Month: August 2009

Joys of Chinese Language: Discovering A Business Model


Jin Dynasty from China First Capital blog post

My Chinese language skills remain sub-standard. At best. But, that doesn’t prevent me from taking enormous pleasure in my wall-to-wall waking-hours’ immersion in Chinese. Often, it’s just the sound and cadences of Chinese local accents, which occur in extraordinary numbers and varieties. Even calling them “accents” doesn’t capture the bewildering array, since to an English speaker, the comparison that comes to mind is likely the difference between an English and American accent. In China, regional accents can be so extreme they are mutually incomprehensible. I often feel like the most common phrase I hear in Chinese is “What?”, accompanied by a puzzled expression that shows the listener didn’t catch a word of the Mandarin just spoken at him. 

In other words, I often feel like I’m in the majority in China that’s in the dark about the meaning of someone else’s spoken phrases. But, of course, that’s not quite the case. Chinese do just fine here. I stumble, fall flat, get back up and trip again. Again and again. That about sums up the path of my linguistic development. 

There are moments of transcendence as well. For example,  in Shenzhen recently, I listened in on pitches by six Chinese companies seeking private equity or venture funding. They were from different industries, but I heard repeatedly the phrase “shangye moshi” in the presentations. The first ten times or so, I just let it pass through my brain unmolested, assuming it was just another word that was outside my active vocabulary. Then it hit me. I knew both words: “shangye” means business, “moshi” means model, or method. Put them together, you get 商业模式, or “business model”, an increasingly common business jargon term in English that I now know was translated literally into Chinese. 

I never liked the term “business model” in English, and so rarely use it. Companies have a way of making money, it seems to me, not a “business model”. Models are static, not dynamic, ever-mutating structures, which is what most good companies must be in order to keep making money. 

But, my aversion to the term disappears in Chinese. I’ve taken it to using it quite often now. Why? For one thing, at my age, it’s rare that any new word will stick around long enough in my memory for me to use more than once. I’m on an email list that sends me seven Chinese words every day. I read today’s words about 15 minutes ago, and I’ve already forgotten half of them. By tomorrow, the rest will probably be gone also. So, the fact I’ve retained “shangye moshi” is already cause for minor celebration.

The other reason is that it does seem to fill a slight conceptual void in Chinese. Languages, including Chinese,  often import foreign phrases for this reason. Two other well-known Chinese examples of this are “lang man” and “you mo”, meaning “romantic” and “humor”, both of which entered as corrupted versions of the English original. Others have speculated about what this says about China, that it had no native words for “romantic” and “humor”, but I’ll leave that to theoreticians. 

With “shangye moshi”, the missing native concept in Chinese was likely a simple way of saying a company has a recurring source of profit. If so, of course, it’s a welcome addition to the Chinese language, and one hopes, to Chinese management strategy as well.


A Step in The Right Direction – But Capital Allocation Remains Highly Inefficient in China

Vrard Watch from China First Capital blog post

Capital is not a problem in China. Capital allocation is. 

Expansionary credit policies by the government has created a boom in bank lending. This rising tide of bank credit is also lifting Chinese SMEs. Through the first half of this year, loans to SME have increased by 24.1% , or 2.7 trillion yuan ($400bn).  All that new lending, though, has not substantially altered the fact that bank lending in China is still directed overwhelmingly  towards state-owned companies.  So, while lending to SME rose by nearly a quarter, that equates to only a tiny 1.5% increase in the share of all bank loans going to SME. 

State-owned banks and state-owned companies are locked in a mutual embrace. It’s not very good for either of them, or for the Chinese economy as a whole. Faster-growing, credit-worthy private companies find it much harder and more costly to borrow.  Over-collateralization is common. An SME owner must often put up all this company’s assets for collateral, then throw in his personal bank accounts and property, and finally make a cash deposit equal to 30% to 50% of the loan value. 

China isn’t the only country, of course, with inefficient credit policies. Japan’s banking system still puts too much cheap credit in the hands of favored borrowers.  But, the problem is more damaging in China that elsewhere, for two reasons: first, many of China’s best companies are small and private. They are starved of capital and so can’t grow to meet consumer demand. Second, the continuing deluge of credit for state-owned companies distorts the competitive landscape, keeping tired, often loss-making incumbents in business at the expense of better, nimbler and more efficient competitors. 

In other words, China’s credit allocation policies are actually stifling overall economic growth and inhibiting choice for Chinese consumers and businesses. 

State-owned banks everywhere, not just in China, have the same fatal flaw. They like an easy life, which means lending to companies favored by their controlling shareholder, not those that will earn the greatest return.  They can turn a deaf ear to profit signals because, ultimately, profit isn’t the only purpose of their labors. They allocate credit as part of some larger scheme, in China’s case, maintaining output and employment in the country’s less competitive,  clapped-out industries.  

There’s a regional dimension to this too. China’s richest, most developed areas are in South,  particularly the powerhouse provinces of Guangdong, Zhejiang and Fujian.  The economy here is driven by private, entrepreneurial companies, not the state-owned leviathans of the North. As a result, a credit policy that discriminate against private SME also ends up discriminating against the parts of China with the highest levels of private ownership and per capital wealth. 

That’s not sound banking, or sound policy. The good news is that the situation is changing. SME are gradually taking a larger share of all lending. The change is still too slow, too incremental, as the latest figures show. But, with each cautious step, the private sector, led by entrepreneurial SME, gains potency, gains scale and gains more of the resources it needs to provide the products and services Chinese most want to buy.  

No Preference: Disallowing Preferred Shares for Private Companies is Hobbling China’s Venture Capital and Private Equity Industry


Ming Dynasty mother-of-pearl from China First Capital blog post

Chinese securities regulations do not allow private domestic companies to issue preferred shares.  It does not sound particularly problematic, since preferred shares are not all that common anywhere. And yet, this regulatory quirk has serious unintended consequences. It is holding back the flow of private equity and venture capital investment into promising Chinese companies, particularly those with more than one shareholder. 

Preferred shares earn their name for a reason. These shares enjoy certain preferences over common shares, most often greater voting power and better protection in the event of bankruptcy. Preferred shares are the main mechanism through which venture capital and private equity firms invest in private companies. In general, when a PE or VC firm invests, the company receiving the investment creates a special class of preferred shares for the PE or VC. These preferred shares will have a raft of special privileges, above and beyond voting rights and liquidation preference. The theory is, the preferred shares level the playing field, giving the PE or VC firm more power to control the actions of the company, particularly how it uses the VC money,  and so protect its illiquid investment. 

Take away the ability to issue preferred, as is the case in China, and things begin to get much trickier for PE and VC investment. PE and VC firms are loathe to invest in ordinary common shares, since this gives them little of the protection they need to fulfill properly their fiduciary duty to their Limited Partners. There are, of course, all kinds of clever solutions that can be and often are employed to get around this problem in China. For example, the PE or VC firm can ask their very clever lawyers to craft a special shareholders agreement, to be signed by the company it’s investing in, that gives the PE or VC firm the same special treatment conferred by preferred shares. 

The problem here, though, is the legal enforceability of a shareholder agreement is not cut-and-dried.  A basis of most securities law, in China and elsewhere, is that all shareholders holding the same class of shares must be treated equally. In other words, if a PE or VC firm has ordinary common shares, it can’t get better treatment and more rights than any other common shareholder. 

What happens if a PE or VC firm’s shareholder agreement conflicts with this principle of equal treatment? China’s legal system is evolving, and precedent is not unequivocally clear. But, in general, the law takes precedence over any contract. In other words, if it comes down to a court fight, the PE or VC firm might find its shareholders agreement invalidated. 

This is not some remote likelihood, particularly if the company has more than just the founder and the PE or VC firm as shareholders. The “unpreferred” common shareholders have every right and many reasons to feel disadvantaged if they are deprived the same rights enjoyed by a VC firm also holding common shares.

There are many scenarios when this could lead to litigation, not just if the company runs into trouble, and shareholders end up fighting over how to divide whatever assets remain There’s also a big chance of legal mischief if the company does splendidly well. Let’s say the company is preparing for an IPO, and a shareholders agreement gives the VC firm special rights to have their shares registered and fully tradeable. This is a fairly common element in shareholders agreements. Other common shareholders would have ample reason to object, if their shares can’t be liquidated at the same time.  

Sometimes in business, legal uncertainty can be useful In this case, though, there are no clear winners. Anything that makes PE or VC firms less likely to invest disrupts the flow of capital to worthy businesses. That’s the situation now in China, with preferred shares disallowed and much uncertainty surrounding the legality of shareholders agreements. 

I have no special insight into why Chinese regulators have outlawed preferred shares for private domestic companies, or whether they are contemplating a change. But, a change would be beneficial. Most likely, the prohibition of preferred shares was designed to stop private companies from fleecing their unsuspecting equity-holders. In other words, the motive is sound. But, if the result is less growth capital available for successful young Chinese companies, the medicine ends up occasionally killing the patient. That doesn’t serve anyone’s interests: not entrepreneurs, nor investors, nor the country as a whole. 

 There are ways to give common shareholders some protection while still allowing private companies to create preferred shares. Ultimately, these common shareholders will likely benefit from the injection of PE or VC money into a company they’ve also invested in.  A shortage of capital is always a problem for growing companies, but it’s a particularly acute one in China. The PE or VC firm will also usually play a much more active role than other shareholders in building value, giving these other shareholders a free ride. 

Like most, I invest to make money, not exercise voting rights. So, my preference as a common shareholder will be to let the preferred have whatever rights they deem important – as long as they are doing the heavy lifting and pushing hard to build profits. They bring the capital, track record and expertise that often makes all the difference between a successful company and a has-been. I prefer to invest for success, and that often means preferring the presence of preferred investors.

Most Thankless Well-Paid Job in China: Market Forecaster

Calligraphy from China First Capital blog post


Looking for a new career with plenty of growth potential, and low standards for success? Here’s one to consider: China market forecasting. Rapid economic growth and urbanization are both creating huge demand for market research predicting future areas for opportunity and profit. Pay is good. But, there’s another aspect to the job that will appeal to many: repeated failure is no obstacle. 

Market research is, of course, a treacherous profession anywhere. Predicting the future always is. But, in China, market forecasting is particularly hard. It’s mainly been distinguished by how often, and by how much, the predictions turn out to be wrong.  Market segments in China grow so quickly, so explosively, that it makes a fool of just about anyone trying to guess its economic future. 

I’m reminded frequently of this these days. We’re working on a complicated infrastructure financing. One of the central components of the deal is a now two-year-old forecast of car purchases and driving patterns in China. The forecast was prepared by a respectable outfit in Hong Kong, and my guess is that they charged quite a lot to do it. But, looking at the numbers now, they seem ridiculous, like numbers pulled out of thin air – which is probably what they were. The actual growth of car traffic and car purchases over the last two years in China has been much higher than these predictions. In other words, the forecasts weren’t off by a mile, but by a light year. 

Given that track record, it’s surprising these market forecasters can continue to pay the rent, let alone prosper. And yet they do. It’s a familiar paradox: we know projections are often wrong, and yet many business decisions, often with billions of dollars at stake, are made on them. It’s probably connected to what’s sometimes called “the scientific theory of management”, which tried to systematize complex business decisions into quanta of data.

It’s the same approach taught in business schools, and is certainly one of the reasons so few MBAs make successful entrepreneurs. A hunch is often a better tool in business than a spreadsheet. Indeed, I’ve yet to meet a successful entrepreneur who ran his business, or started out in life, based on a market forecast. 

In our case, we’re stuck using the projections on auto traffic, because there’s nothing else available. So, we send them out to investors with the guidance to take the projections with a grain of salt. If not a fistful. This creates its own set of problems, including frequently the request to do a new set of “up-to-date” projections. In other words, the solution to bad projections is – you guessed it — to commission more projections. As I said, it’s a great job, being a market forecaster. 

The errors in a bad projection become cumulative. The longer the time line, the more distorted the projections will usually become.  In our case, we’re using a 25-year projection. So, these sizable errors in the first years will propagate across time. Year by year, the forecast becomes less and less tethered to reality, like the NASA space probe that escaped its flight path, lost contact with Mission Control and ended up, as far as we know, drifting in galactic space. 

Most markets outside China are more stable, so projections, even when they are wrong, don’t diverge quite so much from the actual situation.  Car sales are a great example. They are booming in China. Everyone I meet in Shenzhen, across all social classes, either has a car, is taking driving lessons or plans to begin soon. GM just announced its car sales in July in China rose 77% from a year earlier. 

For several months this year, China has been the world’s largest car market, outpacing the US. A quick web search turns up a supposedly highly credible forecast, from 2008, claiming that China is “on track to become the world’s largest car market by 2020, according to J.D. Power.” In other words, J.D. Power said it would take 12 years. It didn’t even take two. 

The recession in the US is a contributing factor, of course. But, the forecasts also, quite obviously, guessed very wrong about the growth rate of auto sales in China.   These wrong guesses have real-world consequences, because they can impact today’s decisions on investment and employment. In our case, by underestimating the growth rate of auto sales over the last two years, the projected revenues over 25 years from a $300mn toll expressway project in China also come in much lower. How much lower is anyone’s guess. Mine is that the revenue projections are off by at least 80% over the 25 years, and that this particular project will generate a profit of over $2 billion over that time, rather than the $1.2bn in the forecast built on the Hong Kong market researcher’s two year-old guesses. If so, the annual return on investment goes from the outstanding  to stratospheric. 

Here are my two projections: despite a record often unblemished by success, market forecasters in China will continue to ply their particular craft, collect their fees, sell their reports, and mainly miss the mark. Meanwhile, markets in China will continue to grow very fast, for a very long time. 




China Zigs While the Rest of the PE and VC World Zags

Tang vase from China First Capital blog post

This is a time of darkness and despair for most private equity and venture capital guys. Their world came crumbling down last year, as credit and stock markets collapsed and IPO activity came to a halt everywhere —  everywhere that is, except China.  

If ever there were an example of a counter-cyclical trend, it is the private equity industry in China. It is poised now for the most active period, over the next 12 months, in its young history. There are many reasons to explain why China should be so insulated from the deep freeze that’s gripping the industry elsewhere. For one thing, it has always relied less on leverage, and more on plain vanilla equity investing. 

This mattered crucially, since as credit markets seized up last year, PE firms were still able to do deals in China, by putting their own equity to work. Of course, PE firms in the US could have done the same thing. After all, most have very large piles of equity capital raised from limited partners. But, they have habituated themselves to a different form of investing, involving tiny slivers of equity and very large slabs of bank debt. Like any leveraged transaction, it can produce phenomenal results, on a return-on-equity basis. But, without access to the debt component, many PE firms seem adrift. It’s as if they’ve forgotten, or lost the knack of how to properly evaluate a company, to look at cash flows not in relation to potential debt service, but as a telltale sign of overall operating performance. 

Many PE firms these days seem to resemble a hedge fund gone bad:  they once had a formula for making great piles of money. Then, markets changed, the formula stopped working, and the firms are at a loss as to how to proceed. 

China looks very different. Beyond the lack of leverage, there are other, larger factors at work that are the envy of the rest of the PE world. Most importantly, China’s economy remains robust. It’s done a remarkable pirouette, while the rest of the world was falling flat on its face. An economy dependent until recently on exports is now chugging along based on domestic demand. And no, it’s not simply — or even mainly —  because of China’s huge +$600 billion stimulus package. The growth is also fueled by Chinese consumers, who are continuing to spend. 

There’s one other key factor, in my opinion, that sets China apart and makes it the most dynamic and desirable market for PE investing in the world: the rise of world-class private companies, of a sufficient scale and market presence to grow into billion-dollar companies. In other words, PE investing in China is not an exercise in financial engineering. It’s straight-up equity investing into very solid businesses, with very bright futures. 

One common characteristic of PE investing in China, all but absent in the US, is that the first round of equity investment going into a company is smaller than trailing revenues. So, in a typical deal, $10mn will be invested into a company with $50 million of last year’s revenues, and profits of around $5 million. Risk mitigation doesn’t get much better than this: investing into established, profitable companies that are often already market leaders — and doing so at reasonable price-earnings multiples. 

China has other things going for it, from the perspective of PE investors: the IPO window is open; dollar-based investors have the likely prospect of upping their gains through Renminbi appreciation; management and financial systems both have significant room for improvement with a little coaching from a good PE firm. 

It all adds up to a unique set of circumstances for PE investors in China.  It’s a highly positive picture all but unrecognizable to PE and VC firms in the US and elsewhere. Opportunities abound. Risk-adjusted returns in China are higher, I’d argue, than anywhere else in the world. A +300% return over three to five years is a realistic target for most PE investment in China. The PE firms invest at eight times last year’s earnings, and should exit at IPO at 15 times, at a minimum. Pick the right company (and it’s not all that difficult to do so), and the capital will be used efficiently enough to double profits over  the term, between the PE investment and the IPO.  Couple these two forces together — valuation differentials and decent rates of return on invested capital — and the 300% return should becomes a modest target as well as reasonably commonplace occurrence. 

It’s  the kind of return some US PE firms were able to earn during the good years, but only by layering in a lot of bank debt on top of smaller amounts of equity. That model may still work, at some future time when banks again start lending at modest interest rates on deals like this. But, there’s an inherent instability in this highly-leveraged approach: cash flows are stretched to the limit to make debt payments. A bad quarter or two leads to missed repayments, and the whole elaborate structure crumbles: just think of Cerberus’s $7.5 billion purchase of 80% of Chrysler. 

China is in a world of its own, when it comes to PE investing. My best guess is that it remains the world’s best market for PE investment over the next ten years at least. Little wonder that many of the world’s under- or unemployed PE staff members are taking crash courses in Chinese. 

Here’s one of the slides from the PPT that accompanied a recent talk I gave  in Shanghai called “Trends in Global Private Equity: China as Number One”.

Private Equity in China  中国的私募股权投资: 

—Strong present, stronger future—  今天不差钱,明天更美好

—PE firms continue to raise money for investment in China, over $10 billion in committed   capital and growing —  私募股权基金仍在继续募集资金投资国内,规模已经为100亿美元并将继续增长

—Next 12 months : most active in history ; IPO window open; finding and financing China’s next national champions —  未来的一年:历史上最蓬勃发展的时期,IPO 重启,发现并投资中国下一批的企业明星


For whole presentation, please click: 私募股权投资:中国成为第一 



Press Clippings

Shenzhen Economic Daily, article about China First Capital


I spent nine years of my early career as a journalist and foreign correspondent for Forbes. As a result, I’m a little more indifferent than most to seeing my name in print. With one exception. I do catch a thrill seeing my name in the Chinese press. 

An example: “中国首创投资创始人总裁Peter Fuhrman认为中国的创业板企业规模太小,经历较少。企业对上市应保持冷静,应该把重点放到企业自身发展上来。” ( 

I participated in a panel discussion at a well-attended two-day Private Equity conference in Shenzhen last week. The event got some press coverage in China, and I seemed to get more than my share of it. I spoke in Chinese – or more accurately, my own overly-enthusiastic and grammatically-haphazard version of the language. 

The next day headlines should have been “American Investment Banker Maims Our Mother Tongue at Shenzhen Meeting” . But, the media were far too polite, and instead explained my views on the opening of Shenzhen’s new stock market, the Growth Enterprise Market,  later this year.  

I reiterated the point made earlier in this blog, that while the GEM affirms the signal importance of SME in China’s economic future, the stock market itself may inadvertently perpetuate a problem already rampant: of SME going public too early, without the scale to support a successful IPO or perform well once listed. 

One of the articles I saw was illustrated by a photo from the event, taken during the panel. It catches me in full rhetorical flow, gesturing in a way that looks like I’m trying to swat my Chinese words out of mid-air. Not a bad idea, actually. 

Yesterday, two different Shenzhen newspapers had other articles about China First Capital. One of them is shown above, with the article on CFC at the bottom center. 

There is something deeply satisfying in seeing my name sandwiched amid large passages of Chinese text, like this, from a different article: “上海国际创业投资、股权投资论坛17日上午在上海华亭宾馆召开。与会嘉宾围绕创业板、投资人和创业者间联动;如何充分利用创业板机会;如何推动创业投资创新发展等话题展开讨论。以下是嘉宾Peter Fuhrman发言实录。” 

If I spend the time, with online dictionary at-the-ready, I can translate each passage into English. But, long before I extract the meaning, I’ve already enjoyed the symbolism of it, of seeing my name as a very small element in a much larger Chinese context.

The metaphorical significance is absolutely apt. My life in China is an identical process, of me being incorporated and subsumed into a much-larger, infinitely-complex, often incomprehensible Chinese whole.