中小企业

Carlyle Goes Native: Renminbi Investing Gets Big Boost in China

2 Comments / March 1, 2010

 

Qing Dynasty lacquer box from China First Capital blog post

My congratulations, both personal and professional, to Carlyle Group, which announced last week the launch of its first RMB fund, in partnership with China’s Fosun Group. I happen to know some of the people working at Carlyle in China, and I’m excited about the news, and how it will positively impact their careers. 

Carlyle is the first among the private equity industry’s global elite to take this giant public step forward in raising renminbi in partnership with leading Chinese private company. It marks an important milestone in the short but impressive history of private equity in China, and points the way forward for many of the private equity firms already established in China. 

The initial size of the new renminbi fund is $100mn. By Carlyle’s standards, this seems almost like a rounding error – representing a little more than 0.1% of Carlyle’s total assets of $90 billion.  But, don’t let the size fool you. For Carlyle, the new renminbi fund just might play an important role in the firm’s future, as well as China’s. 

The reason: Carlyle will now be able to use renminbi to invest more easily in domestic companies in China, then help take them public in China, on the Shanghai or Shenzhen stock markets. Up to now, Carlyle’s investments in China, like those of its global competitors, have been mainly in dollars, into companies that were structured for a public listing outside China. Carlyle has a lot to gain, since IPO valuations are at least twice as high in China as they are in Hong Kong or USA. 

That means an renminbi investment leading to a Chinese IPO can earn Carlyle a much higher return, likely over 300% higher, than deals they are now doing.  By the way, the deals they are now doing in China are anything but shabby, often earning upwards of five times return in under two years. Access to renminbi potentially will make returns of 10X more routine.  Carlyle has ambitious plans to keep raising renminbi, and push the total well above the current level of $100mn. 

As rosy as things look for Carlyle, the biggest beneficiary may well turn out to be the Chinese companies that land some of this Carlyle money. PE capital is not in short supply in China, including an increasing amount of renminbi. But, smart capital is always at a premium. Capital doesn’t get much smarter – or PE investing more disciplined — than Carlyle. They have the scale, people, track record and value-added approach to make a significant positive impact on the Chinese companies they invest in. 

This is the key point: the best opportunities in private equity are migrating towards those firms that have both renminbi and a highly professional approach to investing. That’s why the leading global PE firms will likely join Carlyle in raising renminbi funds. Blackstone is already hard at work on this, and rumors are that TPG and KKR are also in the hunt. 

Carlyle now joins a very select group of world-class PE firms with access to renminbi. The others are SAIF, CDH, Hony Capital, Legend Capital and New Horizon Fund. These firms are all focused primarily (in the case of SAIF) or exclusively on China. While they lack Carlyle’s scale or global reach, they more than make up for it by commanding the best deal flow in China. SAIF, CDH, Hony, Legend and New Horizon have all been around awhile, starting first as dollar-based investors, and then gradually building up pool of renminbi, including most recently funds from China’s national state pension system. 

Like Carlyle, they also have outstanding people, and very high standards. They are all great firms, and are a cut above the rest. Up to now, they have done more deals in China than Carlyle, and know best how to do renminbi deals. Carlyle and other big global PE firms will learn quickly.  As they raise renminbi, they will elevate the overall level of the PE industry in China, as well as increase the capital available for investment. 

The certain outcome: more of China’s strong private SMEs will get pre-IPO growth capital from firms with the know-how and capital to build great public companies.


Life in the Fast Lane – Driving China’s Expressway Network

Leave a Comment / February 27, 2010

Bamboo painting

 

“Do Not Drive Tiredly”  That’s the message, in English, on large highway signs spanning the roadway in Jiangxi. I was charmed by the idiosyncratic English, and even more by the fact that almost all highway signs in China, including mundane ones announcing upcoming exits or defining the hard shoulder, are all bilingual, Chinese and English.

Based on my recent highway travels through part of Jiangxi Province, I was probably the only one who could get much value from the English. That’s because almost all the other traffic on the highway consisted of very large and heavily-loaded long-distance Chinese trucks. Passenger cars are few and far between. 

Highways are a recent phenomenon in China, of course. I’ve never seen anything quite like them, in my +30 years of driving around the US and lot of the rest of the developed world. The Chinese highways are mainly well-built and usually in pristine condition. Besides the English-language signs, another source of frequent delight are the life-size plastic policemen, pointing plastic radar guns at oncoming traffic. They’re planted in the highway’s central meridian as not-so-subtle reminders to avoid speeding– or as the sign calls it, again in English, “Overspeeding”.

It’s those large trucks, though, that really define for me the current experience of highway driving in China. Despite their huge size – the trailers often have 20-wheels, and seem to stretch the length of seven or eight passenger cars – the trucks are often buckling under the weight of their loads. Most of the time, the cargo hold is open at the top, and covered with a very large tarpaulin, in various colors, intricately tried to the bottom of the flatbed. The trucks have a tendency to wobble and weave as they move along the road – the result of either unbalanced loads or, more likely, less-skilled drivers.

Long-distance trucking may be among the fastest-growing new professions in China. It’s a safe bet few of today’s drivers have been behind the wheel for more than two or three years. Many have their own particular style of driving. Heavy, slow-moving trucks often canter along, 30mph below the speed limit,  in the left-hand passing lane. Their side-view mirrors – the only way the drivers can see traffic behind or alongside them – are often tilted at angles that seem to defeat the purpose.  

Few of the trucks have any kind of marking on them. The concept of a truck as a moving billboard is still an alien one in China. Not so the ordinary highway billboard, which is very common, as are advertisements posted on overpasses. 

China produces so much, including a huge percentage of the world’s manufactured goods, that it’s hard to imagine how all this stuff moved around before the expressway network was built. The traffic on many expressways, including the ones I was on in Jiangxi, must be over 90% trucks. That’s only going to increase, as more production in China is moved to cheaper, inland areas.

The expressways are already quite crowded. Often, they are only two lanes wide in each direction – which may have seemed more-than-adequate 10 years ago when first designed, but now seem to belong in the Pleistocene Age. Within ten years, these roads will almost certainly all need to be widened. That can cost almost as much, per kilometer, as building new expressways. 

China’s toll fees are among the highest ones I’ve seen. In Jiangxi, it’s 0.4 Renminbi ( or around five US cents) per kilometer for passenger cars, and more for trucks. So, financing all this construction won’t necessarily put a big dent in state revenues.  

Even with all the slow-moving truck traffic, the expressway network in China is a godsend. It makes distances much less foreboding than they used to be in China. It’s possible to average over 100 kilometers-an-hour. On the older, ordinary road network, you’d be lucky to average half that speed. Where the trucks thin out, you can “overspeed” at around 160kph, and rustle the plastic policemen in your backdraft.

The Changing Formula of PE Investing in China: Too Much Capital ÷ Too Few PE Partners = Bigger Not Always Better Deals

Leave a Comment / February 16, 2010

Yuan tray


In the midst of one of the worst global recession in generations and the worst crisis in recent history in the global private equity industry, China looks like a nation blessed. Its economy in 2009 outperformed all others of any size, and the PE industry has continued, with barely a hitch,  on its path of blazingly fast growth.

In 2009, over $10 billion  of new capital was raised by PE firms for investing in Asia, with much of that targeting growth investments in China. For the first time, a significant chunk of new PE capital was raised in renminbi, a clear sign of the future direction of the industry. 

This year will almost certainly break all previous records. A good guess would be at least $20 billion in new capital is committed for PE investment in China. For the general partners of funds raising this money, the management fees alone (typically 2% of capital raised) will keep them in regal style for many years to come. 

In such cases, where money is flooding in, the universal impulse in the PE industry is to do larger and larger deals. But, in China especially, bigger deals are almost always worse deals on a risk-adjusted basis. Once you get above a $20 million investment round, the likelihood rises very steeply of a bad outcome. 

The reasons for this are mostly particular to China. The fact is that the best investment opportunities for PE in China are in fast-growing, successful private companies focused on China’s booming domestic market. There are thousands of companies like this. But, few of these great companies have the size (in terms of current revenues and profits) to absorb anything much above $10mn. 

It comes down to valuation. Even with all the capital coming in, PE firms still tend to invest at single-digit multiples on previous year’s earnings. PE firms also generally don’t wish to exceed an ownership level of 20-25% in a company. To be eligible for $20 million or more, a Chinese company must usually have last year’s profits of at least $15 million. Very few have reached that scale. Private companies have only been around in China for a relatively short time, and have only enjoyed the same legal protection of state-owned businesses since 2005. (see my earlier blog post)

Seeing this, a rational PE investor would adjust the size of its proposed investment. In most cases, that will mean an investment round of around $10 million – $15 million. But, rational isn’t exactly the guiding principle here. Instead of doing more deals in the $10 million – $15 million range, PE firms flush with cash most often look to up the ante.  Their reasoning is that they can’t increase the number of deals they do, because they all have a limited number of partners and limited time to review investment opportunities. 

This herd mentality is quite pervasive. The certain outcome: these same cash-rich PE firms will bid up the prices of any companies large enough to absorb investment rounds of $20 million or more. This process can be described as “paying more for less”, since again, there are very few great private Chinese companies with strong profit margins and growth rates, great management, bright prospects and  profits of $20 million and up. 

Some day there will be. But, it’s still too early, given the still limited time span during which private companies have been free to operate in China. There are, of course, quite a few state-owned enterprises (SOEs) with profits above $20 million. Most, however, are the antithesis of an outstanding, high-growth Chinese SME. They are usually tired, uncompetitive businesses with bloated workforces, low margins, clapped-out equipment and declining market shares. They would welcome PE investment, and are likely to get it because of this rush to do larger deals. Some SOEs might even get a new lease on life as a result of the PE capital. 

The certain losers in this process: the endowments, pension funds and other institutions who are shoveling the money into these PE firms as limited partners. They probably believe, as a result of their own credulity and some slick marketing by PE firms,  their money is going to invest in China’s best up and coming private businesses. Instead, some of their money is likely to go to where it’s most easily invested, not where it’s going to earn the highest returns. 

Bigger is clearly not better in Chinese PE. I say this even though we are fortunate enough now to have a client that is both very large and very successful. It is on track to raise as much as $100 million. It is every bit as good (if not better) than our smaller SME clients. Unlike PE firms, we don’t seek bigger deals. We just seek to work with the best entrepreneurs we can find. Most often for us, that means working for companies that are raising $10 million – $15 million, on the strength of profits last year of at least $5 million. 

Our business works by different rules than the PE firms. We aren’t using anyone else’s capital. There’s no imperative to do ever-larger deals. We have the freedom to work with companies without much considering their scale, and can instead choose those whose founders we like and respect, and whose performance is generally off-the-charts. 

The ongoing boom in PE investment in China is likely to continue for many, many years. This is due largely to the strength of the Chinese economy and of the private entrepreneurs who account for a large and growing share of all output. 

But, the push to do larger deals will cause problems down the line for the PE industry in China. It will result in capital being less efficiently allocated and returns being lower than they otherwise would be. PE firms will collect their 2% annual management fee, regardless of how well or poorly their investments perform. 

Raising private capital for PE investment in China is a good business. And, at the moment, it’s also an easier business than finding great places to invest bigger chunks of capital. 

Is This China’s Worst New Brand? Cambridge University Clothing

2 Comments / February 9, 2010

store

 

In a recent blog post, I discussed how and why Chinese brands are not just holding their own in China, but winning against global titans like P&G, Nike, Unilever, Coca-Cola. A big reason is that there are Chinese entrepreneurs with a great feeling for what kind of brand messaging works best in China. 

But, of course, success is not automatic. China can also produce its share of Edsel brands, clunkers that seem from the start preordained to fail.

One such case has some special resonance for me. There’s a new retail clothing brand in China called “University of Cambridge”. It was just launched a few months ago, and there are already about ten stores across China, including one in the Shenzhen shopping mall closest to where I live. The parent company is also based in Shenzhen. 

I was more than a little surprised to see the Cambridge clothing shop open. For one thing, my guess is that I’m one of probably fewer than fifty graduates of the English university living in Shenzhen (Cantab. M.Phil 1985) . So, the “captive population” is going to be very small. What’s more, from a quick look around, I wouldn’t be caught dead wearing any of their clothing , best described as a slinky, polyester mélange of “Ye Olde England” and futuristic Chinese design. 

But, the bigger reason I was surprised to see the University of Cambridge store open is that I can’t believe the university would grant a license to a Chinese retailer to use the University of Cambridge name. Yet, on the walls of the store, as well as on the label of the apparel, it says that this company does, indeed, have the official license from Cambridge. Also, stuck into a lot of the clothing on display are pins emblazoned with the Cambridge emblem: cantab2If anyone can verify that this is legit, that this university did give this Chinese entrepreneur a license, I’d certainly like to know. The store is so brazen in claiming to have the license it’s hard to believe they’re making it all up. But, it could be. 

The store claims they are the first ever to get this kind of license from the university, and that it was granted in 2009, the 800th anniversary of Cambridge’s founding. They also say they have big plans for global expansion. If they don’t have a valid license to use the Cambridge name, then of course any such plan is going to fail from the outset. 

But, if they do have the license, I’d suggest someone at Cambridge should be doing a better job controlling how its name is being used. The clothing is really atrocious. If it were just t-shirts and sweatshirts with the Cambridge logo, it would be one thing. But, the store only has its own designs, both men’s and women’s, and nothing that really connects the styles to the university. 

The store is not without its sources of amusement. In describing the university, it provides a list of famous alumni, based on various categories. My favorite among these: “Politicians: Charles, Mandela, Lee Kuan Yew”.  I’m guessing they mean Prince Charles, though it’s clearly a stretch to describe him as a politician. 

I’m a particularly bad “one man focus group” to evaluate which brands are going to be successful in China. On most things, my tastes are way out of whack with those of the host population. But, I’m pretty confident the Cambridge University retail chain is going to sputter and die. Associating yourself with a famous European institution is not a bad idea by itself, and lots of successful Chinese brands look to capture a kind of European cache. But, this stuff is just too ugly, and too expensive, to catch on. 

The target market seems to be very affluent middle-aged Chinese of both sexes. They have much better, safer and more tasteful choices in the same mall: including Ralph Lauren, Zegna, Lacoste, Louis Vuitton, Canali, Gucci.

Ford marketed its Edsel brand for two years, before killing it off in what is still the biggest and fastest failure for any mainstream auto brand. My guess is that University of Cambridge retail chain won’t survive even that long.


 

China’s Brand New Brand Names

2 Comments / January 30, 2010

Ming Jiajing jar from China First Capital blog post

1837. That’s when the first and still grandest of all consumer brand companies got its start.  Procter & Gamble started off selling soap and candles, then in 1879, introduced its first major branded product, Ivory soap, which quickly became the leading soap brand in the US. P&G then gradually, over the next 130 years, added other brands that became market leaders, including Tide, Crest, Pampers, Gillette, Olay, Head & Shoulders. 

This same slow-and-steady pace characterizes most other well-known consumer brand companies, including: Unilever, Coca-Cola, McDonalds, Mercedes-Benz, Gucci, Tiffany, Nike, Hershey, Crayola (http://www.chinafirstcapital.com/blog/archives/927), etc. 

The lesson: building brands takes time. Lots and lots of time. 

Except, that is, in China. Here, brands go from drawing board to market dominance in a matter of a few years, or less. The reason? Like so much else in China, economic and social change occurs so rapidly that time seems compressed. Three years of economic growth in China is faster than a generation’s economic growth elsewhere. No major economy in modern times has grown as fast, for as long, as China has over the last 30 years.

gdp

 The other reason, peculiar to China, is that there were few brands of any kind before the 1980s. Back then, a stolid proletarian China had a depressingly small number of equally stolid proletarian brands. Many have since disappeared. Those that are still around have often been overwhelmed into irrelevance by newer Chinese brands, or ones imported from abroad.

Good examples of this are Flying Pigeon bicycles and Bee & Flower soap. They were once near-monopolies in China, during Mao’s time. Today, they are bare remnants of their former, dominant selves. Neither has more than a 1% market share, if that. It’s hard to find any other examples outside China during the last 25 years of once-dominant brands losing so much market share so quickly. 

In the US and Europe, older brands often have cache. In China, they are toxic, for the most part, because they are the products of an era of scarcity and little to no consumer choice. So, the tens of thousands of Chinese consumer brands created over the last 25 years entered a market with few, if any, well-established incumbents. A few foreign brands have also done well in China’s mass market over this time: P&G has a great business here with Crest, Tide, Olay, Pantene. Other winners include junk food giants McDonalds & KFC, along with Coca-Cola, Nokia, Apple, Nike, Marlboro, Loreal.

But, in many cases, new Chinese brands have fought and won against competition from well-known imports. Protectionist trade rules have played some part in this, of course. But, a lot of the credit really belongs to smart Chinese entrepreneurs. Thanks to them, China’s consumer market has gone from brand-less to branded in less than a generation.

P&G’s kingpins, like Crest, Pantene and Tide, face a proliferation of Chinese competitors, priced both lower and higher than the global brands. In many other product markets, Chinese brands stand alone, including tissues and toilet paper (sold here in bulky ten-roll packs), bed linen, men’s and women’s underwear, and most food products.

Overall, there are few dominant brands with market shares large enough to discourage new competitors. In fact, new brands arrive all the time. In evolutionary terms, China is in the middle of a kind of Cambrian Explosion, with the rapid appearance of all kinds of new brands. Inevitably, the huge number of brands will shrink, as winners emerge, and has-beens die out. This process took decades in the US and Europe. It will almost certainly happen far more quickly in China. 

One reason for the especially rapid pace: lots of capital is now available to create and support new brands. Why? There is so much to be gained for any company that establishes a dominant brand in China. China will soon have the largest domestic market in the world. Grabbing a few points of market share in China will often equate to billions of dollars in revenue over the next five to ten years. 

In many of the most promising consumer markets, no brand has even emerged yet, with national scope and distribution. Here, smart entrepreneurs can build a brand in fertile virgin turf, rather than trying to force their way into an already crowded patch. If done right, you can turn a new brand into a billion-dollar household name in a short-time. 

I see this process very clearly with one of our clients. It’s still quite a ways from being that billion-dollar colossus, but it has a real potential to become one. The entrepreneur spotted a huge market opportunity five years ago, to create a brand to sell designer accessories to Chinese women from 20 to 35 years-old.

His key insight: the process of urbanization in China is creating an enormous group of working women in this age bracket, with the spare income to spend on not-too-expensive, but well-designed earrings, bracelets, necklaces, sunglasses. 

His business is now growing very fast, with over 100 stores in most of China’s major cities. Sales should double in 2010 to about $50mn, and keep doubling every 18 months for a long time to come. The best part: he faces no real competition, and so every day, his brand grows more and more known, and so less and less vulnerable to whatever competitors may one day come along. My guess is that this brand will be one of the quickest new consumer product companies in Chinese history to reach Rmb 1 billion in sales. 

Like many of the best entrepreneurs, this one makes it look very easy. It isn’t. He takes hands-on responsibility for the four key disciplines needed to build and sustain the brand: marketing, design, management and manufacturing.

That’s the other part about brand-building in China: it not only happens fast, it often happens inside smaller founder-run companies without the input of “specialists” or ad agencies.  I don’t know how many people in China have studied product marketing in school, but my guess is not many.

 

 

New CFC Report on Assessing Risk in PE Investment in China

Leave a Comment / January 25, 2010

China First Capital Report on Assessing Risk in PE Investment in China

“Risk and Reward.  They are the yin and yang of investing.”

So begins the latest of CFC’s Chinese-language research reports on risk and reward in private equity investment in China. The 18-page report (titled 风险与回报 in Chinese)  has just been published, and is downloadable via the CFC website by clicking this link:  http://www.chinafirstcapital.com/Riskandreward.pdf

The report’s goal, as stated in the introduction, is to “summarize the ways PE firms evaluate the risks of an investment opportunity so that entrepreneurs will better understand the decision-making process of PE firms, and so greatly improve the odds of succeeding in raising PE capital.” 

The report identifies five key areas of risk that private equity investors attempt to quantify, manage and where possible, mitigate: They are:

  1. 1.      Market Risk
  2. 2.      Execution Risk
  3. 3.      Technology Risk
  4. 4.      Political Risk 
  5. 5.      Due Diligence Risk

As far as we know, this is the first such detailed report prepared in Chinese, specifically for Chinese entrepreneurs. It was written with input from the entire CFC team, and represents a collation of our experiences in dealing both with the founders and owners of Chinese SME and the PE firms that invest in them. 

Few, if any, Chinese entrepreneurs have experience raising private equity capital, or for that matter, answering pointed questions about their business. So, the whole PE process will often seem to them to be odd and protracted. The report aims to increase entrepreneurs’ level of understanding ahead of any PE fund-raising process. The report puts it this way: 

“ The goal of PE firms is to lower risk when they invest, not completely eliminate it. Risk is a necessary part of any profit-making activity. The basic principle of all PE investing is finding the best “risk-adjusted return” – which means, the best ratio of risk to potential future profit.”

Some strategies for entrepreneurs to lower an investor’s risk are also discussed. It’s practically impossible to fully eliminate these risks. But, an entrepreneur will have an important ally in managing them, if successful in raising PE capital. 

PE investment in China is a process in which an entrepreneur give up sole proprietorship over the risks in his business. It’s a new concept for most of them. But, the results are almost always positive. A problem shared is a problem halved. 

We hope the report contributes to the continued growth and success of the PE industry in China.

It can also be enjoyed, for entirely other reasons, by anyone who shares my love of Song Dynasty porcelains. Some beautiful examples of Jun, Guan, Ge, Yaozhou, Cizhou and Longquan ceramics are used as illustrations. 

Some examples:

Yaozhou4
Jun4

Guan6

 

 

 

 

 


Navigating China’s Treacherous IPO Markets

Leave a Comment / January 11, 2010

Song plate from China First Capital blog post

How do you say “Scylla and Charybdis”  in Chinese? Thankfully, you don’t need to know the translation, or even reference from Homer’s The Odyssey, to understand the severe dilemma faced by China’s stock exchange regulator, the China Securities Regulatory Commission (CSRC). 

Scylla and Charybdis were a pair of sea monsters guarding opposite sides of a narrow straight. Together, they posed an inescapable threat to sailors’ lives. By avoiding one, you sailed directly into the lair of the other. 

The CSRC has been trying to navigate between twin perils over the last months, since the October launch of ChiNext , the new Shenzhen stock exchange for smaller-cap private companies. They have tried to stamp out the trading volatility and big first day gains that characterized earlier IPOs in China. But, in doing so, they’ve created circumstances where the valuations of companies going public on the ChiNext have reached dangerous and unsustainably high levels. 

Monsters to the left, monsters to the right. The regulators at CSRC deserve combat pay. 

Based on most key measures, ChiNext has been a phenomenal success. So far, through the end of 2009, 36 companies have IPO’d on ChiNext, raising a total of over $2 billion from investors. That’s more than double the amount these 36 companies were originally seeking to raise from their IPOs. Therein lies the Scylla-Charybdis problem. 

Before ChiNext  opened, the CSRC was determined to avoid one common problem with Chinese IPOs on the main Shanghai and Shenzhen markets – that the price on the first day of trading typically rose very sharply, with lots of volatility. A sharp jump in the price on the first day is great for investors who were able to buy shares ahead of the IPO. In China, those lucky few investors are usually friends and business contacts of the underwriters, who were typically rewarded with first-day gains of over 20%. These investors could hold their shares for a matter of minutes or hours on the day of the IPO, then sell at a nice profit. 

But, while a first-day surge may be great for these favored investors, it’s bad news for the companies staging the IPOs. It means, quite simply, their shares were underpriced (often significantly so) at IPO. As a result, they raised less money than they could have. The money, instead, is wrongly diverted into the hands of the investors who bought the shares at artificially low prices. An IPO that has a 25% first-day gain is an IPO that failed to maximize the amount the company could raise from investors. 

Underwriters are at fault. When they set the price at IPO, they can start trading at a level that all but guarantees an immediate increase. This locks in profits for the people they choose to allocate shares to ahead of the start of trading. 

The CSRC, rightly,  decided to do something about this. They mandated that the opening price for companies listing on the CSRC should be set more by market demand, not the decision of an underwriter. The result is that the opening day prices on ChiNext have far more accurately reflected the price investors are willing to pay for the new offering.

Gains that used to go to first-day IPO investors are now harvested by the companies. They can raise far more money for the fixed number of shares offered at IPO. So far so good. The problem is: Chinese investors are bidding up the prices of many of these new offerings to levels that are approaching madness. 

The best example so far: when Guangzhou Improve Medical Instruments Co had its IPO last month, its shares traded at an opening price 108 times its 2008 earnings.  The most recent  group of companies to IPO on ChiNext had first-day valuations of over 80 times 2008 earnings. Because of the high valuations, these ChiNext-listed companies have raised more than twice the amount of money they planned from their IPO. 

On one hand, that’s great for the companies. But, the risk is that the companies will not use the extra money wisely (for example by speculating in China’s overheated property market), and so the high valuations they enjoy now will eventually plummet. Indeed, valuations at over 80x  are no more sustainable on the ChiNext now than they were on the Tokyo Stock Exchange a generation ago. 

Having steered ChiNext away from the danger of underpriced IPOs, the CSRC is now trying to cope with this new menace. They have limited tools at their disposal. They clearly don’t want to return pricing power to underwriters. But, neither do they want ChiNext to become a market with insane valuations and companies that are bloated with too much cash and too many temptations to misuse it.   

CSRC’s response: they just introduced new rules to limit the ways ChiNext companies can use the extra cash raised at IPO.  CSRC is also reportedly studying ways to lower IPO valuations on ChiNext. 

The new rules restrict the uses of the extra cash. Shareholder approval is required for any investment over Rmb 50 million, or more than 20% of the extra IPO proceeds on a single project. The CSRC also reiterated that ChiNext companies should use the additional proceeds from their IPOs to fund their main businesses and not for high-risk investments, such as securities, derivatives or venture capital.

The new rules are fine, as far as they go. But, they don’t go very far towards resolving the underlying cause of all these problems, of both underpriced and overpriced IPOs in China.

The problem is that CSRC itself limits the number of new IPOs, to try to maintain overall market stability. Broadly speaking, this restricted supply creates excessive demand for all Chinese IPOs. Regulatory interventions and tinkering with the rules won’t do much. There remains the fundamental imbalance between the number of domestic IPOs and investor interest in new offerings.

Faced with two bad options, Odysseus chose to take his chances with the sea monster Scylla, and survived, while losing quite a few of his crew. The alternative was worse, he figured, since Charybdis could sink the whole ship.

The CSRC may well make a similar decision and return some pricing power to underwriters, to bring down ChiNext’s valuations.  But, without an increased supply of IPOs in China,  the two large hazards will persist. CSRC’s navigation of China’s IPO market will certainly remain treacherous.  


The New Equilibrium – It’s the Best Time Ever to be a Chinese Entrepreneur

1 Comment / January 7, 2010

China Private Equity blog post

As I wrote the last time out, the game is changed in PE investing in China. The firms most certain to prosper in the future are those with ability to raise and invest renminbi, and then guide their portfolio companies to an IPO in China. For many PE firms, we’re at a hinge moment: adapt or die. 

Luckily for me, I work on the other side of the investment ledger, advising private Chinese companies and assisting them with pre-IPO capital raising. So, while the changes now underway are a supreme challenge for PE firms, they are largely positive for the excellent SME businesses I work with.

They now have access to a greater pool of capital and the realistic prospect of a successful domestic IPO in the near future. Both factors will allow the best Chinese entrepreneurs to build their businesses larger and faster, and create significant wealth for themselves. 

As my colleagues and me are reminded every day, we are very fortunate. We have a particularly good vantage point to see what’s happening with China’s entrepreneurs all over the country. On any given week, our company will talk to the bosses of five and ten private Chinese SME. Few of these will become our clients, often because they are still a little small for us, or still focused more on exports than on China’s burgeoning domestic market. We generally look for companies with at least Rmb 25 million in annual profits, and a focus on China’s burgeoning domestic market. 

For the Chinese companies we talk to on a regular basis, the outlook is almost uniformly ideal. China’s economy is generating enormous, once-in-a-business-lifetime opportunities for good entrepreneurs.

Here’s the big change: for the first time ever, the flow of capital in China is beginning to more accurately mirror where these opportunities are. 

China’s state-owned banks have become more willing to lend to private companies, something they’ve done only reluctantly in the past. The bigger change is there is far more equity capital available. Every week brings word that new PE firms have been formed with hundreds of millions of renminbi to invest.

The capital market has also undergone its own evolutionary change. China’s new Growth Enterprise Market, known as Chinext, launched in October 2009. In two months, it has already raised over $1 billion in new capital for private Chinese companies. 

In short, the balance has shifted more in favor of the users rather than the deployers of capital. That because capital is no longer in such short supply. This is among the most significant financial changes taking place in China today: growth capital is no longer the scarcest resource. As recently as a year ago, PE firms were relatively few, and exit opportunities more limited. Within a year, my guess is the number of PE firms and the capital they have to invest in private Chinese companies will both double. 

Of course, raising equity capital remains a difficult exercise in China, just as it is in the US or Europe. Far fewer than 1% of private companies in China will attract outside investment from a PE or VC fund. But, when the business model and entrepreneur are both outstanding,  there is a far better chance now to succeed.

Great business models and great entrepreneurs are both increasingly prevalent in China. I’m literally awestruck by the talent of the Chinese entrepreneurs we meet and work with – and I’ve met quite a few good ones in my past life as a venture capital boss and technology CEO in California, and earlier as a business journalist for Forbes. 

So, while life is getting tougher for the partners of PE firms (especially those with only dollars to invest), it is a better time now than ever before in Chinese history to be a private entrepreneur. That is great news for China, and a big reason why I’m so thrilled to go to work each day.  


The End of the Line for Old-Style PE Investing in China

2 Comments / January 4, 2010

Ming Dynasty flask, from China Private Equity blog post

As 2010 dawns, private equity in China is undergoing epic changes. PE in China got its start ten years ago. The founding era is now drawing to a close.  The result will be a fundamental realignment in the way private equity operates in China. It’s a change few of the PE firms anticipated, or can cope with. 

What’s changed? These PE firms grew large and successful raising and investing US dollars,  and then taking Chinese companies public in Hong Kong or New York. This worked beautifully for a long time, in large part because China’s own capital markets were relatively underdeveloped. Now, the best profit opportunities are for PE investors using renminbi and exiting on China’s domestic stock markets. Many of the first generation PE firms are stuck holding an inferior currency, and an inferior path to IPO. 

The dominant PE firms of yesterday, those that led the industry during its first decade in China, are under pressure, and some will not survive. They once generated hundreds of millions of dollars in profits. Now, these same firms seem antiquated, their methods and approach ill-suited to conditions in China. 

In the end, success in PE investing comes down to one thing: maximizing the difference between your entry and exit price. This differential will often be twice as large for investors with renminbi as those with dollars. The basic reason is that stock market valuations in China, on a current p/e basis, are over twice as high as in Hong Kong and New York – or an average of about 30 times earnings in China, compared to fifteen times earnings in Hong Kong and US. 

The gap has remained large and persistent for years. My view is that it will continue to be wide for many years to come. That’s because profits in China (in step with GDP) are growing faster than anywhere else, and Chinese investors are more willing to bid up the price of those earnings. 

For PE firms, the stark reality is: if you can’t enter with renminbi and exit in China, you cut your profit potential in half. 

chart1









If given the freedom, of course, any PE investor would choose to exit in China. The problem is, they don’t have that freedom. Only fully-Chinese companies can IPO in China. It’s not possible for Chinese companies with what’s called an “offshore structure”, meaning the ultimate holding company is based in Hong Kong, BVI, the Caymans or elsewhere outside China. Offshore companies could take in dollar investment from PE firms, swap it into renminbi to build their business in China, then IPO outside China. The PE firms put dollars in and took dollars out. That’s the way it worked, for example, for the lucky PE firms that invested in successful Chinese companies like Baidu, Suntech, Alibaba, Belle – all of which have offshore structure. 

In September 2006, the game changed. New securities laws in China made it all but impossible for Chinese companies to establish holding companies outside China. Year by year, the number has dwindled of good private companies in China with offshore structure. First generation PE firms with only dollars to invest in China have fewer good deals to chase. At the same time, the appeal of a domestic Chinese IPO has become stronger and stronger. Not only are IPO prices higher, but the stock markets in Shanghai and Shenzhen have become larger, more liquid, less prone to the kind of wild price-swings that were once a defining trait of Chinese investing. 

Of course, it’s not all sweetness and light. A Chinese company seeking a domestic IPO cannot choose its own timing. That’s up to the securities regulators. To IPO in China, a company must first apply to China’s securities market regulator, the CSRC, and once approved, join a queue of uncertain length. At present, the process can take two years or more. Planning and executing an IPO in Hong Kong or the US is far quicker and the regulatory process far more transparent. 

In any IPO, timing is important, but price is more so. That’s why, on balance, a Chinese IPO is still going to be a much better choice for any company that can manage one. 

Some of the first generation PE firms have tried to get around the legal limitations. For example, there is a way for PE firms to invest dollars into a purely Chinese company, by establishing a new joint venture company with the target Chinese firm. However, that only solves the smaller part of the problem. It remains difficult, if not impossible, for these joint venture entities to go public in China. 

For PE investors in China, if you can’t go public in Shanghai or Shenzhen, you’ve cut your potential profits in half. That’s a bad way to run a business, and a bad way to please your Limited Partners, the cash-rich pension funds, insurance firms, family offices and endowments that provide the capital for PE firms to invest.   

The valuation differential has other knock-on effects. A PE firm can afford to pay a higher price when investing in a Chinese company if it knows it can exit domestically.  That leaves more margin for error, and also allows PE firms to compete for the best deals. The only PE firms, however, with this option are those already holding renminbi. This group includes some of the best first generation PE firms, including CDH, SZVC, Legend. But, most first generation firms only have dollars, and that means they can only invest in companies that will exit outside China. 

Seeing the handwriting on the wall, many of the other first generation PE firms are now scrambling to raise renminbi funds. A few have already succeeded, including Prax and SAIF. But, raising an renminbi fund is difficult. Few will succeed. Those that do will usually only be able to raise a fraction of the amount they can raise is dollars. 

Add it up and it spells trouble – deep trouble – for many of the first generation PE firms in China. They made great money over the last ten years for themselves and their Limited Partners. But, the game is changed. And, as always in today’s China, change is swift and irreversible. The successful PE firms of the future will be those that can enter and exit in renminbi, not dollars.


Not Accountable: Why Brilliant 15th-Century Italian Accounting Rules Are Sometimes of Limited Use in China

Leave a Comment / December 21, 2009

 

Luca Pacioli

Luca Pacioli

 

In the history of business, there are no innovations more important, transformative, valuable and widely-used than Luca Pacioli’s. Yet, few know his name. He never made a fortune and likely spent most of his adult life in prayer and cloistered meditation. 

Pacioli was a 15th century Italian mathematician and monk who first codified the system of double-entry bookkeeping. This made modern corporate management possible, by providing a standardized and generally foolproof system for summarizing a business’s financial condition. Pacioli’s system of offsetting credits and debits remains very much the basis of all modern corporate accounting. 

I looked around, but couldn’t discover when double-entry bookkeeping, Pacioli’s brainchild, was first introduced to China. It is certainly pervasive now. The principles of corporate accounting, like mathematics,  don’t change as you move across national borders. In private equity investing, the process of assessing a company’s performance and attractiveness as an investment will be a function, ultimately, of its profitability and net asset value. Pacioli’s methods are the tools to determine both. 

Yet, there are times when I think Pacioli’s accounting principles are no more useful a tool in private equity investment in China than his fellow Italian Marco Polo’s travelogues are to current-day tourists visiting the Great Wall. They are better than nothing. But, you will still need to do a lot of your own strenuous legwork. 

The reason is that accounting principles are not widely applied in the management of many of the better private SME in China. They are entrepreneur-led businesses. Usually the most complete statement of the businesses financial worth is not to be found on a company balance sheet, but in the mind  of the entrepreneur. Some of this is by habit, other by design, to thwart any unwanted outsider, especially the taxman, from knowing exactly what is going on in a company. 

One example from my own work: I made a first visit to an excellent company, with a thriving retail business and brand that’s both well-established and well-known in large parts of China. I was immediately impressed and asked the finance director for the company’s last year’s revenues and profits. “I don’t know,” she replied. Quickly, it became clear she wasn’t being coy or secretive. She genuinely did not know. “Only the boss knows”, she explained, looking over at him. 

He looked momentarily baffled, as if the question had never been posed before, and then did the calculation aloud. He knew precisely how many products he manufactured last year, the average selling price, and unit profit. So with a little multiplication, we were able to get to a number. Turned out, revenues were well north of USD$65mn, and net profits over $7mn. Very solid numbers. We later brought in an accounting firm to do a trial set of financials, and in fact, the true figures were about 15% higher than that first calculation by the boss. Apparently, he hadn’t fully consolidated the results from an outsourced production facility. 

It’s a great company from every perspective – except if you’re trying to evaluate it quickly, using a statement prepared using Luca Pacioli’s principles. Anyone attempting to assess the company using such methods is going to hit a wall, right at the outset. 

The company, like many others of China’s best private firms, does not track its performance with a set of financials, or commission an annual audit. Management stays rigorously attuned to operational details, to cash in the bank, to inputs and outputs, to seizing any available economies to fatten its profit margin. Most often, none of this is ever summarized in a P&L or balance sheet. The boss doesn’t need it. He lives and breathes it every day. 

Any PE firm looking to evaluate the company needs to do the same  – spend time at the company, with the boss, in the factory, and get a feel for how the business is running. If you make it a precondition before any visit to have a set of financials, you’re going to be spending a lot of time anchored to your desk, or visiting only companies that are so hard-up for cash that they’ve spent a good chunk of money getting financials done, to please potential investors. Even in China, an audit done by a local Chinese accounting firm can cost well over USD$50,000. I’d rather have that money spent where it can do more good, like building the business.  

Some good private Chinese companies do have audited financials. They are usually the ones with sizable bank loans. An annual audit is often a covenant of such loans. But, in my experience, most good Chinese companies, with little or no debt and no urgent need to attract investors will not have the sort of financials that some PE firms want to see at the start. 

In China, a set of financials should not be an absolute prerequisite for PE investors. The first step should be to understand the business operationally, and then pay a visit, if the industry and business model both seem attractive. You learn more in two hour site-visit than you would in two days combing through financials.  Besides, any PE firm will commission its own audit, usually by a Big Four accounting firm, before it invests, during the due diligence phase. So, no one is committing money blindly. Eventually, Luca Pacioli’s principles will be put to work. The only issue is whether this is a first step, or one that comes later in the process. 

Accounting rules have enormous value.  Double-entry bookkeeping has never been improved upon, in the 500 years since Pacioli wrote the rules. But, in private equity investment in China, an over-reliance on financial statements, especially as a first-step in getting to know a company, will distort more often than it clarifies. As brilliant as he was, Luca Pacioli could not have anticipated the singular conditions and management style of the current generation of China’s successful private entrepreneurs. 


An Inflationary Epoch – “ a period of extremely rapid exponential expansion”

Leave a Comment / December 13, 2009

China First Capital blog post -- cloisonne censer

It’s been a particularly busy, gratifying workweek. Reaching for a metaphor from the Big Bang’s cosmological model, it felt like we entered an Inflationary Epoch, a period of extremely rapid and exponential expansion.  One measure: the traffic of outstanding “laoban” (company boss, in Chinese) in and out of our office was heavier than any other time in our company’s history. In all, six came by this past week. I expect most, or all, of these companies to become our clients. 

Our recent visitors run businesses with cumulative revenues of well over Rmb 3.5 billion ($500mn). Four are industry leaders in China.  My best guess would be that within five years, their combined revenues will exceed $3 billion, and cumulative market cap exceed $5 billion. To reach these levels, they need nothing more than to do precisely what they’re doing now – seeking out large market opportunities, and then having the products and discipline to prevail over any competitors. 

Raising private equity capital will accelerate the process and heighten the growth trajectory. But, like many of the best private businesses in China, they’ve shown they can succeed when investment capital is limited and very hard to come by. That’s another commonality among the six companies that visited us this week. None has raised equity capital thus far. All are large, successful and well-managed enough to put capital to effective use. But, raising money is not compulsory. 

It may be a bad recipe for success, but my strong preference is for clients like this, ones that don’t really need us. If we have a value, it’s being able to help laoban prioritize and plan over  a longer time frame. In first meetings, I often ask laoban a question along these lines: “If capital were not a problem, and you could invest in areas of your business with the greatest likelihood of success and highest rates of return over the next three years, what would you do?” 

The answers usually come back with little time wasted for deliberation. A good laoban knows where to go without needing to consult a spreadsheet financial model or market research studies. In today’s China, the answer is usually some variation on, “We need to grow larger and be in more areas of China where there is a clear demand for what we are selling”. 

It’s hard for me to comprehend sometimes given their size, but the best private companies in China are often still in their “test marketing phase”. China’s market is so huge, and growing so quickly, that few if any businesses have penetrated more than a fraction of it. The six companies that visited this week are typical. None of them now serves more than 5% of their current easily-addressable market. At the same time, their potential customer base is also increasing quickly every year. A business needs to grow by 30-40% a year just to stay in place, to hold onto existing market share. 

Of course, none of these six laoban would be content with that, with just growing at the speed of the overall market. They need and want to dominate their industries. That’s where capital can make the biggest difference – especially if it’s supplied by an experienced private equity investor that knows how to help, guide, encourage and finance rapid growth. 

These six companies, like our existing clients, are all so good that I envy the investor that gets to own a share of the business. Investment opportunities this good should be much harder to come by. Instead, as this past week has shown,  great private businesses exist in startlingly large numbers in present day China. 

I’ll only get to know about a small portion of them, and will work with an even smaller number. After a week like this one, it’s impossible not to feel extremely positive about China’s economic prospects, and deeply privileged to know some of the laoban who are doing so much to assure that bright future. 

It was a great week. If the coming one is a little quieter, I think me and my China First Capital colleagues will all be quite content. It’s a challenge to keep up with the pace, and to contribute as much as we aim to. We too are in “test marketing phase”, with so much yet to build and to accomplish with clients across China.

 

Going Private: The Unstoppable Rise of China’s Private-Sector Entrepreneurs

1 Comment / December 7, 2009

Qing Jun-style, from China First Capital blog post

China’s private sector economy continues to perform miracles. According to figures just released by China’s National Bureau of Statistics, private companies in China now employ 70 million people, or 80 percent of China’s total industrial workforce. These same private companies account for 70% of all profits earned by Chinese industry. Profits at private companies rose 31.4% in 2008 over a year earlier, while those of China’s state-owned enterprises (so-called SOEs) fell by 16%. 

The rise of China’s private sector is, in my view, the most remarkable aspect of China’s economic development. When I first came to China in 1981, there were no private companies at all. SOEs continued to be favored sons, until recently. Only in 2005 did the Chinese government introduce a policy that gave private companies the same market access, same treatment in project approval, taxation, land use and foreign trade as SOEs. During that time, over 150,000 new private companies have gotten started and by 2008 had annual sales of over Rmb 5 million.   

These statistics only look at industrial companies, where SOEs long predominated. By last year, fully 95% of all industrial businesses in China were privately-owned. In the service sector, the dominance of private companies is even more comprehensive, as far as I can tell. While banks and insurance companies are all still largely state-owned, most of the rest of the service economy is in private hands – shops of all kinds, restaurants, barbers, hotels, dry cleaners, real estate agents, ad agencies, you name it. 

Other than the times I fly around China (airlines are still mainly state-owned) and when I pay my electric bill, I can’t think of any time my money goes directly to an SOE. This is not something, of course, I could have envisioned back in 1981. The transformation has both been so fast and so thoroughgoing. And yet, it still has a long way to go, as these latest figures suggest. Almost certainly, private company business formation and profit-generation will continue to grow strongly in 2009 and beyond. SOE contribution to the Chinese economy, while still significant,  grows proportionately less by the day. 

There once were vast regional disparities in the role of the private sector. Certain areas of China, for example the Northeast and West of the country, were until recently still dominated by SOEs. But, the changeover is occurring in these areas as well, and every year more private companies will reach the size threshold (revenues of over Rmb 5mn) where they will be captured by the statisticians. 

Equally, every year more of these private companies will reach the sort of scale where they become attractive to private equity investors. That happens when sales get above Rmb 100mn.  

Never in human history has so much private wealth been created so fast, by so many, as it has in China over the last 20 years. And yet, all this growth happened despite an almost complete lack of outside investment capital, from private equity and other institutional sources. This shows the resourcefulness of China’s entrepreneurs, to be able to build thriving businesses with little or no outside capital. Imagine how much faster this transformation would have happened if investment capital, and the expertise of PE firms, was more widely available. It is becoming more available by the day. 

China is primed, as it’s never been, for spectacular growth in PE investment over the coming 20 years.

Why Is China Booming? Surprise, It’s Not the Stimulus

1 Comment / November 13, 2009

China First Capital blog post -- Qing Dynasty stupa

Launched amid much worldwide rejoicing when the financial crisis struck last year, China’s Rmb 4 trillion ($585 billion) stimulus package is given much of the credit for China’s continued strong economic performance this year. China’s GDP growth is likely to exceed 8%, and the domestic stock market is up by over 70% since the start of the year. 

A Keynesian miracle? To read a lot of the financial commentary on China, you might well conclude this is so, that government spending has single-handedly kept the economy jaunty, while both firms and consumers sank into a deep funk. It’s a great story, and provides a simple explanation for how China dodged the bullets that struck all other major economies. Other countries looked on enviously, and urged China to continue the fiscal pump-priming to help out the overall world economy. 

Problem is, the analysis is flawed. China’s stimulus plan is not all it’s cracked up to be. While the additional government spending has clearly played a part, it is not the only reason why China’s economy has remained so sound this year. The unsung heroes of China’s economic success this year are its ordinary consumers. It’s their continued confidence and increased spending that have really made the difference. 

Economic statistics are notoriously iffy in China. The further one gets from the economic lever-pullers in Beijing, the harder it becomes to track economic activity. That’s another reason why the stimulus plan was so often singled out as the main spur to China’s growth. It’s easier to calculate how much additional the Chinese government is spending building expressways than it is to see how many pairs of socks or bowls of noodles Chinese are buying. 

Another reason: a lot of the economic commentary comes from folks who believe that governments really are responsible for what happens, good and bad, in an economy. Again, it’s just so much simpler to view things this way, that powerful government men can pull out their checkbooks and spend their way to national prosperity. These are often the same people who will tell you, wrongly, that Roosevelt’s New Deal spending lifted the US out of Depression.

China’s supporters and detractors both give the government too much credit. There are those who are convinced China’s economic growth is all some kind of fraud, cooked up by the central government, and that once the extra government spending is dialed down, the economy is certain to crash. 

Again, pure hogwash. 

In China, the government rightly deserves credit for excellent economic management, for creating the circumstances, both marco and micro,  that allow the Chinese economy to continue to thrive. I’ve said it frequently, including in public forums: China is the best-managed major economy in the world. 

But, again, let’s also commend the country’s one-billion-plus consumers, too often seem as miserly skinflints, saving up all their money for their great-grandchildren’s rainy days. It just ain’t so. China’s consumers, with an ever-increasing choice of products, services and shops, are spending ever-increasing sums on improving the quality of their lives. Newer and better housing. New cars. Holidays. New wardrobes. You name it. 

I see it every day here, the untethered exuberance of the Chinese consumer. It’s true that in the early part of this year, there was a relative lull. Back then, shops were working harder to attract customers, by putting a lot of their goods on sale at steep discounts. About four months ago, the situation began to change markedly. No more major knockdowns. Prices now all seem to carry list price, and the prices for many common consumer products are as high, or higher, than in the US. 

Not much of this, it goes without saying, gets noticed by the world’s financial commentariat. Car sales in China are at an all-time high, and China is now the world’s largest car market. But, listen to the commentators, and they’ll tell you it’s the result of some small government tax breaks on new car purchases. Helpful, yes. The main spur? No. Car prices in China are still, in dollar terms, generally much higher than in the US. Based on a percentage of average disposable income, car prices in China are probably among the most expensive in the world. Same goes for property prices. Yet, Chinese keep buying. 

They will keep buying, at or near this record pace, long after any tax breaks phase out.  Chinese want the new cars to drive on the new expressways to carry them to the new shopping malls to buy the new furniture for their new apartments. 

Of all the economic statistics I’ve seen lately, the one that best captures what is going on now in China is this: revenues in China’s restaurant industry were up 18% during the first half of 2009, to over $120 billion. That’s not due to stimulus, or bank loans, or tax concessions, or a government mandate to entertain more. It’s largely because Chinese are out having a good time, more often, and spending a lot more doing so than they did a year ago. 

It’s one of the best barometers of a nation’s mood, restaurant spending. In China, the mood is buoyant, the outlook bright, and the woks are working overtime.

 


 

International Investors Miss The Boat in China – Because They’re Not Allowed Onboard

Leave a Comment / October 31, 2009

China First Capital blog post Ming jar

Despite my fourteen years living in London,  I needed to fly all the way back to that city this week, from China, to finally get a look at Westminster Central Hall, a stately stone pile across the street from the even statelier, stonier pile that is Westminster Abbey. Central Hall does double duty, both as a main meeting place for British Methodists, and also as an impressive venue for conferences, including the first meeting of the United Nations in 1946. 

This week, it was site of the annual Boao Forum for Asia International Capital Conference. I flew in to attend, and participate in a panel discussion on private equity in China. The Boao Forum is something like the more renowned Davos Forum, but with a particular focus on Asia and China. This annual meeting focused on finance and capital, and drew a large contingent of about 120 Chinese officials and businesspeople, along with an equal number of Western commercial bankers, lawyers, accountants, investors, politicians, academics and a few other investment bankers besides me. 

Central Hall is crowned by a large domed ceiling, said to be the second-largest in the world. I enjoyed sending back a brief live video feed to my China First Capital colleagues in Shenzhen, whirling my laptop camera up towards the dome, and then down to show the conference. It was also the first time any of my colleagues had seen me in a suit. 

The weather was a perfect encapsulation of British autumn climate, with blustery and frigid winds, occasional radiant sunshine and torrential rain. It was my first trip back to London in over two years, and nothing much had changed. What a contrast to China, where in two years, most major cities seem to undergo a radical facelift. 

“How can a non-Chinese invest in Chinese private company?” It was a straightforward question, by a London-based money manager, for the panel I was on. Straightforward, even obvious, but it was actually one I’d never really considered before, to my embarrassment. In my talk (see Powerpoint here: http://www.chinafirstcapital.com/blog/wp-content/uploads/2009/08/trends-in-private-equity.pdf) , I made the case about why Chinese SME are among the world’s best investment opportunities for private equity firms.  It’s an argument I’m used to making to conference audiences in China. This is the first time I’ve done so anywhere else. The question, though, made me feel a bit like a guy telling his friends about the new Porsche Carrera for sale for $8,000, but then saying, “unfortunately, you’re not allowed to buy one.” 

The reality is that it’s effectively impossible for a non-Chinese investor, other than the PE firms we regularly work with,  to buy into a great private Chinese SME. For one thing, the investor would need renminbi to do so, and there’s no legal way to obtain it, for purposes like this. Even if you found a way around that problem, you’d face an even steeper one when you wanted to exit the investment and convert your profits back into dollars or sterling. 

The money manager came up to me later, and I could see the vexation in her eyes. I had persuaded her there were great ways for investors to make money investing in SME in China. Disappointingly, her clients aren’t allowed to do so. Cold comfort was all I could offer,  pointing out the same basic problem exists for any non-Chinese seeking to buy shares quoted on the Shenzhen and Shanghai stock markets. 

It’s a reasonable bet that China eventually will liberalize its exchange rate controls and ultimately allow freer convertibility of the renminbi. But, that doesn’t exist now. As a result, financial investment in renminbi in China is, for the most part, reserved exclusively for Chinese. Unfair? It must seem that way to the sophisticated, well-paid money managers in London, who these days have few, if any,  similarly “sure fire” investment options for their clients. 

China is, itself, awash in liquidity, and sitting on a hoard of over $2 trillion in foreign exchange reserves. So, there really is no shortage of capital domestically. Allowing foreign investors in, of course, would increase the capital available to finance the growth of great companies. But,  it will also add to the mountain of foreign reserves and put more upward pressure on the renminbi. That’s the last thing Chinese authorities need at the moment. So, most of the best investment opportunities in China are likely to remain, for quite a lot longer, open only to Chinese investors. 

Overall, this is a very good time to be Chinese. By my historical reckoning, it’s the best since at least the Tang Dynasty over 1,000 years ago. China has changed out of all recognition over the last 30 years, creating enormous material and social gains. That beneficial change, if anything, is accelerating. The fact Chinese also have some of the world’s best investment opportunities to themselves is just another dividend from all this positive change. 

If I were a money manager, I’d also be asking myself “how can I get some of this?” But, I’m not a money manager, and I formulate things very differently. I’m so happy and privileged to have a chance to help some of China’s great private entrepreneurs. Me and my team invest all our waking hours and all our collective passion in this. We are rewarded daily, by the trust put in us by these entrepreneurs, and by our very small contribution to their continued success. That’s more than adequate return for me.

I guess I’m not cut out for purely financial investing. 

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