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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

–NYT2

 

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

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China’s Most Successful Startup?

Leave a Comment / June 24, 2016

 

Nikkei

OnePlus Never Settle

China’s most successful startup?

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PF

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Ask people in China to name the country’s most successful and innovative new mobile phone brand and most will immediately declare Xiaomi. Ask tech-savvy Americans and Europeans and they will just as quickly suggest OnePlus. Though largely still unknown in China, Shenzhen-headquartered OnePlus, established less than 18 months ago, has achieved more success more quickly in US and European markets than any other Chinese mobile phone company. It is also possibly the China’s most successful startup since Xiaomi was established five years ago.

OnePlus, by my estimate, has now joined the most exclusive club in the technology world, a “unicorn”, meaning technology startups with a valuation of over $1 billion. Other Chinese unicorns besides Xiaomi are China’s Uber, Kuaidi Dache and group buying site Meituan. Unlike those other Chinese companies, OnePlus has not yet raised any money from venture capitalists.   OnePlus is also the only truly international Chinese unicorn, since most of its sales and growth are outside China.

With just a tiny amount of seed capital,  the company began selling its phones little more than a year ago in late April 2014. Its 2014 full-year revenues were $300mn, well behind Xiaomi’s $12 billion.  But, unlike Xiaomi, OnePlus chose to focus its efforts on the US, Western Europe and India. In these places, OnePlus is doing far better than Xiaomi, and is now considered a legitimate competitor to major international Android phone brands like Korea’s Samsung, Taiwan’s HTC, Japan’s Sony and America’s Google Nexus. OnePlus is cheaper than these others, but that doesn’t seem to be the main reason its winning customers as well as enthusiastic reviews from experts. It’s mainly because of the quality of both OnePlus’s hardware and Android software.

According to the Wall Street Journal, the One Plus phone is “exceptional” and it “beats Apple iPhone 6 and Samsung Galaxy S5 in many ways.” The New York Times has called the OnePlus phone “fantastic, about the fastest Android phone you can buy, and its screen is stunning “.  Time Magazine chimed in with OnePlus is “exactly how a smartphone should be.” Engadget, the widely-read US technology blog, recently rated the best phones to buy in the US. Oneplus came out on top. That’s certainly a first for a Chinese brand.

Engadget smartphone rankingIn my seven years as an investment banker in China and before that as CEO of a California venture capital firm, I’ve never met quite such a mold-breaking company. OnePlus set out to achieve what no other Chinese company has ever done, to excel not just at making low-cost fast-to-market products but making ones of the highest quality, in engineering and design, hardware and software.

They next did something else no Chinese, and few American companies have done successfully: use social media sites Twitter, Facebook and Youtube to market its products at almost zero cost, and build a brand with a high reputation and a growing band of loyal customers and followers in the US and European markets.

Both Xiaomi and OnePlus say they plan to make most of their money from selling services and software, not from selling phones. Xiaomi has the advantage of much larger scale, with far more users. But, OnePlus may actually do better with this strategy and make more money for the simple reason that in the US and Europe, compared to China, a lot of people are accustomed to paying for mobile software and services.

OnePlus sold over one million phones last year between May and December, mainly in the US and Europe. It spent a total of about $10,000 on advertising worldwide. Samsung, by contrast, spends over $350mn a year in the US advertising its mobile phones. Worldwide, Samsung is spending over $14bn in advertising and its mobile phone market share has been declining since 2013.

On many fundamental levels, OnePlus thinks and acts differently than any other successful startup in China. Start with its two founders, Pete Lau and Carl Pei. They met while working at a Chinese domestic mobile phone and Blu-ray player manufacturer called Oppo. Lau is responsible for OnePlus’s manufacturing and product engineering, including overseeing a network of outsourced suppliers and manufacturers in and around Shenzhen. “We want to tell the world: Chinese products are great,” Lau says.

Pei’s background is more unusual. He is responsible for the company’s international growth and unique marketing strategy.  Everything about Pei – his background, his way of thinking and his approach to selling mobile phones successfully in the US and Europe – sets him well apart from all other Chinese tech entrepreneurs I’ve met. He is ethnically Chinese, but before coming to Shenzhen three years ago, had never lived or worked in China and his Chinese language ability, by his own admission, is so-so. Now 25, Pei was raised mainly in Sweden.

To understand Pei’s approach to business, it’s useful to understand something about business and culture in Sweden. It’s a small country, with less than 10 million people and fewer than 17,000 Chinese. Yet, it has arguably produced more innovative, world-changing companies, per capita, than any other country in the world. There’s a long list of them. My five favorites are furniture retailer IKEA, milk packaging company Tetra-Pak, bearing manufacturer SKF, fashion retailer H&M and music streaming company Spotify. In each case, these companies now dominate entire industries, with high-quality products and fair prices. Sweden has no real luxury brands. Instead it has a lot of great companies that have changed the ways a huge mass of people across the world live their lives, from the milk they drink to the beds they sleep on, the clothes they wear and now even the music they pay to listen to.

Sweden’s last attempt at success in mobile phones ended up badly. Ericsson once had a decent business selling basic phones, but the birth of smartphones was the death of Ericsson’s mobile business. OnePlus stands a better chance, in part because it’s a mix of Swedish focus on targeting a mass customer market together with Chinese speed and adaptability. I expect to see more of these “mixed blood” companies emerging in China, as China becomes more globalized and more welcoming to non-natives immigrating to start new businesses.

By basing itself in Shenzhen, OnePlus sits inside the world’s most densely-packed ecosystem of component, chip and contract manufacturing companies. It’s hard to imagine OnePlus could have been built as successfully anywhere else in the world. Foxconn, manufacturer of iPhones, is among the companies with its China base in Shenzhen.  Intel has also moved in in force to win business from these small, nimble Chinese electronics companies.

Manufacturing smartphones in Shenzhen is comparatively easy. Far harder is convincing Americans to buy a mobile phone without a subsidy and a service contract from a network provider like Verizon or AT&T. Yet, OnePlus is so far succeeding.  One reason: other companies that tried ended up spending millions of dollars on advertising to try to explain to Americans why they should buy a phone directly. It was mainly burned money. OnePlus spent nothing on advertising but used Twitter, Facebook, Google Plus and Youtube to build up a group of early adopters, who then went out and evangelized their friends.

OnePlus has 1.1mn “likes” on Facebook, double Xiaomi’s, along with four times as many followers on Twitter. On Youtube, the Oneplus channel has five times more subscribers than Xiaomi. Keep in mind Youtube, Twitter and Facebook are banned in China, where all of OnePlus’s employees are. OnePlus has become an expert at selling and brand-building using websites OnePlus’s own team aren’t supposed to even be looking at.

Ask Carl how he figured out how to do things in the US market that American companies, including hundreds with millions of dollars in VC money, weren’t able to do and he just shrugs, like it was all pretty easy. OnePlus still has no office in the US, no staff there, no repair centers, nothing. In the beginning you could only buy a OnePlus in the US and Europe with an invitation. Even with one, OnePlus only accepted orders from new customers one day a week, on Tuesdays.  As OnePlus’s reputation grew, the invitations became themselves valuable commodities. They still sell on eBay for $10-$20 each. OnePlus is now gradually loosening up and letting those without an invitation buy its phones, but again, only one-day-a-week, on Tuesdays.

Selling by invitation only may seem counterproductive. But, it’s proved vital to OnePlus’s success up to now. The reason: making mobile phones is generally a very cash-intensive business, since you need to have huge amounts of working capital to buy parts, build phones, supply to retail channels, and then wait for cash to return. OnePlus had no access to a big pot of working capital. So they have basically built phones to order, after the customer has paid.

One-third of the OnePlus’s 400 staff, including about 50 non-Chinese, are dedicated to customer service, which mainly means answering emails and responding to comments and questions on the company’s website and forums. This is another core thing OnePlus does better than any company I’ve seen in China. It’s establishing a new idea in the US and Europe about what a Chinese company is and does. Not just a source of cheap manufactured goods, but a company with a clear and powerful brand identity, one knows how to communicate well and sell things to college-educated 20-30 year-olds who live in San Francisco, Berlin and London.

Success has come quickly, but Pei, from my discussion over dinner with him, is certainly not complacent. He sees risks everywhere, not only from the obvious examples of Nokia and Blackberry, two once world-conquering mobile phone companies that have all but disappeared from the market. Apple remains very powerful. It and Google also own a lot of the key intellectual property patents for mobile phone signal processing, software and chip design. If either chooses to sue OnePlus, they have far more money to fight a patent lawsuit in a US court. Legal fees could easily top $20mn, money OnePlus does not now have. The US patent law system has been abused before, a big company sues a small but fast-growing one, not because it has a good legal case, but knowing that fighting the lawsuit, paying the legal bills, can put this new competitor out of business.

Pei’s three burning concerns are the OnePlus fails to attract enough talented global executives to join the company, loses its edge in designing hardware and software, or grows too large to maintain its quirky brand image and identity. OnePlus is in the process of opening new offices and moving key people from Shenzhen to Bangalore and Berlin because Pei believes it will be easier to find talented staff there.

Another worry, surprisingly, is how and when to bring in venture capital investors. OnePlus will likely try to raise money from one of the world’s famous Silicon Valley VCs. They have the most experience investing in disruptive businesses, helping startups like OnePlus to grow, especially in the US market, and they also can provide lots of help finding top executives and distribution partners. But, these Silicon Valley VCs have also not seen anything exactly like OnePlus before, a Chinese startup, likely with some core operations in India, and a magical ability to sell to Americans without having any Americans involved.  If successful, OnePlus could have one of the largest Series A VC rounds in history, raising perhaps $100mn-$200mn. Will money spoil the company or improve it?

OnePlus’s revenues are on track to more than triple this year to over $1 billion. But, there are lots of places where OnePlus could stumble and fall. Its new model launches and software upgrades could get delayed. Cost pressures could force them to raise prices in the US as they recently had to do in Europe, because of steep fall in the Euro. Also, US and European early-adopters are a fickle bunch. They could start throwing bricks at OnePlus instead of kisses. Case in point, in less than two years, Taiwanese mobile phone company HTC went from the most talked-about and fastest-growing company in the industry to an also-ran.

China’s mobile phone industry, as well as much of the TMT sector, have a reputation for being not much more than a bunch of knock-off artists, with no real innovation worthy of the name. OnePlus and Xiaomi both point the way towards a different and better future for China industry. Yes, OnePlus is good at assembling components cheaply. But, its core strengths as a company are too rarely found in China: an obsessive focus on product design, product quality, branding and customer engagement. These are what determine a company’s value as well as competitive strength. OnePlus is the first Chinese company to gain a large number of buyers and fans in the US and Europe by being simultaneously good at all these.

China’s long-term economic competiveness requires that more companies like OnePlus emerge. But, until it came along, China didn’t have a single one. It’s the most concrete sign that China may transition away from being a source of copy-cat products sold cheap and begin to play in the global big leagues, generating buzz while competing and taking market share from large, rich incumbents like Google and Samsung.

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http://asia.nikkei.com/Business/Companies/China-s-most-successful-startup

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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.–

 

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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Tencent Stalks Alibaba — China’s Number Two Internet Company Quietly Takes Lethal Aim at its Number One

Leave a Comment / January 8, 2015
China's two most successful internet entrepreneurs share a last name but have very different strategies for mobile e-commerce. The future belongs to which?
China’s two most successful internet entrepreneurs share a last name but have very different strategies for mobile e-commerce. The future belongs to which Ma?

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China’s second-largest private sector company Tencent is aiming a cannon at China’s largest private sector company and new darling of the US stock markets Alibaba. Will Tencent fire? There’s a vast amount of money at stake: these two companies, cumulatively, have market cap of $400 billion, Tencent’s $140bn and Alibaba’s $260bn.

Alibaba, as most now know,  currently has China’s e-commerce market in a stranglehold, processing orders worth over $300 billion a year, or about 80% of all Chinese online sales by China’s 300 million online shoppers. Meanwhile, Tencent is no less dominant in online chat and messaging, with over 400mn users for its mobile chat application WeChat, aka “Weixin” (微信).

The two businesses appear worlds apart. And yet, they are now on a collision course. The reason is social selling, that is, using a mobile phone chat app to sell stuff to one’s friends and contacts. It’s based on the simple, indisputable notion it’s more reliable and trustworthy to buy from people you know. Facebook, Twitter, Linkedin are all quite keen on social selling in the US. But, nowhere is as fertile a market as China, because nowhere else is the trust level from buying through unknown online merchants as low.

Alibaba has accumulated most of its riches from this low-trust model at Taobao’s huge online bazaar. It is a collection of thirty million small-time individual peddlers that Alibaba can’t directly control. The result, especially in a country with no real enforceable consumer protection laws or litigation, Taobao can be a haven for people selling stuff of dubious quality and authenticity.

Chinese know this, and don’t much care for it. It’s one reason both US-listed JD.com and Amazon China both seem to be gaining some ground on Alibaba. Their strategies are similar:  to be the “anti-Taobao”, selling brand-name stuff directly, using their own buying power and inventory, their own delivery people, and a no-questions-asked return policy. Their range of merchandise, however, is far more limited than Taobao’s. Tencent in 2014 bought a significant minority stake in JD.com.

Thanks to Weixin, Tencent now has the capability directly to become Alibaba’s most potent competitor and steal away billions of dollars in transactions. Will it?

As of now, Tencent seems oddly reluctant. Even as millions of Weixin users have started using the app to buy and sell goods directly with their friends, Tencent has countered by making it more difficult. Tencent introduced limits on the number of contacts each Weixin user can add, has made sending money tricky, and has more or less banned users to include price quotes in their mobile messages. For now, Weixin users appear undaunted, and are using various ruses to get around Tencent’s unexplained efforts to limit their profit-making activities. One common one: using the character for “rice” (米） instead of the symbol for the Chinese Renminbi （元）.

This social selling through Weixin is called “Weishang” (微商) in Chinese, literally “commerce on Weixin”. It is without doubt the hottest thing in online selling now in China.

It’s hard to understand why Tencent wouldn’t passionately embrace social selling on Weixin. For now, Weixin looks to be an enormous money sink for Tencent. The Weixin app is free to download and use. What money it earns from it comes mainly from promoting pay-to-play online games. That’s small change compared to the tens of millions of dollars Tencent spends on maintaining the server infrastructure to facilitate and store the hundreds of millions of text, voice, photo and video messages sent daily on the network.

Chinese of all ages are glued to Weixin at all hours of the day. It can be hard for anyone outside China to quite fathom how deeply-woven into daily life Weixin has become in the four years since its launch. Peak Weixin usage can exceed 10mn messages per minute. With only slight exaggeration, Tencent’s founder and chairman Pony Ma explains Weixin has become like a  “vital organ” to Chinese.

It’s not just young kids. I took part in a meeting recently with a partner from KKR and the chairman of a large Chinese publicly-traded company At the end of the discussion, they eagerly swapped Weixin accounts to continue their confidential M&A dialogue.

My office is in the building next to Tencent’s headquarters in Shenzhen. I know quite a few of the senior executives. But, no one can or will articulate why Tencent, at least for now, is unwilling to use Weishang take on Alibaba. Some who claim to know say it’s because the Chinese government is holding them back, not wanting to have Tencent steal Alibaba’s spotlight so soon after its most-successful-in-history Chinese IPO in the US.

The two have sparred before. Tencent years ago launched its own copycat version of Taobao, now called Paipai. But it failed to put a dent in Alibaba’s franchise. Alibaba, in turn,  launched its own online message system to compete with Weixin. But, it’s sunk from sight as quickly as a heavy stone dropped in a deep pond.

Seen from a seller’s perspective, Weishang is fundamentally more attractive than selling on Taobao. Margins are higher, not only because Tencent charges no fees, but it’s getting much harder and more expensive to get noticed on Taobao. That’s good for Alibaba’s all-important ad revenues, but bad for merchants.

How does Weishang work? A woman, for example, buys twenty sweaters at a wholesale price, then takes a selfie wearing one. She sends this out to her 300 contacts on Weixin. Though the message includes neither the price nor much of a sales pitch, since both may be monitored by Tencent, she will often get back replies asking how to buy and how much. The sales are closed either by phone call, or through voice messaging over Weixin, with payment sent direct to the seller’s bank account.

Tencent knows Weixin is being used more and more like this, but because it’s driven the commerce somewhat underground, Tencent has no idea on the exact scale of Weishang. My guess is aggregate Weishang sales are already in the tens, if not hundreds, of millions of dollars.

Alibaba has clearly noticed. But, social selling isn’t something its Taobao e-commerce marketplace can do. Its mobile e-commerce strategy amounts to making it easy to scroll through Taobao items on a small screen. Social selling in China is and will remain Tencent’s natural monopoly.

For anyone wondering, Alibaba’s IPO prospectus from a few months ago did not mention Weishang and Weixin, and Tencent gets a single nod as one of many possible competitors. Weishang really began to gain traction only during the second half of 2014, after the main draft of the Alibaba prospectus was completed.

To those outside China especially on Wall Street, Alibaba seems to be on the top of the world, as well as the top of its game. In the last four months, it’s collected $25 billion from the IPO and another $8 billion in a bond offering. Its share price price is up 50% since the IPO. For a lot of us living here in China, the boundless enthusiasm in the US for “Ali” (as the company is universally known here) can sometimes seem a bit unhinged.

When will Tencent make its move? Why is it now so reticent to promote Weishang, or discuss its plans with the investment community? Is it busy next door to me readying a dedicated secure payment system and warranty program for Weishang purchases?

I don’t have the answer, but this being China, I do know where to look for guidance. Sun Tzu’s “The Art of War”, written 2,500 years ago, remains the country’s main strategic handbook, used as often in business as in combat. The pertinent passage, in Chinese, goes “微乎微乎，至于无形；神乎神乎，至于无声；故能为敌之司命.” In English, you can translate it as “be extremely subtle, even to the point of formlessness. Be extremely mysterious, even to the point of soundlessness. “

In other words, don’t let your competitor see or hear you coming until its already too late.

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General’s Mills’ Stunning Success in China

3 Comments / December 16, 2014

Wanzai Matou 湾仔码头

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America’s most successful M&A deal in China is also possibly its most clandestine. The reason: an old-line Midwestern Fortune 500 company around since 1856 owns a company that is the dominant brand-name supplier in China of a vital Chinese national asset. No, it’s not missile fuel or encrypted handsets for battlefield command-and-control. It’s dumplings.

America’s General Mills, the iconic maker of US breakfast cereals Lucky Charms and Cheerios as well as Häagen-Dazs ice cream, owns a similarly iconic brand in China – Wanzai Matou (湾仔码头), or Wanchai Ferry, as it’s known in English. It is China’s major premium-priced and premium-quality supplier of frozen dumplings. Since acquiring the business thirteen years ago, it’s become a large and especially fast-growing business for General Mills, with China revenues of at least $300mn. Better still, the margins are probably a lot higher than Cheerios and just about any other product General Mills sells worldwide. The Wanzai Matou dumplings sell in China for equivalent of about $3.50 a pound. You can buy fresh hand-made ones just about everywhere in China for quite a bit less. But, people flock to the General Mills product, because it’s considered both tastier and healthier.

Dumplings are a central aspect of Chinese life and culture, a more potent part of national identity and the national diet than the Thanksgiving turkey, Big Mac, beef hotdog or apple pie are to us Americans. Dumplings (whether boiled, steamed or pan-fried) have been a daily staple of the Chinese diet, as far as anyone can judge, for about 1,800 years. They’re eaten here at breakfast, lunch and dinner. Dumplings are also the mainstay for many Chinese at the most important meal of the year, the one that rings in the Chinese New Year. Dumplings symbolize a prosperous year to come.

For all the many global corporates still edgy about investing in or acquiring businesses in China, General Mills is prime evidence that inbound cross-border M&A can work in China. This one deal combines four aspects often thought to be unattainable in China deal-making: a large US company buys a smaller local Chinese brand, builds it into a national leader while piling up big profits. It is, hands down,  my favorite case study of how to do M&A right in China.

Not that General Mills is eager for the world to know. It doesn’t talk about its booming China business in its annual report. Packages of Wanzai Matou sold in China don’t include the General Mills name or famous blue logo.

While everyone knows about KFC, McDonald’s and Starbucks big success in China, they are actually doing something much easier: introducing and selling exotica, American products to Chinese with a whim to try something from afar. General Mills is making money in China the hard way. Not only do they make the most popular brand of frozen dumplings in China (estimated market share of about 50%) , they also had to convert a large number of Chinese to buy in a supermarket a frozen version of a product only available previously fresh, hand-made.

As General Mills foresaw, making dumplings at home, once a daily chore,  has become something fewer and fewer Chinese have the time routinely to do. Done properly, it can take even experienced hands two hours or longer.

General Mills got control of Wanzai Matou in 2001 when it acquired US rival Pillsbury from British company Diageo. Pillsbury had bought majority stake in Wanzai Matou in 1997, when it was a rather tiny Hong Kong company with very limited presence in the PRC. Today, the freezer section of most larger big city supermarkets in China is stocked to bursting with different flavors and fillings of Wanzai Matou dumplings, along with Wanzai Matou frozen wontons and stuffed buns.

General Mills buys some tv advertising, but mainly the success here in China was earned by word-of-mouth. I’ve been a customer for as long as I’ve been living in China. Take it from me. There is no tastier frozen food sold anywhere than the boiled Wanzai Matou pork-and-corn dumplings (see package above).

Pillsbury made a vital strategic move in the early years after buying control of the Hong Kong Wanzai Matou. It was also an atypical one for big corporate buyers. They decided to keep Wanzai Matou founder, Kin Wo Chong, involved. Her photo is still prominently-featured on every package, in much the same way as Betty Crocker used to be pictured on every box of brownie mix made by that General Mills brand.

Betty Crocker is pure fiction, a made-up name for a made-up housewife. Ms. Chong is very much a genuine entrepreneur, a Hong Kong immigrant from dumpling-loving Shandong province. She started her professional life in 1977 selling dumplings from a push cart in a not-too-tony part of Hong Kong.

Keeping Ms. Chong involved, as both a senior executive and minority shareholder, has evidently worked well for both sides. General Mills gets all the benefits of her extensive knowledge of how to make tasty dumplings. She gets a deep-pocketed partner with the skills and resources required to make her small company into a Chinese household name.

This sort of arrangement is rare in the M&A world outside China. Generally, the buyer gives the current owner a two-to-three year earn-out period and then is sent packing. That’s the way MBA textbooks recommend M&A deals get done. The thinking is founders, once they’ve put a large chunk of cash in their pockets, are distracted, demotivated and anyway not amenable to taking orders on how to run their business from a large, often bureaucratic global corporation.

But, in China, the most successful M&A deals we know of all tend to have this same structure, that the founding entrepreneur stays on, stays active, long after the earn-out period expires. By contrast, the list of failures is long where an acquirer gets control of an entrepreneur-founded Chinese company, shows the owner the door and then tries to run it on its own.

General Mills also did add something Ms. Chong never would have managed to do on her own. It started up a frozen stir-fry-it-yourself business for the US market, under the Wanchai Ferry brand. In its first year, it had revenues in the US of over $50 million. Impressive.

As anyone living here can attest, when it comes to food, Chinese are every bit as jingoistic as the French or Italians. It would shock many of them to think Americans can produce dumplings better and more profitably than any domestic competitor. But, even if General Mills is outed, and more Chinese come to know who’s behind Wanzai Matou, I’m confident they will go on buying dumplings made for them by the company from Golden Valley, Minnesota. “Eating”, as the Chinese saying aptly has it, “is more important than the Emperor”. “吃饭皇帝大“.

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China’s Big Banks: learn how they overprice & misallocate loans while treating borrowers like conmen

Leave a Comment / December 11, 2014

Chinese banking loan approval process

Do you have the financial acumen to run the lending department of one of China’s giant state-owned banks? Let’s see if you qualify. Price the following loan to a private sector Chinese company.  Your bank is paying depositors 0.5% interest so that’s your cost of capital. The company has been a bank customer for six years and now needs a loan of Rmb 50mn (USD$8 mn).  The audit shows it’s earning Rmb 60mn a year in net profits, and has cash flow of Rmb 85mn.

You ask the company to provide you with a first lien on collateral appraised at Rmb 75mn and require them to keep 20% or more of the loan in an account at your bank as a compensating deposit. Next up, you ask the owner to pledge all his personal assets worth Rmb 25mn, and on top, you insist on a guarantee from a loan-assurance company your bank regularly does business. The guarantee covers any failure to repay principal or interest. What annual interest rate would you charge for this loan?

If you answered 5% or lower,  you are thinking like a foreigner. American, Japanese or German maybe. If you said 13% a year, then you are ready to start your new career pricing and allocating credit in China. At 10% and up, inflation-adjusted loan spreads to private sector borrowers in China are among the highest in the world, particularly when you factor in the over-collaterallization, that third-party guarantee and fact the loan is one-year term and can’t be rolled over. As a result, the company will actually only have use of the money for about nine months but will pay interest for twelve. Little wonder Chinese banks have some of the fattest operating margins in the industry.

Chinese private businessmen are paying too much to borrow. It’s a deadweight further slowing China’s economy. We are quite keen, by the way,  on private debt investing in China.

The high cost of borrowing negatively impacts corporate growth and so overall gdp growth. It is also among the more obvious manifestations of an even more significant, though often well-hidden, problem in China’s economy: the fact that nobody trusts anybody.  This lack of trust acts like an enormous tax on business and consumers in China, making everything, not just bank credit, far more expensive than it should be.

Online payment systems, business contracts, visits to the doctor, buying luxury products or electronics like mobile phones or computers: all are made more costly, inefficient and frustrating for all in China because one side of a transaction doesn’t trust the other. One example: Alibaba’s online shopping site, Taobao, will facilitate well over USD$200bn in transactions this year. Most are paid for through Alipay, an escrow system part-owned and administered by Alibaba. Chinese shoppers are loathe to buy anything directly from an online merchant. They generally take it as a given that the seller will cheat them.

Most of the world’s computers and mobile phones are made in China. But, Chinese walk a minefield when buying these products in their own country. It’s routine for sellers to swap out the original high-quality parts, including processors, and replace them with low-grade counterfeits, then sell products as new. Chinese, when possible, will travel outside China, particularly to Hong Kong, to buy these electronics, as well as luxury goods like Gucci shoes and Chanel perfume. This is the most certain way to guarantee you are getting the genuine article.

In the banking sector, loans need to have multiple, seemingly excessive layers of collateral, as well as guarantees. Banks simply do not believe the borrower, the auditors, their own in-house credit analysts, or the capacity of the guarantee firms to pay up in the event of a problem.

Disbelief gets priced in. This is the reason for the huge loan spreads in China. Banks regard their own loan documentation as a work of fiction. It stands to reason that if a company’s collateral were solid and the third-party guarantee enforceable, then the cost to borrow money should be at most a few points above the bank’s real cost of capital. Instead, Chinese companies get the worst of all worlds: they have to tie up all their collateral to secure overpriced loans, while also paying an additional 2%-3% a year of loan value to the third-party credit guarantee company for a guarantee the bank requires but treats as basically worthless.

In the event a loan does go sour, the bank will often choose to sell it to a third party at discount to face value, rather than go to court to seize the collateral or get the guarantee company to pay up. The buyer is usually one of the state-owned asset recovery companies formed to take bad debts off bank balance sheets. Why, you ask, does the bank require the guarantee then fail to enforce it? One reason is that Chinese private loan-assurance companies, which usually work hand-in-glove with the banks,  are usually too undercapitalized to actually pay up if the borrower defaults. Going after them will force them into bankruptcy. That would cause more systemic problems in China’s banking system.

Instead, the bank unloads the loan and the asset recovery companies seize and sell the only collateral they believe has any value, the borrower’s real estate. The business may be left to rot. The asset management companies usually come out ahead, as do the loan guarantee companies, which collect an annual fee equal to 2% to 3% of the loan value, but rarely, if ever, need to indemnify a lender.

Don’t feel too sorry for the bank that made the loan. Assuming the borrower stayed current for a while on the high interest payments, the bank should get its money back, or even turn a profit on the deal. Everyone wins, except private sector borrowers, of course. Good and bad like, they are stuck paying some of the highest risk-adjusted interest costs in the world.

When foreign analysts look at Chinese banks, they spend most of their time trying to divine the real, as opposed to reported, level of bad debts, devising ratios and totting up unrealized losses. They don’t seem to know how the credit game is really played in China.

Most of the so-called bad debts, it should be said, come from loans made to SOEs and other organs of the state. Trust is not much of an issue. SOEs and local governments generally don’t need to pledge as much collateral or get third-party guarantees to borrow. A call from a local Party bigwig is often enough. The government has shown it will find ways to keep banks from losing money on loans to SOEs. The system protects its own.

Chinese banks should be understood as engaged in two unrelated lines of business: one is as part of a revolving credit system that channels money to and through different, often cash-rich, arms of the state. The other is to take in deposits and make loans to private customers.  In one, trust is absolute. In the other, it is wholly absent.

Many Chinese private companies do still thrive despite a banking system that treats them like con artists, rather than legitimate businesses with a legitimate need for credit. The end result: the Chinese economy, though often the envy of the world,  grows slower and is more frail than it otherwise would be. Everyone here in China is paying a steep price for the lack of trust, and the mispricing of credit.

 

 

Why and how Beijing became one of the world’s more unmanageable major cities

Leave a Comment / August 21, 2014

Beijing Bactrian camel–

What if most of what we think about government spending was wrong? What if government money causes, rather than cures,  pollution, unaffordable and substandard housing, impossible traffic, more expensive and less available healthcare? Sounds impossible, right? Not if you live in or have traveled to Beijing lately. The city’s now infamous urban problems are at least in part the result of a deluge of government spending since the onset of the financial crisis in 2008. Direct central government funding doubled to over Rmb 14 trillion ($2.2 trillion) over this period while local governments borrowed an additional Rmb 13 trillion ($2.1 trillion) to finance their spending.

The government money, of course, wasn’t meant to turn Beijing into an urban sprawl with a population larger than every state in the US except California. In fact, most of the government stimulus was targeted for big projects outside the capital. But, in China, the nature of things is that much of government spending travels on a round-trip ticket. It is dispensed in Beijing and then a big part of it eventually returns home. And no, this isn’t all in kickbacks. A large part is from the build out of a huge new infrastructure in Beijing to support, steer and encourage the distribution of more government cash.

In the last five years, it seems like everyone rushed to open or expand offices in Beijing：  companies of all sizes from all part of China and the world; governments from the smallest local hamlet 3,000 kilometers away to provinces with populations larger than every country in Western Europe also staffed up. Result: commercial and residential real estate prices skyrocketed to the point now where they are among the highest anywhere in the world.

More people begets more cars, more cars begets more traffic, more traffic begets restrictions on the days-per-week any car can be on the road, which in turn begets Beijingers buying an extra car to get around the prohibition. End result: pollution that is now substantially caused by auto emissions, not as in the old days by nearby-factories burning coal. Many polluting factories have been shut down, which added to the available land for development into commercial and residential property in and around Beijing, particularly in areas you need a car to get to.

Here are the two charts, showing residential real estate prices and cars registered in Beijing from 2008 through last year. The numbers are likely underestimates. But, they show the trend.

data

 

The torrent of government cash had all kinds of spillover effects that have altered Beijing permanently. More restaurants, higher prices, more wining and dining, leading to prohibitions last year, as part of the big anti-corruption crusade, on government officials accepting invitations to party outside the office. This then drives the behavior underground, so high-end restaurants empty out, while more expensive and exclusive “members only” clubs flourish.

Beijing has morphed into the financial capital of China. That’s attracted a large group of players to move from Shanghai and Hong Kong to get a piece. PE funds, private bankers, lawyers, consultants, so-called “guanxi merchants” who arrange access to government officials. Among my circle of friends in PE industry, I can count 15 who have moved to Beijing in recent years, to get closer to the action, and only one who left, who finally couldn’t take the crowds, pollution, high cost.

Beijing’s precise population is unknown. The official number is 21.1 million. Some in government say 25 million. Others claim the real number is closer to 30 million, when you count more recent migrants living rough, plus the huge throngs in Beijing for shorter periods, either for work or pleasure.

Since 2008, far more of China’s total economic activity is decided by government bureaucrats in Beijing. Overall government spending has more than doubled. Result, more people need to travel to Beijing more often.

Look at passenger numbers at Beijing’s Capital Airport. Between 2008 and 2013, this already crowded-facility saw passenger numbers increase by a remarkable 50%. It is, as of March this year, now the busiest airport in the world, eclipsing Atlanta’s Hartsfield. Capital Airport is now breaking under the load, and so Beijing is about to embark on building an even larger new airport in the southern part of the city. This mammoth $11 billion project by itself could support a lot of Beijing’s gdp growth in the coming few years. But, it will be just the cherry on top.

Beijing has the best hospitals in China, so people come from all over the country to try to get admitted for medical treatment. This has led to price increases and longer waiting times. Equally, those with a serious grievance about their local government, or who feel maltreated, will often gather up their documents go to Beijing to try to get redress. This trek to Beijing has been around since the days of the Emperors. As China’s government grows in power and economic clout and ordinary Chinese have the money to fight back, those seeking to petition central government’s help increase.

To serve all the new arrivals and visitors, Beijing continues to expand its Metro system. The average daily ridership is now 10 million, about triple London’s, and also triple the amount five years ago in Beijing.  Waits at rush hour to get into some stations can be horrific, so the government recently proposed to raise fares. Beijing currently has the cheapest public transportation of any big city in China.  While some may leave Beijing, the likely result of higher Metro fares will be more people trying to buy a car.

How bad is traffic in Beijing. Horror stories abound. A more reasonable evaluation: the manager of a big telecommunications company I know told me recently if he doesn’t leave his house by 7am, it will take 90 minutes to drive 10 km from his house to his office. That’s about speed of sedan chairs used to carry emperor and his cohorts within the Forbidden City.

To be sure, Beijing is not Dhaka. Since 2008, many aspects of the city’s infrastructure have been upgraded. It is a thoroughly modern city, with scarcely a trace of either poverty or blight. When I first visited the city in 1981, Bactrian camels were still occasionally seen on the streets hauling cargo.

For first time since 1949, the leader of the country, Xi Jinping,  is Beijing born and bred. Since he was a boy, Beijing’s population has about quadrupled, while China overall has almost exactly doubled.  Will he try to shift gears, slow or even reverse the growth in the city’s population? It won’t be easy. Government stimulus spending, once turned on is notoriously hard to scale back in any serious way. Do so and overall GDP growth will likely suffer.

In its 3,000 years as China’s major urban outpost on the country’s northern perimeter,  Beijing has experienced countless invasions, barbarian pillages, conquests, uprisings. But, nothing in history has altered Beijing as quickly, deeply, and perhaps permanently as five years of bounce-back and kickback from trillions in government pump-priming.

 

 

 

China juices liquidity, and risk, at OTC exchange — Reuters

Leave a Comment / June 24, 2016

Reuters

China juices liquidity, and risk, at OTC exchange

By Pete Sweeney

SHANGHAI August 22 Thu Aug 21, 2014 5:10pm EDT

(Reuters) – Chinese brokerages will start making markets next week on China’s New Third Board, its leading over-the-counter (OTC) exchange but one long derided as a dead-end market populated by small little-known, opaquely managed firms.

The move has revitalized interest and trading volumes have exploded, but analysts warn of significant risk.

Most of the 66 Chinese brokerages so far approved to make markets – a business that requires deep cash reserves and sophisticated risk management skills – have little experience.

Market makers quote both a buy and sell price and guarantee share availability by holding shares themselves in inventory, which requires careful real-time management.

For brokerages it means extra profits, while China’s policymakers hope the liberalization will boost liquidity in an exchange that can provide capital for small innovative firms, needed for the next phase of economic expansion.

But, analysts fear that brokerages inexperience coupled with inadequate disclosure by listed companies could led to trouble for an exchange already saddled with image problems.

“Like all OTC markets – including… America’s Bulletin Board and Pink Sheets – China’s Third Board suffers from inherent fundamental flaws,” said Peter Fuhrman, chief executive at China First Capital.

“Liquidity and valuations are persistently low and disclosure is spotty. If it was designed to be a solution to the problem of erratic mainstream IPO policy and approvals on China’s main Shenzhen and Shanghai stock exchanges, the Third Board must be judged a major disappointment.”

Regardless of critics, trading volumes on the exchange soared almost 700 percent in May when Chinese media first reported the advent of market-makers, ChinaScope Financial data shows. Foreign investors are unable to trade on the exchange.

A Reuters analysis of daily data from the National Equities Exchange and Quotations (NEEQ), which runs the New Third Board, shows that August volumes are set to surpass May’s record. Transactions worth 1.16 billion yuan ($188.63 million), as of Aug. 19, were nearly double July’s total, while the volume of shares traded has more than tripled month-on-month.

SMALL CAP CELEBRATION

Smaller private companies in China are the country’s biggest aggregate employers and generators of GDP, but they have difficulty getting bank loans and even more difficulty getting regulatory approval to list on major markets or issue bonds.

However, while dozens of local governments have created OTC markets to help match companies with investors, the lack of market makers and lack of a clear upgrade path to major exchanges has caused most firms and investors to steer clear.

But that may be about to change.

“The expectation is that the Third Board can be an entree onto the growth enterprise board for select small companies,” said Brian Ingram, chief investment manager at Russell Ping An Investment Management.

“If the board does serve that purpose, it’s likely to see pretty rapid growth, and the catalyst for that growth is the fact that regulators are allowing brokerage houses to serve as market makers.”

Brokerages hope it will boost in profits, something they need badly having struggled since 2010 as investors steadily switched out of Chinese stocks, among the world’s worst performers, in favor of housing and high-yielding wealth management products.

SMALL-CAP FEEDING FRENZY

Chinese investors enthusiastically trade small, volatile tickers listed on Shenzhen’s ChiNext growth board, so some predict a revitalized OTC board will attract similar speculative interest, further supporting liquidity.

However, sustained interest from both investors and companies depends on whether regulators formally commit to allowing companies on the New Third Board upgrade to ChiNext.

“We’re now considering listing on the New Third Board, but we are waiting for policy confirmation that we can upgrade to ChiNext,” said Cui Lijun, deputy general manager at robotics firm LEN in Shenzhen.

Similar experiments have disappointed in the past, such as the hard-currency-denominated “B-share” board. Speculators bought B-shares hoping they would ultimately be upgraded to yuan-denominated A-shares, but in the end only a few companies were allowed to transfer, leaving the rest stranded.

CALLS FOR CAUTION

The chequered history of OTC markets in China and abroad, especially with regards to disclosure standards, also has many calling for caution.

In the late 2000s, small Chinese companies began listing on American OTC boards, and some managed to upgrade to major exchanges such as NASDAQ. But many were subsequently found to be riddled with accounting irregularities, causing a swathe of delistings.

Given this history, it is unclear whether regulators want to expand the aggregate OTC market or consolidate it.

Out of all of China’s 26 OTC markets, the New Third Board is the only one that companies from anywhere in China can list on, and it will now be the only one where making markets will be allowed.

Some analysts said that this means the government may be elevating the Third Board, so it can then kill off the rest.

But Zhang Yunfeng, the head of Shanghai’s rival OTC market, said in an interview published in China’s Securities Times on Wednesday that he doesn’t feel threatened.

“I’m not optimistic about the market making institution … if there’s not enough base liquidity, market making will have a hard time enabling market performance.”

www.reuters.com/article/2014/08/21/us-china-markets-otc-idUSKBN0GL26920140821

Download PDF version.

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China’s rise enters a more challenging phase, where bold ambitions confront stubborn, often centuries-old obstacles

Leave a Comment / August 5, 2014

China First Capital 2014 Survey cover

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China’s economy and society have both reached levels of wealth and development that were unimaginable 30 years ago. What comes next? How can China continue to push forward, against some deep-seated problems, including how to generate globally-competitive innovation, how to sort out land ownership, how to attract and reward global investment flows? These issues are examined in detail in the new research study published by China First Capital.

The new report is titled ” China Survey 2014: The Rise Continues, New Directions & Challenges“. Copies may be downloaded by clicking here or from the research reports page of the company’s website.

China’s economy remains vibrant and fast-evolving. Many of the Fortune 500 successes stories of recent years – KFC, P&G, Coca-Cola – are finding it harder and harder to keep winning in the China market. As they lose share, other companies are gaining, both domestic and international. The report looks at this transformation through the vantage point of China First Capital’s rather long experience working in China,  alongside some talented CEOs in both domestic and global corporations, the incumbents and the disrupters both.

Investing successfully in China, either through the stock market or through M&A, also remains challenging. But, it’s worth the strain, the report asserts, since no other country can rival China today in terms of both the number and scale of money-making opportunities.

The new China First Capital report discusses these broad trends, and also examines the following in depth:

  •  is China’s investment community (PE and VC firms, stock market investors)  over-allocating now to mobile services and online shopping;
  •  an assessment of the serious challenge facing traditional shopping mall operators and retailers mainly because of competition from soon-to-IPO Alibaba’s online shopping giant;
  • a sober analysis of actual disappointing state of China’s high-tech industry;
  • how China triumphed over India, and won the battle as the world’s best and biggest Emerging Market,
  • why 3M may be the most successful American company in China, but flies so far beneath everyone’s radar

Some of the contents have already been published here on this blog and on Seeking Alpha.

The report’s core conclusion is that China has come a long way and in raw terms is certainly the most successful emerging economy of all time. But, it needs to become more innovative, generate more globally important technology breakthroughs, not just copycatting. There’s no absence of hype around about how China is poised to become a global technology powerhouse. The report, though,  cites China’s failure to serially produce an aircraft engine as a concrete, if not often talked-about, reminder of its technology frustrations and limitations.

 

 

Chinese PE Firms Too Tech-Focused: Report. AsianInvestor

Leave a Comment / December 5, 2014

AI

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Chinese PE firms too tech-focused: report

By Elva Muk | 28 July 2014

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Company valuations are being pushed up as PE firms chase the same targets, and market domination by big players like Alibaba is squeezing profit, says China First Capital.

Spurred by the success of the likes of Tencent and Alibaba, Chinese private equity and venture capital firms have become too focused on technology and e-commerce investments, argues a new report.

Nearly all publicly announced deals this year have been in the technology sector, says the China Private Equity 2014 report from China First Capital, a private capital markets advisory firm. They include online shopping sites and mobile travel, game and taxi-booking services.

Though China has restarted its initial public offering process after a hiatus of more than a year, US listing also provides an effective way for PE firms to exit their investments. Chinese internet and mobile companies Zhaopin, Cheetah Mobile, Sina Weibo and Qihoo 360 have already floated in the US market this year.

Though Tencent and Alibaba are shining examples of success, the investment outlook for newly established technology companies may not be as rosy, the report says. These firms do not enjoy a technological barrier to entry and rely “on the same prayer-for-low-profitability outcome: a purchase down the road by China’s two internet leviathans, Tencent or Alibaba”.

But China First Capital forecasts that the duo will soon lose their appetite for buying smaller Chinese internet firms.

Moreover, domination by the major players has squeezed the growth potential of newcomers. Alibaba commands close to 50% market share of the country’s online shopping in terms of transaction volume, while Tencent is similarly dominant in online gaming. Almost all the money goes to these two firms, the report notes.

Further, the investment landscape in China is less dynamic than some elsewhere. The US has a greater number of venture capital trade buyers for successful VC-backed companies, and less monopolistic internet and mobile industries and a richer early adaptor market to tap, the report notes.

In China over the past two years, PE firms have invested heavily in Chinese shopping sites that follow a model similar to Groupon. However, some projects have lost money because monetising the sites has proved difficult.

Another obstacle in China for private equity in building up investment is the high cost of acquiring clients. In most VC-backed companies in the US, the head of business development is responsible for generating growth at the cheapest cost.

This approach is uncommon in China. A typical method of acquiring customers in the mainland is to pay for a high-ranked listing on search engine Baidu, which handles over 60% of search requests in the country.

“The ‘pay to play’ rules of China’s internet [industry] lead to companies taking lots of expensive shortcuts, often burning a lot of PE and VC firms’ cash,” the report said.

Further, PE firms are chasing the same investment themes and companies, resulting in rising valuations. “It is an ongoing example of inadequate diversification by industry or stage,” it added.

China’s PE capital raised has grown five-fold to over $100 billion since 2005, while the number of firms has grown to 1,000.

– Haymarket Media Limited. All rights reserved.

http://www.asianinvestor.net/News/388932,chinese-pe-firms-too-tech-focused-report.aspx

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Going for broke: the PE world’s big risky bet on China’s internet and mobile industries

Leave a Comment / June 18, 2014

China fortune-teller–

The World Cup has begun. Along with being the globe’s most watched event it is also certainly the most gambled upon. Thirty-two teams, sixty-four matches to determine the winner on July 13th in Rio de Janiero. To choose the winner, you want to look at the individuals, the team management, the history of past success, the competition. In other words, it’s a lot like the process a private equity or venture capital firm uses to choose which companies to invest in.

It would be ill-advised, if not borderline crazy, to bet one’s life savings on the USA team to win the World Cup this year. Coral, the big British bookmaker itself owned by three PE firms, is offering odds of four hundred to one.

While no one is offering odds or a betting pool, the current mania among PE firms in China for investing in loss-making internet and mobile services businesses looks like an even wilder bet. Herd behavior is a familiar enough phenomenon across the PE and VC world. But, the situation in China has reached almost comical proportions. At the moment, there is little, if any, PE money going to large, profitable, mature, comparatively “de-risked” manufacturing companies. Instead, almost all the publicly-announced deals are investments in a variety of mainly online shopping sites or mobile-phone travel, game and taxi-booking services, none of which has a true technological barrier to entry, and all of which seem to hinge mainly on the same prayed-for low-probability outcome: a purchase down the road by China’s two internet leviathans, Tencent or Alibaba.

A US IPO is also at least theoretically possible. This year has already seen successful IPOs for Chinese internet and mobile companies, including Zhaopin, Cheetah Mobile, Qihoo 360, Leju, Chukong Technologies, Sina Weibo, Tuniu. But, deals being done now are for smaller, newer less well-established China companies that mainly face a steep failure-filled mountain climb of at least two to three years to even reach a point at which an IPO in New York might even be possible.

It is true that China’s online shopping and services industry is booming. Problem is, almost all the money is being earned by these same two large firms. In online shopping, 80% goes to Alibaba. In online gaming, a far smaller money-maker, Tencent is about as dominant. Both have done a few deals in the last year, buying out or investing alongside PE firms in smaller Chinese companies which have gained some traction. At the same time a few Chinese internet companies have gone public in the US and Hong Kong. But, the overall environment is much less positive. There are far too many “me too” businesses with business models copy-catted from the US pouring out PE and VC cash to buy customers or a thin allotment of a 20 year-old Chinese male’s online gaming budget.

China is the world’s best mass manufacturer with the world’s largest, or second-largest, domestic market in just about every imaginable category. Simply put: there are so many better, less risky, more defended Chinese companies out there than the ones now getting most of the PE and VC time and money.

My bet is that Tencent and Alibaba will also soon lose their appetite for buying smaller Chinese internet players. They are at a similar phase as companies like Amazon, Google, eBay, Cisco, Microsoft, Electronic Arts, IAC/InterActiveCorp, once were. These giants at one time bought small US internet companies by the bucket-load. But, most have either quit or cut back doing so. The businesses usually fail to prosper, are non-core, and prove hard to integrate. Minority deals usually turn out worse. Corporate investors make bad VCs.

In other key respects, there is every difference in the world between the US VC scene and this current activity in China. The US has far more trade buyers for successful VC-backed companies, far more genuine innovation, far more success stories, far less monopolistic internet and mobile industries, and a far richer “early adaptor” market to tap. You don’t need to look back very far to see where this kind of investing activity can lead. It’s only a little more than two years since PE firms poured hundreds of millions of Renminbi into Chinese group shopping sites modeled to some extent on US Groupon. Almost all these companies are now out of business or losing serious money. Chinese like group-buying. They just don’t let any company make any money from offering such a service.

Scan through the last three weekly summaries of new PE and VC deals in China, as digested by Asia Private Equity in Hong Kong. Virtually all involve deals to invest in online and mobile services. (Click here to look at the list of these deals.)

I talk or meet with PE partners on a regular basis. I can recall only a single discussion, over the last six months, where the PE firm’s primary focus was not on these kind of deals. This lonesome PE is the captive fund of one of China’s largest state-owned automobile groups. At this stage, about as differentiated as Chinese PE investment gets is whether the money should go into one of the many online sites for takeaway meals or one of the even larger number selling cosmetics.

China PE is slowly emerging from a prolonged period of inactivity and crisis, the result of both a slowdown in IPO activity and PE portfolios bloated with unexited deals. It’s good to see some sign of animal spirits again, that some PE firms at least are looking to do deals. But at least up to now, it looks like some bad old habits are being repeated: too many PE firms enslaved to the same investment thesis, chasing the same few companies, bidding up their valuations, inadequate diversification by industry or stage.

In the US, in most VC-backed companies, one of the busiest members of senior management is the head of business development. This job is often to find strategic partnerships, barter and co-bundling deals to generate more growth at less expense. This kind of thing is much rarer in China. Instead, for most, the primary method of customer acquisition is to spend a lot of money on Baidu advertising.

Baidu is far more accommodating than Google. It’s the dirty, not-so-well-kept secret of China’s internet industry. Baidu, which handles over 60% of all Chinese search requests, lets advertisers buy placement on the first page of what are called  “organic search results”. There is basically no such thing in China as “most relevant” search results. The only search algorithm is: “who has paid us the most”. It’s one reason Google’s pullback from the China market is so damaging overall for the Chinese internet.

The “pay to play” rules in China’s internet leads to companies taking lots of expensive short cuts, often using PE and VC firm cash. There’s more than a little here to remind me of the Internet Bubble years in the US. I ended up running a VC firm in California right after the bubble burst. I still shake my head at some of the deals this VC firm invested in before I got there, when, as is now in China, pouring lots of LP money in any kind of dot.com or shopping site was seen as prudent fiduciary investing. Things turned out otherwise. They turned out messy. They will too with this PE infatuation with online and mobile anything in China. A bet on the USA to win the World Cup offers more attractive odds and upside.

 

Who should own China’s land and who should farm it remain the central questions of China’s five-thousand year-old civilization

Leave a Comment / May 21, 2014

 

 

 

Qing porcelain

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When I first came to China 33 years ago, 80% of China’s population was rural, mainly small-scale peasant farmers. Today, half the 1.3 billion population is off the farm, living in cities. Two obvious results: China is over twenty times richer per capita in dollar terms. And, from a country with a handful of major cities three decades ago, China now has 160 cities with a population of at least one million.

The Chinese government’s plan is for another 150 million Chinese to go from farm to city in the next decade. But even then, there would still be as many as 300mn too many people living in rural villages. China, according to reliable estimates I’ve seen,  could be efficiently farmed by as few as 100mn full-time farmers, or 7% of the total population. In the US, less than 2% of the population works on farms. They live well. A farming family in the US now earns on average $108,000, 53% above the national household average.

In China, peasants earn on average one-third as much as urban Chinese.  As peasant numbers decline, the incomes rise of those remaining. A depopulating countryside, however, won’t directly solve rural China’s age-old problem: farm plots are too small and often on uneven terrain. This limits the use of farm machinery and modern farming methods. Farm yields remain stubbornly below US and European levels. This, in turn, means food imports must rise inexorably. Year by year, China moves farther away from an often-expressed goal to increase its food self-sufficiency.

The solutions aren’t hard to formulate. China needs fewer and bigger farms with more leveled ground to permit efficient mechanization. But, achieving this remains, for now, all but impossible. Part of the problem is that all rural land in China is owned by the state, so there’s no way for peasants to buy land from one another. A larger problem is the adverse impact this would likely have on Chinese society.

China’s describes itself, even today, as a 农业大国, “nongye daguo“, or  “agricultural great power”. This is in some sense an artifact of history. But, it also reflects a deeper reality, that most Chinese, even the most thoroughly urban, still have some concrete connection to village China. Often this is through extended family members still engaged in peasant farming.

More directly, many people living in cities — if not the majority than close to it — still hold rural “hukou” and so generally have an entitlement to farm a plot of land in their ancestral village. This hukou system, though much criticized for depriving many city-dwelling Chinese of full rights to low-cost healthcare and schooling, acts as an almost-universal national insurance plan. Those now long-removed from farming life still have the comfort of knowing, if things ever got really tough, if they lost their jobs or the small business they started goes bust, they could go back to where they or their parents came from. They always have a place to live and enough land to feed themselves and scratch out a bare living.

China is the most entrepreneurial place in the world, which creates huge benefits for everyone living here, including better products, services and fast-growing incomes. Small farm plots widely held is one reason for this. They act as the safety net.

So, creating a more efficient farming system by giving peasants the right to sell or mortgage the land they farm or hold title to might ultimately do more economic harm than good. Chinese government has so far stalled on major reforms of peasant land ownership. Instead, city-dwellers are renting the rights to farm their rural plots to local peasants who have the energy and ability to manage larger holdings. The incremental effect is that average farm size will grow gradually. But, of course, renting land isn’t the same as owning it.

No one will invest in improving the quality of the land if they are renting it year-by-year It’s not only efficiency that suffers. The levels of heavy metal soil contamination is reaching alarming levels in many areas, especially Hunan Province, source of 13% of the rice grown in China. Who will pay to clean up the soil and so improve food safety in China is a national problem without an obvious answer.

The price of fruits, vegetables and grains are all rising in China, lifting peasant incomes. But, so are cash salaries for low-skilled jobs in cities. Run the numbers and it still looks to be wiser in many cases to leave the land. The standard land measurement in China is the “mu”, equal to one-sixth of an acre or about one-twentieth of a hectare. The income from farming one mu in China is about equal now to one week of low-pay wages, for example, the salary for sweeping up factory floors. Not many peasants own and farm 50 mu.

As I write this, I’m intermittently staring out the window of a high-speed train traveling 300kph through rural parts of Shandong Province. It takes less than a second for the train to pass a typical small plot of farmed land. The spring wheat is already about 18 inches high. There is no one out in the fields. Thanks to pesticides and chemical fertilizers, far fewer people are needed to grow food than when I first came here in 1981. Every day people leave the land and will continue to for decades to come. But, who should own China’s land and who should farm it remain the central questions of China’s five-thousand year-old civilization.

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Alibaba files for IPO in US — China Daily article

Leave a Comment / May 8, 2014

China Daily

 

 

Updated: 2014-05-07 06:56

By MICHAEL BARRIS in New York (chinadaily.com.cn)

Alibaba files for IPO in US

Alibaba Chairman and Non-executive Director Jack Ma participates in a teleconference in Hong Kong in this October 22, 2007 file photo, one day before its initial public offering in the territory. [Photo/Agencies]

Chinese e-commerce giant Alibaba Group Holding officially filed on Tuesday to go public in the US in what could be the largest initial public offering ever.

A regulatory filing gave a $1 billion placeholder value for the offering, but the actual amount is expected to be far higher, possibly exceeding $20 billion and topping not only Facebook’s $16 billion 2012 listing, but Agricultural Bank of China Ltd’s record $22.1 billion offering in Shanghai and Hong Kong in 2010.

Alibaba, founded by former English teacher Jack Ma in a Hangzhou apartment, and its bankers have been moving to throw their own shares behind the IPO, analysts have said.

In its filing Alibaba gave no date for the proposed IPO or whether it would be on the New York Stock Exchange or Nasdaq. It cited its advantageous placement in a nation in which e-commerce is fast becoming a way of life, as Chinese consumers turn to the Internet to buy innumerable items. But Alibaba’s prospectus cited statistics showing that the market hasn’t been fully tapped. Just 45.8 percent of China’s population used the Internet, while 49 percent of customers shopped online.

Often described as a combination of eBay and Amazon, Alibaba handled $240 billion of merchandise in 2013. With more than 7 million merchants, it has more than $2 billion in revenue and profit of more than $1 billion.

Alibaba’s sheer size could weigh on the stock price of US rival Amazon.com if the Chinese company’s shares are added to indexes and portfolios targeting e-commerce and related sectors, analysts said.

“Amazon simply doesn’t measure up to the size of Alibaba’s earnings and earnings growth rate,” analyst Robert Wagner wrote.

Shares aren’t expected to begin trading for several months, as the US Securities and Exchange Commission reviews Alibaba’s offering materials and the company promotes its prospects to institutional investors.

The offering managers are Credit Suisse, Deutsche Bank, Goldman Sachs, JP Morgan, Morgan Stanley and Citigroup.

Ma, who has described the challenge of providing what he calls personal business as “my religion”, is Alibaba’s biggest individual shareholder, with an 8.9 percent stake.

Alibaba’s announcement continues a flurry of IPO filings by Chinese technology companies. Internet security application developer Cheetah Mobile is expected to go public on the New York Stock Exchange on Thursday and is expected to raise $153.75 million to $178.35 million. Three weeks ago, Weibo Corp, the Chinese micro blogging service owned by Sina Corp and Alibaba Group Holdings Ltd, raised $285.6 million in a Nasdaq IPO, while real-estate listings website Leju Holdings Ltd raised $100 million in an initial offering on the NYSE.

“The key question for China is how much new money, if any, Alibaba will raise in this US IPO,” Peter Fuhrman, chairman and CEO of China First Capital, told China Daily.

“If all the cash goes to Japan’s Softbank and US’s Yahoo, then it’s hard to see how Alibaba, its customers and the hundreds of millions of Taobao-addicted Chinese consumers will benefit from the IPO.” US web-portal company Yahoo is a 24-percent Alibaba shareholder, while Japan’s Softbank has a 37-percent stake.

http://usa.chinadaily.com.cn/business/2014-05/07/content_17490099.htm