China Industry

Qianhai investors fret over soaring property prices — China Daily

Leave a Comment / August 12, 2020

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Qianhai investors fret over soaring property prices

By Zhou Mo

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Qianhai

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Shenzhen – Hong Kong and foreign enterprises operating in the Qianhai special economic zone have expressed concern over Shenzhen’s high property prices and entrepreneurs’ ability to integrate with the mainland market.

But, they acknowledge that Qianhai’s preferential policies and open environment have made the zone an ideal place for businesses from Hong Kong and abroad to tap into the mainland market.

“From the aspect of government administration and environment, Shenzhen, I believe, is the best place to set up business in the country, and Qianhai is the best area in Shenzhen,” said Peter Fuhrman, chairman and chief executive officer of China First Capital, an investment bank.

“However, from the aspect of cost, it’s not the best. Soaring property prices in the city have increased costs for businesses, and there needs to be a solution,” the US entrepreneur said.

Wednesday marked the first anniversary of Shenzhen’s Qianhai and Shekou zones coming into operation as part of the China (Guangdong) Pilot Free Trade Zone, which also includes Zhuhai’s Hengqin and Guangzhou’s Nansha districts.

As of April 15, more than 91,000 enterprises had been registered in the zone, with registered capital amounting to 4 trillion yuan ($616 billion). Among them, over 3,100 were Hong Kong-funded enterprises, which contributed nearly one-third of the zone’s tax revenue.

“Qianhai will continue to focus on cross-border cooperation between Shenzhen and Hong Kong, and strive to create a platform to support Hong Kong’s stability and prosperity,” Tian Fu, director of the administrative committee of Qianhai and Shekou, said at a ceremony marking the first anniversary on Wednesday.

Innovation and entrepreneurship are among the key areas of cross-border cooperation. To attract Hong Kong entrepreneurs to set up business across the border, the Qianhai Shenzhen-Hong Kong Youth Innovation and Entrepreneur Hub (E Hub) was launched, providing tax incentives, funding opportunities and free accommodation to Hong Kong entrepreneurs. As a result, more and more startups from the SAR are setting up offices in the E Hub.

“The opportunity cost in Hong Kong for entrepreneurs is relatively high, with high rents and labor costs, and the Hong Kong market is small,” said Amy Fung Dun-mi, deputy executive director of the Hong Kong Federation of Youth Groups. “Therefore, it’s wise for them to tap into the mainland market.”

Many of the companies have been doing well, Fung said, while noting that some have not made much progress so far.

Fung said when Hong Kong entrepreneurs start operating on the mainland, it’s necessary that mentors are provided to help them, as environment, laws and policies between Shenzhen and Hong Kong are different.

She also urged the authorities to provide more support to help Hong Kong startups find investors.

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http://www.chinadailyasia.com/business/2016-04/28/content_15424101.html

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In China, Yum and McDonald’s likely need more than an ownership change — Nikkei Asian Review

Leave a Comment / August 12, 2020

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HONG KONG — China’s fast-food sector has been dominated by U.S. chains like Yum’s KFC and Pizza Hut as well as McDonald’s. But now a question hangs over these household brands: Can new owners reverse their declining fortunes?

China Investment Corporation, a sovereign wealth fund, is reportedly leading a consortium that also includes Baring Private Equity Asia and KKR & Co. to acquire as much as 100% of Yum’s China division, valued at up to $8 billion. According to a Bloomberg report, Singaporean sovereign wealth fund Temasek Holdings, teaming with Primavera Capital, is also vying for a stake in Yum China, whose spinoff plans were announced on Oct. 20 — five days after Keith Meister, an activist hedge fund manager and protege of corporate raider Carl Icahn, joined the board.

Meanwhile, McDonald’s is likely to start auctioning its North Asian businesses in three to four weeks. Among its would-be suitors are state-owned China Resources, Bain Capital of the U.S. and South Korea’s MBK Partners, among other buyout firms. The winner or winners would oversee more than 2,800 franchises — plus another 1,500 to be added during the next five years — in China, Hong Kong and South Korea.

The company on Friday reported that sales in China surged 7.2% in the first quarter ended in March.

Yum’s and McDonald’s goal to become pure-play franchisers comes as competition in China’s food services market is heating up and as middle-class consumers grow increasingly concerned about food safety and nutrition.

http://asia.nikkei.com/Business/Trends/In-China-Yum-and-McDonald-s-likely-need-more-than-an-ownership-change?page=1

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Reworking a formula for economic success — China Daily Commentary

Leave a Comment / August 12, 2020

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Reworking a formula for economic success

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By PETER FUHRMAN (China Daily) Updated: 2016-04-08

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Reworking a formula for economic success
An assembly line of a Daimler AG venture in Minhou, Fujian province.

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My on-the-ground experience in China stretches back to the beginnings of the reform era in 1981. Yet I cannot recall a time when so much pessimism, especially in English-language media, has surrounded the Chinese economy. Yes, it is a time of large, perhaps unprecedented transition and challenge.

But the negative outlook is overdone, and starts from a false premise. China does not need to search for a new economic model to generate further prosperity. Instead, what is happening now is a return to a simple formula that has previously worked extraordinarily well: applying pressure on China’s State-owned enterprises to improve their efficiency and profitability, while also doing more to tap China’s most abundant and valuable “natural resource”－the entrepreneurial spirit of the Chinese people, the talent to start a company, provide new jobs and build a successful new business.

These two together provided the impetus for the economic growth since the 1990s. In the 1990s, SOEs accounted for perhaps as much as 90 percent of China’s total economic output. Today, the SOEs’ share has fallen to below 40 percent by most counts. Once the main engine of growth, SOEs are now more like an anchor. Profits across the SOEs have been sinking, while their debt has risen sharply.

Arresting that slide of SOEs is now vital. SOE reform has long been on the agenda of the Chinese government. But such a reform has become more urgent than ever, as well as more difficult. There are fewer SOEs today than in 1991 when serious SOE reform was first undertaken. Among those that remain, many are now extremely big and rank among the biggest companies in the world. The restructuring of any such large company is always difficult.

China, however, has taken some key first steps in that direction. The Chinese government has divided SOEs into those that will operate entirely based on market principles and those that perform a social function. It is downsizing the coal and steel industries, two of the largest red-ink sectors. Senior managers of some large SOEs have been dismissed or are under investigation for corruption, and experiments linking SOEs’ salaries more directly with profitability are underway.

Less noticed, but in my opinion, as important is a strong push now at some SOEs and SOE-affiliated companies to become not better but among the best in the world at what they do. Tsinghua Unigroup in semiconductors, China National Nuclear Corporation and China General Nuclear Power in building and operating nuclear power plants, and CITIC Group in eldercare are seeking global glory. They are trying to sprint while most other SOEs are limping.

Luckily for China, the overall situation in the entrepreneurial sector is far rosier. All it needs is a more level playing field. Important steps to further free up the private sector are now underway－taxes are being cut, banks pushed to lend more, and markets long closed to protect SOE monopolies are being pried open. Healthcare is a good example in this regard.

All these moves are part of what the government calls its new “supply side” policy. The aim is to demolish barriers to competition and efficiency. Chinese entrepreneurs have shown time and again they have world-class aptitude to spot and seize opportunities. They are leading the charge now into China’s underdeveloped service sector. This, more than manufacturing or exports, is where new jobs, profits and growth will come from.

Opportunities also await smart entrepreneurs in less efficient industries like agriculture, in getting food products to market quickly, cheaply and safely. In cities, traditional retail has been hit hard by online shopping. Struggling shopping malls are becoming giant laboratories where entrepreneurs are incubating new ideas on how Chinese consumers will shop, play, eat and be entertained.

China’s economy is now 30 times larger than what it was in 1991, and far more complex. The private sector 25 years ago was then truly in its infancy. But, there is still huge scope today for China to gain from its original policy prescription: prodding SOEs to get in line for reform while letting entrepreneurs meet the needs of Chinese consumers.

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The author is chairman and CEO of China First Capital.

http://www.chinadaily.com.cn/opinion/2016-04/08/content_24364851.htm

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How Renminbi funds took over Chinese private equity (Part 2) — SuperReturn Commentary

1 Comment / August 12, 2020

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How Renminbi funds took over Chinese private equity

(Part 2)

By Peter Fuhrman –
 
Large and small ships traverse the Huangpu River 24 hours a day, 7 days a week, and 365 days a year.

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Part two of a series. Read part one.

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Gresham’s Law, as many of us were taught a while back, stipulates that bad money drives out good. There’s something analogous at work in China’s private equity and venture capital industry. Only here it’s not a debased currency that’s dominating transactions. Instead, it’s Renminbi private equity (PE) firms. Flush with cash and often insensitive to valuation and without any clear imperative to make money for their investors, they are changing the PE industry in China beyond recognition and making life miserable for many dollar-based PE and venture capital (VC) firms.

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Outbid, outspent and outhustled

From a tiny speck on the PE horizon five years ago, Reminbi (RMB) funds have quickly grown into a hulking presence in China. In many ways, they now run the show, eclipsing global dollar funds in every meaningful category – number of active funds, deals closed and capital raised. RMB funds have proliferated irrespective of the fact there have so far been few successful exits with cash distributions.

The RMB fund industry works by a logic all its own. Valuations are often double, triple or even higher than those offered by dollar funds. Term sheets come in faster, with fewer of the investor preferences dollar funds insist on. Due diligence can often seem perfunctory.  Post-deal monitoring? Often lax, by global standards. From the perspective of many Chinese company owners, dollar PE firms look stingy, slow and troublesome.

The RMB fund industry’s greatest success so far was not the IPO of a portfolio company, but of one of the larger RMB general partners, Jiuding Capital. It listed its shares in 2015 on a largely-unregulated over-the-counter market called The New Third Board. For a time earlier this year, Jiuding had a market cap on par with Blackstone, although its assets under management, profits, and successful deal record are a fraction of the American firm’s.

The main investment thesis of RMB funds has shifted in recent years. Originally, it was to invest in traditional manufacturing companies just ahead of their China IPO. The emphasis has now shifted towards investing in earlier-stage Chinese technology companies. This is in line with China’s central government policy to foster more domestic innovation as a way to sustain long-term GDP growth.

The Shanghai government, which through different agencies and localities has become a major sponsor of new funds, has recently announced a policy to rebate a percentage of failed investments made by RMB funds in Shanghai-based tech companies. Moral hazard isn’t, evidently, as high on their list of priorities as taking some of the risk out of risk-capital investing in start-ups.

Dollar funds, in the main, have mainly been observing all this with sullen expressions. Making matters worse, they are often sitting on portfolios of unexited deals dating back five years or more. The US and Hong Kong stock markets have mainly lost their taste for PE-backed Chinese companies. While RMB funds seem to draw from a bottomless well of available capital, for most dollar funds, raising new money for China investing has never been more difficult.

RMB funds seldom explain themselves, seldom appear at industry forums like SuperReturn. One reason: few of the senior people speak English. Another: they have no interest or need to raise money from global limited partners. They have no real pretensions to expand outside China. They are adapted only and perhaps ideally to their native environment. Dollar funds have come to look a bit like dinosaurs after the asteroid strike.

Can dollar-denominated firms strike back?

Can dollar funds find a way to regain their central role in Chinese alternative investing? It won’t be easy. Start with the fact the dollar funds are all generally the slow movers in a big pack chasing the same sort of deals as their RMB brethren. At the moment, that means companies engaged in online shopping, games, healthcare and mobile services.

A wiser and differentiated approach would probably be to look for opportunities elsewhere. There are plenty of possibilities, not only in traditional manufacturing industry, but in control deals and roll-ups. So far, with few exceptions, there’s little sign of differentiation taking place. Read the fund-raising pitch for dollar and RMB funds and, apart from the difference in language, the two are eerily similar. They sport the same statistics on internet, mobile, online shopping penetration: the same plan to pluck future winners from a crop of look-alike money-losing start-ups.

There is one investment thesis the dollar PE funds have pretty much all to themselves. It’s so-called “delist-relist” deals, where US-quoted Chinese companies are acquired by a PE fund together with the company’s own management, delisted from the US market with the plan to one day IPO on China’s domestic stock exchange. There have been a few successes, such as the relisting last year of Focus Media, a deal partly financed by Carlyle. But, there are at least another forty such deals with over $20bn in equity and debt sunk into them waiting for their chance to relist. These plans suffered a rather sizeable setback recently when the Chinese central government abruptly shelved plans to open a new “strategic stock market” that was meant to be specially suited to these returnee companies. The choice is now between prolonged limbo, or buying a Chinese-listed shell to reverse into, a highly expensive endeavor that sucks out a lot of the profit PE firms hoped to make.

Outspent, outbid and outhustled by the RMB funds, dollar PE funds are on the defensive, struggling just to stay relevant in a market they once dominated. Some are trying to go with the flow and raise RMB funds of their own. Most others are simply waiting and hoping for RMB funds to implode.

So much has lately gone so wrong for many dollar PE and VC in China. Complicating things still further, China’s economy has turned sour of late. But, there’s still a game worth playing. Globally, most institutional investors are under-allocated to China.  A new approach and some new strategies at dollar funds are overdue.

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Peter Fuhrman moderates our SuperReturn China 2016 Big Debate: ‘How Do You Best Manage Your Exposure To China?’. Discussants include:

  • John Lin, Managing Partner, NDE Capital (GP)
  • Xisheng Zhang, Founding Partner & President, Hua Capital (GP)
  • Bo Liu, Chief Investment Officer, Wanda Investment (LP)
The Big Debate takes place on Tuesday 19 April 2016 at 11:55 – 12:25 at SuperReturn China in Beijing. Can’t make it? Follow the action on Twitter.
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Outbid, outspent and outhustled: How Renminbi funds took over Chinese private equity (Part 1) — SuperReturn Commentary

1 Comment / August 12, 2020

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Outbid, outspent and outhustled

Renminbi-denominated private equity funds basically didn’t exist until about five years ago. Up until that point, for ten golden years, China’s PE and VC industry was the exclusive province of a hundred or so dollar-based funds: a mix of global heavyweights like Blackstone, KKR, Carlyle and Sequoia, together with pan-Asian firms based in Hong Kong and Singapore and some “China only” dollar general partners like CDH, New Horizon and CITIC Capital. These firms all raised money from much the same group of larger global limited partners (LPs), with a similar sales pitch, to make minority pre-IPO investments in high-growth Chinese private sector companies then take them public in New York or Hong Kong.

All played by pretty much the same set of rules used by PE firms in the US and Europe: valuations would be set at a reasonable price-to-earnings multiple, often single digits, with the usual toolkit of downside protections. Due diligence was to be done according to accepted professional standards, usually by retaining the same Big Four accounting firms and consulting shops doing the same well-paid helper work they perform for PE firms working in the US and Europe. Deals got underwritten to a minimum IRR of about 25%, with an expected hold period of anything up to ten years.

There were some home-run deals done during this time, including investments in companies that grew into some of China’s largest and most profitable: now-familiar names like Baidu, Alibaba, Pingan, Tencent. It was a very good time to be in the China PE and VC game – perhaps a little too good. Chinese government and financial institutions began taking notice of all the money being made in China by these offshore dollar-investing entities. They decided to get in on the action. Rather than relying on raising dollars from LPs outside China, the domestic PE and VC firms chose to raise money in Renminbi (RMB) from investors, often with government connections, in China. Off the bat, this gave these new Renminbi funds one huge advantage. Unlike the dollar funds, the RMB upstarts didn’t need to go through the laborious process of getting official Chinese government approval to convert currency. This meant they could close deals far more quickly.

Stock market liberalization and the birth of a strategy

Helpfully, too, the domestic Chinese stock market was liberalized to allow more private sector companies to go public. Even after last year’s stock market tumble, IPO valuations of 70X previous year’s net income are not unheard of. Yes, RMB firms generally had to wait out a three-year mandated lock-up after IPO. But, the mark-to-market profits from their deals made the earlier gains of the dollar PE and VC firms look like chump change. RMB funds were off to the races.

Almost overnight, China developed a huge, deep pool of institutional money these new RMB funds could tap. The distinction between LP and GP is often blurry. Many of the RMB funds are affiliates of the organizations they raise capital from. Chinese government departments at all levels – local, provincial and national – now play a particularly active role, both committing money and establishing PE and VC funds under their general control.

For these government-backed PE firms, earning money from investing is, at best, only part of their purpose. They are also meant to support the growth of private sector companies by filling a serious financing gap. Bank lending in China is reserved, overwhelmingly, for state-owned companies.

A global LP has fiduciary commitments to honor, and needs to earn a risk-adjusted return. A Chinese government LP, on the other hand, often has no such demand placed on it. PE investing is generally an end-unto-itself, yet another government-funded way to nurture China’s economic development, like building airports and train lines.

Chinese publicly-traded companies also soon got in the act, establishing and funding VC and PE firms of their own using balance sheet cash. They can use these nominally-independent funds to finance M&A deals that would otherwise be either impossible or extremely time-consuming for the listed company to do itself. A Chinese publicly-traded company needs regulatory approval, in most cases, to acquire a company. An RMB fund does not.

The fund buys the company on behalf of the listed company, holding it while the regulatory approvals are sought, including permission to sell new shares to raise cash. When all that’s completed, the fund sells the acquired company at a nice mark-up to its listed company cousin. The listco is happy to pay, since valuations rise like clockwork when M&A deals are announced. It’s called “market cap management” in Chinese. If you’re wondering how the fund and the listco resolve the obvious conflicts of interest, you are raising a question that doesn’t seem to come up often, if at all.

Peter continues his discussion of the growth of Renminbi funds next week. Stay tuned! He also moderates our SuperReturn China 2016 Big Debate: ‘How Do You Best Manage Your Exposure To China?’.

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http://www.superreturnlive.com/

New Year gambling hints at Chinese entrepreneurial vigour — The Financial Times

Leave a Comment / August 12, 2020

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FT beyondbrics

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With about every major leading economic indicator in a tailspin, it’s easy, even obvious, to be bearish about China. But, one sign of economic activity could hardly seem more robust: the crowds and cash at gambling tables during this year’s Chinese New Year.

The two-week long lunar New Year celebration finally drew to a close on Monday with the Lantern Festival. Here in Shenzhen, China’s richest city per capita, no sooner do the shops all shut down for the long break than the gambling tables spill out onto the street, like the cork flying out of a bottle.

Gambling, especially in public places with large sums being wagered, is illegal everywhere in China. All the same, the New Year is ready-made for gamblers and street-corner croupiers to gather. For one thing, most police and urban street patrols are also away from their jobs with family.

Along with over-eating and giving cash-stuffed red envelopes, gambling is the other main popular indulgence during the New Year. Most of it happens behind closed doors with families gathered around the mahjong and card table. But parts of Shenzhen soon take on the appearance of an al fresco Macau (see photo).

 

 

 

 

 

 

 

 

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This year, from what I could see, the number of punters and sums being wagered was far higher than years past. This matters not only as a statement of consumer optimism here but also as affirmation of the love of risk-taking that helps make China such a hotbed of entrepreneurial activity.

The two forces operating together – not only at street corner casinos — are perhaps the best reason to be optimistic that China’s economy may yet avoid a “hard landing” and continue to thrive.

In my neighborhood, the favorite game on the street is a form of craps where people bet on which of six auspicious animals and lucky symbols will turn up. Hundreds of renminbi change hands with each roll. No small bets allowed. The gambling goes on from morning until late at night.

It’s a game that requires no skill and one that also gives the house a huge advantage, since winning bets only make four times the sum wagered. This puts it in a somewhat similar league with punto banco baccarat, the casino game Chinese seem to like the most. It’s also game of pure chance, where the house has a built-in edge.

In China, gamblers’ capital flows to games with unfair odds, where dumb luck counts for more than smarts. In this there is cogent parallel with the investment culture in China. China is simply awash in risk-loving risk capital.

Street-side gambling is popular during the New Year break in part because the other more organised mainstream forms of taking a punt are shut down. Top of the list, of course, is the Chinese domestic stock market. It’s rightly called the world’s largest gambling den. Shares bob up and down in unison, prices decoupled from underlying economic factors, a company’s own prospects or comparable valuations elsewhere.

The simple reason is that almost all shares are owned by individual traders. Fed on rumors and goaded by state-owned brokerage houses, they seem to give no more thought to which shares to buy than my neighbors do before betting Rmb200 on which dice will land on the lucky crab.

The housing market, too, traces a similar erratic arc, driven far more by short-term speculation than the need to put a roof over one’s head. Billions pour in, bidding up local housing prices in many Chinese cities to a per-square-foot level higher than just about anywhere in the West except London, Paris, New York and San Francisco. Eventually prices do begin to moderate or even fall, as happened in most smaller cities this past twelve months.

The other big pool of risk capital in China goes into direct investment in entrepreneurial ventures of all sizes and calibers. Nowhere in the world is it easier to raise money to start or grow a business than China. In part, because Chinese have a marked preference for being their own boss, so the number of new companies started each year is high. The other big factor, call it the demand side, is that there is both a lot of money available and a great enthusiasm for investing in the new, the untried, the risky.

Before coming here, I used to work in the venture capital industry in California. VCs there are occasionally accused of turning a blind eye toward risk. Compared to venture investing in China, however, even the most starry-eyed venture investor in Silicon Valley looks like a Swiss money manager.

Just about any idea here seems to attract funding, a lot of it institutional. China now almost certainly has more venture firms than the rest of the world combined. No one can keep proper count. Along with all the big global names like Sequoia and Kleiner Perkins, there are thousands of other China-only venture firms operating, along with at least as many angel groups. In addition, just about every Chinese town, city and province, along with most listed companies, have their own venture funds.

I marvel at the ease with which early-stage businesses get funded, the valuations they command and the less than diligent due diligence that takes sometimes place before money moves. Of course, a few of these venture-backed companies hit the jackpot.

Alibaba or Tencent are two that come to mind. But, initial public offering (IPO) exits for Chinese startups remain rare, and so taken as a whole, venture investing returns in China have proved meager. But, activity never seems to wane. Fad follows fad. From group shopping, to what’s known in China as “O2O” (offline-to-online) thousands of companies get started, funded and then often within less than 18 months, go pffft.

With the New Year celebrations winding down, the outdoor gambling tables in my neighborhood are being put away for another year. Work schedules are returning to normal. For all the headwinds China’s economy now faces, Chinese household savings are still apparently growing faster than GDP. This means Chinese will likely go on year-after-year amassing more money to invest, to gamble or to speculate.

 

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http://blogs.ft.com/beyond-brics/2016/02/22/new-year-gambling-hints-at-chinese-entrepreneurial-vigour/

Download Financial Times article

 

 

Why Taiwan has a Largan and China doesn’t — Nikkei Asian Review

Leave a Comment / June 24, 2016

–Nikkei 1

 

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Why Taiwan has a Largan and China doesn’t

PSF

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No Asian technology company is currently more successful, dominant and more deeply engrained in the daily lives of a billion-plus people worldwide than Largan Precision. While you may not know the name, odds are you carry Largan technology around with you every day.

Largan makes the tiny plastic camera lenses for the high-megapixel cameras built into the iPhone and most higher-end Android devices. Largan enjoys a near-monopoly and is probably the only company in the world supplying an important high-margin component to both Apple and its Android rivals. That means even if Apple’s growth begins to cool, Largan won’t suffer as acutely as other key Apple component suppliers like Silicon Valley favorites Cirrus Logic and InvenSense. Apple may now be more dependent on Largan than Largan is on Apple.

Not that Largan is eager for the world-at-large to know. Though publicly-traded on the Taiwan Stock Exchange, the company is extremely reticent about sharing much information on its robust financial health and its current hammerlock hold on Apple. Largan habitually issues rather gloomy-sounding forecasts, as it did earlier this month, suggesting its growth rate may be slowing. Though its share price has nearly doubled in the last two years, it still trades at an anemic p/e multiple of under 10 times projected 2016 net income.

Smartphone sales are beginning to plateau Also casting a potential shadow, Apple is said to be keen to find an alternative camera lens supplier. The Cupertino company loathes having single-source suppliers like Largan. But, so far it’s proving all but impossible for Apple to find another supplier to match Largan’s price, volume and quality. Patents, Largan has them in abundance. But, its most valuable innovations, the ones Apple and its other customers pay good money for,  are mainly unpublished: the sophisticated manufacturing know-how needed to produce in massive quantities at low-cost tiny specs of curved plastic at optical quality.

Fortunes rise and fall quickly in the mobile phone industry. If more proof were needed, just look at Xiaomi, which went from the world’s highest valued to perhaps most overvalued startup in less than a year. Largan, meanwhile, quarter after quarter, remains the envy of the entire Apple and Android manufacturing world.

Cameras — and the quality of photos they take — have never been a more important selling point for mobile handset makers. All the key trends — higher resolution lenses with larger apertures, high-quality cameras front and back, optical zoom and image stabilization — play directly to Largan’s proprietary strengths and know-how.  The result, Largan also enjoys about the highest growth rate and market share along with net profit margins among all key mobile component manufacturers.

Despite the slowdown in the growth of mobile phone sales, Largan’s 2015 revenues rose by over 20% to reach $1.7bn, while net income surpassed $700mn. Largan’s +40% net profit margin are double Apple’s.

Few are the public companies anywhere that throw up numbers like Largan’s:

Largan is an example of a company that waited a long time for its moment in the sun. It was started 29 years ago and is still run by its two original founders, Tony Chen and Scott Lin. Both are now dollar billionaires and well past Taiwan’s official retirement age of 65.

I’ve never met the founders, or anyone else from Largan. I’ve learned about the company from the CEOs of some other large Apple and Android suppliers we work with. They uniformly sing Largan’s praises. “Though I try, I can’t find a single weak point except maybe that the founders should probably be retired and working on their golf game” muses one whose Hong Kong-listed company has been trying without success to get into the business selling plastic camera lens to Apple.

If rumors are correct, the next version of the larger iPhone will include dual cameras, front and back, each with much higher megapixel count than the current iPhone6. If so, and Largan as is likely remains the principal supplier, Largan’s revenues and profits from each iPhone sold will increase. Largan already makes similar lenses in bulk for Android brands.

For many years, the company was a small, niche manufacturer, one of dozens in the optics industry clustered around the city of Taichung. Largan’s focus then and now was producing high-quality lenses from plastic rather than glass. Early on plastic lenses seemed more like a novelty, too low in quality to ever seriously compete with the fine glass optical lenses made in Japan for the country’s major camera brands like Nikon, Canon and Minolta.

Largan’s plastic lenses were originally consigned mainly for use inside desktop scanners and projectors. Then the smartphone came along. A decade ago, only half the smartphones sold each year had a built-in camera. Now, it’s nearly 100%. Megapixel count has risen from two to sixteen and sometimes higher. Largan has been at the forefront throughout, but especially over the last five years as specs get higher and customers more demanding. A handset camera needs to take great pictures, but do so without adding much weight, sucking too much battery life or hogging too much space. Glass simply can’t cut it.

Among plastic lens manufacturers, no one else can currently match Largan’s know-how, precision and manufacturing skill. The camera in your mobile phone is a remarkable bit of gear. A typical high-end smartphone camera now has multiple aspherical Largan lenses with different dispersion and refractive properties, stacked about four millimeters high inside a plastic mount. To achieve perfect focus, the lenses need to be perfectly aligned, moveable, have as wide an aperture as possible and optical image stabilization.

Largan makes only lenses. The complete camera module (see photo below of the module from the iPhone) is assembled by other manufacturers, a task that still requires some hand labor and offers tiny margins of 5% or less.

Hon Hai, more commonly known as Foxconn, is one of the companies doing the low-paid module assembly work. Foxconn and Largan are both key Apple suppliers, but sit at opposite ends of the margin spectrum.

Two other things they share in common: both are Taiwanese companies with a large manufacturing presence in China. This underscores an important point about the relative level of technology development in Taiwan and the PRC. Taiwan companies remain light-years ahead in the majority of cases.

Looking just at the Apple ecosystem, while most components as well as finished products are manufactured in China, mainland Chinese companies barely earn a dime from all this. There is no more unbalanced balance-of-trade than the iPhone’s manufacturing and sales in China. Chinese bought around 70 million iPhones last year, with a retail value of over $70bn. But, only a fraction of that stays in China, mainly in the form of sales tax collected by the government from sales in official retail channels and the wages paid to assembly staff at hundreds of factories producing for Apple. The picture isn’t very different with Android phones. What profits there are end up in the hands of high-value non-PRC software and component suppliers, including Largan.

Despite the PRC’s generous subsidies to technology companies and a massive government push to foster indigenous innovation, China’s domestic technology manufacturers remain overwhelmingly stuck producing low-margin commoditized products without any globally significant high-margin IP. True, the PRC got a late start compared to Taiwan. But, there are some other often overlooked systemic factors at work here.

Start with the fact intellectual property remains weakly protected. Mainland Chinese companies have less incentive to do as Largan did and plow years of effort and investment into a new technology with an uncertain path to market.

Seeking risk capital is most often a hopeless quest. The Shanghai and Shenzhen stock exchanges do not allow smaller companies with promising technology and zero profits to go public. China’s domestic venture capital industry most always shuns start-ups working on truly innovative high-tech products, preferring knock-offs of successful US online business models where revenues, if not profits, can be generated more quickly. Longer-term bank lending is all but non-existent.

Another factor that I believe inhibits innovation in China – the country relied on technology transfer, on forcing companies from the developed world to turn over to Chinese joint venture partners some proprietary technology in return for access to the Chinese market. Why innovate at home when foreign companies can be made to hand over trade secrets, albeit outdated ones, for free? This has stunted the growth of a strong foundation of homegrown innovation in China.

China took on low-margin work spurned by earlier generations of Japanese, Korean and Taiwanese manufacturers. But, Chinese companies have so far mainly failed to build something more substantial on top of this by adding their own proprietary improvements that can command higher prices. Margins, always threadbare, are instead vaporizing across the domestic manufacturing sector due to rising wages, benefits, environmental compliance and energy costs as well as taxes.

Then look at Largan. Its margins, despite weak overall mobile phone growth, are on track to actually increase this year above already stellar levels. As good as the camera on your mobile is, there is enormous scope for the hardware to get better, smaller, lighter, faster, flatter. It’s hard to envisage anyone else pushing the process more propulsively and successfully than Largan.

 

Download our Chinese-language article on Largan as published in Caijing Magazine

As published in Nikkei Asian Review

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Government cyber-surveillance is the norm in China — and it’s popular: Washington Post

Leave a Comment / June 24, 2016

–Washpo2

Opinions

Government cyber-surveillance is the norm in China — and it’s popular

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SHENZHEN, China

When they met most recently, President Obama extracted from his Chinese counterpart, Xi Jinping, a solemn pledge to rein in Chinese surveillance and hacking of U.S. government agencies, companies and individuals. The backsliding seems to have begun almost immediately , with new reports of attacks by Chinese hackers in the United States. This conflict is not only a matter of competing national interests. At its heart are radically opposed conceptions of personal privacy and the legality of government monitoring.

Within China, government monitoring of private communication is not only common, but it is also explicit, institutionalized and generally quite popular. How much so? Just about every time I get an international phone call on my Chinese mobile phone, I’m pinged within seconds by a text message. It’s an automated message from the anti-fraud department of the city of Shenzhen’s Public Security Bureau (PSB), China’s version of the FBI.

This message informs me in polite Chinese that the PSB knows I’m on the phone with someone calling from outside China, and so I should be especially vigilant, because the caller could be part of some scheme to steal my money or otherwise cheat me. The phone number for the anti-fraud hotline is included. International fraud is, as of now, the only criminal activity that China’s government uses the mobile network to warn me about.

I do like knowing the Chinese police are on the job, warning and protecting the innocent. But I find it a little unsettling that they know immediately when I get an international call and are eager to inform me that they are keeping tabs. There’s also the fact that I get these messages every time my 83-year-old father calls from Florida. Does the Chinese security apparatus know something about him that I don’t?

China Mobile is the world’s largest mobile phone company, with more than 800 million customers. To generate that automatic anti-fraud text message, international calls routed across the network in all likelihood pass through a server layer controlled and monitored by the PSB; calls from certain countries get flagged, and the text message is dispatched as the call is taking place. This isn’t cyberspying. This is a deep integration.

It’s not only the PSB. Upon landing on a trip to another country, I usually get an automatic Chinese-language text message from the Chinese Ministry of Foreign Affairs reminding me to behave politely and providing me with emergency contact numbers. It’s a neat bit of coding. China Mobile reports to the foreign ministry, and perhaps other departments as well, when a user’s phone begins seeking a roaming signal outside China. The system then generates the text welcoming the user to that country and populating the message with the number for the nearest Chinese embassy and consulate.

The U.S. National Security Agency has ways, if Edward Snowden’s revelations are to be believed, to detect when a U.S. mobile phone is being used anywhere in the world. But it goes to a lot of trouble to keep a user from knowing that. Not so the Chinese state.

I’ve asked Chinese friends about this, and none expressed the slightest quibble about their government knowing where they travel or when they receive international calls. The government is just trying to be helpful, they explain. There’s no real civil liberties debate about it, not even in the online channels where criticisms of Chinese policy are voiced.

In contrast, the United States has gone through a particularly bitter and protracted national debate over whether and how mobile phone companies, along with email providers, should share information and communications metadata with the NSA. It’s not certain how much U.S. companies actively assisted the NSA in its domestic surveillance. But it’s beyond doubt that none cooperates to the extent China Mobile evidently does with the PSB.

In the past several years, China has introduced some of the world’s toughest laws, regulations and guidelines on data privacy. These tightly circumscribe what data companies can collect and introduce strict penalties for privacy breaches. Xi cites the laws as evidence that China has zero tolerance for hacking.

The quizzical result is: E-commerce giant Alibaba must not share anything about my Taobao account and is legally and financially responsible if my account gets hacked. But state-owned China Mobile (along with its two state-owned rivals, China Unicom and China Telecom) will freely share my private data with government departments at the national, provincial and local levels.

According to China’s latest cybersecurity law, all companies operating in China, foreign and domestic, must share private data with the government to aid in official investigations. No specific mention is made of state-owned enterprises such as China Mobile. So, we don’t know if China Mobile is required, encouraged or expected to share data that isn’t part of any official investigation — such as who is getting international calls or traveling outside the country.

Some U.S. companies, including Apple, have introduced encryption techniques that make it harder for the NSA to access user data and conversations. No such effort is underway in China, nor, as far as I can tell, is anyone seriously suggesting it.

I’m no civil-liberties purist, so I don’t particularly mind getting these text messages from the Chinese government. But it does serve as a vivid reminder that while living in China I’m subject to a set of rules and an official mind-set that are the obverse of those in the United States. Online and mobile communication privacy as we Americans understand it simply does not exist here.

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https://www.washingtonpost.com/opinions/cyber-surveillance-is-a-way-of-life-in-china/2016/01/29/e4e856dc-c476-11e5-a4aa-f25866ba0dc6_story.html

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China’s Xiaomi Under Pressure to Prove Value to Investors — Wall Street Journal

Leave a Comment / January 11, 2016

WSJ

Headline

Xiaomi’s Redmi 2 smartphones on display during a launch in Brazil in June, 2015.
Xiaomi’s Redmi 2 smartphones on display during a launch in Brazil in June, 2015. Photo: Reuters
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By  Eva Dou

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BEIJING—In January 2015, Xiaomi Corp. founder Lei Jun announced to his staff in an open letter that the Chinese smartphone maker was the world’s most valuable technology startup.

“We will journey into the constellations, to places where others haven’t dreamed of,” he wrote.

Living up to those high expectations has been a challenge. Xiaomi missed its 2015 sales target of 80 million smartphones, according to people familiar with the company, and investors are beginning to question its $46 billion valuation, which was based on yet unrealized plans to generate substantial revenue from Internet services.

China’s economic slowdown, coupled with turbulence in the stock market, is prompting investors to take a second look at China’s high startup valuations. Startups such as Xiaomi, which raised vast sums on China’s mobile Internet boom, are now facing growing pressure to live up to expectations.

“With China’s economy slowing, many startups will need to be more cautious in their expansion strategies,” said Nicole Peng, an analyst for market research firm Canalys.

Xiaomi shot to the top of China’s smartphone market in 2014 with the novel idea of selling hardware by gathering a large user base, a business model usually favored by Internet companies, not those selling a physical product. Sales that year tripled to 61 million smartphones, compared with a year earlier. Mr. Lei cultivated fan clubs and used “flash sales” to sell smartphones with iPhone-rivaling hardware at a fraction of the price. He swallowed thin margins, betting he could later sell services to users.

Investors swooned. In December 2014, Xiaomi raised a $1.1 billion round that valued it at $46 billion, topping even ride-sharing startup Uber Technologies Inc. at the time, although Uber has since regained the lead.

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But Xiaomi’s smartphones, which once sold out in minutes in limited batches via online flash sales, are now easily available—a shift that analysts say signals slowing demand.

A slowdown in China’s smartphone market has laid bare Xiaomi’s weaknesses.

Xiaomi has lost market share against established competitors with more financial and technological firepower, such as Huawei Technologies Co., which launched a high-end smartphone line and overtook Xiaomi as China’s top handset maker in the third quarter 2015, according to research firm Canalys.

Huawei, which sold more than 100 million mobile devices last year, is beefing up its marketing in overseas markets in a bid to challenge Apple Inc. and Samsung Electronics Co. , the world’s two biggest smartphone makers. Huawei’s engineering strength and brand image built up over decades make it difficult for Xiaomi to compete in China, analysts say.

“The competition in China’s smartphone market has intensified tremendously this year,” said a Xiaomi spokeswoman, who declined to comment on the company’s valuation or say whether it met its 2015 sales target. She said Xiaomi sales were “within expectations” and its flash sales are primarily for new phones when production ramps up.

The lack of its own high-end chip technology also proved to be a competitive disadvantage for Xiaomi in 2015. When early versions of the Qualcomm Inc. ’s Snapdragon 810 processor were reported to overheat, it dampened sales of Xiaomi’s most expensive handset yet, the 2,299 yuan (US$349) Mi Note, analysts said. Xiaomi couldn’t fall back on an in-house developed chip to get around the problem, as Huawei and Samsung did.

Xiaomi and Qualcomm declined to comment on the processor. Analysts say the problems have since been fixed.

Overseas growth has also been slow for Xiaomi, with the percentage of its smartphones sold overseas in the first nine months of 2015 rising to 8%, compared with 7% in the 2014 calendar year, according to Canalys. It faced tough competition overseas, and found consumers unaccustomed to online phone-buying, said Ms. Peng, the analyst from Canalys.

Xiaomi’s thin patent portfolio also became a hurdle as it sought to expand in markets such as India. A lack of patents led to a court ruling that crimped its access to the crucial India market. In December 2014, India’s Delhi High Court ordered Xiaomi to stop selling all smartphones not running on Qualcomm chips due to a patent lawsuit filed by Sweden’s Ericsson. A year later, the injunction remains, which means Xiaomi can’t sell its popular models running chips made by Taiwanese chip maker MediaTek Inc.

Xiaomi said it sold 3 million smartphones in India from July 2014 through August 2015, and 1 million smartphones there in the third quarter. Its average quarter-over-quarter growth is 45%, it said.

The lack of a diversified customer base is another challenge for Xiaomi. It remains “locked in a Chinese demographic ghetto of mainly males 18 to 30,” said Peter Fuhrman, chairman of China-focused boutique investment bank China First Capital. Xiaomi’s focus on low prices has hit its brand image, he said.

Xiaomi’s average smartphone price fell to $122 in the third quarter from $160 a year earlier, despite China’s smartphone sector moving upmarket, according to IDC. The average price of a smartphone in China rose to $240 from $202. Huawei’s rose to $209 from $201. Xiaomi’s best-selling model last year was its cheapest, the $76 Redmi 2A, IDC analyst James Yan said.

Xiaomi’s supporters say the outlook is still bright, as it shifts to building an ecosystem of smart home products. The company has invested in 56 startups so far, ranging from iconic scooter maker Segway to a manufacturer of air purifiers, essential in China’s smog-choked cities.

“Xiaomi’s promise lies in its ecosystem,” said Steven Hu, former partner in Xiaomi investor Qiming Venture Partners.

But others are skeptical.

“Mobile services, e-commerce, branded consumer products—these still are largely just a figment rather than a huge and growing source of profits that could validate last year’s sky-high valuation,” said Mr. Fuhrman.

 

http://www.wsj.com/articles/chinas-xiaomi-under-pressure-to-prove-value-to-investors-1452454204

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At the hub of China’s “One Belt, One Road” – a visit to Manzhouli, the frozen city where China, Russia and Mongolian converge

Leave a Comment / December 30, 2015

Manzhouli

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Where did you spend Christmas? Mine was spent in temperatures reaching 38-below zero on the frozen lakes and grasslands of Northeastern China. I was there to give a speech on Christmas Day at a conference in Manzhouli on Russian, Chinese and Mongolian economic integration.

Manzhouli is a Chinese city but with a unique pedigree and location. First settled around 1900 by the Russians building the Trans-Manchurian spur of the Trans-Siberian Railway, it was then conquered by the Japanese before China took control after World War Two. It sits at the single point on the map where the borders of China, Russia and Mongolia all converge. Manzhouli’s train and road border crossing between Russia and China is the busiest inland port in China, with most of China’s $50 billion in annual exports to Russia passing through here.

China, Russia and Mongolia are now partners in China’s ambitious new strategic trade initiative known as “One Belt, One Road“, or OBOR, as well as the Chinese-sponsored Asia Infrastructure Investment Bank. The conference was meant to encourage closer trade ties among the three. OBOR is designed in part to redirect China’s investment focus away from more developed countries, especially those participating in the US-led Trans-Pacific Partnership.

China’s exclusion from TPP is perhaps the biggest single economic policy setback for China in the last decade. The TPP countries include most of China’s key trading partners. If enacted, TPP will cause trade and investment flows to shift away from China especially towards Vietnam, Malaysia and Philippines. The three are all parties to the TPP agreement, and so will benefit from preferential tariffs. All have aspirations to take market share away from China as a global manufacturing center. TPP will grant them a significant long-term cost and market-access advantages.

OBOR is a consolation prize of China’s own construction. The countries inside the OBOR plan look more like a cast of economic misfits, not dynamic free traders like the TPP nations and China itself. I don’t believe anyone in Beijing policy-making circles believes that increased trading with OBOR nations Pakistan, Myanmar and the Central Asian -stans is a credible substitute. China’s best option is to find a way to persuade TPP countries to allow it to enter the group. There’s not even a remote sign of this happening. China was excluded from TPP by design.

China does not live in a particularly desirable or affluent neighborhood. It shares land borders with fourteen countries. Of these, Russia is by far and away the richest of these countries. Mongolia, with its three million inhabitants most of whom still live in yurts as nomadic herdsmen, ranks third. This gives some sense of how poor many of the places that are now the focus of China’s OBOR are.

Another key component of OBOR, but one often overlooked, is to open up new markets to the most troubled part of China’s industrial economy, the manufacturers of basic products like steel, aluminum, basic machinery and chemicals, turbines, cars, trucks, trains. They all are suffering from acute overcapacity with vanishing profit margins up and down the supply chain.

The Chinese leadership recently announced that dealing with overcapacity in China will be one of its major economic policy priorities for 2016. The problems are most severe among state-owned industrial conglomerates. The Chinese government is their controlling shareholder. Two obvious solutions — shrinking capacity and cutting employment — are, for the time being at least, politically off limits. OBOR is meant to be a lifeline.

China itself cannot absorb this excess domestic capacity. Demand for basic industrial products is already evaporating, never to return, China is already well along in the transition to a service economy. China will pay or lend tens of billions of dollars to poorer OBOR countries to finance their imports of Chinese capital goods. The trade won’t likely be very profitable but it will keep jobs and revenues from deteriorating even more sharply.

You may download the seven-page English-language talking points, map and charts from my speech by clicking here.

At night, there was a banquet for political leaders from the three countries. Afterward, a beauty contest was staged, featuring Chinese, Russian and Mongolian contestants in bikinis and evening gowns. You can see photos here, including ones of me with the Chinese winner and the nine Mongolian contestants. An ice fishing expedition was also organized.

If OBOR does achieve its goal by drawing Russia and Mongolia into a closer economic relationship with China, Manzhouli stands to benefit more than anywhere else in China. As if in readiness, Manzhouli storefronts are in Chinese and Cyrillic, the new airport terminal is in the Russian style, and the main park in the city lorded over by a 10-story Matryoshka doll.

For now, though, no one is seeing much sign of OBOR stimulating greater trade. The main focus for investment in Manzhouli is in tourism facilities to attract Chinese summer vacationers to the surrounding grasslands, China’s finest. This time of year, the cement tourist yurts are empty and the long-haired riding ponies are left to graze and amble in the arctic wind and snow.

 

 

 

 

Fosun boss ‘assisting investigation’ — South China Morning Post

Leave a Comment / December 15, 2015

–SCMP

 

Fosun arrest

 

Fosun Group chairman Guo Guangchang, who went missing on Thursday, has been “assisting an investigation” since Thursday afternoon but is now in contact with his staff, Shanghai Fosun Pharmaceutical said in a stock exchange filing last night.

The tycoon, whose disappearance triggered speculation that he may have become the latest victim of President Xi Jinping’s crackdown on corruption, can participate in his company’s decision making “in proper ways”, Shanghai Fosun said.

Shares of Shanghai Fosun Pharmaceutical will resume trading on Monday. It was suspended yesterday along with six other Fosun companies, including two listed in Hong Kong.

Two Fosun officials told the South China Morning Post that Guo was allowed to make phone calls but his movements have been restricted.

The Guo incident comes amid a nationwide probe into alleged market wrongdoings in the wake of the summer’s stock market rout that has already netted senior government officials and top executives at state-owned banks and brokerages.

“Chinese entrepreneurs are struggling with the most complicated legal environment in the world, given the government’s heavy meddling in the economy and business. It is just too easy to take away their wealth by abusing the judiciary,” said Hangzhou-based lawyer Chen Youxi.

The pillars of China’s powerful private sector are shaking, said Peter Fuhrman, chairman and chief executive of investment advisory firm China First Capital, “possibly for the first time ever”.

Fosun, more than any other of the 60-million-plus private companies in the mainland, embodies and exemplifies the rise of the private sector from illegality and irrelevance 20 years ago to its current position as the main source of growth, employment and taxes in China, Fuhrman said.

“The incident brings home, as no previous event has, the fact that China’s anti-corruption campaign means to usher in a new way of doing business for all of China Inc, not only the state-owned rump.”

Industry sources said the investigation into Guo started as early as the summer. A source with knowledge of the matter said Guo was detained in July by graft busters to assist in probes into high-level party officials, including some from Shanghai.

In August, Wang Zongnan, a former head of state-owned Bright Food Group, was sentenced to 18 years in jail for embezzlement and bribery. A court verdict said Fosun had sold property below market rates to Wang.

A businessman, who cannot be identified, told the Post that Guo could have been questioned over his relationships with either Yao Gang, a vice-chairman of the China Securities Regulatory Commission, or Ai Baojun, a vice-mayor of Shanghai.

Meanwhile, several mainland media sources reported orders from their headquarters to delete articles related to Guo. Fosun holds substantial stakes in many mainland media, including the influential 21st Century Media.

Dollar bonds of Fosun International fell by a record yesterday while stocks related to Guo’s companies trading in the US and Europe took a beating as well.

 

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China SOEs, the meaning of their existence — Week In China Magazine

Leave a Comment / June 9, 2016

Week In China logo

 

 

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His was a deceptively simple question. “What exactly is the purpose of a Chinese SOE?”

I had just finished speaking to the Asian management committee of one of the larger and more successful Fortune 500 companies operating in China. They have for years done profitable business with large SOEs in China. That business has begun to evaporate. Having just heard me summarize the deteriorating situation at many SOEs, and the decision last month by the Chinese government to quietly shelve plans for a root-and-branch restructuring, one senior executive wanted to know what Chinese SOEs are now in business to do. Make money? Provide and protect jobs? Project national power?

I reminded him Chairman Mao was a keen student and devoted follower of Lenin. He fully embraced the Leninist concept of the state and party controlling the “commanding heights” of the economy. China’s SOEs are still very much in that business: owning most, sometimes all, of China’s large-scale assets in petroleum, gas, electricity generation and distribution, coal, banking and finance, transport, steel, aluminum and a wide range industrial chemicals.

The executive then reminded me that Mao had been gone a long time and anyway hadn’t Deng Xiaoping begun 35 years ago dismantling state power to create the conditions where today’s vibrant Chinese private sector could emerge. The private sector is the source of all net new job creation in China and contribute far more to GDP than the SOE segment. The country’s best companies are private sector firms, not SOEs. What, he insisted, were SOEs in business to do?

It was obvious he wasn’t going to accept an answer based on Leninist political economic theory. “Why don’t they just privatize the state-owned sector?”, he pushed back. That, I told him, was out of the question, at least for now. “Why?” he wanted to know.

Looking for an opening to collect my thoughts, I steered him toward the coffee machine.

Above all” I started in again, “an SOE is an instrument to achieve Chinese government and party policy goals. This is as true today as it was at their origin. Sometimes those policies, at least originally, were quite high-minded, even socialistic, like providing sufficient energy at an affordable price to everyone in the country.

Energy is today plentiful in China, but cheap it’s not. Subsidies have been eliminated and prices hiked to levels generally well above those in the US. The money paid to the petroleum and power monopolies are a transfer of private wealth to state-owned coffers, in other words, a mechanism for hidden tax collection.

 

Download complete article here.

http://www.weekinchina.com/2015/12/fit-for-purpose-2/

 

Xiaomi’s $45 Billion Valuation Seen `Unfeasible’ as Growth Cools — Bloomberg

Leave a Comment / June 24, 2016

Bloomberg

Xiaomi’s $45 Billion Valuation Seen `Unfeasible’ as Growth Cools

By Tim Culpan

November 25, 2015 — 7:00 PM HKT

Things were going so well for Xiaomi Corp. Customers were lining up, investors were swooning and the Beijing-based startup closed funding at a $45 billion valuation. That was last year.

Now the high-flying smartphone maker is stumbling. Founder Lei Jun’s latest business, one of China’s most exciting startup stories of the past few years, is likely to miss its own goal of selling 80 million smartphones this year, according to two people with knowledge of its production plans. Suppliers also cut their internal targets for Xiaomi in anticipation of the shortfall, they said.
Xiaomi’s falter shows the startup’s challenge in trying to maintain momentum after a meteoric ascent past Apple Inc. and Samsung Electronics Co. in China. Investors bought into the company’s story of youthful disruption and online sales, yet the subsequent lowering of China’s growth target and the copying of its sales strategy by rivals have neutralized Xiaomi’s first-mover advantage, putting its high price tag in doubt.

“All those expectations of growth aren’t being realized, which now makes that $45 billion valuation unfeasible,” said Alberto Moel, an analyst at Sanford C Bernstein in Hong Kong. “The argument was that their business is kind of like Apple and they’re growing very fast, but they’re no longer growing so fast and they’re not as good as Apple.”
Shipments Drop

Xiaomi doesn’t provide exact shipment targets to its suppliers, instead working on a real-time basis with orders fulfilled as they come in on Xiaomi’s website. Yet the companies tasked with preparing the components and capacity to meet Xiaomi’s needs have started scaling back production and diverting resources elsewhere, said the people, who have knowledge of the supply chain and asked not to be identified because the details are private.

Domestic shipments of Xiaomi smartphones, including its premium Mi 4 and more economical Redmi series, dropped 8 percent in the third quarter from a year earlier, its first-ever decline, according to researcher Canalys. IHS, another research firm, estimates that Xiaomi shipments dropped 3.9 percent, barely maintaining the lead over Huawei Technologies Co.

That’s a big change from the bold growth projections used to justify Xiaomi’s tag as one of the world’s most-valuable technology startups. In March of last year, Lei predicted selling 100 million smartphones in 2015. Through the first nine months of this year, Xiaomi shipped about 53 million smartphones.

With its optimistic forecast, Xiaomi secured $1.1 billion in December from investors including GIC Pte., All-Stars Investment Ltd. and DST. Xiaomi drew comparisons to Alibaba Group Holding Ltd., the Chinese e-commerce company that months earlier held the largest initial public offering ever.

‘Hype, Hope’

At 3.75 times last year’s $12 billion in revenue, Xiaomi’s fundraising gave it a price-to-sales ratio exceeding that of Apple, which currently trades at 2.9.

That pricing of Xiaomi does not seem to have been based on any known or accepted valuation methodology, said Peter Fuhrman, chairman and CEO of China First Capital. “Hype and hope seem to have been the two key drivers,” he said.

In March, after that round of funding and after China set its lowest growth target in 15 years, Lei trimmed his earlier prediction to “80 million to 100 million” units for the year.

Its first year-on-year decline came during a quarter when Xiaomi released its Redmi Note 2, a lower-priced handset that sold for an average of 801 yuan ($125) each. On Tuesday it unveiled a metallic version of that phone with a fingerprint sensor, as well as a new tablet computer and air purifier.

‘Substantial’ Market

Growth might be reignited in the fourth quarter by China’s Nov. 11 Singles’ Day shopping promotions and the latest version of the Redmi Note. The company, which traditionally unveils an update to its marquee Mi smartphones during the third quarter, hasn’t yet announced a Mi 5 after last year’s Mi 4.

“I am not concerned about the valuation because, over time, their market is substantial,” said Hans Tung, managing partner at Xiaomi investor GGV Capital in Menlo Park, Calif. “Over the next 12 months, it’ll become increasingly obvious what Xiaomi is doing in the smart home and services space.”

Hugo Barra, a Xiaomi vice president, declined to comment on shipment targets or valuations and referred questions to Chief Financial Officer Shou Zi Chew, who didn’t reply to an e-mail seeking comment.

Xiaomi eschews the label of smartphone maker, claiming instead to be an “Internet company” furnishing a range of devices and online services. Xiaomi and its affiliates sell TVs, air filters, battery packs, action cameras, fitness trackers and even a self-balancing scooter. Its non-hardware offerings include games, payments, mobile-phone services and cloud storage.

No Loyalty

It’s those other products, such as the Mi Air Purifier 2 released this week, which Tung sees helping Xiaomi expand its sales and keeping consumers coming back to an ecosystem that connects home devices to the Internet and through mobile apps.

The ancillary businesses are still relatively small, with the company expecting the services units to account for just $1 billion of its $16 billion in projected revenue this year, Barra said in a July interview. Sales of smartphones outside China accounted for just 7 percent of its total in the third quarter, according to Strategy Analytics.

Xiaomi has struggled partly because competitors Huawei, Lenovo Group Ltd. and Gionee — among others — quickly copied its business model with ultra-thin devices, glossy websites and lower prices, allowing consumers to easily switch to the hippest new phone.

“Xiaomi was very popular because it was the first brand that marketed its phones as being limited edition,” said Chen Si, a 25-year-old real estate worker in Beijing who bought the Mi 3 after its 2013 release, citing its cool design. “I wouldn’t say I am loyal to Xiaomi, I just think that a phone should be affordable and easy to use. If not, then I’ll just change.”

A year later, she switched to the iPhone 6.

 

http://www.bloomberg.com/news/articles/2015-11-25/xiaomi-s-45-billion-valuation-seen-unfeasible-as-growth-cools

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Shale Gas, China’s Very Buried Treasure — Nikkei Asian Review

1 Comment / December 17, 2015

Nikkei2

 

Water, water not a drop to drink. While that may not precisely sum up China’s dilemma, it is clear that the country with the world’s largest shale gas reserves, and urgent need to extract it,  will have problems achieving its ambitious long-term goals. The newly-finalized Five Year Plan calls for an enormous increases in natural gas output in China. The carbon emission reduction agreement signed by President Obama and Chinese leader Xi Jinping also requires China to diversify away from coal. Shale gas is the obvious replacement.

As of now, virtually all that gas remains trapped in the ground. The two companies given the plum rights to develop the gas, China’s oil giants Sinopec and PetroChina, may not have the technical competence to fully develop the resource. The companies that have the skills, mainly a group of small entrepreneurial US drillers, has so far shown zero inclination to either come to China or come to the aid of the two SOE giants by providing equipment and know-how.

To attract them to China will likely require a significant shift in the way China’s energy resources are owned and allocated. It will mean creating terms in China every bit as favorable, if not more so, than skilled shale gas drilling companies enjoy in the US and elsewhere.

 

shaleMap

This is why for China’s senior leaders and economic planners, this map is as much a curse as blessing. Knowing that vast quantities of much-needed clean energy is in the ground but not having the domestic infrastructure and technology to get it to market efficiently is about as tough and frustrating as any economic problem China now confronts.

The Chinese policy goal and the on-and-in-the-ground situation in China are on opposite sides of the spectrum. China has said it must quickly increase the share of natural gas as part of total energy consumption to around 8% by the end of 2015 and 10% by 2020 to alleviate high pollution resulting from the country’s heavy coal use.  The original target announced with great fanfare was for shale gas production to increase almost 200-fold between 2012 and the end of the decade. But, this goal was quietly slashed by 30% last year. More slashes may be on the way.

What’s most needed and in shortest supply in China: more commercial competition, more players, more market signals.

Based on the US experience, drilling for shale gas isn’t the kind of thing that big oil companies are good at. Unfortunately for China, all it has are giants. Rather inefficient ones at that. Sinopec, PetroChina are, based on metrics like output-per-employee, perhaps only one-tenth as efficient as the majors like Royal Dutch Shell, Exxon and BP. Note, these big Western companies all pretty much missed the boat with shale gas. In other words, the bigger the oil company the worse it’s been so far at exploiting shale gas. Yes, it’s these big global giants who now seem the most interested to work with Sinopec and PetroChina to develop shale gas China. In fact, Shell is already partnered up with Sinopec. How’s this likely to work out? Think of a pack of elephants ice fishing.

China’s dilemma comes down to this: it’s probably the most entrepreneurially-endowed country on the planet, but entrepreneurs are basically not allowed in the oil and gas extraction businesses. It’s a legacy of old-style Leninism, that the state must hold control over the pillars of the economy. It works okay when the problem is pumping petroleum or natural gas from giant onshore or offshore fields. But, shale gas is another world, with many and smaller wells. A typical one in the Barnett Shale gas region of Texas costs $2mn – $5mn, barely a rounding error for large oil and gas companies. These smaller wells, depending on prevailing price and drilling direction, can achieve a return within one year or less.

Profits are usually much higher for shale wells with horizontal drilling capability. But, it’s also much trickier to do. Production drops off dramatically in most shale gas wells, falling by about 90% during the first two years. So, you need to know how to make money efficiently, quickly, then move on to another opportunity.

The one place where Sinopec is now producing a decent amount of shale gas, at field in Sichuan province, the cost of getting the gas out of the ground is running at least twice the US level. Partly its geography and partly it’s the fact giant state-owned companies operating in a competition-free environment usually need three dollars to do what an entrepreneurial company can do for one.

Ancient Chinese oil well

China was the first country to drill successfully for oil, over 1500 years ago.   It could use more of that native ingenuity to unlock the country’s buried wealth. The shale gas industry is largely the product of one brilliant and stubborn Greek-American entrepreneur, George Mitchell, who began experimenting with horizontal drilling in Texas about 30 years ago. He had his big breakthrough in 1998. Everyone knew the gas was down there, as they do now in China. The trick Mitchell solved was getting it out of the ground at a low-cost. The company he started Mitchell Energy & Development, now part of Devon Energy, remains at the forefront of shale gas exploration and production.

China needs Mitchell Energy as well its own George Mitchells, who can use their pluck and tolerance for risk to make the gas pay. Not only shale gas, but China is also blessed with equally abundant deposits of coalbed methane. Pretty much all this methane is in the hands of big state-owned coal companies. Talk about a wasting asset. The coal miners have zero expertise, and for now it seems zero incentive to go after this fuel in a big way. Just about everything about the oil and gas business in China is state-owned and price-controlled.

The applause was nearly deafening, especially in the US and Europe, when the leaders of the US and China announced the big agreement to reduce carbon emissions. No one can argue with the sentiments, with the policy goal of creating a cleaner world. But, absent from the discussion are specifics on how China will meet its promises. It’s only going to happen if and when natural gas becomes a major part of the energy mix.

China has of course built pipelines to bring gas from Russia and more are on the way. But, even this huge flow of Russian gas, an expected 98 billion cubic meters per year by 2020,  will provide at most 17% of China’s projected gas needs by that year. Clearly then, the most meaningful thing that could happen is for the shale fields in China to be thrown open to all-comers, but especially the mainly-US companies that are experts at doing this. That isn’t happening.

I’ve been in the room with Chinese government officials when the topic was discussed about how to make it enticing for US specialist shale companies to drill in China. There’s a growing understanding this is the right way to go, but still the policy environment remains inhospitable. While China has the most shale gas, there is a lot of it in countries including stalwart US allies like Poland and Australia where the US companies are far more welcome and don’t have to deal with a market rigged in favor of state-owned goliaths. Everyone who wants to see a cleaner China and so a cleaner world should wish above all else that China’s shale and methane fields become a stomping ground rather than a no-go area for great entrepreneurs.

An edited version was published in the Nikkei Asia Review. 

Click here to download article. 

 

 

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Shining lights brighten future of SOEs — China Daily Commentary

Leave a Comment / December 8, 2015

 

China Daily

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Shining lights brighten future of SOEs

By PETER FUHRMAN (China Daily) Updated: 2015-10-23 07:29

Shining lights brighten future of SOEs
While the need for SOE reform is great and too many SOEs still fight to maintain the troubled status quo, there are also some Chinese SOEs leading by example.

As China’s leadership prepares its 13th Five-Year Plan (2016-20), it confronts multiple economic challenges, reform of State-owned enterprises being one of them.

Shining lights brighten future of SOEs

SOEs account for at least 30 percent of China’s total GDP. Some estimates put the share as high as 45 percent. But there are two worrying signs of the worsening situation for China’s SOEs: Their profits are dropping and indebtedness is rising sharply. According to the Ministry of Finance on Wednesday, the profits of the SOEs from January to August decreased by 8.2 percent year-on-year, while the total debt of SOEs from January to September has surpassed 77 trillion yuan, a 20 percent year-on-year increase.

Last month, the government introduced its guidelines for the next stage of SOE reform, including more outside capital. The guidelines are in the right direction, but, there is also some enormous potential within the SOE sector in China that, if unleashed, would also help contribute to the overall turnaround.

There are centers of research excellence, especially in applied engineering, on par with the best in the US and Europe. One example is the China Iron and Steel Research Institute Group in Beijing. It employs 2,000 staff with doctorates along with other experienced research scientists. Every visit, I leave impressed not only by the commitment of the large staff, but also the level of the research institute’s globally-important innovation.

If there is an area that needs improving－one not uncommon for SOE research institutes－it is in how to commercialize their many technologies and how to initiate and structure profitable licensing deals, both with other SOEs in China and global steel and new materials companies. The Institute, based in Beijing’s Haidian district, is making great strides, but, a greater focus as well as a stronger push from the government to get technologies out of the lab and into factories would be helpful.

SOEs too often focus excessively on increasing gross output rather than on pleasing customers and accumulating profits. One positive mold-breaker here is Yangzhou’s AVIC Baosheng Group, which makes steel and copper cable. Though operating in a brutally-competitive market with lots of competitors, Baosheng holds its own. Also in Yangzhou are two examples of how SOEs can take a valuable traditional brand name and rejuvenate it. Restaurant chain Yechun Teahouse and cosmetic manufacturer Xiefuchun have both been around since the Qing Dynasty (1644-1911) and became SOEs in the 1950s.

Yechun is now opening beautiful restaurants both inside and outside China that maintain consistently high quality. Xiefuchun is more of a jewel-in-the-making, with great all-natural products in tune with buying trends in China and abroad. However, Xiefuchun is not as good as it could be on branding, packaging and retail, areas where SOEs often tend to do poorly. Xiefuchun, against all commercial logic, is now stuck inside a large SOE chemicals holding company.

Meanwhile, China Huadian Corporation stands out for its success doing something few SOEs have mastered－investing to build from the ground up and then running profitable large-scale projects outside China. All SOEs know about the central government’s “Go Global” policy. Huadian is getting it right and so has much to teach other globally-ambitious SOEs.

Then there’s my choice for most exceptional high-tech SOE in China, Sichuan Aerospace Tuoxin Basalt Industrial. Though little known, it could be a model for how SOEs might develop in the future. Based in Chengdu, 90 percent of the company is owned by the giant centrally-managed SOE, China Aerospace Group. Tuoxin internally developed a revolutionary process for using ordinary quarried stone to produce a lightweight waterproof, heat-resistant material with broad applications in everything from auto parts to wind-energy. It is on track to become a billion-dollar company within the next five years. Tuoxin suggests what more SOEs could be capable of.

But to get to where it is, Tuoxin needed an owner with long-term vision and patient capital, as well as a senior management team that wants to break out of the cocoon of supplying mainly other SOEs by partnering extensively with China’s private sector companies.

While the need for SOE reform is great and too many SOEs still fight to maintain the troubled status quo, there are also some Chinese SOEs leading by example. They are blazing a path toward a more productive and profitable SOE sector all Chinese can take pride in.

The author is chairman and chief executive officer of China First Capital

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http://www.chinadaily.com.cn/opinion/2015-10/23/content_22260934.htm

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