his release in 1994, he met with the founder of Lenovo and apologized, according to the website of The People’s Daily, the ruling Communist Party’s official newspaper. The Lenovo founder eventually lent Mr. Sun about $74,000, which he used to start a predecessor real estate firm to Sunac.

Lenovo did not immediately respond to a request for comment.

When Mr. Sun started Sunac in 2003, he focused on the cities of Wuxi and Chongqing and then moved on to China’s most developed cities, among them Beijing, Shanghai, Tianjin and Hangzhou, building apartments with names like Beijing Fontainebleau Chateau. Sunac built its residential projects in good locations near city centers and was aggressive in acquiring land plots — with higher debt.

 Sun Hongbin, the founder and chairman of Sunac China Holdings.

“People who have failed are those who have been defeated by themselves,” Mr. Sun told a newspaper, China Business News, in 2013. “But I often tell others: After you fail, you can start again.”

With the Wanda deal, Sunac is extending its reach into tourism, paying $9.3 billion for 76 hotels and a major chunk of its 13 tourism projects, in the country’s largest property acquisition ever. The purchase will help Sunac diversify its business, which is hurting from government restrictions on home sales as Beijing seeks to cool a frothy property market. It also strengthens the company’s hand in an industry dominated by bigwigs like the China Vanke Group and Country Garden.

“Within the housing industry, the powerhouses are really strong,” said Lu Wenxi, an analyst for Centaline Properties who is based in Shanghai. “If you don’t gobble up the fat ones, it is easy to be eaten up by others. Taking on more projects will prevent you from being eaten.”

Investors have rewarded Sunac for the deal. Shares of Sunac rose 14 percent in Hong Kong on Tuesday after they resumed trading after the deal announcement.

But the deal will add to an already significant debt load. In 2016, the company’s net gearing ratio — a measure of total debt to shareholders’ equity — rose to 121.5 percent, from to 75.9 percent in 2015. Fitch Ratings recently downgraded the company’s credit rating to BB-, saying Sunac’s acquisitive approach had made its financial profile “more volatile.”

Wanda is helping finance the acquisition. Sunac, in a statement to the Hong Kong Stock Exchange on Monday, said Wanda would procure a loan for the company worth about $4.4 billion.

Seller financing is not uncommon, both in China and the West. But Wanda’s role means that Sunac doesn’t have all the money upfront.

“In my experience, I’ve never seen it anywhere,” said Lester Ross, a Beijing-based partner with the law firm WilmerHale, who has advised deals in China for the last 20 years. “No client that I represent would accept a deal like that where you’re responsible for raising the money to pay for somebody else.”

Sunac did not return multiple calls for comment. The company said in a statement to the Hong Kong Stock Exchange on Tuesday that the deal with Wanda “will add a large number of prime land reserves and property assets for the company at a reasonable cost.”

The LeEco deal is also prompting concern.

Sunac invested $2.2 billion in LeEco, buying minority stakes in three of the conglomerate’s more stable businesses, including the smart TV affiliate Leshi Zhixin, Le Vision Pictures, and Leshi Internet. The two companies don’t have many overlapping interests, and LeEco’s finances have continued to sour. Before the Wanda deal, shares of Sunac were falling on fears that LeEco’s problems would spread.

In a January news conference, Mr. Sun said many people had tried to dissuade him from investing in LeEco, adding that several were “resolutely opposed” to it.

“I seriously considered their views, but I don’t think their opinions are sufficient to change my mind,” he said.

Article as published in the New York Times

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China’s Healthcare Sector a Big Draw for Private Equity Investors — South China Morning Post

January 19th, 2017 No comments

 

China’s healthcare sector a big draw for private equity investors

 
PUBLISHED : Wednesday, 18 January, 2017

Private equity firms and hedge funds are investing heavily into China’s healthcare industry in a bet on the sector’s upbeat growth potential, fund managers told a Hong Kong forum.

Private hospitals and drug makers are among the bright spots for investors focusing on China, where rising income and an ageing population are boosting the demand for quality medical services.

Private hospitals are set to attract large amounts of capital in the coming decade amid an underdeveloped private medical industry and a shortage of doctors, said investment professionals.

“Healthcare has been the single area that probably everyone can foresee globally an enormous amount of capital and investment,” Peter Fuhrman, chairman of China First Capital told the Asia Private Equity Forum in Hong Kong on Wednesday.

China’s population of individuals aged 60 or older is set to rise 90 per cent to 240 million by 2020, according to the World Health Organisation.

Meanwhile, one consequence of the nation’s one-child policy, introduced in 1979 and officially phased out in 2015, is that the burden of caring for ageing parents will put tremendous pressures on the young generations.

The healthcare sector in China will become a US$1 trillion a year business by 2020, according to a report by consulting firm McKinsey & Company.

Among healthcare institutions, private hospitals are set to become the best investment for this sector, said Li Bin, chief executive of Ally Bridge LB Healthcare Fund, a hedge fund that focuses on investing in China and Asia healthcare companies.

However, he said there are problems that will likely hinder the industry’s growth.

Among barriers, Li cited a shortage of quality doctors, the lack of an ecosystem to support the development of private hospitals, as well as the long time frame needed to build up a trusted reputation.

Although about half of the hospitals in the country are private, more than 80 per cent of medical professionals work in the public sector, which offer higher salaries and better career prospects, according to a recent report by Citi.

“Five years ago I said it would take 10 years for private hospitals to mature in China, now I think it would take another 10 years,” he said.

Alice Au Miu Hing from SpencerStuart, an executive search consultancy, said it remains extremely difficult to find experienced private hospital executives with China experience who can speak Putonghua.

“The common approach now is to bring someone from the industry from outside and see if the person can survive in the mainland market,” said Au.

Meanwhile, pharmaceutical and biotech start-ups will flourish with China’s emerging middle class seeking better healthcare services.

Judith Li, partner at the life science-focused Lilly Asia Ventures, told the forum that China spends about 6 per cent of its GDP on healthcare, versus an Organization for Economic Cooperation and Development average of 10 per cent.

“China has so many white spaces where there is nothing exists, and it’s very compelling,” she said.

“If you can bring it [a drug] from the US, you can then avoid the fundamental scientific risk of developing something that’s completely unavailable.”

http://www.scmp.com/business/article/2063273/chinas-healthcare-sector-big-draw-private-equity-investors

CICC eyes return to greatness — IFR Asia

November 23rd, 2016 No comments

 

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China International Capital Corp has unveiled its much-anticipated acquisition of unlisted China Investment Securities, in a move that may see the PRC’s oldest investment bank regain the top spot in the country’s securities industry.

CICC said on November 4 it planned to acquire 100% of Shenzhen-based CIS for Rmb16.7bn (US$2.47bn) through the issuance of 1.68bn domestic shares to current owner Central Huijin Investment at Rmb9.95 each. The issuance price represents a discount of 0.6% to CICC’s closing prior to the announcement of the proposed acquisition.

The move marks a significant shift in strategy for CICC, which has long flirted with the idea of setting up a retail brokerage unit as its share of business has dwindled, but has so far remained wedded to its institutional clients.

“If you look at CICC’s business model, it has a very strong institutional focus, but we all know China’s capital markets are primarily driven by retail investors,” said Benjamin Quinlan, chief executive officer and managing partner at Quinlan & Associates. “CIS has a strong retail franchise, so it seems to complement CICC’s existing business quite well.”

CICC made its reputation bringing some of China’s biggest state-owned enterprises and red chips to the equity and debt markets. This included the US$21.9bn IPO of Industrial and Commercial Bank of China in 2006 and the US$22bn IPO of Agricultural Bank of China four years later.

After being ranked the number one brokerage firm in China in 2010, it fell to number 23 last year, according to Securities Association of China data, as the flow of giant SOE listings dried up and other Chinese securities firms expanded rapidly, using their stronger capital bases and wider branch networks to build intermediary businesses, especially around margin trading.

Bi Mingjian, appointed CEO of CICC last December, has made expanding the bank’s brokerage and asset management units a key part of his overall strategy and has sought to reduce reliance on institutional and wealthy clients.

CICC has only 20 branches in the PRC versus the 200 of CIS, according to its website. CICC’s small retail footprint has affected its earning capacity from retail investors, who account for most of the trading in the onshore capital markets.

“CICC was originally founded to be China’s one ready-for-Wall Street, global investment bank, but that strategy is no longer perfectly aligned with the profits and priorities of China’s banking industry,” said Peter Fuhrman, chairman and CEO at China First Capital.

“Instead of trying to compete with Goldman Sachs and Morgan Stanley, CICC will now be matched against a group of domestic competitors. This is ideal as investment banking fees within China, both for IPOs and the secondary market, are high and not that troublesome to earn.”

ADVISORY BUSINESS

Most analysts consider the acquisition, at around 1.1 times forward book value, as good value and a good strategic fit that should help propel CICC up the league tables.

“If you aggregate the market share of both firms across the equity and debt capital markets and M&A advisory, the combined entity could come out as number one in all three rankings,” said Quinlan.

“This might not be the case, but we expect CICC to be at least a top-five player in ECM and DCM, following the acquisition, and most probably top three for M&A advisory.”

The proposed acquisition will boost CICC’s balance sheet. CICC ranked 24 in terms of total assets in 2015 with Rmb63bn, while CIS was 18th with Rmb92bn. Their ranking would advance to 13 after the integration, still far short of the industry leader Citic Securities with total assets of Rmb484bn.

CICC ranked 23 among China’s 125 securities firms in 2015 in revenue terms, while CIS ranked 17, according to the Securities Association of China.

Some questions have been raised about the potential cultural mismatch between the two firms and there have also been suggestions that the Chinese government may be directing the acquisition as it seeks to improve the sector’s reputation for probity.

China’s securities sector has expanded at a considerable pace in the last few years with the combined asset base of the 125 securities companies operating there increasing fourfold between 2011 and 2015 to Rmb6.4trn and there are few signs that the pace of growth is likely to abate.

“It could be a win-win situation for the two firms, because their business models are very complementary,” said an analyst.

“However, it is also a big challenge for CICC on whether it can generate the synergies it expects, by applying its strengths in high-end services to the huge customer base and network of CIS,” said the analyst.

Following the acquisition, CIS will become a wholly owned subsidiary of CICC, while Huijin’s stake in CICC will increase to 58.7% from 28.6%.

CICC and ABC International are financial advisers for the transaction. The deal requires approval from shareholders and regulators.

 

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The Big Sort — The Economist

November 11th, 2016 No comments

 

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“THE vultures all start circling, they’re whispering, ‘You’re out of time’…but I still rise!” Those lyrics, from a song by Katy Perry, an American pop star, sounded often at Hillary Clinton’s campaign rallies but will shortly ring out over a less serious event: a late-night party in Shenzhen to kick off “Singles’ Day”, an online shopping extravaganza that takes place in China on November 11th every year.

The event was not dreamt up by Alibaba, but the e-commerce giant dominates it. Shoppers spent $14.3bn through its portals during last year’s event. That figure, a rise of 60% on a year earlier, was over double the sales racked up on America’s two main retail dates, Black Friday and Cyber Monday, put together. Chinese consumers are still confident, so sales on this Singles’ Day should again break records.

It points to an intriguing question: how will all of those purchases get to consumers? Around 540m delivery orders were generated during the 24-hour spree last year. That is nearly ten times the average daily volume, but even a slow shopping day in China generates an enormous number. By the reckoning of the State Post Bureau, 21bn parcels were delivered during the first three quarters of this year.

The country’s express-delivery sector, accordingly, is doing well. In spite of a cooling economy, revenues rose by 43% year on year in the first eight months of 2016, to 234bn yuan ($36bn). And although the state’s grip on China’s economy is tightening, the private sector’s share of this market is actually growing. The state-run postal carrier once had a monopoly on all post and parcels. Now far more parcels are delivered than letters, and the share of the market that is commanded by the country’s private express-delivery firms far exceeds that of Express Mail Service, the state-owned courier.

China’s very biggest couriers have been rushing to go public on the back of the strong growth. Most of them started life as scrappy startups, and are privately held. But because of regulatory delays, which mean a big backlog of initial public offerings, many companies have resorted to other means. Last month, two of them, YTO Express and STO Express, used “reverse mergers”, in which a private company goes public by combining with a listed shell company, to list on local exchanges. In what looks to be the largest public flotation in America so far this year, another, ZTO Express, raised $1.4bn in New York on October 27th. Yet another, SF Express, China’s biggest courier, recently won approval to use a reverse merger too.

But investors could be in for a rocky ride. Shares in ZTO, for example, have plunged sharply since its flotation. That is because the breakneck growth of courier companies masks structural problems. For now, the industry is highly fragmented, with some 8,000 domestic competitors, and it is inefficient.

One reason is that regulation, inspired by a sort of regional protectionism, obliges delivery firms to maintain multiple local licences and offices. Cargoes are unpacked and repacked numerous times as they cross the country to satisfy local regulations. Firms therefore find it hard to build up national networks with scale and pricing power. All the competition has led to prices falling by over a third since 2011. The average freight rate for two-day ground delivery between distant cities in America is roughly $15 per kg, whereas in China it is a measly 60 cents, according to research by Peter Fuhrman of China First Capital, an advisory firm.

A handful of the biggest companies now aim to modernise the industry. Some are spending on advanced technology: SF Express’s new package-handling hub in Shanghai is thought to have greatly increased efficiency by replacing labour with expensive European sorting equipment. A semi-automated warehouse in nearby Suzhou run by Alog, a smaller courier in which Alibaba has a stake, seems behind by comparison but in fact Alog is a partner in Alibaba’s logistics coalition, which is known as Cainiao. The e-commerce firm has helped member companies to co-ordinate routes and to improve efficiency through big data.

Other investments are also under way. Yu Weijiao, the chairman of YTO, recalls visiting FedEx, a giant American courier, in Memphis at its so-called “aerotropolis” (an urban centre around an airport) in 2007. He was awed by the firm’s embrace of advanced technology. He returned to China and sought advice from IBM on how his company could follow suit. YTO is using the proceeds of its recent reverse merger to expand its fleet of aircraft, buy automatic parcel-sorting kit and introduce heavy-logistics capabilities for packages over 50kg.

There is as yet little sign that China’s regions will begin allowing packages to move freely, so regulation will remain a brake on the industry. More ominously, labour costs are rising. There are fewer migrant labourers today who are willing to work for a pittance delivering parcels. This week China Daily, a state-owned newspaper, reported that ahead of Singles’ Day, courier firms were offering salaries on the level of university graduates.

http://www.economist.com/news/business/21710004-chinas-express-delivery-sector-needs-consolidation-and-modernisation-big-sort

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ZTO Spurns Huge China Valuations For Benefits of U.S. Listing — Reuters

October 21st, 2016 No comments

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By Elzio Barreto and Julie Zhu | HONG KONG

Chinese logistics company ZTO Express is turning up the chance of a much more lucrative share listing at home in favor of an overseas IPO that lets its founder retain control and its investors cash out more easily.

To steal a march on its rivals in the world’s largest express delivery market, it is taking the quicker U.S. route to raise $1.3 billion for new warehouses and long-haul trucks to ride breakneck growth fueled by China’s e-commerce boom.

Its competitors SF Express, YTO Express, STO Express and Yunda Express all unveiled plans several months ago for backdoor listings in Shenzhen and Shanghai, but ZTO’s head start could prove crucial, analysts and investors said.

“ZTO will have a clear, certain route to raise additional capital via U.S. markets, which their competitors, assuming they all end up quoted in China, will not,” said Peter Fuhrman, CEO of China-focused investment bank China First Capital.

With a backlog of about 800 companies waiting for approval to go public in China and frequent changes to the listing rules by regulators, a New York listing is generally a quicker and more predictable way of raising funds and taps a broader mix of investors, bankers and investors said.

“ZTO will have a built-in long-term competitive advantage – more reliable access to equity capital,” Fuhrman added.

U.S. rules that allow founder Meisong Lai to retain control over the company and make it easier for ZTO’s private equity investors to sell their shares were some of the main reasons to go for an overseas listing, according to four people close to the company. U.S. markets allow a dual-class share structure that will give Lai 80 percent voting power in the company, even though he will only hold 28 percent of the stock after the IPO.

Most of Lai’s shares are Class B ordinary shares carrying 10 votes, while Class A shares, including the new U.S. shares, have one vote. China’s markets do not allow shares with different voting power.

ZTO’s existing shareholders, including private equity firms Warburg Pincus, Hillhouse Capital and venture capital firm Sequoia Capital will also get much more leeway and flexibility to exit their investment under U.S. market rules. In China, they would be locked in for one to three years after the IPO.

As concerns grow about a weakening Chinese currency, the New York IPO also gives it more stable dollar-denominated shares it can use for international acquisitions, the people close to the company said.

IN DEMAND

Demand for the IPO, the biggest by a Chinese company in the United States since e-commerce giant Alibaba Group’s $25 billion record in 2014, already exceeds the shares on offer multiple times, two of the people said.

That underscores the appeal of the fast-growing company to global investors, despite a valuation that places it above household names United Parcel Service Inc and FedEx Corp.

The shares will be priced on Oct. 26 and start trading the following day.

ZTO is selling 72.1 million new American Depositary Shares (ADS), equivalent to about 10 percent of its outstanding stock, in the range $16.50 to $18.50 each. The range is equal to 23.4-26.3 times its expected 2017 earnings per share, according to people familiar with the matter.

By comparison, Chinese rivals SF Express, YTO Express, STO Express and Yunda shares trade between 43 and 106 times earnings, according to Haitong Securities estimates.

UPS and FedEx, which are growing at a much slower pace, trade at multiples of 17.8 and 13.4 times.

“The A-share market (in China) does give you a higher valuation, but the U.S. market can help improve your transparency and corporate governance,” said one of the people close to ZTO. “Becoming a New York-listed company will also benefit the company in the long-term if it plans to conduct M&A overseas and seek more capital from the international market.”

China’s express delivery firms handled 20.7 billion parcels in 2015, shifting 1.5 times the volume in the United States, according to consulting firm iResearch data cited in the ZTO prospectus.

The market will grow an average 23.7 percent a year through 2020 and reach 60 billion parcels, iResearch forecasts.

Domestic rivals STO Express and YTO Express have unveiled plans to go public with reverse takeovers worth $2.5 billion and $2.6 billion, while the country’s biggest player, SF Express, is working on a $6.4 billion deal and Yunda Express on a $2.7 billion listing.

ZTO plans to use $720 million of the IPO proceeds to purchase land and invest in new facilities to expand its packaged sorting capacity, according to the listing prospectus.

The rest will be used to expand its truck fleet, invest in new technology and for potential acquisitions.

“It’s a competitive industry and you do need fresh capital for your expansion, in particular when all your rivals are doing so or plan to do so,” said one of the people close to the company.

 

http://www.reuters.com/article/us-zto-express-ipo-idUSKCN12L0QH

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Fresh Ideas For Making Money in China Private Equity and Venture Capital

September 21st, 2016 No comments

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2016 is looking like it may be another year to forget for PE and VC in China.  The problem, as always, is with exits. For years, IPOs in China for PE-backed deals have been too few and far between.  There was initially a lot of  hope for improvement this year. But, prospects unexpectedly turned bleak when the Chinese securities regulator, the CSRC, suddenly reversed course. Not only did they put on hold previously-announced plans to liberalize IPOs by opening a new “strategic board” in Shanghai and to shift to a registration-based IPO system, they also began clamping down hard on the two main exit alternatives, backdoor shell listings and trade sales to Chinese listed companies.

IPO multiples remain sky-high in China. The IPO queue sits at 830 companies, with at least another 700 now lined up to get provincial approval to join the main waiting list. The CSRC did finally announce one liberalization of the IPO regime in China, but it will likely be of little help to the hundreds of PE and VC firms with thousands of unexited deals. Companies based in China’s poorest, most backward areas, the CSRC announced earlier this month, will now get to jump to the head of the queue.

Not for the first time, it looks like PE and VC portfolios may be mismatched with IPO regulatory policy in China. PE and VC firms have of late invested overwhelmingly in two areas. First is healthcare. The industry in China is growing and reforming. But, entry valuations have been bid up to astronomical levels.

In terms of number of deals closed, Chinese tech startups are getting the lion’s share of the attention. China’s online and smartphone population as well as e-commerce industry, after all, are the world’s largest. What’s missing at most of the funded startups are profits or a high-probability path to making money one day soon. Many are using PE money as part of a “last man standing” strategy to win customers by subsidizing purchases. Loss-making companies are still barred from having an IPO in China.

The main building blocks of China’s corporate sector, manufacturing companies and bricks-and-mortar businesses, are both highly out of favor with PE firms.

Amid so much misfortune, where should the PE and VC industry look next to invest profitably in China? What seems most clear is that any strategy linked to short-term IPO exit-chasing, or seeking to intuit the next flux in CSRC policy, has proved fundamentally risky. Some fresh approaches may be in order.

One priority should be on backing companies that can deliver sustainably high margins and positive cash flow over time to support regular dividend payments. Invest more for yield and less for capital gains.

There are such investment opportunities in China. I want to share six here. There are certainly many others. Looking outside the current China PE investment mainstream has other pluses. A troubling term has entered the Chinese financial vocabulary in the last two years, called “2VC”. It means a Chinese company started and run primarily for the purpose of attracting PE and VC money and less about making money from customers. 2VC deserves a detailed analysis of its own, how much it may be warping the investment landscape in China.

GPs and LPs looking for durable margins, scaleability, and a dearth of competition in China could start their search here:

  1. Robotics gearbox. China’s robot industry is hot. By now, about everyone has read the stories suggesting China’s robotics market, already the largest in the world, will boom for decades to come. For now, the investment money in China has gone overwhelmingly into companies that are making simple robots, rather than the robot industry supply chain. This overlooks perhaps the best opportunity of all. Robots rely on sophisticated gearboxes to make parts move. Making and selling gearboxes, rather than the final robot, is where the big margins and demand are. The technology has been around for a while, but the industry is dominated by two big foreign manufacturers, ABB of Switzerland and Rexnord of the US. They make a ton doing it. A Chinese robotics gearbox maker, assuming they get the product right, could immediately roll up sales in the hundreds of millions of dollars, both to Chinese robot makers as well as US, European and Japanese ones. From conversations I’ve had with C Level execs at both ABB and Rexnord, this is the Chinese competition they fear most, but which to their surprise has yet to materialize.  —————————————————————————–
  2. Hospice and specialized late stage care. PE investment in healthcare, especially into biosimilar pharma companies, hospitals and clinics for plastic surgery and dental care has been abundant, averaging well over a billion dollars a year in China. Competition is rampant in all these areas. Late stage critical care, however, has largely gone unfunded. The unmet need in China is almost unfathomably large. There are basically no hospices in China, though some 10 million Chinese die every year, including a surging number from cancers and long-term chronic diseases. There are also 30 million Chinese with Alzheimers and virtually no places offering specialized care. The number of Alzheimers sufferers is rising fast as Chinese longevity surges. Make no mistake, it’s harder to provide this kind of medical care than to do Botox injections. But, anywhere money is easily made in China, it’s getting harder to make any money at all. The biggest provider of specialized high-end late stage care in China is the French company, Orpea. They are doing a great job. I’ve had a close look at their business in China. They too are awed by the scale of the untapped market in China. A big plus: pricing freedom. The business doesn’t rely, as most conventional hospitals and drug companies in China do, on state reimbursement. —————————————————————————————————————————
  3. Dog food and other pet items. When I first came to China in 1981, it was basically illegal to keep a dog or cat as a pet. There was barely enough food to feed the human population and food was rationed. To say the growth in pet ownership since then has been explosive would risk understating things. China is now the third largest dog-owning market globally, with 27.4 million dogs (behind the US with 55.3 million dogs and Brazil with 35.7 million), and the second largest cat-owning country with 58.1 million cats, behind only the US with 80.6 million. China’s pet market will soon blow past that of the US. Everywhere this is presenting great opportunities in pet care, pet food, pet hotels. The US pet food giant Mars has a large chunk of the dog food market here. But, there are still many opportunities to carve out a niche in pet food, both via sales at veterinary clinics and online. The other vast uncharted market: pet insurance.   ——————————————————————————————–
  4. Server storage. Chinese law mandates that the country now has and will continue to have the largest ongoing demand for high-end servers, as well as the software that powers them. The reason: all the major sources of online traffic — Alibaba, Tencent, JD.com, Baidu — must permanently store virtually everything that runs across their network. In the case of Tencent’s Wechat business, that means keeping billions of text, audio, video and photo messages generated every day by its 600 million users. Tencent’s ongoing investment in servers is almost certainly larger than any other company in the world, with the other big Chinese internet companies following closely behind. The growth rate is dizzying. This has created a wonderful profit-center for otherwise troubled chip giant Intel. Its Xeon chips power virtually all high-end servers. No single domestic company has yet emerged to build a sizeable business in storage software, maintenance and integration tailored to the regulatory needs in China. In parallel, there’s also a large market for similar made-at-home software solutions to sell to the Chinese government. They are the reason all this server storage demand exists.   ————————————————————————————————————————————————
  5. Mall-based attractions. Shopping malls in China are in a fight for survival. Clothing retailers, which just two to three years ago took at least half the floor space in Chinese malls, are disappearing. They can’t compete with online merchants offering the same products for one-third to one-half less. The going has proved especially hard for Chinese domestic retail brands, quite a few got PE money back when this sector was hot. Chinese malls need to change, and fast. Their main strategy so far is increasing the floor space allocated to restaurants and movie theaters. Another area with huge potential, but so far little concrete activity, is “edu-tainment” attractions. A prime example is a mall-based aquarium. I was recently shown around one-such mall aquarium in a major Chinese city by its owners, a large Chinese real estate developer. Though they initially knew nothing about aquariums, their design and selection of fish are mediocre, the owner is coining money with over 45% margins. Tickets sell days in advance, not just on weekends, for average of $15 for adults and less for kids. It’s been open and thriving for three years. Every mall they are building now will have a similar attraction. A better operator should be able to push margins higher and roll out nationwide. On average, 55 million Chinese go to the mall each week. —————————————————————————–
  6. Indoor LED vegetable growing.  China has a big appetite for vegetables, about 100 kilos per person per year, or seventy billion tons. Many Chinese, especially the 55% living in cities, have concerns about where and how the vegetables are grown and how they get to market. The worry rises in lock step with per capita income.  Catering to worried Chinese consumers could keep a company in profit for decades. One good idea that’s not yet in China but should be: growing vegetables indoors, using LED lights.The cost of LED lighting has fallen by over 90% since 2010 and will continue to decline, thanks in large part to over-investment in this sector in China. LED efficiency has also nearly doubled over that time. It now costs about the same to grow vegetables indoors with LEDs as it does in well-irrigated farmland. Supplying vegetables to urban China this way has a lot of other advantages, including the ability to provide a secure chain of custody, from the place where the food is picked all the way to the customer’s hands. Lots of models would work in China — large growing areas inside abandoned urban factories to supply better Chinese supermarket chains like Walmart, Carrefour and China Resources, or smaller-scale packages home-delivered or sold through vending machines placed inside high-end residential complexes in China. Organic or non-organic, catering to Chinese picky consumers could keep a company in profit for decades.

 

Since PE first took off in China in 2005,  China’s economy has grown by almost four-fold. Few GPs in China have done as well in DPI terms. It’s likely not going to get any easier to make or raise money, nor to rack up IPO exits. More than ever, PE firms need to back or incubate ideas to catch and hold some of the new wealth that’s getting created every day in China.

As published by SuperReturn

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Chinese Firms Are Reinventing Private Equity — Nikkei Asian Review

July 27th, 2016 No comments

 

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July 26, 2016  Commentary

Chinese firms are reinventing private equity

Henry Kravis, his cousin George Roberts and his mentor Jerry Kohlberg are generally credited with having invented private equity buyouts after forming KKR 40 years ago. Even after other firms like Blackstone and Carlyle piled in and deals reached mammoth scale, the rules of the buyout game changed little: Select an underperforming company, buy it with lots of borrowed money, cut costs and kick it into shape, then sell out at a big markup, either in an initial public offering or to a strategic buyer.

This has proved a lucrative business that lots of small private equity firms worldwide have sought to copy. China’s domestic buyout funds, however, are trying to reinvent the PE buyout in ways that Kravis would barely recognize. Instead of using fancy financial engineering, leverage and tight operational efficiencies to earn a return, the Chinese firms are counting on Chinese consumers to turn their buyout deals into moneymakers.

Compared to KKR and other global giants, Chinese buyout firms are tiny, new to the game and little known inside China or out. Firms such as AGIC, Golden Brick, PAG, JAC and Hua Capital have billions of dollars at their disposal to buy international companies. Within the last year, these five have successfully led deals to acquire large technology and computer hardware companies in the U.S. and Europe, including the makers of Lexmark printers, OmniVision semiconductors and the Opera web browser.

So what’s up here? The Chinese government is urgently seeking to upgrade the country’s manufacturing and technology base. The goal is to sustain manufacturing profits as domestic costs rise and sales slow worldwide for made-in-China industrial products. The government is pouring money into supporting more research and development. It is also spreading its bets by providing encouragement and sometimes cash to Chinese investment companies to buy U.S. and European companies with global brands and valuable intellectual property.

While the hope is that acquired companies will help China move out of the basement of the global supply chain, the buyout funds have a more immediate goal in sight, namely a huge expansion of the acquired companies’ sales within China.

This is where the Chinese buyout firms differ so fundamentally from their global counterparts. They aren’t focusing much on streamlining acquired operations, shaving costs and improving margins. Instead, they plan to leave things more or less unchanged at each target company’s headquarters while seeking to bolt on a major new source of revenues that was either ignored or poorly managed.

So for example, now that the Lexmark printer business is Chinese-owned, the plan will be to push growth in China and capture market share from domestic manufacturers that lack a well-known global brand and proprietary technologies. With OmniVision Technologies, the plan will be to aggressively build sales to China’s domestic mobile phone producers such as Huawei Technologies, Oppo Electronics and Xiaomi.

The China Android phone market is the biggest in the world.  Omnivision used to be the main supplier of mobile phone camera sensor chips to the Apple iPhone, but lost much of the business to Sony.

In launching last year the $1.8bn takeover of then then Nasdaq-quoted Omnivision, Hua Capital took on significant and unhedgeable risk. The deal needed the approval of the US Committee for Foreign Investment in the United States, also known as CFIUS. This somewhat-shadowy interagency body vets foreign takeovers of US companies to decide if US national security might be compromised. CFIUS has occasionally blocked deals by Chinese acquirers where the target had patents and other know-how that might potentially have non-civilian applications.

CFIUS also arrogates to itself approval rights over takeovers by Chinese companies of non-US businesses, if the target has some presence in the US. It used this justification to block the $2.8 billion takeover by Chinese buyout fund GO Scale Capital of 80% of the LED business of Netherlands-based Philips. CFIUS acted almost a year after GO Scale and Philips first agreed to the deal. All the time and money spent by GO Scale with US and Dutch lawyers, consultants and accountants to conclude the deal went down the drain. CFIUS rulings cannot be readily appealed.

Worrying about CFIUS approval isn’t something KKR or Blackstone need do, but it’s a core part of the workload at Chinese buyout funds. Hua Capital ultimately got the okay to buy Omnivision five months after announcing the deal to the US stock exchange.

The Chinese buyout firms see their role as encouraging and assisting acquired companies to build their business in China. This often boils down to business development and market access consulting. Global buyout firms say they also do some similar work on behalf of acquired companies, but it is never their primary strategy for making a buyout financially successful.

Chinese buyout funds count on two things happening to make a decent return on their overseas deals. First is a boost in revenues and profits from China. Second, the funds have to sell down their stake for a higher price than they paid. The favored route on paper has been to seek an IPO in China where valuations can be the highest in the world. This path always had its complications since it generally required a minimum three-year waiting period before submitting an application to join what is now a 900-company-long IPO waiting list.

The IPO route has gotten far more difficult this year. The Chinese government delivered a one-two punch, first scrapping its previous plan to open a new stock exchange board in Shanghai for Chinese-owned international companies, then moving to shut down backdoor market listings through reverse mergers.

The main hope for buyout funds seeking deal exits now is to sell to Chinese listed companies. In some cases, the buyout funds have enlisted such companies from the start as minority partners in their company takeovers. This isn’t a deal structure one commonly runs across outside China, but may prove a brilliant strategy to prepare for eventual exits.

There is one other important way in which the new Chinese buyout funds differ from their global peers. They don’t know the meaning of the term “hostile takeover.” Chinese buyout funds seek to position themselves as loyal friends and generous partners of a business’s current owners. A lot of sellers, especially among family-controlled companies in Europe, say they prefer to sell to a gentle pair of hands — someone who promises to build on rather than gut what they have put together. Chinese buyout funds sing precisely this soothing tune, opening up some deal-making opportunities that may be closed to KKR, Blackstone, Carlyle and other global buyout giants.

The global firms are also finding it harder to compete with Chinese buyout funds for deals within China, even though they have raised more than $10 billion in new funds over the last six years to put into investments in the country. They have basically been shut out of the game lately because they can’t and won’t bid up valuations to the levels to which domestic funds are willing to go.

The global buyout giants won’t be too concerned that they face an existential threat from their new Chinese competitors. It is also unlikely that they will adopt similar deal strategies. Instead, they are getting busy now prettying up companies they have previously bought in the U.S. and Europe. They will hope to sell some to Chinese buyers. Along with offering genial negotiations and a big potential market in China, the Chinese buyout funds are also gaining renown for paying large premiums on every deal. No one ever said that about Henry Kravis.

Peter Fuhrman is the founder, chairman and CEO of China First Capital, an investment bank based in Shenzhen.

Abridged version as published in Nikkei Asian Review

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The Secret to Alibaba’s Success: Dirt Cheap Third-Party Shipping — Nikkei Asian Review

July 6th, 2016 No comments

 

Nikkei 1

ZTO

Procter & Gamble’s staple brands – Crest, Tide, Head & Shoulders, Pantene, Pampers — dominate the mass-market premium segment in China just as they do in the US. Buy them at the local Walmart supermarket in China, and just about everything costs more, in dollar terms, than it does at Walmart in the US. Shop online, though, and China wins hands down the P&G low-price battle.

Alibabas Taobao marketplace deserves part of the credit. Its 10 million merchants, most of whom are small traders with their own limited inventory, offer things at prices well-below those at brick-and-mortar shops. But, the biggest savings comes from ridiculously low overnight shipping costs in China. Alibaba doesn’t directly arrange shipping for Taobao merchants. It’s up to each seller to sort things out with one of the country’s big nationwide private courier companies.

There are four giants, market leader Shunfeng and three almost identically named firms, YTO, STO and ZTO. Those three were started and are owned by entrepreneurs from the same small county in Zhejiang, called Tonglu, about 50 miles from. Alibaba’s headquarters in Hangzhou.

So, just how cheap is online shopping for P&G products in China? I ran out of detergent and for the first time decided to buy it on Taobao. I was thinking I might save some money. But, the bigger benefit is not having to shlep the three kilo sack of Tide powder from the supermarket, where it sells for around Rmb 50.

On Taobao, I paid Rmb 20.90, or $3.18, for three kilos of Tide and two-day express ground shipping from Shijiazhuang, a city 1,200 miles away from me in Shenzhen. The same weight of Tide bought online in the US from the cheapest eBay seller and ground-shipped the same distance and time by Fedex would cost $53, at a minimum. Of that, at least $35 goes to shipping.

Yes, Chinese labor costs are much less. But, gasoline costs twice as much in China as the US and highway tolls are exorbitant in China, as much as 60 cents for every mile a truck travels. I bought the bag of Tide on Taobao half-thinking I’d never receive anything. But, the parcel showed up intact and on time. Who, if anyone, made any money on this?

Even if the Tide detergent is completely phony — Taobao does have a reputation for selling lots of counterfeit merchandise — the shipping costs can’t be faked. My detergent was shipped and delivered by ZTO. By some counts, it is now moved ahead of Shunfeng in volume, if not revenue. At year-end last year ZTO was said to be delivering 10 million parcels a day. ZTO is mainly a network of independent local franchisees, with the ZTO parent owning and operating the main warehouses. ZTO is planning to IPO sometime soon in Hong Kong. Warburg Pincus and Sequoia Capital are both investors.

The other three big courier companies are also well along in their IPO planning. Each is saying they need billions in new capital. They can’t be earning much if anything and continue to plow money into infrastructure. Parcel shipping is still growing by about 30% a year. Every week, courier companies deliver about 500 million packages in China.

All four big courier companies are saying they want to buy or lease jets to move things around, to save on gasoline and tolls. They’re also all looking to use drones for the last mile. As of now, parcels in China are delivered by an army, perhaps as many as one million strong, of electric-scooter riding delivery guys. Contrary to what you may think, this isn’t low-paid work in China. You can earn at least double what you’d be paid for factory work. A lot of recent college graduates are taking their first job delivering packages. The career ladder for many is to move up from YTO, STO and ZTO, who get most of their business through Taobao, to work for either JD.com or Amazon in China. Both have their own in-house courier staff, with better pay, hours, equipment and genuine uniforms.

Alibaba doesn’t directly own or control a courier company. So far, that strategy has worked out splendidly. As long as the courier companies are competing furiously, things on Taobao will remain dramatically cheaper than in stores. If the couriers ever decided to seek profits rather than market share, it would certainly put a dent in Taobao’s growth. An Alibaba-backed logistics company called Cainiao just raised $1.5bn, at a $7bn valuation, to better coordinate the deliveries made by ZTO and the other Tonglu firms.

Ecommerce in China works like nowhere else in the world. Sales are still growing at breakneck speed and are on course by 2017 to reach $1 trillion annually, far higher than anywhere else. Cheap delivery makes it a bargain not only to buy P&G products, but even the lowest-priced goods on Taobao.

For years, Chinese law made it illegal for Fedex and UPS to enter the domestic delivery business in China. The Chinese government finally rescinded the law two years ago. The two American giants took one look at the cutthroat competition and ridiculously low prices charged by their Chinese counterparts and chose to stay out of the fray.  In the US, they get paid $15.50 a kilo to move goods by ground in two days between two far-off cities. In China, the going rate is about four Renminbi, or 60 cents.

We’ll likely know soon, once IPO prospectuses appear, if ZTO and the others are making any money at all. An IPO requires a GAAP audit and full compliance with China’s burdensome tax code. This often extinguishes all profit.

Ecommerce in China has so far created only two big beneficiaries. Taobao is one. It earns billions a year in ad fees paid by merchants trying to get noticed. The other is China’s 500 million online shoppers. We save big, and enjoy the luxury of cheap home delivery, on just about everything we care to buy.

 

As published in Nikkei Asian Review

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Investors rush to fund China tech start-ups — Singapore Straits Times

June 28th, 2016 No comments

 Straits Times

 Investors rush to fund China tech start-ups

Staff at Beijing-based tech start-up ABD Entertainment. Many such firms have been drawing substantial investments from the government and venture capitalists, even amid China's slowing economy.
Staff at Beijing-based tech start-up ABD Entertainment. Many such firms have been drawing substantial investments from the government and venture capitalists, even amid China’s slowing economy.

Amid flow of money, hopeful entrepreneurs warned that innovation is crucial to success

Former media man Lei Ming has programmers, budding actresses and even an Internet celebrity on staff at his data-driven start-up in Beijing.

His two-year-old firm focuses on using big data and analytics – a relatively new tech sector worldwide – to help consumer brands figure out how to get the best bang for their marketing buck.

“There’s an immense amount of data we can glean from weibo accounts,” said Mr Lei, referring to the Chinese version of Twitter, which now has 261 million monthly active users.

Through data analysis, he aims to help clients find the most cost-effective ways to sell their products – through celebrity endorsement, product placement or other innovative means, especially on online platforms.

Valued at about 100 million yuan (S$20 million), the start-up received nearly 10 million yuan in funding last year.

While Mr Lei, 34, is not anxious about revenue for now, he is very clear that he must focus on making his start-up profitable. “It is important that we must be able to make money on our own instead of relying on investors’ money,” he said.

The next step is to become a major player in entertainment advertising – a market he estimates is worth 100 billion yuan. In three years, he aims to get the firm listed on a stock exchange. Mr Lei’s start-up is one of millions that have sprung up in China in recent years amid a tech startup boom. According to a report on the China.org.cn government website, some 4.9 million new companies were set up between March 2014 and May last year, with more than half being Internet firms.

Despite a slowing economy, tech start-ups of all sizes are attracting billions of dollars in investment funds from the government and venture capitalists.

According to research firm Preqin, private investors had poured around US$26.2 billion (S$35 billion) into 796 Chinese tech firms as of the middle of this month.

And last year, government-backed venture funds targeted at tech start-ups raised about 1.5 trillion yuan, increasing the amount under management to 2.2 trillion yuan, according to a Bloomberg report. However, regulations and market practices have yet to be finalised, and it is unclear how quickly the funds will be deployed, said the report.

Even though many of these 780 government guidance funds have been around for more than 10 years, the tech investment boom started after Chinese Premier Li Keqiang rolled out his “Internet Plus” initiative in 2014, encouraging innovation and entrepreneurship. This comes as China seeks to move away from a reliance on low-end manufacturing and heavy industries.

With labour and living costs on the rise, China can no longer rely on labour-intensive industries to keep its economy humming, said Ms Jenny Lee, a Shanghai-based venture capitalist who has been investing in Chinese tech firms for the past 15 years. “The old way of throwing labour at tasks is over,” she said. “China must change.”

It must adopt firms that leverage on technology, for these will help increase efficiency and sometimes replace labour, she added.

But while there is no shortage of money out there, with billions of dollars being poured into thousands of tech start-ups each year, just as many are going belly-up for shortage of funds or failure to commercialise their products.

This is because investors and consumers are becoming more discerning, and it is no longer enough for entrepreneurial hopefuls to just go and copy someone else’s idea and hope to thrive, investors and entrepreneurs told The Straits Times.

“These firms need to innovate to compete,” said Ms Lee. And innovation can be in terms of the business model, product or technology.

Some venture capitalists, such as Beijing-based James Tan, find Chinese tech firms to be very good at localising new ideas from Silicon Valley and achieving superior results on the mainland.

Still, Mr Peter Fuhrman, the chairman of China First Capital, a Shenzhen-based investment bank and advisory firm, pointed out that while this strategy has helped some of the home-grown tech giants to grow, it is not sustainable.

Successful tech players like Baidu, Alibaba and Tencent benefited greatly from an intellectual property and legal regime that allowed them to copy American business models and intellectual property without punishment, he said.

China’s market is also closed to foreign competitors, so that domestic firms can grow and thrive within a walled garden free from outside competition, he added.

However, he noted, it is harder now for China to shield its domestic firms from competition than in the late 1990s, when the tech giants got started, as China has since become a World Trade Organisation member.

“Walled gardens are basically illegal under WTO,” he said.

Another problem that could make it hard for China to grow the tech sector is the unique and “occasionally dysfunctional” capital market and initial public offering (IPO) regime, he said.

“This has now made it between difficult and impossible for Chinese tech companies to IPO within China,” he said.

Despite the problems, the push towards innovation and entrepreneurship looks set to continue, with more than 1,600 high-tech incubators nurturing start-ups across the nation.

Ms Mao Donghui, the executive director of Tsinghua x-lab, a university-based education platform for start-ups, said China is just beginning to wake up to the need for innovation. For start-ups to succeed, however, being innovative is not good enough – young people also need to know how to do business. For them to have the right combination of innovation and entrepreneurship would “require years of effort, right methods and experience”, said Ms Mao.

“It’s not that easy to just shout about innovation and entrepreneurship for a year or two, and expect to see results blossom, and affect economic growth. There is still a long way to go,” she said.

http://www.straitstimes.com/asia/east-asia/investors-rush-to-fund-china-tech-start-ups

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