China Private Equity

It’s been a particularly busy, gratifying workweek. Reaching for a metaphor from the Big Bang’s cosmological model, it felt like we entered an Inflationary Epoch, a period of extremely rapid and exponential expansion.  One measure: the traffic of outstanding “laoban” (company boss, in Chinese) in and out of our office was heavier than any other time in our company’s history. In all, six came by this past week. I expect most, or all, of these companies to become our clients. 

Our recent visitors run businesses with cumulative revenues of well over Rmb 3.5 billion ($500mn). Four are industry leaders in China.  My best guess would be that within five years, their combined revenues will exceed $3 billion, and cumulative market cap exceed $5 billion. To reach these levels, they need nothing more than to do precisely what they’re doing now – seeking out large market opportunities, and then having the products and discipline to prevail over any competitors. 

Raising private equity capital will accelerate the process and heighten the growth trajectory. But, like many of the best private businesses in China, they’ve shown they can succeed when investment capital is limited and very hard to come by. That’s another commonality among the six companies that visited us this week. None has raised equity capital thus far. All are large, successful and well-managed enough to put capital to effective use. But, raising money is not compulsory. 

It may be a bad recipe for success, but my strong preference is for clients like this, ones that don’t really need us. If we have a value, it’s being able to help laoban prioritize and plan over  a longer time frame. In first meetings, I often ask laoban a question along these lines: “If capital were not a problem, and you could invest in areas of your business with the greatest likelihood of success and highest rates of return over the next three years, what would you do?” 

The answers usually come back with little time wasted for deliberation. A good laoban knows where to go without needing to consult a spreadsheet financial model or market research studies. In today’s China, the answer is usually some variation on, “We need to grow larger and be in more areas of China where there is a clear demand for what we are selling”. 

It’s hard for me to comprehend sometimes given their size, but the best private companies in China are often still in their “test marketing phase”. China’s market is so huge, and growing so quickly, that few if any businesses have penetrated more than a fraction of it. The six companies that visited this week are typical. None of them now serves more than 5% of their current easily-addressable market. At the same time, their potential customer base is also increasing quickly every year. A business needs to grow by 30-40% a year just to stay in place, to hold onto existing market share. 

Of course, none of these six laoban would be content with that, with just growing at the speed of the overall market. They need and want to dominate their industries. That’s where capital can make the biggest difference – especially if it’s supplied by an experienced private equity investor that knows how to help, guide, encourage and finance rapid growth. 

These six companies, like our existing clients, are all so good that I envy the investor that gets to own a share of the business. Investment opportunities this good should be much harder to come by. Instead, as this past week has shown,  great private businesses exist in startlingly large numbers in present day China. 

I’ll only get to know about a small portion of them, and will work with an even smaller number. After a week like this one, it’s impossible not to feel extremely positive about China’s economic prospects, and deeply privileged to know some of the laoban who are doing so much to assure that bright future. 

It was a great week. If the coming one is a little quieter, I think me and my China First Capital colleagues will all be quite content. It’s a challenge to keep up with the pace, and to contribute as much as we aim to. We too are in “test marketing phase”, with so much yet to build and to accomplish with clients across China.

China’s private sector economy continues to perform miracles. According to figures just released by China’s National Bureau of Statistics, private companies in China now employ 70 million people, or 80 percent of China’s total industrial workforce. These same private companies account for 70% of all profits earned by Chinese industry. Profits at private companies rose 31.4% in 2008 over a year earlier, while those of China’s state-owned enterprises (so-called SOEs) fell by 16%. 

The rise of China’s private sector is, in my view, the most remarkable aspect of China’s economic development. When I first came to China in 1981, there were no private companies at all. SOEs continued to be favored sons, until recently. Only in 2005 did the Chinese government introduce a policy that gave private companies the same market access, same treatment in project approval, taxation, land use and foreign trade as SOEs. During that time, over 150,000 new private companies have gotten started and by 2008 had annual sales of over Rmb 5 million.   

These statistics only look at industrial companies, where SOEs long predominated. By last year, fully 95% of all industrial businesses in China were privately-owned. In the service sector, the dominance of private companies is even more comprehensive, as far as I can tell. While banks and insurance companies are all still largely state-owned, most of the rest of the service economy is in private hands – shops of all kinds, restaurants, barbers, hotels, dry cleaners, real estate agents, ad agencies, you name it. 

Other than the times I fly around China (airlines are still mainly state-owned) and when I pay my electric bill, I can’t think of any time my money goes directly to an SOE. This is not something, of course, I could have envisioned back in 1981. The transformation has both been so fast and so thoroughgoing. And yet, it still has a long way to go, as these latest figures suggest. Almost certainly, private company business formation and profit-generation will continue to grow strongly in 2009 and beyond. SOE contribution to the Chinese economy, while still significant,  grows proportionately less by the day. 

There once were vast regional disparities in the role of the private sector. Certain areas of China, for example the Northeast and West of the country, were until recently still dominated by SOEs. But, the changeover is occurring in these areas as well, and every year more private companies will reach the size threshold (revenues of over Rmb 5mn) where they will be captured by the statisticians. 

Equally, every year more of these private companies will reach the sort of scale where they become attractive to private equity investors. That happens when sales get above Rmb 100mn.  

Never in human history has so much private wealth been created so fast, by so many, as it has in China over the last 20 years. And yet, all this growth happened despite an almost complete lack of outside investment capital, from private equity and other institutional sources. This shows the resourcefulness of China’s entrepreneurs, to be able to build thriving businesses with little or no outside capital. Imagine how much faster this transformation would have happened if investment capital, and the expertise of PE firms, was more widely available. It is becoming more available by the day. 

China is primed, as it’s never been, for spectacular growth in PE investment over the coming 20 years.

The financial rule first postulated by Sir Thomas Gresham 500 years ago famously holds that “bad money drives out good”. In other words, if two different currencies are circulating together, the “bad” one will be used more frequently. By “bad”, what Gresham meant was a currency of equal face value but lower real value than its competitor. A simple way to understand it: if you had two $100 bills in your wallet, and suspected one is counterfeit and the other genuine, you’d likely try to spend the counterfeit $100 bill first, hoping you can pass it off at its nominal value. 

While it’s a bit of a stretch from Sir Thomas’s original precept, it’s possible to see a modified version of Gresham’s Law beginning to emerge in the private equity industry in China. How so? Money from some of “bad” PE investors may drive out money from “good” PE investors. If this happens, it could result in companies growing less strongly, less solidly and, ultimately, having less successful IPOs. 

Good money belongs to the PE investors who have the experience, temperament, patience, connections, managerial knowledge and financial techniques to help a company after it receives investment. Bad money, on the other hand, comes from private equity and other investment firms that either cannot or will not do much to help the companies it invests in. Instead, it pushes for the earliest possible IPO. 

Good money can be transformational for a company, putting it on a better pathway financially, operationally and strategically. We see it all the time in our work: a good PE investor will usually lift a company’s performance, and help implement long-term improvements. They do it by having operational experience of their own, running companies, and also knowing who to bring in to tighten up things like financial controls and inventory management. 

You only need to look at some of China’s most successful private businesses, before and after they received pre-IPO PE finance, to see how effective this “good money” can be. Baidu, Suntech, Focus Media, Belle and a host of the other most successful fully-private companies on the stock market had pre-IPO PE investment. After the PE firms invested, up to the time of IPO, these companies showed significant improvements in operating and financial performance. 

The problem the “good money” PEs face in China is that they are being squeezed out by other investors who will invest at higher valuations, more quickly and with less time and money spent on due diligence. All money spends the same, of course. So, from the perspective of many company bosses, these firms offering “bad money” have a lot going for them. They pay more, intrude less, demand little. Sure, they don’t have the experience or inclination to get involved improving a company’s operations. But, many bosses see that also as a plus. They are usually, rightly or wrongly,  pretty sure of themselves and the direction they are moving. The “good money” PE firms can be seen as nosy and meddlesome. The “bad money” guys as trusting and fully-supportive. 

Every week, new private equity companies are being formed to invest in China – with billions of renminbi in capital from government departments, banks, state-owned companies, rich individuals. “Stampede” isn’t too strong a word. The reason is simple: investing in private Chinese companies, ahead of their eventual IPOs, can be a very good way to make money. It also looks (deceptively) easy: you find a decent company, buy their shares at ten times this year’s earnings, hold for a few years while profits increase, and then sell your shares in an IPO on the Shanghai or Shenzhen stock markets for thirty times earnings. 

The management of these firms often have very different backgrounds (and pay structures) than the partners at the global PE firms. Many are former stockbrokers or accountants, have never run companies, nor do they know what to do to turn around an investment that goes wrong. They do know how to ride a favorable wave – and that wave is China’s booming domestic economy, and high profit growth at lots of private Chinese companies. 

Having both served on boards and run companies with outside directors and investors, I am a big believer in their importance. Having a smart, experienced, active, hands-on minority investor is often a real boon. In the best cases, the minority investors can more than make up for any value they extract (by driving a hard bargain when buying the shares) by introducing more rigorous financial controls, strategic planning and corporate governance. The best proof of this: private companies with pre-IPO investment from a “good money” PE firm tend to get higher valuations, and better underwriters, at the time of their initial public offering. 

But, the precise dollar value of “good money” investment is hard to measure. It’s easy enough for a “bad money” PE firm to claim it’s very knowledgeable about the best way to structure the company ahead of an IPO.  So, then it comes back to: who is willing to pay the highest price, act the quickest, do the most perfunctory due diligence and attach the fewest punitive terms (no ratchets or anti-dilution measures) in their investment contracts. In PE in China, bad money drives out the good, because it drives faster and looser.

For 18 months or so,  until last month, I tried burning my work candle at both ends. The goal was to play a constructive role both as Chairman of China First Capital, and CEO of Awareness Technologies. For me, it’s been something of a dream come true, this chance to work with two great companies, at different points in their lifecycle, in wholly different industries, with different home markets, different customers, different languages, and vastly different business models.  So much the better. 

It’s also exposed, in way that nothing else ever quite has, just how limited my managerial skills are. They are, at best, barely adequate for managing one business. Cleaved in two, they are woe-begotten. It probably also helps explain why bigamy never really caught on. Attention divided is attention corrupted. 

Or so I thought, until I began spending time with one supremely talented entrepreneur in China. He’s the boss of at least four different companies. There could be more, for all I know. Each time we meet, he mentions, in passing, another business that he founded and runs. Other than the fact they’re all based in China, they are all as different from one another as chalk and cheese. This entrepreneur owns and manages a very consumer goods company, a mining business, an advertising agency and a high-technology business.

And when I say “manage”, I mean manage. He’s not some absentee landlord. He spends significant time with each, and established each to seize what is a very large market opportunity. I only know in detail one of these companies, and it’s outstanding. My sense is that the others are no less so. 

So, how does this one guy do it? For one thing, he’s probably a lot smarter, and certainly more locked-in and ambitious than I am. He sees the world, so far as I can tell, as a vast and intricate delta, of multiple earning streams and innumerable opportunities for profit. He grabs only those that he knows he can readily seize – by being clearer, smarter, and richer than any competitor. 

Me, I look in my business life more for purpose than for profit, for the chance to work on large and complex problems, rather than ways to make a killing. It’s probably why I’ll never be as rich, or as managerially capable, as this Chinese businessman. Some businessmen enter new areas for the very sound reason of diversifying their sources of wealth.

This businessman does so because he visualizes the world as a series of P&L statements. He sees (better than anyone I’ve ever met) where the money is. Then he goes for it. He also chooses businesses that let him maximize his managerial skills, by setting a concrete direction, funneling in the capital, hiring strong management, and then waiting for the money to flow. 

Knowing him more and more, I’m convinced he’d never have entered the two businesses I’m now involved with: investment banking and enterprise software. Investment banking, especially for Chinese SME,  has too many moving parts, too many vagaries (for example, of market prices and investor predilections); enterprise software is crowded, and competitive, prone to technological disruption,  and has many smart people chasing the same limited supply of dollars. 

As I said, I like challenge. He likes making money. 

The kicker here is that it turns out, we need each other. I need him, because my investment banking business thrives by having the very best Chinese entrepreneurs as clients. He needs me to help him get additional capital to build the most promising of his businesses. I am equally confident we can get him that capital as I am that he will put it to very productive use, and so earn his investor a fortune. 

Of all the entrepreneurs I work with, this guy is the one that I’m most awed by, probably because he is so obviously so much better at this “CEO multi-tasking” than I am. He is very comfortable in his skin, and clearly having a great time in life.  It’s a joy to be a small part of his intricate, expansive and beautifully-engineered business empire.

Too many inventive minds over too many years have focused on trying to solve environmental problems that may be insoluble: like a internal-combustion engine that gets +100mpg, or a new fuel that will burn cleaner and cost less than gasoline. Of course, a solution to either of these would earn its inventor a multi-billion fortune. That’s a very powerful motivator.

But, let’s face it. Some of these bigger problems may be beyond the wit of man and the realms of molecular science. There are so many smaller, more manageable problems to be solved that will both lower pollution and earn its inventor a very tidy sum. Case in point: a new water cooler for China. 

Here’s a problem crying out for a solution. Solve it and you could build one of the largest consumer products companies in the world, much like how Sony’s Akio Morita got his start inventing a small, portable transistor radio in the 1950s. 

Most offices, as well as a large percentage of urban households in China, have a water cooler. They look like the kind you see in the US, but with one addition: Chinese water coolers also have a hot water spigot. The machines keep hot water, as well as cold water, on tap. They do this by having a small in-built heating system to keep about one liter of water continuously heated to around 80-degrees centigrade (176-degrees Fahrenheit). The reason is obvious: many Chinese still like drinking tea. 

When I first came to China almost 30 years ago, cold potable water and bottled water were both all but nonexistent. Today, they are both pervasively common. Tea often seems like a dying brand in China, except as an accompaniment to a cooked meal. 

But, most Chinese water coolers still offer the hot water function, and will likely continue to do so for many long years to come. There are two problems with the current design in China. First, the hot water is produced continuously, even outside of working hours, at enormous cost in wasted electricity. Since in China most electricity is produced by burning coal, this equates to a lot more coal being mined and burned than is necessary. 

Problem number two: though heated, the water is kept at a temperature too low to make a decent cup of tea.  For that, you need water at or about boiling point. It’s not a difference discernible only by tea connoisseurs. You need the hotter water to get the flavor, as well as get the tea leaves to sink to the bottom of the cup. All tap water needs to be boiled, for health reasons in China. But, the water coolers use bottled water (in 18.9 liter jugs). Each jug weighs over forty pounds. The massive infrastructure to deliver these water bottles, mainly done by guys riding specially-configured bicycles that can hold four of the jugs over the back wheel, is another problem crying out for a solution. But, we’ll leave that one be, for the time being.   

China needs a better water cooler. The person who can invent one, and can protect it from copycats with patents,  is going to become very rich. Two relatively small changes would achieve the goal: (1) incorporate a timer so that the machine will waste less energy;  and (2) design a system that will bring water to a boil and then dispense it. Better air and better tea. Both marketing messages should resonate deeply with a large part of China’s urban population.   

I’m no engineer, but assume there will be a positive energy trade-off here. The new system will likely use more power to get water 25% hotter, to boiling point.  But, the timer would shut down the hot water production, in most cases, for at least 40% of the time, outside of office hours. 

How big is the potential market? My guess would be it’s quite big. In most of the larger hypermarkets in China like Wal-Mart or Carrefour, the section devoted to water coolers is quite large, with at least ten models on display – more space than is given to vacuum cleaners, for example. This gives some approximation of overall sales volume. The current models are all roughly equivalent. Top-of-the-line models not only have the hot water, but refrigerate the cold water before dispensing. These generally cost around $150-$200. An eco- and flavor-friendly model should be in the same price range. If so, it would likely become market leader. 

Inventors mostly like to tackle life’s biggest problems. But, there’s a lot of money to be made in “gradual innovation”, particularly when it delivers improvements on a product that is a ubiquitous in a country as large as China.

Launched amid much worldwide rejoicing when the financial crisis struck last year, China’s Rmb 4 trillion ($585 billion) stimulus package is given much of the credit for China’s continued strong economic performance this year. China’s GDP growth is likely to exceed 8%, and the domestic stock market is up by over 70% since the start of the year. 

A Keynesian miracle? To read a lot of the financial commentary on China, you might well conclude this is so, that government spending has single-handedly kept the economy jaunty, while both firms and consumers sank into a deep funk. It’s a great story, and provides a simple explanation for how China dodged the bullets that struck all other major economies. Other countries looked on enviously, and urged China to continue the fiscal pump-priming to help out the overall world economy. 

Problem is, the analysis is flawed. China’s stimulus plan is not all it’s cracked up to be. While the additional government spending has clearly played a part, it is not the only reason why China’s economy has remained so sound this year. The unsung heroes of China’s economic success this year are its ordinary consumers. It’s their continued confidence and increased spending that have really made the difference. 

Economic statistics are notoriously iffy in China. The further one gets from the economic lever-pullers in Beijing, the harder it becomes to track economic activity. That’s another reason why the stimulus plan was so often singled out as the main spur to China’s growth. It’s easier to calculate how much additional the Chinese government is spending building expressways than it is to see how many pairs of socks or bowls of noodles Chinese are buying. 

Another reason: a lot of the economic commentary comes from folks who believe that governments really are responsible for what happens, good and bad, in an economy. Again, it’s just so much simpler to view things this way, that powerful government men can pull out their checkbooks and spend their way to national prosperity. These are often the same people who will tell you, wrongly, that Roosevelt’s New Deal spending lifted the US out of Depression.

China’s supporters and detractors both give the government too much credit. There are those who are convinced China’s economic growth is all some kind of fraud, cooked up by the central government, and that once the extra government spending is dialed down, the economy is certain to crash. 

Again, pure hogwash. 

In China, the government rightly deserves credit for excellent economic management, for creating the circumstances, both marco and micro,  that allow the Chinese economy to continue to thrive. I’ve said it frequently, including in public forums: China is the best-managed major economy in the world. 

But, again, let’s also commend the country’s one-billion-plus consumers, too often seem as miserly skinflints, saving up all their money for their great-grandchildren’s rainy days. It just ain’t so. China’s consumers, with an ever-increasing choice of products, services and shops, are spending ever-increasing sums on improving the quality of their lives. Newer and better housing. New cars. Holidays. New wardrobes. You name it. 

I see it every day here, the untethered exuberance of the Chinese consumer. It’s true that in the early part of this year, there was a relative lull. Back then, shops were working harder to attract customers, by putting a lot of their goods on sale at steep discounts. About four months ago, the situation began to change markedly. No more major knockdowns. Prices now all seem to carry list price, and the prices for many common consumer products are as high, or higher, than in the US. 

Not much of this, it goes without saying, gets noticed by the world’s financial commentariat. Car sales in China are at an all-time high, and China is now the world’s largest car market. But, listen to the commentators, and they’ll tell you it’s the result of some small government tax breaks on new car purchases. Helpful, yes. The main spur? No. Car prices in China are still, in dollar terms, generally much higher than in the US. Based on a percentage of average disposable income, car prices in China are probably among the most expensive in the world. Same goes for property prices. Yet, Chinese keep buying. 

They will keep buying, at or near this record pace, long after any tax breaks phase out.  Chinese want the new cars to drive on the new expressways to carry them to the new shopping malls to buy the new furniture for their new apartments. 

Of all the economic statistics I’ve seen lately, the one that best captures what is going on now in China is this: revenues in China’s restaurant industry were up 18% during the first half of 2009, to over $120 billion. That’s not due to stimulus, or bank loans, or tax concessions, or a government mandate to entertain more. It’s largely because Chinese are out having a good time, more often, and spending a lot more doing so than they did a year ago. 

It’s one of the best barometers of a nation’s mood, restaurant spending. In China, the mood is buoyant, the outlook bright, and the woks are working overtime.

Blackstone, the giant American PE firm, is now trying to raise its first renminbi fund. Its stated goal is to provide growth capital for China’s fast-growing companies. Blackstone isn’t the only international private equity firm seeking to raise renminbi to invest in China.  In fact, many of the world’s largest private equity firms, including those already investing in China using dollars, are looking to tap domestic Chinese sources for investment capital.

Dollar-based investors are increasingly at a serious disadvantage in China’s private equity industry: investing is more difficult, often impossible, and deals take longer to close than competing investors with access to renminbi.

Blackstone enjoys a big leg up in China over other international private equity firms looking to raise renminbi. Its largest institutional shareholder is China’s sovereign wealth fund, CIC. Knowing how to get Chinese investors to open their wallets is a skill both highly rare and highly advantageous in today’s global private equity industry.  

There are two reasons for this stampede to raise renminbi. First, more and more of the best investment opportunities in China are SME with purely domestic structure – meaning they cannot easily raise equity in any other currency except renminbi. The second reason is the most basic of all in the financial industry: if you want money, you go where there’s the most to spare. Right now, that means looking in China.   

In theory, the big international private equity companies have a lot to offer Chinese investors – principally, very long track records of successful deal-making that richly rewarded their earlier investors.

The international PE firms have more experience picking companies and exiting from them with fat gains. They also do a good job, in general, of keeping their investors informed about what they’re doing, and acting as prudent fiduciaries. 

So far so good. But, there’s one enormous problem here, one that Blackstone and others presumably don’t like talking about to prospective Chinese investors. Their main way of making money in the past is now both broken, and wholly unsuited to China. They’re trying to sell a beautiful left-hand drive Rolls-Royce to people who drive on the right. 

Blackstone, Carlyle, KKR, Cerberus and most of the other largest global private equity companies grew large, rich and powerful by buying controlling stakes in companies, using mainly money borrowed from banks. They then would improve the operating performance over several years, and make their real money by either selling the company in an M&A deal or listing it on the stock market.

The leverage (in the form of the bank borrowing) was key to their financial success. Like buying a house, the trick was to put a little money down, borrow the rest, and then pocket most of any increase in the value of the asset. 

It can be a great way to make money, as long as banks are happy to lend. They no longer are. As a result, these kinds of private equity deals – which really ought to be called by their original name of “leveraged buyouts”, have all but vanished from the financial landscape.  It was always a rickety structure, reliant as much on access to cheap bank debt as on a talent for spotting great, undervalued businesses. If proof were needed, just look at Cerberus’s disastrous takeover of Chrysler last year, which will result in likely losses for Cerberus of over $5 billion. 

In his annual letter to shareholders this year, Warren Buffett highlighted the inherent weaknesses in this form of private equity: “A purchase of a business by these [private equity] firms almost invariably results in dramatic reductions in the equity portion of the acquiree’s capital structure compared to that previously existing. A number of these acquirees, purchased only two to three years ago, are now in mortal danger because of the debt piled on them by their private-equity buyers. The private equity firms, it should be noted, are not rushing in to inject the equity their wards now desperately need. Instead, they’re keeping their remaining funds very private.” 

On their backs at home, it’s no wonder Blackstone, Carlyle, KKR are looking to expand in China, All have a presence in China, having invested in some larger deals involving mainly State-Owned Enterprises. But, to really flourish in China, these PE firms will need to hone a different set of skills: choosing solid companies, investing their own capital for a minority position, and then waiting patiently for an exit. 

There’s no legal way to use the formula that worked so well for so long in the US. In China, highly-leveraged transactions are prohibited. PE firms also, in most cases, can’t buy a controlling stake in a business. That runs afoul of strict takeover rules in China. 

I have little doubt Blackstone, KKR, Carlyle can all succeed doing these smaller, unleveraged deals in China. After all, they employ some of the smartest people on the planet. But, these firms all still have a serious preference for doing larger deals, investing at least $50mn. This is also true in China.

There are few good deals on this scale around. Very few private companies have the level of annual profits (at least $15mn) to absorb that amount of capital for a minority stake. Private companies that large have likely already had an IPO or are well along in the planning process. As for large SOEs, the good ones are mostly already public, and those that remain are often sick beyond the point of cure. In these cases, private equity investors find it tough to push through an effective restructuring plan because they don’t control a majority on the board seats. 

Result: some of the companies best-positioned to raise renminbi funds, including Blackstone, have an investment model that seems ill-suited to Chinese conditions. They may well succeed in raising money, but then what? They’ll either need to learn to do smaller deals (of $10mn-$20mn) or bear the heavy risk of making investments in the few larger deals around in China.  

Any prospective Chinese LP should be asking Blackstone and the other large global private equity firms some very searching questions about their investment models for China. True, these firms all have excellent track records, by and large. But, that past performance, based on the leveraged buyouts that went well, is of scant consequence in today’s China. What matters most is an eye for spotting great entrepreneurs, in fast-growing industries, and then offering them both capital and the knowledge that comes from building value as investors in earlier deals. 

Prediction: raising huge wads of cash in China will turn out to be easier for Blackstone and other large global PE firms than putting it to work where it will do the most good and earn the highest returns.

Shenzhen is such a relentless modern city that it’s often hard to discern the influence of 3,000 years of Chinese history and culture. The skyline is so futuristic that it often resembles the home planet of a higher civilization.(See photo above, of the City Center and buildings near CFC’s office). 

But, of course, this is still a part of China, with all its embedded messages and references to a history longer and richer than any other. It just takes a little wisdom to perceive it. I can’t lay claim to any such wisdom. Luckily, though, I have a friend here who has both the historical knowledge and scholar’s temperament to properly put modern Shenzhen into a more classically Chinese context. 

This friend, Zhen Qinan, has had a exemplary career in the financial industry, first as part of the working team formed in 1990 to establish the Shenzhen Stock Exchange, and then as head of a joint venture between four Chinese financial firms and Merrill Lynch, where he worked with leading Chinese companies like Huawei and Taitai Pharmaceutical. 

These days, Qinan is semi-retired. I try to spend time with him whenever I can. He’s warm and thoughtful, and I know now from experience that he’ll offer astoundingly wise insights to even my most mundane questions. How mundane? Over a meal at one of Shenzhen’s better Sichuan places, I commented on how lucky we were to be in a city with so many good restaurants, even by Chinese standards. 

If I had to come up with reasons why, I would settle for the fact Shenzhen is richer than other cities, and has a population drawn from all parts of China. Qinan, however, offered a much richer explanation, rooted in his learning and respect for Chinese history. 

Shenzhen is part of an unbroken tradition, reaching back at least 1,200 years, of commercial centers in China having the best food and also the most beautiful women. So, in their day, the great trading cities along the Grand Canal – Hangzhou, Suzhou, Yangzhou — were particularly renowned as places with the finest and most varied cuisine, and the most desirable women. This reputation has remained largely intact in those cities, even as the commercial locus of China shifted elsewhere. 

The reason then, and the reason now, is the same: in wealthier commercial cities, there’s a heightened appreciation, as well as larger audience, for the pleasures that money can buy. Qinan is from Xian, and to drive home the point, he drew the comparison for me between Shenzhen and his home city.

Xian was always a center of learning and political power, rather than a city with vibrant trade and a large, successful merchant class. As a result, the food, though still quite delicious, has always been a little more basic, less expensive, less intricate, less subtle than that of the trading centers to the east, along the Grand Canal. There’s just not enough money around to support a thriving community of top-quality chefs and restaurants. They migrate to where the money is. 

The same logic, of course, applies to why beautiful women are more prevalent in rich commercial cities in China. Traditionally, beautiful women went to Suzhou, Hangzhou or Yangzhou to find a rich patron to take them as a subsidiary wife. They then produced better-looking children, on average, so creating a virtuous cycle. Let the process run, uninterrupted, for several centuries and the results would be that the cities gained a reputation, probably grounded in fact, for having particularly good-looking ladies. 

To this day, Chinese will always aver that Suzhou has the most beautiful women in the country. I haven’t been to Suzhou in over 25 years, so I can’t say if the reputation is deserved or not. But, I do know that most Chinese believe this to be true of Suzhou, even though, of course, few will have ever been there to see for themselves. 

While concubinage is officially no more in China, there is still a similar process at work in today’s Shenzhen. Concubines are no more. Polygamy is outlawed. Today, the term is 二奶 “er nai”, or “second lady”. It’s analogous to a mistress. Shenzhen, I’m told, has more “er nai” than any other city in China. These tend to be pretty girls in their early 20s who come to Shenzhen from all over China, and often end up clothed, housed, fed and otherwise supported financially by an older, usually married man. Nowhere else in the world (not Paris, Milan, or other centers of mistress culture) have I ever seen so many dreary older men in the company of stunningly beautiful women. 

Shenzhen has more “er nai” both because it’s the richest city in China, and also because there are a lot of men from neighboring Hong Kong who either live or work here, during the week. Part of the standard “expat package” would seem to be taking a Chinese girl as a mistress. I’m told the going rate, in terms of monthly cash stipend, is at least $1,000 a month, with apartment, car and clothing budget extra. That’s about five times more than a woman of similar age can make working in one of Shenzhen’s factories.

One other difference from the China of yore: these women will usually return to their home village with quite a nice nest-egg, marry locally and start a family. This then creates a “job opening”. The man will now find a new “er nai” and so start again the process of clothing, feeding and housing an attractive woman new to Shenzhen.   

Food and sex. They are life’s two most basic drives, as well as the fuel that has kept China’s commercial centers buzzing for well over a thousand years.

I recently returned from a two-week stay in the US. I was very busy seeing friends and business colleagues, which means I was also very busy answering questions about China. 

China occupies a very special place in the minds of many Americans, including many who’ve never been. The level of curiosity in America about China is enormous. This contrasts notably with the indifference with which many Americans view the world abroad. For example, during the 14 years I spent in London, I never found my American friends to be very interested in what life was like in England. Not so China. 

But, this intense curiosity is not matched by a deep knowledge among Americans about the current situation in China. In fact, even among the most well-read and worldly-wise of my friends, the level of ignorance about today’s China is high. That’s largely because the American media, for the most part, does an execrable job covering China. The result is that most Americans have an excessive focus on what’s perceived to be “human rights problems” in China, and a vast under-appreciation of the monumental, positive changes that China is now undergoing. 

My local shoe repair guy in Shenzhen has a more nuanced understanding of the US than most educated Americans have about China. Every time I get my shoes polished, I end up discussing the genesis of the American credit crisis and the challenges President Obama faces in trying to change America’s health care system. In the US, the main topics of discussion about China reflect an exaggerated negative view of what’s going on. Nine times out of ten, people want to comment on pollution and product quality, as if China was one large Satanic mill turning out killer toys. 

Of course, the speed and scope of all the positive changes in China are so awesome it’s difficult for anyone, including Chinese, to fully appreciate just how far the country has come in a short time. But, in my experience, the American misapprehensions about China have a stale, time-worn quality about them, as if America’s view of China stop evolving about five years ago. 

A friend of mine, for example, writes about Chinese-American relations for a leading US publication. He talked about the issues he’s most busy writing about and what is of greatest concern to the Americans now guiding policy toward China. North Korea and Iran figured prominently in the discussion, and he relayed the US strategy to win China’s backing for the American position.

There was lots of talk of high-level diplomatic meetings and various quids-pro-quo. While all this is no doubt important to the safety of the world,  I couldn’t help feeling that it also demonstrated a lot of wishful thinking on America’s part, that China would still be, as it often once was,  highly responsive to America’s strategic needs. 

The US has long commanded significant leverage over China. But, that leverage is lessening by the day. One reason, of course, is China’s own rising economic and military power. But, less noticed and perhaps even more important is that China is less and less reliant on access to the US market to sustain its own economy.

China’s economy is increasingly driven by its own domestic market, rather than exports. This is why China could absorb without much dislocation the sharp fall in exports to the US over the last year. Exports will continue to play a larger role in China’s economy than in America’s. But, its economy is changing, and growing far more balanced. 

China will more and more resemble the US — a large, continent-sized economy that grows by meeting the needs of its own citizens, and providing a stable environment for business to invest. This change has many more years to run. The simple formula: China can listen less to what the US wants because it needs less of what the US has to offer in return. 

This, too, is a change that seems to have escaped the notice of most Americans, including those in a policy-making position. China isn’t simply being difficult or stubborn by failing to tow a US line. It’s also less concerned about calibrating its own policies to expand the markets for its exports to the US. The last time the US was in recession, China’s economy was also badly bruised. Not so this time. OEM exporters have suffered, but not the businesses that focus on selling to Chinese consumers. They’ve played a key role in keeping China’s economy healthy, while the US has faltered. 

Americans need to see China for what it is, not what it was. It’s a better, richer, cleaner, freer place than they think. Americans may just learn to like what they see..

The current issue of “Corporate Finance Magazine” has a Chinese-language research report written by the China First Capital management team. It’s the cover story. The title of the report is: “如何选择上市的时机和地点”. It examines some of the right  and wrong ways for a Chinese SME to IPO. 

The article begins on page 10. Download report here

We are very happy about the planned opening of trading later this month on the new Growth Enterprise Market (创业板 ) here in Shenzhen. We hope it will give many successful SME new opportunities to go public properly and efficiently.

Our goal is that the report in Corporate Finance will contribute towards a successful future for the Growth Enterprise Market and for all of China’s best-performing SME. 

Back in Beijing after an absence of two years. I know enough to expect big changes every time I return to Beijing, a city that is undergoing the most “meta” of metamorphoses. The most noticeable one this time, in the midst of a short and busy stay, is the completion of at least four new subway lines, and a high-speed train to the airport.

While crowded, the subway is a far better way to get around than above-ground, where the traffic situation in Beijing continues to worsen. This in spite of the fact that 20% of the city’s cars are kept off the street each weekday. Weekends are a free-for-all. With car sales in China running now at over one million per month, traffic is only going to worsen, especially in Beijing. 

Beijing is the most car-crazy city in China. The simple trope is: in Shanghai, people would rather spend money to live in a nicer place and then ride the bus. In Beijing, the opposite is true. Having four wheels under you matter more than the four walls around you. 

October is, famously, the nicest month of the year in Beijing. Daytimes are still warm, the air fresh and the sky often a shimmering blue. The streets are filled with vendors selling the wonderful assortment of autumn foods that have been an inseparable part of October in Beijing for hundreds of years: candied crabapples, persimmons, chestnuts. 

I’m here to participate in a private equity conference organized by and held at Tsinghua University. I readily accepted the invitation to appear, both because it’s an honor to be invited to speak at Tsinghua, and also because I wanted very much to return to the northwestern part of Beijing where the university is based. I was last here (gulp) 28 years ago, when I first arrived in China. I haven’t been back since. 

The changes are so comprehensive that, but for a few old candy-striped smokestacks, nothing seems to remain from the early 1980s. The area around Tsinghua is now filled with shops and modernist glass towers. I remember the university district of Beijing (which houses both Tsinghua and Beijing University) as being very gray, remote and very somber,  with nothing either to comfort or disrupt the life of a student at China’s two most elite universities.  Now, it’s got a hip, Harvard Square kind of vibe.

Tsinghua has a special history, one that has always symbolized for me the unique nature of the relationship between US and China. The university was founded by the American government, using some of the indemnity paid by the Qing emperor following the Boxer Uprising in 1900. While the circumstances that led to the payment of the Boxer reparations are mainly ignoble, I’m nonetheless proud that my country used its relatively small share of the money to establish first a scholarship program for Chinese to study in the US, and then, later, to establish Tsinghua University. The Russians, Germans, British, French and Japanese, who collectively got 93% of the indemnity,  took their share of the money and did nothing of any kind to benefit China. 

Not always adequately or consistently, but America has mainly viewed its role in China as mentor and friend, the least barbarous of the foreign barbarians. 

The conference just ended. I’m going to huddle up against the nighttime cold, and go out to smell the roasted chestnuts, and dodge the fierce Mongolian winds that are juddering the trees.

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Private companies the world over share one common trait: a preference for paying as little tax as possible. In Italy, for example, under-reporting of taxable income by privately-owned companies is an accepted national pastime. Italy even created a special national police force, the Guardia di Finanza,  just to go after this rampant tax-cheating. They haven’t had much luck, as far as anyone can tell. 

China is no different, of course. Private companies here will try to organize their affairs in such a way that taxable income is kept as low as is plausibly possible. Business taxes are large in number and relatively high considering China is still a developing country. Corporate income taxes, for example, can reach 33% depending where you are. This is on top of a national VAT of 13%-17%, and all kinds of other assessments on wages, assets, real property. 

The usual practice is to maintain three sets of books, one for tax authorities, one for banks that show a better picture to keep the loans flowing, and the third lets the owner see the real picture. Again, this is pretty much standard practice the world over.

Public companies, of course, have far less latitude to under-report taxable income, since they undergo a properly intensive audit every year. They also have a very different incentive than private companies. A public company’s share price is usually determined by its profitability. The higher the profit, the higher the share price. Many public companies have gotten into trouble by reporting too much profit, sometimes by fabricating sales, as a way to bolster their share price. 

This opposing approach in reporting taxable income creates a very nice arbitrage opportunity investing in private Chinese companies on the road to a public listing. This tax arbitrage often turbocharges the already high risk-adjusted returns for PE investors in China. 

Here’s how it works: PE investors generally use a Price-Earnings multiple to value a company on the way in. The multiple will usually be between six and nine times last year’s profits. That’s already a little low, given how large and fast-growing these companies often are. But, the 6-9X  valuation multiple becomes more akin to highway robbery when you look at it more closely. Everyone knows, of course, that the profit number used to make this valuation calculation is understated. It’s generally based on the only set of audited returns that are available, and those are the books prepared for China’s tax authorities. 

So, if the company’s tax records show a profit last year, for example, of $5mn, it’s a reasonable assumption the real figure is anywhere from 40% to more than 100% higher. But, the the purposes of calculating valuation, only the under-reported number is used. The effect is to lower the PE multiple from 6-9x. to perhaps 3-5x.  That makes these PE investments China in a screaming bargain, assuming everything goes well, of course, after the investment. 

But, from the PE firm’s standpoint, it gets even better than being able to buy in at very low valuations. They know that a big part of the plan, after investment, will be the get the company ready for an IPO. This is usually a two to three year process that involves reporting a larger and larger percentage of the actual profit as taxable profit, since this will also be the profit number used for IPO valuation. 

For every dollar of “found” profits inside a company, the PE investor stands to make at least five extra dollars in return, based on a typical-sized investment where the PE firms buys 25% of the shares. This gain occurs even if the company does nothing after investment to increase its profits. All that’s happening is an accounting change that puts money in PE firm’s pocket. 

It’s a reasonable assumption that a Chinese company going public will get a PE multiple of 20x. (Currently, in China, the PE multiples are often twice that level.) The PE firm buys the same dollar of profits for $4, and then sells it for $20 a few years later. 

Of course, the plan will be to do even better, by putting the PE capital to work in ways that will earn a good return over the same two to three year period. So, let’s assume that profits at least double, but perhaps even triple, from the taxable- reported income the PE investor used to make this original valuation.  The IPO valuation captures not just the profit from the accounting arbitrage, but the company’s own high-octane performance after the investment. 

Add it up, and it’s not unreasonable for the PE firm to make a +300% return in only two to three years. Of course, it’ll never be seen quite this way. Instead, the PE firm will get a lot of credit for improving a company’s financial reporting and controls, and so enhancing profits. The PE firms do play a role in this. But, a lot of the profit was there to begin with. All the PE firm did was ask the company’s owner to report more of it, pay more tax, and so bring his books into alignment with public company standards. 

Now, my friends in PE firms will probably view things differently, stressing the part about the work they do after investment to improve accounting controls, and that they will never know precisely how much buried profit there is a company until after they’ve invested. It’s a basic principle of finance that there’s an information asymmetry between the owner-manager and outside shareholders.

Sometimes, not only profits are hidden, but all kinds of other unpleasantness. Both are true, and yet on balance, PE firms are getting by far the better of the deal. Their due diligence, which is both extensive and expensive, should uncover anything serious before money is committed. Once the money is invested, however, the PE firm can start benefitting from profits that remained hidden from the taxman..

With CFC’s business motoring along nicely, I decided in late spring to redesign our very bare-bones website, to add more information, and make it a little more pleasing to the eye. After four months of sometimes tedious labor, the process is now complete. The English-version of the new CFC website went live earlier this week. The Chinese version will follow after the October holidays in China.

During my journalism career at Forbes, I had some experience working with designers, so I generally understand how words and images can best interact on a page.  Or, at least I thought so. Web design is a whole different ballgame. The web format allows for a lot more flexibility than designing print pages to in a particular newspaper or magazine’s existing template. You can incorporate animation, videos, pictures, sound.  But, there’s also a lot more chaos about the whole process. Maybe it’s the fact that a good web designer must be combine the character traits of a graphic designer and a computer programmer. Rendered in mathematical terms: flakiness ²

Everything turned out well. But, completing the site took far longer than I’d expected at the outset. I helped contribute to the delays by frequently changing my mind about which images should appear on the site. I decided one thing emphatically from the start:  I did not want to reproduce the hackneyed sort of imagery you see on every other financial industry website I’ve ever seen, from Goldman Sachs’ to a small regional bank’s. So, I wanted no photos of men shaking hands, or gathered around a conference room table, or walking purposefully down a busy urban street holding a briefcase. For one thing, I don’t even own a briefcase.

Instead, I wanted to do something far more personally meaningful on the site, and use only close-up images of Chinese art.  After some experimenting with images of Ming Dynasty porcelains and sculptures, I decided to use only Chinese paintings. I wanted them to reflect many of the broader thematic and stylistic movements in Chinese painting, from the Tang Dynasty to the Qing Dynasty.  And, of course, I wanted to feel a connection with each image, both aesthetically and also as  metaphorical statement of core principles and values that animate our work at CFC.

That’s a pretty tall order. I probably looked at over 1,000 paintings, and did my own, on-screen close-up crops of several hundred, before deciding on the 25 I liked most. In the end, there was room on the new site for only 13.  Early on, I’d thought of using close-ups from several thangkas I’m lucky enough to own. The images were gorgeous, but my team felt (and I ultimately agreed), they were too unmistakably religious, even in extreme close-up,to fit well on the site.

The text was not as difficult. We’re lucky in that our business has a very clear, narrow focus that’s easily expressed.  Ours is also, importantly, not a business that relies on website traffic, or Google search results, to create awareness and revenue. I know this other world very well, through my role at Awareness Technologies, which is a web-marketer par excellence. Every day, Awareness Technologies’ websites and Google strategy will deliver new customers who buy our software. It’s highly-specialized work, this kind of online marketing, and my Awareness colleagues do it as well as, and often better than,  anyone else in the world. Awareness Technologies also builds great software, which matters even more, of course, to the success of the business. 

CFC, on the other hand, is mainly a “word of mouth” business. Chinese SME come to us not through an online search, but because we’ve been introduced to them by others they know and trust.  In fact, I wouldn’t be surprised to learn none of our clients have ever visited our website.  They’re generally too busy running their companies to spend much, if any time, online – let alone searching the web to find an investment bank.

I wouldn’t have it any other way. I don’t look to the CFC website to generate “walk-in” traffic. We do no search advertising, or web marketing. So, someone finding our website will usually do so through following a link on what’s called a “natural search result” at Google, Yahoo, Baidu or other search engines. 

My main hope for the new website is that all those who do visit it, first and foremost, will get enjoyment from looking at the paintings, and allow the close-ups to meander around in their minds for awhile.  If that gets them then to read about what we do, so much the better.

My thanks go to our web designer, Rune Ecklon, a Dane living in Shenzhen. (His email: rune_ecklon@hotmail.com ) Rune sometimes needed the patience of Job to put up such a persnickety client. In turn, I needed more patience than I normally exhibit to deal with a designer who seems to work only in the middle of the night, and is often in pain after breaking his ankle last year after some kind of romantic entanglement with a very strong Chinese girl.

We had our share of struggles, and missed one “deadline” after another. But, now that I can see the new site live, by typing in our company URL (www.chinafirstcapital.com), I finally feel it was all worth it, the game was worth the candle.  

“Manage people’s expectations. Then, exceed them.” That’s not a bad rule to live by, or management principle to apply in regulating China’s fast-moving capital markets. This past week, China Regulatory Securities Commission, the nation’s stock market regulator, moved one step closer to opening trading in the new, Shenzhen-based, Growth Enterprise Market. It’s been ten years in the planning. The names were finally announced of the first companies that will list on the new market when trading begins later in October. All are private SME, and several had pre-IPO private equity funding.

The total amount of capital this first crop of IPOs will raise is well above most earlier estimates. The original stated plan was for smaller companies to list on the GEM, which, in turn, suggested the GEM market would be only a marginal contributor of growth capital for private SME. The minimum requirement was set at just $1.5mn in aggregate profits over the last two years. Even at high Chinese multiples, firms of that size would struggle to raise more than $10mn in an IPO.

But, in something of a surprise, CSRC chose larger companies to be in the first group to list. It now looks like that the ten companies will raise a total of over $400mn when their IPOs close, or an average of $40mn each. This, in turn, points to a cumulative market capitalization for this first group of around $2 billion. That bodes well for the market’s long-term future. A larger market capitalization means more liquidity and so less volatility in the share price. This will help attract more capital to the new Shenzhen market, and to subsequent future IPOs there.

Bravo, I say! The CSRC may well get the formula right, and so prove that these smaller-capitalization “growth stock markets” can work, both for companies and investors.

Elsewhere, these growth stock markets have mainly failed in their stated purpose to create an efficient platform for smaller companies to attract investors and raise capital. Germany’s Neuer Markt shut down soon after it was created. The small-cap markets in Singapore and Hong Kong have been disappointments. Small-cap companies stayed small-cap companies, which is entirely contrary to the purpose of a “growth board” like this. The granddaddy of them all, America’s OTC Bulletin Board, has become an all-purpose dumping ground for shady American firms, stock manipulators, and, sadly, several hundred once-strong Chinese SME who listed there after taking very bad advice from self-interested advisors and brokers looking to make a quick buck.

It’s anybody’s guess how many companies will list on Shenzhen’s GEM this year, or next. There is a backlog of at least 100 that have applied, and been provisionally accepted by CSRC. One thing we know: each IPO in China will get its final approval as part of an orderly process that takes into account the performance of companies already listed on GEM, and stock prices trends overall.

The Shenzhen GEM shows every sign of beginning to fill a very large, very important funding gap in China. Assuming, as I hope, that CSRC continues its preference for companies able to raise at least $30mn-$40mn in a public listing, these IPOs will channel capital to companies who would otherwise find it very hard to come by. Most of the private equity and venture firms that we work with don’t write checks that large. They generally invest around $10mn-$25mn in pre-IPO equity capital to own 20%-30% of a private Chinese SME. These investments are done at valuations of around eight times last year’s profits. So, a GEM listing could become the best source of growth capital for an SME that already has achieved some success, has profits of over $10mn-$20mn a year, but is still too small for a main board listing, in China or outside.

The public markets have two big advantages over private equity financing: they offer much higher price-earnings valuations, and give shareholders a liquid market to trade their shares. On the other hand, for Chinese SME, staging an IPO in China always has a level of deep unpredictability. The CSRC makes all the decisions about which companies can IPO and when. So, SME can wait two years or more to apply, get approval, and then put the IPO proceeds in the bank. If that SME is now growing quickly, has outsized opportunities near-to-hand with a high rate of return, but can’t finance its growth internally or with bank debt, a round of private equity will almost certainly be the best route to follow.

Done right (see my earlier blog post, on Foshan Saturday ’s IPO) a company’s market capitalization, when it eventually completes its IPO, can be at least three times larger than it is at present. That means the laoban gets richer (nothing wrong with that), and investors are happier, too, because of the increased liquidity and stability from the higher market cap at IPO.

I’m extremely positive about the role the GEM will play in helping to build even stronger private Chinese SME. The CSRC and Chinese government have taken over ten years to plan this new stock market, and learn from the mistakes of others. All signs now are that they have done so, and the GEM will gradually create a group of publicly-traded private companies that will go on to achieve far more impressive results in the future.

Every list of America’s most valuable brands includes the same parade of names, year after year – Coca-Cola, McDonalds, Disney, Google. Every year, these lists also ignore what could be the single most dominant brand of all. This brand is known by everyone in America, enjoys a higher market share than any of those on the list, and is able to charge a price premium as much as 300% above its competitors. The brand? Crayola Crayons. 

That’s right, that most humble and low-tech of children’s toys. No one outside the company knows Crayola’s exact market share. A good estimate is at least 80% of the US crayon market. Maybe higher. In other words, Crayola is dominant enough not just to warrant an anti-trust investigation, but to be broken up as a monopoly. 

Of course, I’m partly joking here – about the anti-trust part, not about the market share. Heaven forbid the US Department of Justice should ever decide to police kids toys. But, Crayola really is astoundingly powerful and dominant in its market. It enjoys, according to the company’s own research, 99% brand recognition in the US. Its name is not only synonymous with crayons, but has more or less shut down any lower-cost competitor from grabbing much of its market share. How it does this is also something of a miracle, since as far as I can tell, they do comparatively little advertising to sustain this. In other words, they are not only the most dominant brand, they are also the thriftiest, in terms of how much is spent each year sustaining that position in parents’ minds and kids’ playrooms. 

We don’t know exactly how big Crayola is, or any other fact about its financial performance, because it’s a private company. In fact, even more impenetrably, it’s a private company inside a private company. Binney & Smith, the original manufacturer, was sold to famously-secretive Hallmark in 1984. It’s all educated guesswork. 

But, I’m lucky to know a Chinese boss whose guesswork is far more educated than most. David Zhan is boss and majority shareholder of Wingart, a manufacturer of children’s art supplies based in Shenzhen. David is one of the smartest, savviest and most delightful businesspeople I know. Wingart is also one of my very favorite companies – though they are not a client, nor an especially large and fast-growing SME. But, Wingart is exceptionally well-run and focused, with well-made and well-designed products, as well as the most kaleidoscopically colorful assembly line I’ve ever seen. 

Wingart makes crayons. They are better than Crayola’s. That’s not David’s pride speaking, but the results of some side-by-side testing done by one of the larger American art supply companies. I personally have no doubt this is true. I’ve seen Wingart’s crayon production. Not only are they better, but they are much cheaper too. 

Still, it’s almost impossible for Wingart to gain any ground on Crayola. Wingart mainly sells under other companies’ brand names in the US, including Palmers, KrazyArt and Elmer’s. They have good distribution for many of their products at Wal-Mart and Target. But, not crayons. Wal-Mart would like to start selling Wingart’s crayons – not just, presumably, because they are better than Crayola. But, Wal-Mart, famously, does not like to be reliant on a single brand, a single supplier, for any of the products it carries. 

For the time being, Wingart’s factory is too small to produce crayons in the quantity Wal-Mart requires. This should change within a year or so, when Wingart moves to a new and larger factory about two hours from Shenzhen. Then, perhaps for the first time ever, Crayola will begin to face some real competition. I can’t wait. I think Wingart has a realistic chance to build a crayon business, worldwide, that will compete in size with Crayola, which is pretty much a US-dependent company. 

I have a lot of admiration for Crayola – not so much the crayons, but the fact that a 106 year-old brand could be so predominant in its market, and enjoy such unrivaled – and largely uncelebrated — supremacy for so long. But, I’d still like to see Wingart knock them down a few notches, or more. Crayola has it too good for too long.  American kids deserve the best crayons – as, for that matter,  do European, Chinese and other kids on the planet.