Entrepreneurship

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/

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

Leave a Comment / June 24, 2016

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Why Taiwan has a Largan and China doesn’t

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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

Download PDF version.

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

Leave a Comment / January 11, 2016

WSJ

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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

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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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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. 

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One of China’s Best State Enterprises Shows Need for Reform — Financial Times

Leave a Comment / December 14, 2015

FT logo

 

Financial Times article Peter Fuhrman

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China’s ruling State Council last month released a much-anticipated plan meant to kick the country’s huge state-owned enterprise (SOE) sector into shape. No small amount of kicking is required. Not all but many of China’s 155,000 SOEs are inefficient and often loss-making. Where SOEs do make money, it’s usually because of markets and lending rules rigged by the government in their favor.

Finding a truly good SOE, one that can take on and outcompete private sector rivals in a fair fight is hard. Gong He Chun is one. Customers throng daily to buy its high-quality products, often forming long queues. The employees, unlike at so many SOEs in China, are helpful and enthusiastic and take evident pride in what they are doing. Though local private sector competitors number in their hundreds, Gong He Chun has them all beat.

Gong He Chun is a small restaurant chain, with just four shops in the ancient and Grand Canal city of Yangzhou, about 300km up the Yangtze river from Shanghai. It specializes in preparing and serving meticulously-prepared versions of dishes that have for over 1,000 years made Yangzhou synonymous with fine eating in China.

It’s a rather long and mouth-watering list, including crab and pork-stuffed xiaolongbao dumplings (below centre), potstickers (below right), steamed shrimp dumplings, shredded tofu and of course Yangzhou’s most famous culinary export, Yangzhou fried rice.

Gong Hechun

Gong He Chun was founded in 1933 as a private concern, but was then, like almost all other private businesses, expropriated in 1949. It’s been an SOE ever since, its shares owned by the Yangzhou government branch of SASAC, the government agency now responsible for holding shares and guiding the management of all SOEs. Gong He Chun somehow held on through the long dark years during Mao Zedong’s rule when most restaurants in China were shuttered, and investment in the SOE sector was directed toward Stalinist heavy industry – steel mills, coal mines, power plants, railroad rolling stock and the like.

Yangzhou, Yangzhou cuisine and places like Gong He Chun represented just about everything that Chairman Mao Zedong most detested. Since at least the Tang Dynasty (618-907), the town has had a reputation for its mercantile traditions, beautiful women and traditional culture. To eradicate such bourgeois roots, Mao and his planners crammed the city in the 1950s and 1960s with ugly sooty chemical factories and smelters.

I remember first visiting Yangzhou in 1981 and being shocked by the sight of once-splendid Ming Dynasty temples and courtyard homes converted to makeshift factories and communal dwellings. In those days, finding anything to eat, even at the few hotels where foreigners were allowed to stay, was no simple matter. All food, including dumplings, was available only with ration coupons.

Things have improved over the last twenty-five years. One not-unimportant reason for this is that Jiang Zemin, who ran China from 1989-2002 is a native son of Yangzhou while his successor, Hu Jintao, was raised in the next door town of Taizhou. Jiang still visits Yangzhou at least once a year, usually during Qingming Festival when filial Chinese return to their home to sweep the graves of their ancestors. Yangzhou this year is celebrating with pomp the 2,500th anniversary of its founding.

Gong He Chun (see photo) still hews closely to the recipes and cooking methods perfected in the 1930s by the founder Wang Xuecheng. This means cutting thin soup noodles by hand, preparing the dumplin skins in such a way as to create tiny pores and air pockets that allow flavor to seep in.

Ever wonder exactly how a properly prepared potsticker should look?

At Gong He Chun, as all its many cooks are taught, they must fulfill Wang’s precise prescription: the overall outward appearance of a sparrow’s head, with its slender sides resembling a lotus leaf and its bottom fried to the color of a gold coin. If only the management and workers at China’s huge substandard SOE oil refineries took as much care, China’s polluted skies would surely improve.

While the quality of what comes out of the kitchen is world class, there are places where the dead hand of state ownership can be detected. The toilets are primitive, plastic plates and bowls are old and chipped, and the overall décor looks like a 1950s US high school lunchroom.

Though its brand-name and reputation are known nationally, Gong He Chun has no apparent intention to expand outside Yangzhou. The three-tiered system of SOE management in China, with ownership spread among national, provincial and local branches of SASAC, makes it both rare and difficult for any local SOE like Gong He Chun to expand outside its home base.

Meantime, a Taiwan company, Din Tai Fung, has taken Yangzhou cuisine, especially the crab xiaolongbao, and built a high-end chain of global renown, with Michelin-starred restaurants across East and Southeast Asia as well as the US, Australia and Dubai. Its China outlets sell dumplings at three times the price of Gong He Chun.

I’m lucky to know the China chairman of Din Tai Fung, and have spent time with him inside Din Tai Fung restaurants. Every detail is sweated over by the chairman, from the starched white tablecloths to the polish on the bamboo steamers to the precise number of times a xiaolongbao dumpling should be pinched closed. Gong He Chun’s state owners are utterly devoid of the drive, vision and hunger for profits and expansion that only a private proprietor can bring.

A newly-announced government policy on SOE restructuring has already come in for criticism in China. Xi Jinping and his State Council – once keen to expose SOEs to more market rigor and competition – have opted for a more “softly-softly” approach, with no specific targets for improving the woeful performance of many SOEs. One reason is that a fair chunk of China’s SOE system is in chaos, thanks to a more high-priority policy of the Xi government. Every week brings new reports about bosses and senior management at China’s largest SOEs being investigated or arrested for corruption.

If there was ever an economic rationale for a small chain of traditional dumpling shops to be owned by the state, no one seems able to recall it. What profit Gong He Chun makes is not being reinvested in this rare SOE jewel, but is used instead to prop up SOE losers in Yangzhou. As China’s new SOE reform policy now begins its tentative roll-out, it looks certain Gong He Chun will for years to come remain a rare bright spot in a blighted SOE landscape.

Peter Fuhrman is Chairman & CEO China First Capital. He has no business relationship with Gong He Chun.

 

http://blogs.ft.com/beyond-brics/2015/10/05/one-of-chinas-best-state-enterprises-shows-need-for-reform/

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“A lot hasn’t gone to plan”: SuperReturn Interview

Leave a Comment / December 14, 2015

Superretrun

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Does [China’s] shift from a manufacturing-driven economy to a service-driven one make macroeconomic shocks like those seen this summer inevitable?

Peter Fuhrman: China has enjoyed something of a worldwide monopoly on hair-raising economic news of late: a stock market collapse followed by a klutzy bail-out, then a devaluation followed by a catastrophic explosion and finally near-hourly reports of sinking economic indicators. As someone who first set foot in China 34 years ago, my view is we’re in an unprecedented time of economic and financial uncertainty . Consumers and corporates are noticeably wobbling. For a Chinese government long used to ordering “Jump!” and the economy shouting back “How high?” this is not the China they thought they were commanding.  Everyone is looking for a bannister to grab.

And yet, China still has some powerful fundamentals working in its favour. Urbanization is a big one. It alone should add at least 3-4% to annual GDP a year for many years to come. The shift towards services and domestic growth as opposed to exports are two others. For now, these forces are strong enough to keep China propelling forward even as it tows heavy anchors like an ageing population, and a cohort of monopolistic state-owned enterprises (SOEs) that suck up too much of China’s capital and often achieve appalling results with it.

Look, the Chinese stock market had no business in the first place almost tripling from June last year to June of this. The correction was long, long overdue. It’s often overlooked that China’s domestic stock market has a pronounced negative selection bias. Heavily represented among the 3,000 listed companies are quite a number of China’s very worst companies, with the balance made up of lethargic, low-growth, often loss-making SOEs. The good companies, like Tencent or Baidu, predominantly expatriate themselves when it comes time to IPO. To my way of thinking, China’s domestic market still seems overpriced. The dead cats are, for now, still bouncing.

 

Given this overall picture, do you expect to see greater or fewer opportunities [in China] for alternative investments and why? 

Peter Fuhrman: The environment in China has been challenging, to say the least, for alternative investment firms not just in the last year, but for the better part of the last decade. A lot hasn’t gone to plan. China’s growth and opportunities proved alluring to both GPs and LPs. And yet too often, almost systematically, the big money has slipped between their fingers. Partly it’s because of too much competition, and with it ballooning valuations, from over 500 newly-launched domestic Chinese PE and VC firms. The fault also sits with home-grown mistakes, with errors by private equity firms in investment approach. This includes an excessive reliance on a single source of deal exit, the IPO, all but unheard-of in other major alternative investment environments.

Overall PE returns have been lacklustre in China, especially distributions, before the economy began to slip off the rails. In the current environment, challenges multiply. A certain rare set of investing skills should prove well-adapted: firms that can do control deals, including industry consolidating roll-ups. In other words, a whole different set of prey than China PE investors have up to now mainly stalked. These are not pre-IPO deals, not ones predicated on valuation arbitrage or the predilections of Chinese young online shoppers. There’s money to be made in China’s own Rust Belt, backing solid well-managed manufacturers, a la Berkshire Hathaway. There’s too much fragmentation across the industrial board. China will remain the manufacturing locus for the world, as well as for its own gigantic domestic market.

Another anomaly that needs correcting: Global alternative investing has been overwhelmingly skewed in China towards equity not debt. The ratio could be as high as 99:1. This imbalance looks even more freakish when you consider real lending rates to credit-worthy corporates in China are probably the highest anywhere in the advanced world, even a lot higher than in less developed places like India and Indonesia. Regulation is one reason why global capital hasn’t poured in in search of these fat yields. Another is the fact PE firms on the ground in China have few if any team members with the requisite background and experience to source, qualify, diligence and execute China securitized debt deals. There’s a bit of action in the China NPL and distress world. But, straight up direct collateralized lending to China’s AA-and-up corporates and municipalities remains an opportunity global capital has yet to seize. Meanwhile, China’s shadow banking sector has exploded in size, with over $2.5 trillion in credit outstanding, almost all of which is current. There’s big money being made in China’s securitized high-yield debt, just not by dollar investors.

 

What’s the overall story of alternative investors engaging with central planning? How would you characterise the regulatory environment?

Peter Fuhrman: China has had a state regulatory and administrative apparatus since Europeans were running around in pelts and throwing spears at one another. So, yes, there is a large regulatory system in China overseen by a powerful government that is very deeply involved in economic and financial planning and rule-making. One must tread carefully here. Rules are numerous, occasionally contradictory, oft-time opaque and liable to sudden change.

Less observed, however, and less harrowing for foreign investors is the core fact that the planning and regulatory system in China has a strong inbuilt bias towards the goal of lifting GDP growth and employment. Other governments talk this talk. But it’s actually China that walks the walk. The days of anything-goes, rip-roaring, pollute-as-you-go development are about done with. But, still the compass needle remains fixed in the direction of encouraging strong rates of growth.

The Chinese government has also gotten more and more comfortable with the fact that most of the growth is now coming from the highly-competitive, generally lightly-regulated private sector. Along with a fair degree of deregulation lately in industries like banking and transport, China also often pursues a policy of benign neglect, of letting entrepreneurs duke it out, and only imposing rules-of-the-game where it looks like a lot of innocents’ money may be lost or conned. To be sure, foreign investors in most cases cannot and should not operate in these more free-form areas of China’s economy. They often seem to be the first as well as the fattest targets when the clamps come down. Just ask some larger Western pharmaceutical companies about this.

 

In the long view, how long can the parallel USD-RMB system run? Do you expect to see the experiments in Shanghai’s Pilot Free Trade Zone (FTZ) replicated and extended? 

Peter Fuhrman: Unravelling China’s rigged exchange rate system will not happen quickly. Every baby step — and the steps are coming more fast of late — is one in the direction of a more open capital account, of greater liberalization. But, big change will all unfold with a kind of stately sluggishness in my view. Not because policy-makers are particularly wed to the notion of an unconvertible currency. There’s the deadweight problem of nearly $4 trillion in foreign exchange reserves. What’s the market equilibrium rate of the Dollar-Renminbi? Ask someone facing competition from a Chinese exporter and they’re likely to say three-to-one, or an almost 100% appreciation. Ask 1.4 billion Chinese consumers and they will, with eminent good reason, say it should be more like 12-to-one. Prices of just about everything sold to consumers in China is higher, often markedly higher, than in the US where I’m from. This runs from fruit, to supermarket staples, to housing, brand-name clothing up to ladder to cars and the fuel that powers them.

I think the irrational exuberance about Shanghai’s FTZ has slammed into the wall of actual central government policy of late.  It will not, cannot, act like a free market pathogen.

 

Reform of China’s state-owned enterprises has been piecemeal, and private equity has had patchy success with SOEs. Do you expect this to change, and why?

Peter Fuhrman: For those keeping score, reform of SOEs has yet to really put any points on the board. The SOE economy-within-an-economy remains substantially the same today as it was three years ago. Senior managers continue to be appointed not by competence, vision and experience, but by rotation. The major shareholder of all these SOEs, both at centrally-administered level as for well as those at provincial and local level, act like indifferent absentee proprietors, demanding little by way of dividends and showing scant concern as margins and return-on-investment droop year-by-year at the companies they own.

There are good deals to be done for PE firms in the SOE patch. The dirty little secret is that the government uses a net asset value system for state-owned assets that is often out-of-kilter with market valuations. Choose right and there’s scope to make money from this. But, if you’re a junior partner behind a state owner who cares more about jobs-for-the-boys than maximizing (or even earning) profits then no asset however cheaply bought will ever really be in the money.

 

TPP has been described as ‘a club with China left out’. If it comes to pass, how do you expect China to respond?

Peter Fuhrman: China has responded. Along with its rather clumsy-sounding “One Belt, One Road” initiative it also has its Asia Infrastructure Investment Bank. The logic isn’t alien to me. When American Jews were barred from joining WASP country clubs, they tried to build better clubs of their own. When Chase Manhattan, JP Morgan and America’s largest commercial banks wouldn’t hire Jews, they went instead into investment banking, where there was more money to be made anyway.

But, China may not so easily and successfully shrug off their exclusion from TPP. It increases their aggrieved sense of being ganged-up upon. The US understands this and now frets more about China’s military power. The partners China are turning to instead – especially the countries transected by the “One Belt, One Road” – look more like a cast of economic misfits, not dynamic free traders like the TPP nations and China itself. I don’t think anyone in Beijing seriously believes that increased trading with the Central Asian -stans is a credible substitute. Even so, China will not soon be invited to join the TPP. China has hardly acted like a cozy neighbour of late to the countries with the markets and with the money. Being feared may have its strategic dividends. But the neighbourhood bully rarely if ever gets invited to the block party.

 

Peter Fuhrman will be speaking at SuperReturn Asia 2015, 21-24 September 2015, JW Marriott, Hong Kong.

 

http://www.superreturnasia.com/blog/super-return-private-equity-conference/post/id/7653_A-lot-hasnt-gone-to-plan-Peter-Fuhrman-China-First-Capital-on-alternative-investments-in-the-PRC?xtssot=0

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The Economist Survey on China Business

Leave a Comment / June 25, 2016

Econ

Econ survey2–

With a timing that can only be described as exquisite, the Economist today publishes their in-depth survey of business in China. It appears at a time when the media is brimming with stories, often in my view overblown,  about China’s economic problems and challenges. The Economist survey provides light where there’s been way too much heat of late. I couldn’t recommend more highly taking the time to read it in full.

Please click here to go direct to the survey on the Economist website. It includes nine separate articles, each offering a banquet of analysis, ideas and insights on where China’s economy, both private sector and SOE, is heading.

The author of the survey is Vijay Vaitheeswaran, the China business and finance editor. This is the first Economist China business survey in many years. It was certainly no small undertaking. China’s size, complexity and ever-morphing business environment make a comprehensive future-looking summary of this kind difficult in the extreme to do well.

I got to meet Vijay during his research phase. I took him for Tibetan food in Shenzhen. He ended up quoting me briefly in one of the articles in the survey.

Vijay paid particular attention to accelerating innovation cycles in China’s hardware industry. He spent a few days in Shenzhen including attending a kind of hacker forum for hardware geeks. He calls Shenzhen “the world’s best place to start a hardware firm” and visited my favorite exemplar of this, 18-month-old mobile phone brand OnePlus.

Quick aside, since the launch of its new model, the OnePlus 2 six weeks ago, the waiting list to buy one has grown to over five million people. If OnePlus’s factories can keep pace with the exploding demand, the company is on track to sell over $2 billion of phones in coming twelve months.

While overall highly positive about China’s economic prospects and the ambitions of its vast pool of private sector entrepreneurs, the survey sounds a note of caution. It argues that the less efficient state-owned sector appears more and more like an unevolved creature from a foregone era.  They are, the survey warns, sucking up too much of China’s capital and achieving too little with it, all the while fighting to maintain the cozy monopolies that keep the far more dynamic and efficient private sector shut out.

How much market? How much government control and ownership? All countries struggle to find a balance. China stands out because the private sector has come so far so fast. Thirty years ago when I first set foot in China there was no private sector to speak of. Now, in all but the so-called “commanding heights” of China’s economy, entrepreneurs run rampant. 1.4 billion Chinese benefit from this fact every day.

 

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Trials and tribulations: China’s shifting business landscape highlighted in new report — Financier Worldwide

Leave a Comment / July 23, 2015

Financier–

Trials and tribulations: China’s shifting business landscape highlighted in new report

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BY Fraser Tennant

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The deeper trends reshaping the business and investment environment in China today are the focus of a new report – ‘China 2015: China’s shifting landscape’ – by the boutique investment bank and advisory firm, China First Capital.

As well as highlighting slowing growth and a gyrating stock market as the two most obvious sources of turbulence in China at the midway point of 2015, the report also delves into the deeper trends radically reshaping the country’s overall business environment.

Chief among these trends is the steady erosion in margins and competitiveness among many, if not most, companies operating in China’s industrial and service economy. As the report makes abundantly clear, there are few sectors and few companies enjoying growth and profit expansion to match that seen in previous years.

The China First Capital report, quite simply, paints a none too rosy picture of China’s long-term development prospects.

“China’s consumer market, while healthy overall, is also becoming a more difficult place for businesses to earn decent returns,” explains Peter Fuhrman, China First Capital’s chairman and chief executive. “Relentless competition is one part, as are problematic rising costs and inefficient poorly-evolved management systems.”

To read complete article, click here.

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China 2015 — China’s Shifting Landscape — China First Capital new research report published

Leave a Comment / July 20, 2015

China First Capital research report

 

Slowing growth and a gyrating stock market are the two most obvious sources of turbulence in China at the midway point of 2015. Less noticed, perhaps, but certainly no less important for China’s long-term development are deeper trends radically reshaping the overall business environment. Among these are a steady erosion in margins and competitiveness in many, if not most, of China’s industrial and service economy. There are few sectors and few companies that are enjoying growth and profit expansion to match last year and the years before.

China’s consumer market, while healthy overall, is also becoming a more difficult place for businesses to earn decent returns. Relentless competition is one part. As problematic are rising costs and inefficient poorly-evolved management systems.  From a producer economy dominated by large SOEs, China is shifting fast to one where consumers enjoy vastly more choice, more pricing leverage and more opportunities to buy better and buy cheaper. Online shopping is one helpful factor, since it allows Chinese to escape from the poor service and high prices that characterize so much of the traditional bricks-and-mortar retail sector. It’s hard to find anything positive to say about either the current state or future prospects for China’s “offline economy”.

Meanwhile, more Chinese are taking their spending money elsewhere, traveling and buying abroad in record numbers. They have the money to buy premium products, both at home and abroad. But, too much of what’s made and sold within China, belongs to an earlier age. Too many domestic Chinese companies are left manufacturing products no longer quite meet current demands. Adapting and changing is difficult because so many companies gorged themselves previously on bank loans. Declining margins mean that debt service every year swallows up more and more available cash flow. When the economy was still purring along, it was easier for companies and their banks to pretend debt levels were manageable. In 2015, across much of the industrial economy, the strained position of many corporate borrowers has become brutally obvious.

These are a few of the broad themes discussed in our latest research report, “China 2015 — China’s Shifting Landscape”. To download a copy click here.

Inside, you will not find much discussion of GDP growth or the stock market. Instead, we try here to illuminate some less-seen, but relevant, aspects of China’s changing business and investment environment.

For those interested in the stock market’s current woes, I can recommend this article (click here) published in The New York Times, with a good summary of how and why the Chinese stock market arrived at its current difficult state. I’m quoted about the preference among many of China’s better, bigger and more dynamic private sector companies to IPO outside China.

In our new report, I can point to a few articles that may be of special interest, for the signals they provide about future opportunities for growth and profit in China:

  1. China’s most successful cross-border M&A ever, General Mills of the USA acquisition and development of dumpling brand Wanchai Ferry (湾仔码头), using a strategy also favored by Nestle in China
  2. China’s new rules and rationale for domestic M&A – “buy first and pay later”
  3. China’s most successful, if little known, recent start-up, mobile phone brand OnePlus – in its first full year of operations, 2015 worldwide revenues should reach $1 billion, while redefining positively the way Chinese brand manufacturers are viewed in the US and Europe
  4. Shale gas – by shutting out most private sector investment, will China fail to create conditions to exploit the vast reserves, larger than America’s, buried under its soil?
  5. Nanjing – left behind during the early years of Chinese economic reform and development, it is emerging as a core of China’s “inland economy”, linking prosperous Jiangsu and Shanghai with less developed heavily-populated Hubei, Anhui, Sichuan

We’re at a fascinating moment in China’s story of 35 years of rapid and remarkable economic transformation. The report’s conclusion: for businesses and investors both global and China-based, it will take ever more insight, guts and focus to outsmart the competition and succeed.

 

The Shenzhen Unicorn — Week in China Magazine

Leave a Comment / December 8, 2015

week-in-china

 

OnePlus Two

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A sizeable quotient of the techno-hip crowd in the US and Europe is counting down the days to the launch next week of the newest Android mobile phone by China’s OnePlus. It’s called the OnePlus Two and follows a little more than a year after the 18-month-old company’s first phone, the OnePlue One, went on sale in the US and Europe. With barely a nickel to spend on marketing and promotion, OnePlus insouciantly dubbed its OnePlus One a “flagship killer” claiming it delivered similar or better performance than Samsung, LG and HTC Android phones costing twice as much.

The tech media swooned, and buyers formed long online queues to buy one from the OnePlus website, www.oneplus.net, the only place the phones are sold. In little more than six months last year, OnePlus sold over one million phones.

The new OnePlus model is rumored to be built around a new top-of-the-line Qualcomm processor, and features a larger screen, an upgraded in-house version of Android software, fingerprint recognition. Price? Around $300. It will be available, as was the OnePlus One for most of the last year, on an “invitation-only cash-upfront” basis to prospective buyers. How to get a coveted invitation remains something of a dark art. New OnePlus owners are given a certain number of invitations to send to whoever they please.

The July 27th launch will be an online event broadcast in virtual reality. OnePlus manufactured and is giving away a cardboard virtual reality viewer said to be as good or better than the ones sold by Google for $20. The viewers have been flying out the door for the last month.

To read complete article, click here.

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China’s Incendiary Market Is Fanned by Borrowers and Manipulation — The New York Times

Leave a Comment / December 8, 2015

NYT–

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China’s Incendiary Market Is Fanned by Borrowers and Manipulation

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SHANGHAI — At the height of the frenzy for Chinese stocks, just about every company was a winner.

An online gaming start-up was valued at $7 billion. Shares in a fireworks company that had moved into finance shot up 300 percent. A struggling property developer was transformed into a stock market darling, just by changing its name to suggest it was an Internet company.

Then there was the case of Beijing Baofeng Technology, an online video company whose stock price soared 4,200 percent in the three months after it went public early this year. The company’s shares climbed by 10 percent — the maximum amount allowable under exchange rules — nearly every day for more than 30 days.

Before things fell apart a few weeks ago, China’s remarkable bull run was reminiscent of the Internet bubble that gripped the Nasdaq stock market between 1998 and 2000, when companies like Pets.com and Webvan that had no profit quickly became more valuable than some industrial stalwarts. At the time, everyone talked about how technologies and industries would transform society, justifying eye-popping valuations. They were right about the future, just not necessarily about specific companies and the high stock prices.

To read complete article, click here.

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