Investment Banking

The Shenzhen Unicorn — Week in China Magazine

Leave a Comment / December 8, 2015

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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

By   

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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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Focus Media Reaches $7.4 Billion Deal to List in Shenzhen — New York Times

Leave a Comment / June 24, 2016

NYT

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Focus Media Reaches $7.4 Billion Deal to List in Shenzhen

By

HONG KONG — Years after delisting in the United States after a short-selling attack, one of China’s biggest advertising companies is hoping to cash in on a market rally on its home turf.

Focus Media, a company based in Shanghai that was privatized and delisted from the Nasdaq two years ago after being targeted by short-sellers, on Wednesday reached a 45.7 billion renminbi, or about $7.4 billion, deal for a listing on the Shenzhen Stock Exchange. The transaction values Focus at about twice the $3.7 billion that its management and private equity backers — led by the Carlyle Group — paid to take the company private in 2013.

Focus and its investors, which also include the Chinese companies FountainVest Partners, Citic Capital Partners, CDH Investments and China Everbright, are trying to tap into China’s surging domestic stock markets. The main Shanghai share index has risen 51 percent this year, while the Shenzhen index, where Focus will be listed, has more than doubled, increasing by 114 percent.

Other Chinese companies that retreated from American markets, as well as their private equity backers, are likely to be watching the Focus deal closely. If it goes through and the new shares rise sharply, it could offer an incentive for others to follow suit — and give private equity firms an easier way to sell their stakes.

Some other big Chinese companies that delisted from the United States market in recent years include Shanda Interactive Entertainment, which was valued at $2.3 billion when it was privatized by its main shareholders in 2012; and Giant Interactive, which was privatized last year in a $3 billion deal.

Focus is coming back to the market through a so-called backdoor listing, in which its main assets are sold to a company already listed in exchange for a controlling stake in the listed firm. Such an approach can offer a more direct path to the market than an initial public offering — especially in mainland China, where hundreds of companies are waiting for regulatory approval for their I.P.O.s.

But such deals can also be complex. In mainland China, they often subject shareholders to lengthy periods during which they are prohibited from selling or transferring shares. Also, unlike an I.P.O., the moves tend not to help the companies involved raise cash.

“All backdoor listings are convoluted exercises, not capital-raising events,” said Peter Fuhrman, the chairman of China First Capital, an investment bank based in Shenzhen, which is in southern China. “When you do them domestically in China, they become even more hair-raising.”

Dozens of Chinese companies retreated from American exchanges in the last five years after a wave of accounting scandals and attacks by short-sellers. Some of those companies were forcibly delisted by the Securities and Exchange Commission; others were taken private by management after their share prices slumped.

Focus was the biggest of those privatizations. In November 2011, the company was targeted by Muddy Waters Research, a short-selling firm founded by Carson C. Block. Muddy Waters accused Focus of overstating the number of digital advertising display screens it operated in China, and of overpaying for acquisitions.

Focus rejected the accusations, but its shares fell 40 percent on publication of the initial report by Muddy Waters. In summer 2012, the company’s chairman, Jason Jiang, and a group of Chinese and foreign private equity firms announced plans to delist Focus and take it private, a deal that was completed in early 2013.

On Wednesday, Jiangsu Hongda New Material, a Shenzhen-listed manufacturer of silicone rubber products, said it would pay 45.7 billion renminbi, mostly by issuing new stock, to acquire control of Focus. Shares in Jiangsu Hongda have been suspended from trading since December, when it first announced plans for a restructuring that did not mention Focus. The shares remain suspended pending further approvals of the Focus deal, including from shareholders and regulators in China.

If completed, the deal would leave Mr. Jiang, the Focus chairman, as the biggest single shareholder of Jiangsu Hongda, with a 25 percent stake.

The mainland China brokerages Huatai United Securities and Southwest Securities are acting as financial advisers on the deal.

Just a few of the Chinese companies delisted from stock exchanges in the United States in recent years have attempted a new listing elsewhere.

Last year, China Metal Resources Utilization, a small metal recycling company, successfully listed in Hong Kong. It had been listed on the New York Stock Exchange, under the name Gushan Environmental Energy.

http://www.nytimes.com/2015/06/04/business/dealbook/focus-media-in-shenzhen-listing-deal.html?_r=0

Download PDF version

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M&A the Chinese Way: Buying First and Paying Later — Financial Times

Leave a Comment / May 9, 2015

FTlogo

FT article

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China is in the early stages of a domestic M&A boom unlike any other elsewhere in the world. Deal pricing, timing, terms, financing and structure are all markedly different than in other major economies, with likely consequences, good and bad, for global corporations and buyout firms eyeing M&A transactions in China.

For these two, as well as companies wishing to find a buyer in China, the game now is to learn the new rules of China M&A and then learn to use them to one’s advantage.

Chinese companies mainly pursue M&A for the same reasons others do – to improve margins, gain efficiencies and please investors. The main difference, and it’s a striking one, is that in most cases domestic Chinese corporate buyers, especially the publicly-quoted ones who are most active now trying to do deals, have no money to buy another business.

Outside of China, there are three known ways to pay for an acquisition – with cash, borrowed money, or shares. All three are generally between excruciatingly slow and impossible for publicly-listed Chinese companies. The reason: companies’ retained earnings are just about always insufficient.

Banking and securities rules in China severely restrict the way publicly-traded companies in China can finance acquisitions using debt or by issuing new shares. Deals financed with leverage are basically forbidden. So, Chinese companies have invented two convoluted ways to get M&A done. They display a certain genius. Both involve trying to buy first and pay later.

Method One is for the acquirer to first negotiate a purchase then ask the Chinese stock market to suspend trading in its own shares. The acquirer will announce the deal publicly and if all goes to plan its share price will surge, often by as much as 50 per cent to 75 per cent.

This predictable outcome is the result of the fact almost all shares quoted in China are owned by small retail investors, commonly called Chinese brokers “old grandpas and grandmas”. Most have never cared to look at a company’s financials or studied its competitive position. Instead, they trade in and out of stocks depending mainly on rumor and hype fed to them by brokers or online tip sheets.

In China, an announced M&A deal is now always a market-moving event. The movement tends to be all in one direction. Up.

Once trading in the acquirer’s shares resumes and the price duly jumps up, the acquirer then initiates the laborious process of applying to the Chinese securities regulator, the China Securities Regulatory Commission (CSRC), for permission to do a secondary share offering.

This will then, it’s hoped, yield the cash to complete the acquisition. The approval process will generally take six months or longer. Chinese securities rules are cumbersome and mandate that the new shares be issued at a discount to the share price at the time of application.

The result: the sequence of “announce first, then apply” means the acquirer can raise the cash needed to buy the target on more favorable terms for the acquiring company, lowering the amount of dilution.

Method Two, a close cousin, is to persuade a friendly domestic investment fund to buy the target company then hold onto it for as long as it takes the intended final owner to get the money in place through the secondary offering. In other jurisdictions, this might be deemed a “concert party” and so likely to land everyone in jail. In China, it’s becoming common practice.

In fact, a new form of investment fund has come into being especially to do deals like this. They call themselves “市值管理基金” which you can translate as “market cap management funds”. They exist to help publicly-traded companies do M&A deals that will lift the company’s share price, and not much else.

They make money buying and selling shares, as well as marking up for resale companies they buy on behalf of publicly-traded companies. They are not buyout funds as understood elsewhere, since these market cap management funds are buying on behalf of a specific company and have no particular industry expertise or experience managing an acquired company. They act purely as a temporary custodian.

Most often, the acquirer will contribute a small amount of limited partner capital to the “market cap management fund” as a way to bind the two organisations together. It can take a year or more from when the market cap management fund first buys the target company then sells to the publicly-traded acquirer, and from there, several more years before this acquisition starts to have an impact, if any, on the acquiring company’s earnings. In other words, a very long timetable.

That by itself is not a problem for the acquirer, since it is as eager to give a shot of adrenalin to its own share price and maintain it on this higher plane as it is to get control of the target company and integrate it into its business. Market cap management trumps industrial logic as a reason to pursue M&A.

I’ve yet to see evidence of much skepticism from Chinese stock market investors that an announced M&A deal may not benefit the acquirer. In the US and other more developed capital markets, it’s frequently the opposite. An acquiring company will as often as not see its shares fall when it announces plans for a takeover. That’s because in most cases, as far as hard empirical evidence can determine, the main beneficiaries of any M&A deal are the target company’s shareholders. Too often, for acquirers M&A deals prove to be too expensive and synergies elusive.

We’ve been invited by domestic listed companies in China to help consult on M&A deals where “market cap management” was an explicit purpose. Finding an attractive target is also a consideration, but a somewhat secondary one.

The discussions, in the main, are unlike anywhere else where M&A deals are being planned and executed. They revolve around how to get the money together, when and for how long to halt share trading, and by how much the listed company’s shares will likely go up, and stay up, once the M&A announcement is made.

Where the publicly-listed company has private sector, rather than State-owned enterprise background, the chairman will usually be the largest single shareholder. The chairman’s net worth stands to get the biggest boost if market cap management works as planned.

Opportunities for global buyout funds
The lengthy, roundabout nature of Chinese M&A is creating attractive opportunities for global corporations and buyout firms. They are the only participants in the M&A arena in China both with cash in hand or easily accessed to close deals and the experience to manage a company well once it’s bought.

From the perspective of potential Chinese sellers, both of these are extremely valuable, since they remove much of the uncertainty in agreeing to sell to a domestic acquirer. Global corporates and buyout firms will thus often be buyers of first choice for sellers.

For now, few global corporates and buyout firms are busy closing M&A deals in China. There are a host of reasons, including China’s slowing economic growth, the perception China is becoming more hostile towards foreign investment, the difficulty persuading owners of better Chinese companies to give up majority control. All valid concerns. But, there are larger forces now at work that make it attractive to expand through acquisition in the world’s largest fast-growing market.

First, in almost all industrial and service industries, China is beginning at last a process of rationalisation and consolidation. Costs are rising quickly, especially for labor, energy and debt service. These are applying vice-like pressure on margins. Markets for most products and services in China are no longer growing by +25 per cent a year and suffer from overcapacity.

Scale, efficiency, quality, modern management are the only ways to combat the punishing margin pressure. This plays directly to the strengths of larger global corporations and buyout firms. They know how to do this, how to transform a capable smaller business into a large market-share leader.

It’s something of a well-kept secret, but some of the world’s most successful M&A deals have seen large global corporations buying private sector businesses in China. The successful buyers generally prefer it this way, that few know how well they are doing after buying and upgrading a Chinese domestic company.

Why tip off competitors? For every well-publicized horror story there are at least three quiet successes. Indeed, one can find within a single Fortune 500 company three great examples of how to do domestic M&A well in China, and achieve a big payoff. The company is Swiss food giant Nestle.

They first opened an office in China in 1908. The big transformation began a hundred years later, in 1998, when they decided to buy an 80 per cent ownership in a Chinese powdered bullion company Taitaile. That company is now more than twelve times the size it was when Nestle bought in.

They followed that up with two other large acquisitions of domestic Chinese food and beverage brands, drinks company Yinlu and candy brand Hsu Fu Chi. In all cases, Nestle bought majority control, but not 100 per cent. They kept the founder in place, as CEO and a minority owner.

That has proved a brilliant model for successful M&A in China, and not only at Nestle. When discussing with Chinese business owners the advantages of selling control to a capable global company, we often share details of Nestle’s M&A activity in China, including the fact that the Chinese owner stays but gets to spend Nestle’s money, leverage its resources, to build a giant business. That’s a pretty attractive proposition.

All three acquisitions have thrived under Nestle’s ownership and now enjoy significant market shares. Thanks largely to these acquisitions, China is Nestle’s second-largest market overall. It was number seven just four years ago.

From my discussions with the China M&A team at Nestle, they are frank that it’s not always been smooth sailing. The M&A deals all involved trying to blend one of the world’s most fastidious, slow-moving and more bureaucratic cultures with the free-wheeling, “ready, fire, aim” style common to all Chinese domestic entrepreneurs. Corporate culture gaps could not get any wider. And yet, it’s worked out well, better in fact than Nestle hoped when going in.

Nestle tells us it is hungry to do more acquisitions in China. Chinese still spend half as much on food per capita as Mexicans. That’s where the growth will come from. Market dynamics in China are also moving strongly in Nestle’s favor, as food quality and safety become paramount concerns. Further acquisitions should help Nestle gather in billions more in revenue in China along with higher market shares.

Across multiple industries, the circumstances are similar in China, and so favor smart, bold acquirers. Choose good targets, buy them at a good price, convert great entrepreneurs to great managers and partners, don’t script everything from your far-off global headquarters. Do these right and M&A can work in China. No market cap management required.

(Originally published Financial Times BeyondBrics)

http://blogs.ft.com/beyond-brics/2015/05/08/ma-the-chinese-way-buying-first-and-paying-later/

http://www.chinafirstcapital.com/en/FT.pdf

 

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China First Capital Interview: Cashing in and cashing out — China Law & Practice

1 Comment / May 7, 2015

 

China Law & Practice

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Peter Fuhrman, CEO of China First Capital, explains how the country’s private equity market has struggled with profit returns and the importance of diversified exit strategies. He also predicts the rise of new funds to execute high-yield deals

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Date: 05 May 2015

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What is China First Capital?

China First Capital is an investment bank and advisory firm with a focus on Greater China. Our business is helping larger Chinese companies, along with a select group of Fortune 500 companies, sustain and enlarge market leadership in the country, by raising capital and advising on strategic M&A. Like our clients, we operate in an opportunity-rich environment. Though realistic about the many challenges China faces as its economy and society evolve, we are as a firm fully convinced there is no better market than China to build businesses of enduring value. China still has so much going for it, with so much more growth and positive change ahead. As someone who first came to China in 1981 as a graduate student, my optimism is perhaps understandable. The positive changes this country has undergone during those years have surpassed by orders of magnitude anything I might have imagined possible.

After a rather long career in the US and Europe, including a stint as CEO of a California venture capital company as well as a venture-backed enterprise software company, I came back to China in 2008 and established China First Capital with a headquarters in Shenzhen, a place I like to think of as the California of China. It has the same mainly immigrant population and, like the Silicon Valley, is home to many leading private sector high-tech companies.

What is happening in China’s private equity (PE) market?

Back in 2008, China’s financial markets, the domestic PE industry, were far less developed. It was, we now can see, a honeymoon period. Hundreds of new PE firms were formed, while the big global players like Blackstone, Carlyle, TPG and KKR all built big new operations in China and raised tons of new money to invest there. From a standing start a decade ago, China PE grew into a colossus, the second-largest PE market in the world. But, it also, almost as quickly, became one of the more troubled. The plans to make quick money investing in Chinese companies right ahead of their planned IPO worked brilliantly for a brief time, then fell apart, as first the US, then Hong Kong and finally China’s own domestic stock exchanges shut the doors to Chinese companies. Things have since improved. IPOs for Chinese companies are back in all three markets. But PE firms are still sitting on thousands of unexited investments. The inevitable result, PE in China has had a disappointing record in the category that ultimately matters most: returning profits to limited partners (LPs).

Read complete interview

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China High-Yield Debt Investing — the new China First Capital Research Report Published Today

Leave a Comment / April 21, 2015

China High Yield Investing -- China First Capital research report

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China First Capital today publishes a special research report titled, “China Debt Investing: An Overlooked Opportunity”. You can download a copy by clicking here.

This report examines some of the unique attributes of China debt investing, especially its fast-growing high-yield “non bank” shadow banking sector. Do the high yields adequately price in risk? Is this an investment class international investors should consider? Can the regulatory Great Wall be scaled to get dollars legally in and out for lending in China?

Little has been written in English about China’s huge high-yield debt market except constant predictions of its imminent catastrophic demise. Search “China shadow banking crash” and Google turns up 390,000 books and articles in English, some dating back five years now. One sample among many, a 2013 book by James Gorrie titled, “The China Crisis: How China’s Economic Collapse Will Lead to a Global Depression”. It perfectly captures the near-unanimous tenor of Western experts and analysts that shadow banking is the iceberg China has already struck. Losses will run into the billions of dollars, we are told, and China’s entire banking industry will teeter and perhaps collapse in a devastating replay of the 2008 financial crisis in the US and Europe.

Those of us in China inhabiting the world of fact rather than prediction, however, will have noticed that there is no crisis, no iceberg, no titanic upsurge of defaults in China’s shadow banking systems. In fact, it is by far the world’s largest, and using actual default statistics rather than somebody’s forecast, the least risky high-yield debt market in the world. There’s good money to be made.

Our report offers only one prediction — that as rules are loosened, global institutional capital will begin to put money into high-yield lending in China, likely by making direct loans to the best of China’s corporate and municipal borrowers. They will do so because debt investing in China offers institutional investors diversification as well as potentially higher risk-adjusted returns than private equity or venture capital.

The report examines high-yield lending in China as an investment strategy for fixed-income investors.  In that, it may well be a first to do so. Are there risks in the high-yield market in China? Of course, as there is in all fixed-income investing, including, in theory, the safest and most liquid of all instruments, US Treasury bills, bonds and notes.

Are actual default rates in China high-yield lending likely to surge above the current reported level of 1%? Yes, it seems entirely possible. But, this hardly invalidates the attractions of lending there. Instead, it means lenders, be they large credit funds or institutional investors acting directly as a source of debt capital to borrowers in China, should perfect their collateral at the outset,  do first-rate credit analysis before money moves and then, no less important, be extremely hands-on with on-site cash flow monitoring after a loan has been made.

There are 1,000 good reasons for institutional investors to consider China’s high-yield debt market. That’s because of the 1,000-basis point yield premium available in China compared to making similar types of loans against similar collateral to similarly rated companies outside China. In other words, an investor can earn far more with an intelligent direct lending strategy than is possible in all other major economies, as well as more than one can earn even in poorer domains like Indonesia and India.

The report looks at lending and credit markets in China from several different vantage points, including a few case studies. It’s a fascinating topic for anyone who wishes to learn more. Why are interest rates so much higher in China? Who are the winners and losers? Why is it there this near-unanimous view among English-speaking financial analysts and media folk that the high-yield market in China is on the verge of a ruinous crash? Do they share a common gift for doom-laden exaggeration like Nostradamus or will before very long be proven right at last?

I know which way I vote on that, that the shadow banking industry will certainly suffer some stumbles, with individual deals going sour and money being lost. But, as more money enters China for the purpose of providing debt capital, the shadow banking industry will mature, will improve its credit-analysis and credit-pricing skills, and smart investors will do well both relative to other fixed-income investment strategies worldwide as well as compared to private equity investing in China.–

 

Treating the Cancer of High Interest Rates in China — Caijing Magazine commentary

Leave a Comment / March 31, 2015

caijing

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The cost of borrowing money is a huge and growing burden for most companies and municipal governments in China. But, it is also the most attractive untapped large investment opportunity in China for foreign institutional investors. This is the broad outline of the Chinese-language essay published in this week’s Caijing Magazine, among China’s most well-read business publications. The authors are me and Dr. Yansong Wang, China First Capital’s Chief Operating Officer.

Foreign investors and asset managers have mainly been kept out of China’s lucrative lending market, one reason why interest rates are so high here. But, the foreign capital is now trying to find ways to lend directly to Chinese companies and municipalities, offering Chinese borrowers lower interest rates, longer-terms and less onerous collateral than in the Rmb15 trillion (USD $2.5 trillion) shadow banking market. Foreign debt investment should be welcomed rather than shunned, our commentary argues.

If Chinese rules are one day liberalized, a waterfall of foreign capital will likely pour into China, attracted by the fact that interest rates on securitized loans here are often 2-3 times higher than on loans to similar-size and credit-worthy companies and municipalities in US, Europe, Japan, Korea and other major economies. The likely long-term result: lower interest rates for company and municipal borrowers in China and more profitable fixed-income returns for investors worldwide.

I’ve written in English on the problem of stubbornly high borrowing costs in China, including here and here. But, this is the first time I tried to evaluate the problem for a Chinese audience — in this case, for one of the more influential readerships (political and business leaders) in the country.

The Chinese article can be downloaded by clicking here.

For those who prefer English, here’s a summary: high lending rates exist in China in large part because the country is closed to the free flow of international capital. The two pillars are a non-exchangeable currency and a case-by-case government approval system, managed by the State Administration of Foreign Exchange (SAFE) to let financial investment enter, convert to Renminbi and then leave again. This makes it all but impossible to arbitrage the 1,000 basis point interest rate differential between China domestic corporate borrowers and similar Chinese companies borrowing in Hong Kong.

Foreign financial investment in China is 180-degrees different than in other major economies. In China, almost all foreign investment is in equities, either through buying quoted shares or through giving money to any of the hundreds of private equity and venture capital firms active in China. Outside China, most of the world’s institutional investment – the capital invested by pension funds, sovereign wealth funds, insurance companies, charities, university endowments — is invested in fixed-income debt.

The total size of institutional investment assets outside China is estimated to be about $50 trillion. There is a simple reason why institutional investors prefer to invest more in debt rather than equity. Debt offers a fixed annual return and equities do not. Institutional investors, especially the two largest types, insurance companies and pension funds, need to match their future liabilities by owning assets with a known future income stream. Debt is also higher up the capital structure, providing more risk protection.

Direct loans — where an asset manager lends money directly to a company rather than buying bonds on the secondary market — is a large business outside China, but still a small business here. Direct lending is among the fastest-growing areas for institutional and PE investors now worldwide. Get it right, and there’s no better place in the world to do direct corporate lending than in China.

For now, direct lending to Chinese companies is being done mainly by a few large US hedge funds. They operate in a gray area legally in China, and have so far mainly kept the deals secret. The hedge fund lending deals I’ve seen have mainly been short-term lending to Chinese property developers, at monthly interest rates of 2%-3%.

I see no benefit to China from such deals, nor would I risk a dollar of my own money. A good rule in all debt investing is whenever interest rates go above 20% a year, the lender is effectively taking on “equity risk”. In other words, there are no borrowers anywhere that can easily afford to pay such high interest rates. Anyone who will take money at that price is probably unfit to hold it. At 20% and above, the investor is basically gambling that the desperate borrower will not run out of cash while the loan is still outstanding.

Interest rates are only one component of the total cost of borrowing for companies and municipalities in China’s shadow banking system. Fees paid to lawyers, accountants, credit-rating agencies, brokerage firms can easily add another 2% to the cost of borrowing. But, the biggest hidden cost, as well as inefficiency of China’s shadow banking loan market is that most loans from this channel are one-year term, without an automatic rollover.

Though they pay interest for 12 months, borrowers only have use of the money for eight or nine months. The rest of the time, they need to accumulate capital to pay back principal at the end of one year. China is the only major economy in the world where such a small percentage of company borrowing is of over one-year maturity. China’s economy is guided by a Five Year Plan, but it’s domestic lenders operate on the shortest of all time-frames.

If more global institutional capital were allowed into China for lending, I would expect these investors to want to do their own deals here in China, negotiate directly with the borrower, rather than buying existing securitized shadow banking debt. These investors would want to do more of their own due diligence, and also tailor each deal, in a way that China’s domestic shadow banking system cannot, so that the maturity, terms, covenants, collateral are all set in ways that correspond to each borrowers’ cash flow and assets.

China does not need one more dollar of “hot money” in its economy. It does need more stable long-term investment capital as direct lending to companies, priced more closely to levels outside China. Foreign institutional capital and large global investment funds could perform a useful role. They are knocking on the door.

http://magazine.caijing.com.cn/20150330/3851367.shtml

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Blackrock, Fidelity and others learn a painful lesson about China debt pricing

Leave a Comment / March 23, 2015

Kaisa bonds

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For all the media ink spilled, including by Reuters’ excellent Asia fixed income correspondent Umesh Desai, you’d think the ongoing fight in Hong Kong between severely-troubled Chinese real estate developer Kaisa Group and its creditors was the biggest, nastiest, most portentous blood feud the capital markets have ever seen. It’s none of that. It’s a reasonably small deal ($2.5 billion in total Hong Kong bond debt that may prove worthless) involving a Chinese company of no great significance and a group of unnamed bond-holders who are screaming bloody murder about being asked to take a 50% haircut on the face value of the bonds. The creditors have brought in high-priced legal talent to argue their case, both in court and in the media. Me thinks they doth protest too much.

Nothing wrong with creditors fighting to get back all the money they loaned and interest they were promised. But, what goes unspoken in this whole dispute is the core question of what in heaven’s name were bond investors thinking when they bought these bonds to begin with. Kaisa was, if not a train wreck waiting to happen, then clearly the kind of borrower that should be made to pay interest rates sufficiently high to compensate investors for the manifold risks. Instead, just the opposite went down. The six different Kaisa bond issues were sold without problem by Hong Kong-based global securities houses including Citigroup, Credit Suisse and UBS to some of the world’s most sophisticated investors including Fidelity and Blackrock by offering average interest rates of around 8%. If Kaisa were trying to raise loans on its home territory in China, rather than Hong Kong, there is likely no way anyone would have loaned such sums to them, with the conditions attached, for anything less than 16%-20% a year, probably even higher. Kaisa’s Hong Kong bonds were entirely mispriced at their offering.

It may strain mercy, therefore, to feel much sympathy for investors who lose money on this deal. Start with the fact Kaisa, based where I am in Shenzhen, is a PRC company that sought a stock market listing and issued debt in Hong Kong, rather than at home. Not always, but often, this is itself a big red flag. Hong Kong’s stock exchange had laxer listing rules than those on the mainland. As a result, a significant number of PRC companies that would never get approval to IPO in China because of dodgy finances and laughable corporate governance managed to go public in Hong Kong. Kaisa looks like one of these. It has a corporate structure, which since 2009 has been basically illegal, that used to allow PRC companies to slip an offshore holding company at the top of its capital structure.

The bigger issue, though, was that bond buyers clearly didn’t understand, or price in, the now-obvious-to-all fact that offshore creditors (meaning anyone holding the Hong Kong issued debt of a PRC domestic company) would get treated less generously in a default situation than creditors in the PRC itself. The collateral is basically all in China. Hong Kong debt holders are effectively junior to Chinese secured creditors. True to form, in the Kaisa case, the domestic creditors, including Chinese banks, are likely to get a better deal in Kaisa’s restructuring than the folks in Hong Kong.

This fact alone should have mandated Kaisa would need to promise much sweeter returns and more protections to Hong Kong investors in order to get the $2.5 billion. Investors piled in all the same, and are now enraged to discover that the IOUs and collateral aren’t worth nearly as much as they expected. Kaisa bonds were, in effect, junk sold successfully as something close to investment grade. As long as the company didn’t pull a fast one with its disclosure – an issue still in dispute – it’s fair to conclude that bond-buyers really have no one to blame but themselves.

At this point, it’s probable many of the original owners of the Kaisa bonds, including Fidelity and Blackrock, have sold their Kaisa bonds at a loss. Kaisa’s bonds are trading now at about half their face value, suggesting that for all the creditors’ grousing, they will end up swallowing the restructuring terms put forward by Kaisa. If the creditors don’t agree, well then the whole thing will head to court in Hong Kong. If that happens, Kaisa has threatened to default, which would probably leave these Hong Kong bondholders with little or nothing. Indeed, Deloitte Touche Tohmatsu has calculated that offshore creditors in a liquidation would receive just 2.4% of what they are owed. The collateral Kaisa pledged in Hong Kong may be worth more than the paper it was printed on, but not much.

The real story here is the systematic mispricing of PRC company debt issued in Hong Kong. It’s still possible, believe it or not, for other Chinese property developers with similar structure and offering similar protections as Kaisa to sell bonds bearing interest rates of under 9%. Meantime, as discussed here, Chinese property companies in some trouble but not lucky enough to have a holding company outside China are now forced to borrow from Chinese investors, both individuals and institutions,  at 2%-3% a month.

It’s a situation rarely seen – investors in a foreign domain provide money much more cheaply against shakier collateral than the locals will. Kaisa’s current woes are part-and-parcel of at least some of the real estate development industry in China. It seems to have engaged in corrupt practices to acquire land at concessionary prices. Kaisa got punished by the Shenzhen government. It was forbidden to sell newly-built apartment units in Shenzhen. No sales means no cash flow which means no money to pay debt-holders. Kaisa is far from the first Chinese real estate developer to run into problems like this. And yet, again, none of this, the “politico-existential” risk many real estate development companies face in China, seems to have made much of an imprint on the minds of international investors who lined up to buy the 8% bonds originally. After all, the interest rate on offer from Kaisa was a few points higher than for bonds issued by Hong Kong’s own property developers.

Global institutional investors like Blackrock and Fidelity might control more capital and have far more experience pricing debt than Chinese ones. But, in this case at least, they showed they are far more willing to be taken for a ride than those on the mainland.

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China’s loan shark economy — Nikkei Asian Review

Leave a Comment / June 25, 2016

Nikkei2

China loan sharking

China’s loan shark economy

PF

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What’s ailing China? Explanations aren’t hard to come by: slowing growth, bloated and inefficient state-owned enterprises, and a ferocious anti-corruption campaign that seems to take precedence over needed economic reforms.

Yet for all that, there is probably no bigger, more detrimental, disruptive or overlooked problem in China’s economy than the high cost of borrowing money. Real interest rates on collateralized loans for most companies, especially in the private sector where most of the best Chinese companies can be found, are rarely below 10%. They are usually at least 15% and are not uncommonly over 20%. Nowhere else are so many good companies diced up for chum and fed to the loan sharks.

Logic would suggest that the high rates price in some of the world’s highest loan default rates. This is not the case. The official percentage of bad loans in the Chinese banking sector is 1%, less than half the rate in the U.S., Japan or Germany, all countries incidentally where companies can borrow money for 2-4% a year.

You could be forgiven for thinking that China is a place where lenders are drowning in a sea of bad credit. After all, major English-language business publications are replete with articles suggesting that the banking system in China is in the early days of a bad-loan crisis of earth-shattering proportions. A few Chinese companies borrowing money overseas, including Hong Kong-listed property developer Kaisa Group, have come near default or restructured their debts. But overall, Chinese borrowers pay back loans in full and on time.

Combine sky-high real interest rates with near-zero defaults and what you get in China is now probably the single most profitable place on a risk-adjusted basis to lend money in the world. Also one of the most exclusive: the lending and the sometimes obscene profits earned from it all pretty much stay on the mainland. Foreign investors are effectively shut out.

The big-time pools of investment capital — American university endowments, insurance companies, and pension and sovereign wealth funds — must salivate at the interest rates being paid in China by credit-worthy borrowers. They would consider it a triumph to put some of their billions to work lending to earn a 7% return. They are kept out of China’s lucrative lending market through a web of regulations, including controls on exchanging dollars for yuan, as well as licensing procedures.

This is starting to change. But it takes clever structuring to get around a thicket of regulations originally put in place to protect the interests of China’s state-owned banking system. As an investment banker in China with a niche in this area, I spend more of my time on debt deals than just about anything else. The aim is to give Chinese borrowers lower rates and better terms while giving lenders outside China access to the high yields best found there.

China’s high-yield debt market is enormous. The country’s big banks, trust companies and securities houses have packaged over $2.5 trillion in corporate and municipal debt, securitized it, and sold it to institutional and retail investors in China. These so-called shadow-banking loans have become the favorite low-risk and high fixed-return investment in China.

Overpriced loans waste capital in epic proportions. Total loans outstanding in China, both from banks and the so-called shadow-banking sector, are now in excess of 100 trillion yuan ($15.9 trillion) or about double total outstanding commercial loans in the U.S. The high price of much of that lending amounts to a colossal tax on Chinese business, reducing profitability and distorting investment and rational long-term planning.

A Chinese company with its assets in China but a parent company based in Hong Kong or the Cayman Islands can borrow for 5% or less, as Alibaba Group Holding recently has done. The same company with the same assets, but without that offshore shell at the top, may pay triple that rate. So why don’t all Chinese companies set up an offshore parent? Because this was made illegal by Chinese regulators in 2008.

Chinese loans are not only expensive, they are just about all short-term in duration — one year or less in the overwhelming majority of cases. Banks and the shadow-lending system won’t lend for longer.

The loans get called every year, meaning borrowers really only have the use of the money for eight to nine months. The remainder is spent hoarding money to pay back principal. The remarkable thing is that China still has such a dynamic, fast-growing economy, shackled as it is to one of the world’s most overpriced and rigid credit systems.

It is now taking longer and longer to renew the one-year loans. It used to take a few days to process the paperwork. Now, two months or more is not uncommon. As a result, many Chinese companies have nowhere else to turn except illegal money-lenders to tide them over after repaying last year’s loan while waiting for this year’s to be dispersed. The cost for this so-called “bridge lending” in China? Anywhere from 3% a month and up.

Again, we’re talking here not only about small, poorly capitalized and struggling borrowers, but also some of the titans of Chinese business, private-sector companies with revenues well in excess of 1 billion yuan, with solid cash flows and net income. Chinese policymakers are now beginning to wake up to the problem that you can’t build long-term prosperity where long-term lending is unavailable.

Same goes for a banking system that wants to lend only against fixed assets, not cash flow or receivables. China says it wants to build a sleek new economy based on services, but nobody seems to have told the banks. They won’t go near services companies, unless of course, they own and can pledge as collateral a large tract of land and a few thousand square feet of factory space.

Chinese companies used to find it easier to absorb the cost of their high-yield debt. No longer. Companies, along with the overall Chinese economy, are no longer growing at such a furious pace. Margins are squeezed. Interest costs are now swallowing up a dangerously high percentage of profits at many companies.

Not surprisingly, in China there is probably no better business to be in than banking. Chinese banks, almost all of which are state-owned, earned one-third of all profits of the entire global banking industry, amounting to $292 billion in 2013. The government is trying to force a little more competition into the market, and has licensed several new private banks. Tencent Holdings and Alibaba, China’s two Internet giants, both own pieces of new private banks.

Lending in China is a market rigged to transfer an ever-larger chunk of corporate profits to a domestic rentier class. High interest rates sap China’s economy of dynamism and make entrepreneurial risk-taking far less attractive. Those looking for signs China’s economy is moving more in the direction of the market should look to a single touchstone: is foreign capital being more warmly welcomed in China as a way to help lower the usurious cost of borrowing?

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

 

http://asia.nikkei.com/Viewpoints/Perspectives/Chinas-loan-shark-economy

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US Private Equity Soars While China Stalls

1 Comment / February 9, 2015

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In 2014, the gap between the performance of the private equity industry in China and the US opened wide.  The US had a record-breaking year, with ten-year net annualized return hitting 14.6%. Final data is still coming in, but it appears certain US PE raised more capital more quickly and returned more profits to LPs than any year previously.  China, on the other hand, had another so-so year. Exits picked up over 2013, but still remain significantly below highs reached in 2011. As a result profit distributions to LPs and closing of new China-focused funds are also well down on previous highs.

China’s economy, of course, also had an off year, with growth trending down. But, it’s hard to place the blame there. At 7.5%, China’s economy is still growing at around triple the rate of the US. China’s publicly-traded equities market, meanwhile, turned in a stellar performance, with the overall Chinese stock exchange average up 52% in 2014, compared to a 11.4% rise in the US S&P. When stock markets do well, PE firms should also, especially with exits.

While IPO exits for Chinese companies in US, HK and China reached 221, compared to only 66 in 2013, the ultimate measure of success in PE investing is not the number of IPOs. It’s the amount of capital and profits paid back to LP investors. This is China PE’s greatest weakness.

Over the last decade, China PE firms have returned only about 30% of the money invested with them to their LPs. This compares to the US, where PE firms over the same period returned twice the money invested by LPs. In other words, in China, as 2015 commences, PE firm investors are sitting on large cash losses.

China private equity distributions to LPs

 

China PE firms say they hope to return more money to their LPs in the future.  But, this poor pay-out performance is already having an adverse impact on the China PE industry. It is getting harder for most China PE firms to raise new capital. If this trend continues, there will be two negative consequences – first, the China PE industry, now the second largest in the world,  will shrink in size. Second, and more damaging for China’s overall economic competitiveness, the investment capital available for Chinese companies will decline. PE capital has provided over the past decade much-needed fuel for the growth of China’s private sector.

What accounts for this poor performance of China private equity compared to the US? One overlooked reason: China PE has lost the knack of investing and exiting profitably from Chinese industrial and manufacturing companies. Broadly speaking, this sector was the focus of about half the PE deals done up to 2011 when new deals peaked. That mirrors the fact manufacturing accounts for half of China’s GDP and traditionally has achieved high levels (over 30%) of value-added.

Manufacturing has now fallen very far from favor in China. Partly it’s the familiar China macro story of slowing export growth and margin pressures from rising labor costs and other inputs. But, another factor is at work: China’s own stock market, as well as those of the US and Hong Kong, have developed a finicky appetite when it comes to Chinese companies. In the US, only e-commerce and other internet-related companies need apply for an IPO. In Hong Kong, the door is open more widely and the bias against manufacturing companies isn’t quite so pronounced, especially if the company is state-owned. But, among private sector companies, the biggest China-company IPO have been concentrated in financial services, real estate, food production, retail.

For China-investing PE firms, this means in most cases their portfolios are mismatched with what capital markets want. They hold stakes in thousands of Chinese industrial and manufacturing companies representing a total investment of over $20 billion in LP money.  For now, the money is trapped and time is growing short. PE fund life, of course, is finite. Many of these investments were made five to eight years ago. China PE need rather urgently to find a way to turn these investments into cash and return money to LPs. Here too the comparison with US private equity is especially instructive.

The colossus that is today’s US private equity industry, with 3,300 firms invested in 11,000 US companies, was built in part by doing successful buyouts in the 1980s and 1990s of manufacturing and industrial companies, often troubled ones. Deals like Blackstone‘s most successful investment of all time, chemicals company Celanese, together with American Axle and TRW Automotive, KKR‘s Amphenol Corporation, Bain‘s takeover of  Sealy Corporation and many, many others led the way. Meanwhile, smart corporate investors like Warren Buffett’s Berkshire Hathaway, Honeywell, Johnson Controls, Emerson Electric and were also pouring billions into acquiring and shaping up industrial businesses. So successful has this strategy been over the last 30 years, it can seem like there are no decent industrial or manufacturing companies left for US PEs to target.

Along the way, US PEs became experts at selecting, acquiring, fixing up and then exiting from industrial companies. US PEs have shown again and again they are good at rationalizing, consolidating, modernizing and systematizing industrial companies and entire industrial sectors. These are all things China’s manufacturing industry is crying out for. Market shares are fragmented, management systems often non-existent, inventory control and other tools of “lean manufacturing” often nowhere to be found.

So here’s a pathway forward for China PE, to use in China the identical investing skills honed in the US. It should be rather easy, since among the US’s 100 biggest private equity firms, the majority have sizeable operations now in China, including giants like Carlyle, Blackstone, KKR, TPG, Bain Capital, Warburg Pincus. For these firms, it should be no more complicated than the left hand following what the right hand is doing.

It isn’t working out that way. This is a big reason why China PE is performing poorly compared to the US. PE partners in China in the main came into the industry after getting an MBA in the US or UK, then getting a job on Wall Street or a consulting shop. Few have experience working in,  managing or restructuring industrial companies. They often, in my experience, look a little out of place walking a factory floor. This is the other big mismatch in China PE — between the skill-sets of those running the PE firms what’s needed to turn their portfolio companies into winners.

Roll-up, about the most basic and time-tested of all US PE money-making strategies, has yet to take root in China. Inhospitable terrain? No, to the contrary. But, it requires a fair bit of sweat and grit from PE firms.

This may account for the fact that China PE firms are now mainly herding together to try to close deals in e-commerce, healthcare services, mobile games and other places where no metal gets bashed. PE firms formed such a crush to try to invest in Xiaomi, the mobile phone brand, that they drove the valuation up in the latest round of funding to $46 billion, so high none of them decided to invest. China PE is that paradoxical – fewer deals are getting done, fewer have profitable exits and yet valuations are often much higher than anywhere else.

Another worrying sign: of the big successful China company IPOs in 2014 – Alibaba, Dalian Wanda‘s commercial real estate arm, CGN, CITIC Securities, Shaanxi Coal, JD.com, WH Group  – only one had large global PE firms inside as large shareholders. That was WH Group, a troubled deal that had a hard time IPOing and has since sunk rather sharply. For the big global PE firms, 2014 had no big China IPO successes, which is probably a first.

The giant US PEs (Blackstone, Carlyle, KKR, Goldman Sachs Capital Partners, Bain Capital, TPG and the others) all voyaged to China a decade or more ago with high hopes. Some even dared predict China would become as important and profitable a market for them as the US. They were able to raise billions at the start, build big teams, but it’s been getting noticeably harder both to raise money and notch big successful deals. And so their focus is shifting back to the US.

China has so much going for it as an investment destination, such an abundance of what the US lacks. High overall growth, a government rolling in cash, a burgeoning and rapidly prospering middle class, rampant entrepreneurship, huge new markets ripe for taking. Why then are so many of the world’s most professional and successful investors finding it so tough to make a buck here?

 

China’s Caijing Magazine on America’s All-Conquering Dumpling Maker

1 Comment / January 17, 2015

caijing

Caijing Magazine

 

The secret is out. Chinese now know, in far greater numbers than before, that the favorite brand of the favorite staple food of hundreds of millions of them is made by a huge American company, General Mills, best known for sugar-coated cereals served to American children. (See my earlier article here.) In the current issue of China’s weekly business magazine Caijing is my Chinese-language article blowing the cover off the well-hidden fact that China’s tastiest and most popular brand of frozen dumplings, known in Chinese as 湾仔码头, “Wanzai Matou”, is made by the same guys who make Cheerios, Cocoa Puffs and Lucky Charms in the US.

You can read a copy of my Caijing article by clicking here.

Getting these facts in print was not simple. I’ve been an online columnist for Caijing for years. When I sent the manuscript the magazine’s editor, he did the journalistic version of a double take, refusing to believe at first that this dumpling brand he knows well is actually owned and run by a non-Chinese company, and a huge American conglomerate to boot. He asked many questions and apparently did his own digging around to confirm the truth of what I was claiming.

He asked me to reveal to him and Caijing’s readers the secret techniques General Mills has used to conquer the Chinese market. That further complicated things. It wasn’t, I explained,  by selling stuff cheap, since Wanzai Matou sells in supermarkets for about double the price of pure domestic brands. Nor was it because they used the same kind of saturation television advertising P&G has pioneered in China to promote sales of its market-leading products Head & Shoulders and Tide. General Mills spends little on media advertising in China, relying instead on word of mouth and an efficient supply chain.

My explanation, such as it is, was that the Americans were either brave or crazy enough, beginning fifteen years ago, to believe Chinese would (a) start buying frozen food in supermarkets, and (b) when they did, they’d be willing to pay more for it than fresh-made stuff. Wanzai Matou costs more per dumpling than buying the hand-made ones available at the small dumpling restaurants that are so numerous in China just about everyone living in a city or reasonably-sized town is within a ten-minute walk of several.

In my case, I’ve got at least twenty places within that radius. I flat-out love Chinese dumplings. With only a small degree of exaggeration I tell people here that the chance to eat dumplings every day, three times a day, was a prime reason behind my move to China. For my money, and more important for that of many tens of millions of Chinese, the Wanzai Matou ones just taste better.

The article, though, does explain the complexities of building and managing a frozen “cold chain” in China. General Mills had more reason to master this than any company, domestic or foreign. That’s because along with Wanzai Matou they have a second frozen blockbuster in China: Häagen-Dazs ice cream, sold both in supermarkets and stand-alone Häagen-Dazs ice cream shops. Either way, it’s out of my price range, at something like $5 for a few thimblefuls, but lots of Chinese seem to love it. Both Wanzai Matou and Häagen-Dazs China are big enough and fast-growing enough to begin to have an impact on General Mills’ overall performance, $18 billion in revenues and $1.8bn in profits in 2014.

For whatever reason, General Mills doesn’t like to draw attention to its two stellar businesses in China. The annual report barely mentions China. This is in contrast to their Minnesota neighbor 3M which will tell anyone who’s listening including on Wall Street that it’s future is all about further expanding in China. But, the fundamentals of General Mills’ business in China look as strong, or stronger, than any other large American company operating here.

The title of my Caijing article is “外来的厨子会做饺子” which translates as “Foreign cooks can make dumplings”. It expresses the surprise I’ve encountered at every turn here whenever I mention to people here that China’s most popular dumpling company is from my homeland not theirs.

 

China’s central government gets serious about changing IPO rules and helping SMEs raise capital, Global Times article

Leave a Comment / December 5, 2014

globatimes

 

Govt calls for progress in IPO reform to help small firms

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By Wang Xinyuan Source:Global Times Published: 2014-11-24

 

Amid a slowing economy, the Chinese government is considering strategies to help the country’s cash-starved micro and small companies. Upcoming IPO reform is expected to offer easier access to stock market funding, but investors are concerned it could divert funds from existing stocks.

 

While China’s economy has been affected by a weakening property sector, erratic foreign demand and sagging domestic investment growth, the authorities are hoping that the country’s millions of micro and small enterprises (MSEs) can offer a source of economic energy.

The State Council, the country’s cabinet, pledged on Wednesday to lower the cost of raising funds by giving banks more flexibility to lend and removing rigid profit requirements for a firm to get listed in stock markets, among other measures aimed at making it easier for small firms to grow.

At the meeting on Wednesday, Premier Li Keqiang urged the securities regulator to speed up plans to unveil simplified rules for new IPOs.

Two days after the cabinet’s meeting, the central bank cut interest rates for the first time in two years.

While the rate cut will be of particular benefit for large State-owned enterprises, simplified IPO access is expected to make it easier for cash-starved smaller firms to raise money directly in the markets.

Under the existing IPO scheme, applicants must meet certain conditions in order to get listed in Shanghai or Shenzhen, including having made a profit for at least two consecutive years and having net profit of at least 10 million yuan ($1.63 million).

Even if they meet these requirements, IPO applicants are also subject to the review and approval procedures of the China Securities Regulatory Commission (CSRC), the securities watchdog.

The CSRC suspended its IPO reviews in late 2012 in a bid to enhance information disclosure and crack down on rampant financial fraud and insider trading.

The CSRC also wanted to lay solid foundations for a new round of IPO reform intended to diminish government intervention and establish a more efficient, market-based IPO filing system.

The regulator restarted IPO approvals in December 2013 after a 13-month hiatus.

However, the suspension had resulted in a long queue of IPO applicants. As of mid-November this year, 570 firms were waiting for their applications to be reviewed, according to media reports.

A plan for an IPO filing system with a focus on information disclosure is likely to be released by the end of 2014, the 21st Century Business Herald reported on Thursday, citing a source close to the CSRC.

Equal access

Under the new IPO registration system, the CSRC will no longer intervene in the listing process and will focus on supervision rather than review and approval, analysts said.

The system will provide access to market financing for all firms, not just those at the front of the queue for IPO approval, and the investment value shall be judged by investors, not the government, Dong Dengxin, director of the Finance and Securities Institute at Wuhan University of Science and Technology, wrote on his Weibo on Saturday.

The CSRC was not available for comment on the schedule of IPO registration reform when reached by the Global Times on Thursday.

As China tries to move up the value chain and restructure its economy, small firms have become increasingly important. They also account for more than 70 percent of the country’s jobs.

“While the IPO reforms are absolutely correct in their direction and implementation, the capital markets in China are still unable to provide the financing needed for most MSEs to continue to grow,” Peter Fuhrman, chairman and CEO of Shenzhen-based investment bank China First Capital, told the Global Times in an e-mail on Saturday.

Relatively slow approval of IPOs and the exceptionally long waiting list are seen as the major reasons for the difficult funding.

There are “thousands of Chinese MSEs with good size and profits” that are waiting to go public, said Fuhrman.

Read full article.

Nanjing: A Special Kind of Chinese Boomtown

Leave a Comment / November 25, 2014

Nanjing City Investment Promotion Consultant

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In 1981, when I first arrived in Nanjing as a student,  the ancient and rather sleepy city had a population of four million and a GDP of Rmb 4 billion. Today, the population has doubled to eight million and GDP is two hundred times larger. Yes, you read that right. This year’s GDP will exceed Rmb 850bn. Even by recent Chinese standards, that kind of growth rate for a major city is just about unheard of. Since 1981, Nanjing’s GDP has grown almost twice as fast as China as a whole. It is now richer in per capita terms than Beijing, and its economy continues to expand more quickly than the capital, Shanghai and just about every other major city in the country.

I was back in Nanjing in the last week to visit friends and clients, as well as receive from the Nanjing city government an official appointment as an “investment promotion consultant”. That’s me in the photo above celebrating with Mr. Kong Qiuyun, the cultured an charismatic director-general of Nanjing Municipal Investment Promotion Commission. It’s an especially welcome honor since I consider Nanjing, all these years later, my hometown in China, my  “laojia”. Every return is a homecoming.

With or without the official status, saying good things about Nanjing comes easily. It’s a special kind of boomtown. Despite the steep economic ascent over the last 33 years, today’s Nanjing is visibly woven from strands of its 2,500 year-old history as a city at the core of Chinese civilization. Old parks, streets and buildings stand. Though stained by tragedy – including the Nanjing Massacre in 1937 and bloody civil war at the end of the Taiping Rebellion civil war 73 years earlier — Nanjing is a city with a lightness of spirit and an intimate association with Chinese traditional culture of painting, calligraphy, poetry.

There is an ease, prosperity and comfort to life in Nanjing that is largely absent in Beijing. One is built upon the parched steppes below the Gobi Desert. Camel country. The other is set amid China’s most fertile, well-irrigated patch of bottomland –a kind of Chinese Eden, saturated by rivers, lakes, ponds and paddies, where just about everything can be grown or reared in abundance. The city is a symbiosis of man and duck. In a typical year, the people of Nanjing will consume over one hundred million of them. Every trip, including this most recent one, I return to Shenzhen with a suitcase padded out with three or four salt-preserved Osmanthus-scented ducks. Each trip back to the US I carry several with me and deliver them to my father in Florida. Somehow, age 82, he has developed a fine appreciation for them.

Nanjing took awhile to get its economic act together. During much of the 1980s, it was a backwater, trailing far behind the nearby cities of Shanghai and Suzhou as well as the coastal cities of Guangdong and Fujian. Earlier it had a reputation for being not very well-managed. Today the opposite is true.

Nanjing is the most ideally-situated large city in China. It is at the back door of China’s richest, most developed region, the Yangtze River Delta, stretching from Shanghai through Hangzhou, Suzhou, Wuxi and Changzhou. It is also now the front door for China’s huge market of the future, the inland regions where growth is now strongest, particularly the provinces of Hubei, Sichuan, Chongqing, Anhui farther up the Yangtze.

Nanjing’s is a large economy but without especially large and dominant companies. Few even in China can name its largest businesses or employers. This sets it apart from Beijing, Shanghai, Shenzhen, Hangzhou, Tianjin. Credit Nanjing government’s hands-on far-sighted economic management. It’s made up for the lack of large businesses by encouraging the growth of smaller mainly private-sector entrepreneurial businesses, as well as bringing in investment from abroad. Sharp, BASF, A.O. Smith, ThyssenKrupp are among the larger foreign companies with significant investment in Nanjing.

Major American investors are still comparatively few. This needs correcting. I hope to help in my new role as a consultant. Americans in the first half of the 20th century played a conspicuously positive role in Nanjing’s development. US academics and missionaries helped establish the city’s two oldest universities, Nanjing University (where I studied) and Nanjing Normal University. They remain the rock-solid backbones of Nanjing’s outstanding university system with over 25 institutions of higher learning.

An American team of architects and urban designers were responsible for creating the layout of much of the modern city of Nanjing, including the city’s main shopping district of Xinjiekou. The city was designed to combine elements of Paris and Washington D.C., with wide boulevards, stately traffic roundabouts like the Place de l’Etoile, and an elegant diplomatic quarter with large mansions spread along arching plane tree-shaded streets.

During the pre-1949 era, American companies were the most prominent and successful businesses in Nanjing. Two in particular – Socony (then the world’s leading petroleum company, a part of the Rockefeller Standard Oil group, and now ExxonMobil.) and British American Tobacco – managed large operations in China from their headquarters in Nanjing. They were then among the largest companies in China of any kind. They left in 1949 never to return to Nanjing and their previous prominence.

An individual American, a long-term resident of Nanjing, wrote while there the most popular and influential book about China in English. It was then made into a successful film which etched in the minds of many Westerners the enduring image of China’s Confucian values and pre-revolution rural poverty. Pearl Buck’s “The Good Earth” was for years a best-seller and played an influential role in winning her the Nobel Prize for Literature in 1938. *

To my thinking, America has an unfulfilled destiny in Nanjing. It’s a smart place for smart capital to locate. In modernizing, it has kept its soul intact.

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* For sharing his rich and consummate knowledge of America’s multi-facetted engagement with  Nanjing in the first half of the 20th century, I’m indebted to John Pomfret. John’s book “Chinese Lessons”, about his years as a student at Nanjing University and the lives thereafter of his Chinese classmates, is as good as anything published about China’s remarkable transformation these last thirty years. You can read more about the book, and about John, by visiting http://www.johnpomfret.org/

 

Alibaba grabs the IPO money but the future belongs to Jeff Bezos and Amazon China

4 Comments / October 3, 2014

Amazon China & Alibaba

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Alibaba Group should next week collect the big money from its NYSE IPO. But, Seattle’s Amazon owns the future of China’s $400 billion online shopping industry. Amazon’s China business is better in just about every crucial respect: customer service, delivery, product quality even price when compared to Alibaba’s towering Taobao business. Hand it to Jeff Bezos. While few have been watching, he is building in China what looks to me to be a better, more long-term sustainable business than Alibaba’s Jack Ma.

Amazon’s China business fits a familiar pattern. The company is often mocked for keeping too much secret, investing too much and earning too little. In China, far away from the Wall Street spotlight, Amazon has invested hugely, with a long-term aim perhaps to overtake Alibaba and become a dominant online retailer in the country. But, it has zero interest in letting its shareholders, competitors, or the world at large know what it’s doing in China. Open the company’s most recent SEC 10-K filing and there are three passing mentions of China, and nothing about the size of its business there, the strategy.

Amazon shareholders may well wake up one day and suddenly find Bezos has built for them one of the most valuable online businesses in the world’s largest e-commerce market, the only one not owned and managed by a Chinese corporation. No rickety and risky VIE structure, unlike Alibaba and virtually all the other Chinese online companies quoted in the US.  (Read damning report by US Congress investigators on these Chinese VIE companies here. )

Jeff Bezos has been in the online shopping business from its genesis, in 1994. He first got serious in China ten years later, by buying a small online shopping business called Joyo in 2004. Taobao was founded by Jack Ma a year earlier. Within three years Taobao had demolished eBay’s then-lucrative China online auction business, by making it free for sellers to list their products on Taobao. Buyers and sellers both pay Taobao zero commission. It earns most of its money from advertising. EBay China closed its doors in 2006. Since then, Alibaba has grown from about $170mn in revenues to over $6 billion in 2013. Approximately three out of every four dollars spent online shopping in China goes through Alibaba’s hands. Overall, online shopping transaction value is on track to exceed $1 trillion by the end of this decade.

online shopping China

The champagne and baijiu will flow at Alibaba next week. Meantime, Bezos will continue executing on his plan, begun in earnest around 2012, to first gain on Taobao, and one day outduel it in China. How? To buy from Amazon China is to see Bezos’s mind at work. He has clearly assessed Taobao’s pivotal weaknesses, and is targeting them with precision.

Taobao has done phenomenally well. But, it is much the same business today as a decade ago. It is mainly a raucous collection of individual sellers where counterfeit, used-sold-as-new or substandard goods are rife. Everything is ad hoc. Sellers can appear and disappear overnight. They charge whatever they like to ship you your merchandise. Try to return things and it can be anything from complicated to impossible. Most payments are processed by Alipay, a business with similar ownership to Alibaba, but not fully consolidated as part of the IPO. Alipay tries to act like an impartial escrow service between Chinese buyers and sellers who too often seem to be out to try to cheat one another.

Taobao is a product of its time, a China where getting stuff cheap, of whatever origin, authenticity and quality, was paramount. It’s also been a great way to create an army of small entrepreneurs in China, eight million in total, with their own shops selling merchandise to over 200 million different individual customers on Taobao. But, Chinese are much richer and more discriminating today than ten years ago. They are getting richer by the day. The larger trends all point in Amazon’s favor.

Here’s why. When you buy things on Amazon China, you mainly purchase direct from Amazon, not from individual sellers. As in the US, Amazon China sells a full range of merchandise not just books. While it has far fewer items for sale than Taobao, it does many things that Taobao cannot. First, it has its own nationwide delivery service. Where I am in Shenzhen, I get delivery the next morning from a guy in an Amazon shirt with his electric motorcycle parked on the sidewalk in front of my building. You can either pay online by credit card, or pay the delivery guy in cash, COD. Delivery is free and reliable. Parcels are professionally packaged in Amazon boxes and generally arrive in mint condition. It’s a limousine service compared to Taobao.

Stuff ordered on Taobao can take days to arrive, and is sent using any of a group of different independently-owned parcel delivery companies. They don’t accept returns, or cash, and often in my experience as a Taobao customer for the last five years the parcels arrive pretty badly roughed up. The Taobao sellers do their own packaging, sometimes good and sometimes no, usually with boxes rescued from the trash, then call whichever parcel company offers them the cheapest rate. The seller usually takes a mark-up since delivery on Taobao is generally not included.

Amazon China is putting its brand and reputation behind everything it sells. This provides a quality guarantee that no individual seller on Taobao can match. I’ve also found over the course of the last year that prices for similar items are often now cheaper on Amazon than on Taobao. How so? For one thing, unlike the Taobao army, Amazon can use its buying power to extract lower prices and better payment terms from its suppliers. Taobao has a subsidiary business called TMall, where major brands directly sell their products. Here at least there should be no worries about the quality and authenticity of what’s being sold. But since each brand manages its own store on TMall, the prices are often higher than on Amazon China. Delivery is also less efficient, in my experience.

What does Taobao still do better than Amazon China? Its website seems a bit easier for Chinese to navigate than Amazon China’s, which looks and acts a lot like the main Amazon website designed and managed in Seattle.

As Bezos’s shareholders know well and occasionally grumble about, he loves spending money on warehouses, shipping technology and other expensive infrastructure. The China business is a marvel of its kind, a kind of “Bezosian” tour de force. The scale and complexity of what Amazon China are doing is formidable. Bezos started and prospered originally with a no inventory business model, letting outside wholesalers hold and so finance the inventory of books he was selling online.

In China, Amazon must stock huge inventories to get products delivered to customers overnight. Where these facilities are and how much Amazon has spent is beyond knowing. Anything I buy on Amazon China — most recently three books, an electronic garlic-mincer and some ceramic carving knives — is delivered to me next day, within about 15 hours of when I ordered it. In a country China’s size, where moving things around long-distance by truck as UPS and Fedex do in the US is difficult and expensive, Amazon has apparently invested in a large nationwide distributed network of warehouses to hold all this inventory. Whether these are owned by Amazon or third parties is also not disclosed. But, it all works smoothly. I get what I order quickly and efficiently, direct from Amazon’s own liveried delivery team, at prices Taobao can’t match.

Every delivered package drives home the message how much faster, cheaper and more reliable Amazon China is compared to Taobao. Try us once, Bezos seems to be saying here in China, and you’ll try us again.

Amazon China delivery guyCan Amazon China be making any money here? My guess is No, that the current operation in China is a big money sink. How big? China’s other big online shopping business, JD.com, which went public earlier this year and has a business model more like Amazon China than Alibaba’s, is losing money every quarter. (Nonetheless, it has a current market cap of $40bn.)

Alibaba, by contrast, is making money hand-over-fist, Rmb8 billion ($1.3bn) in net income the last quarter of 2013. To get noticed, those eight million individual Taobao sellers, as well as TMall brands, need to pay more and more to Taobao for ads and preferential placement.

Longer term, though, the Taobao ad-supported model looks ill-adapted to where China is headed. Traditional store retailers in China are getting slaughtered by online competitors. Among those online players, it seems likely business will shift to those that can guarantee quality, authenticity, easy product returns and efficient next-day-delivery. That describes Amazon.

One reason it’s crazy to bet against Bezos is he has shown no compunction about using shareholder money to build a business that can only start to make real money in ten maybe fifteen years. Jack Ma has no such luxury, especially now that Alibaba will be quoted on the NYSE. Alibaba is not likely to attract the kind of patient shareholders drawn to Amazon.

This is perhaps one reason why Ma has been out spending a huge pile of Alibaba money buying into all kinds of businesses to tack onto Alibaba. These include US car service Lyft, messaging business Tango, and all sorts of domestic Chinese businesses, including a big slice of China’s Twitter, Weibo, the digital mapping company AutoNavi,  16.5% of China’s YouTube knockoff, NYSE-quoted Youku and a Hong Kong-quoted film studio that seems to have been cooking its books. He also bought control of a professional soccer team in China, hoping to upgrade the much-maligned image of the domestic game. Add it up and it looks like even Ma isn’t fully convinced Taobao will be able to keep spinning money for years to come.

His most successful recent venture begun last year is an online money management business called Yuebao that pays Chinese savers about 4% on deposits, compared to the less than 0.5% offered by local Chinese banks. As of early September, it had Rmb574 billion, nearly $100 billion, under management. This business is not included in the Alibaba entity going public in New York. That points up another worrying aspect of Jack Ma’s business style. He has shown a proclivity to put some of the more valuable assets into vehicles that only he, rather than the shareholder-owned company, controls. Yahoo! and Japan’s SoftBank have some bitter direct experience with this.

How far can Bezos go in China? After all, he doesn’t speak Chinese and doesn’t seem to visit China all that often. Can a kid from a Miami high school really build a better China business than scrappy Hangzhou-native Jack Ma? One pointer is that the most successful traditional retailers are now mainly foreign-owned and managed. Domestic retailers couldn’t adapt to this new era of rampant low-price online competition. But, Zara, H&M and Sephora are all thriving here. They, too, focused on details often overlooked here, like good customer service, no-questions-asked return policy, competitive prices and great merchandising.

Alibaba’s market cap next week, after its biggest-of-all-time IPO, may temporarily overtake Amazon’s, at $160 billion. But, make no mistake, Amazon will likely prove the more valuable business over time, both in China and globally.

 

Investment in China PIPEs grows on Alibaba’s coattails — The Deal

Leave a Comment / December 5, 2014

deal

 

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Investment in China PIPEs grows on Alibaba’s coattails

By Bill Meagher    Updated 07:45 PM, Sep-09-2014 ET

 

Fueled by the anticipated initial public offering of Alibaba Group Holding Ltd., a renewed wave of investor interest has swept into U.S.-registered Chinese companies.

Such companies have raised $4.43 billion in 35 private-investment-in-public-equity transactions this year, compared to $276.8 million in 13 PIPEs last year, according to PrivateRaise, The Deal’s data service that tracks the PIPE market. Those figures exclude transactions that raised less than $1 million.

“Everything ultimately comes back to Alibaba,” said Peter Fuhrman, CEO of China First Capital, an investment bank in Shenzhen, China.

Alibaba’s imminent IPO has increased investor awareness that all things related to Internet shopping in China could be a “money-spinner,” Fuhrman said in an e-mail.

“Pretty much all the China IPOs in US this past 12 months have been internet-related. Now comes the Daddy of them all,” he wrote. “This perception of a boom of titanic proportions in online shopping in China is well-founded. The challenge for US investors is whether the companies that have gone public, with exception of Alibaba and to a lesser extent Jingdong will be able to scale up and make real money over time in China.”

To read complete article, click here.

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