创业板

Kleiner Perkins Adrift in China

1 Comment / May 13, 2010

Gold ornament from China First Capital blog post

No firm in the venture capital industry can match the reputation, global influence and swagger of Kleiner Perkins Caufield & Byers (“KP”). KP is accustomed to outsized success and glory  – which makes the lackluster performance of KP’s China operation all the more baffling. For all its Midas-touch reputation in Silicon Valley, KP’s China operation looks more like 100% pyrite. It seems beset by some poor investment choices, setbacks and even rancor among its partners and team. The firm’s Chinese-language website even manages to misspell the Kleiner Perkins name. (See below.)

Two years ago, Joe Zhou, one of the founding managing partners of KP in China left the firm to set up a rival VC shop, Keytone Ventures. Two other KP partners in China have also left. Losing so many of its partners in such a short time is an unprecedented occurrence at KP — even more so that two of these partners left KP to set up rival VC firms in China.

A partnership at KP is considered among the ultimate achievements in the business world. Al Gore took up a partnership at KP in 2007, after serving as Vice President for eight years and then losing the presidential election in 2000. Colin Powell also later joined the firm, as a “Strategic Limited Partner”.

Joe Zhou left KP just 13 months after joining. When he left, he also took some of the senior KP staff in China with him. Zhou also negotiated to buy out the portfolio of China investments he and his team had overseen at KP China. They paid cost, according to someone directly involved in the transaction. In other words, KP sold its positions in these investments at a 0% gain. Factor in the cost of that capital, and the portfolio was offloaded at a loss.

This isn’t going to endear KP to the Limited Partners whose money it invests.  It also signals how little confidence KP had in the future value of these China investments the firm made. Other top VCs and PEs are earning compounded annual rates of return of +50% in China.

There was every reason to believe that KP would achieve great success when it opened in China in 2007. Indeed, when KP opened its China office, it issued a celebratory press release, titled “Kleiner Perkins Caufield & Byers Goes Global;Joe Zhou and Tina Ju to Launch KPCB China”.

Along with having the most respected brand in the VC industry, KP arguably has more accumulated and referenceable knowledge than any other VC firm on where to invest, how best to nurture young companies into global leaders. It’s roster of successful investments includes many of the most successful technology companies in history, including: Amazon, AOL, Sun, Genentech, Electronic Arts, Intuit, Macromedia and Google.

Opening in China was KP’s first major move outside the US – indeed, its first move outside its base in Silicon Valley. KP has only three offices in total, one in Menlo Park , California and one each in Shanghai and Beijing.  On its website, the firm’s China operations receive very prominent position. Two of the firm’s most renowned and respected partners, John Doerr and Ted Schlein, apparently played an active part in KP’s entry into China. Along with the high-level backing, KP also raised over $300mn in new capital especially for its China operations. One can assume KP has already taken over $15mn in management fees for itself out of that capital.

Beyond the capital and high-level backing, KP also prides itself on being better than all others in the VC world at building successful companies. So, it’s more than a little surprising that KP’s own business in China has so far failed to excel, failed even to make much of an imprint. Physician heal thyself?

I’m in no way privy to what’s going on at KP in China, and thus far have not had any direct dealings with them. I’ve always admired the firm, and fully expect the China operation to flourish eventually. For one thing, great entrepreneurs and good investment opportunities in China are just too numerous. A firm with KP’s deal flow, capital and experience should find abundant opportunities to make significant returns investing in IPO-bound businesses.

From the beginning, KP’s operation was  a kind of outsourced operation. Rather than sending over partners from KP in the US, the firm instead hired away from other firms partners at other China-based VCs. While this meant KP could ramp up in China more quickly, it also put the firm’s stellar reputation, as well as its capital, in the hands of people with no direct experience working at the firm.

The KP website lists 14 companies in the China portfolio. The portfolio is very heavily weighted towards biotech, cleantech and computer technology, mirroring KP’s focus in the US. Other tech—focused VCs in China have run into trouble, and are now shifting much of their investment activity towards established Chinese SME in more traditional industries. In the best cases, these SME have strong brands and very robust sales growth in China’s domestic market.

In my view, investing in these SME offers the best risk-adjusted return of any PE or VC investing in the world right now. KP has yet to make the shift. I wish KP nothing but success, and hope for opportunities in the future to work with them. Its technology bets in China may pay off big-time, in due course. But, meantime, KP is in the very unaccustomed position of laggard, rather than leader, here in China.

_________________________

 

It’s surely embarrassing, if not emblematic, that the home page of the Chinese-language version of KP’s own website manages to misspell the company’s name.  Check out the top-most bar on the page, where the firm is named “Kliener,  Perkins, Caufield and Buyers” .

Kleiner Perkins China website


Update: as of May 11, 2010, the Chinese version of Kleiner Perkins’ home page has been corrected.

 



The Worst of the Worst: How One Financial Advisor Mugged Its Chinese Client

1 Comment / April 8, 2010

stamp from China First Capital blog post

One of my hobbies at work is collecting outrageous stories about the greed, crookedness and sleaze of some financial advisors working in China. Sadly, there are too many bad stories – and bad advisors – to keep an accurate, up-to-date accounting. 

Over 600 Chinese companies, of all different stripes,  are listed on the unregulated American OTCBB. The one linking factor here is that most were both badly served and robbed blind by advisors.

Many other Chinese companies pursued reverse mergers in the US and Hong Kong.Some of these deals succeeded, in the sense of a Chinese company gaining a backdoor listing this way. But, all such deals, those both consummated or contemplated, are pursued by advisors to put significant sums of cash into their own pockets. 

Talking to a friend recently in Shanghai, I heard about one such advisor that has set a new standard for unrestrained greed. This friend works at a very good PE firm, and was referred a deal by this particular advisor. I’ve grown pretty familiar with some of the usual ploys used to fleece Chinese entrepreneurs during the process of “fund-raising”. Usual methods include billing tens of thousands of dollars for all kinds of “due diligence fees”, phony “regulatory approvals” and unneeded legal work carried out by firms affiliated with the advisor.  

But, in this one deal my Shanghai friend saw, the advisor not only gorged on all these more commonplace squeezes, as well as taking a 7% fee of all cash raised, but added one that may be rather unique in both its brazenness and financial lunacy. The advisor had negotiated with the client as part of its payment that it would receive 10% of the company’s equity, after completing capital-raising. 

Let’s just contemplate the financial illiteracy at work here.  No PE investor would ever accept this, that for example, their 20% ownership immediately becomes 18% because of a highly dilutive grant to the advisor. It’s such a large disincentive to invest that the advisor might as well ask the PE firm to surrender half its future profits on the deal to put the advisor’s kids through college.

The advisor clearly was a lot more skillful at scamming the entrepreneur than in understanding how actually to raise PE money. The advisor’s total take on this deal would be at least 17% of the investor’s money, factoring in fees and value of dilutive share grant. 

By getting the entrepreneur to agree to pay him 10% of the company’s equity, along with everything else, the advisor raises the company’s pre-money valuation by an amount large enough to frighten off any decent PE investor. Result: the advisor will not succeed raising money, the entrepreneur wastes time and money, along with losing any real hope of every raising capital in the future. What PE firm would ever want to invest with an entrepreneur who was foolish enough to sign this sort of agreement with an advisor? 

This is perhaps the most malignant effect of the “work” done by these kinds of financial advisors. They create deal structures primarily to enrich themselves, at the expense of their client. By doing so, they make it difficult even for good Chinese companies to raise equity capital, now and in the future.  

I’m sure, based on experience, that some people reading this will place blame more on the entrepreneur, for freely signing contracts that pick their own pockets. No surprise, this view is held particularly strongly by people who make a living as financial advisors doing OTCBB and reverse merger deals in China.  This view is wrong, professionally and morally. 

In most aspects of business life, I put great stock in the notion of “caveat emptor”. But, this is an exception. The advisors exploit the credulity and financial naivete of Chinese entrepreneurs, using deception and half-truths to promote transactions that they know will almost certainly harm the entrepreneur’s company, but deliver a fat ill-gotten windfall to themselves. 

Entrepreneurs are the lifeblood of every economy, creating jobs, wealth and enhancing choice and economic freedom. This is nowhere more true than in China. Defraud an entrepreneur and, in many cases,  you defraud society as a whole. 


 

The Harshest Phrase in Chinese Business

Leave a Comment / April 1, 2010

Shou screen from China First Capital blog post

What are the most reckless and self-destructive words to use while doing business in China? “Let’s skip lunch and continue our meeting.”  Of course, I’m kidding, at least partly. But, there’s nothing frivolous about the fact food is a vital ingredient of business life in China. This is, after all, the country where people for hundreds of years have greeted each other with not with “Hello” but with the question “Have you eaten?”. 

China is no longer a country where food is in any way scarce. But, perhaps because of memories of years of scarcity or just because Chinese food is so damn delicious, the daily rhythms of life still revolves around mealtimes in a way no other country can quite match. This is as true in professional as personal life. 

It’s a certainty that any business appointment scheduled within 1-2 hours of mealtime inevitably will end up pausing for food. In practical terms, that means the only times during working hours that a meeting can be scheduled without a high probability of a meal being included is 9-10am, and 1:30-2:30pm.

At any other time, it’s understood that the meeting will either be shortened or lengthened so everyone participating can go share a meal together.  Any other outcome is just about inconceivable. Whatever else gets said in a meeting, however contentious it might be, one can always be sure that the words “我们吃饭吧” , or “let’s go eat”, will achieve a perfect level of agreement.  

Everyone happily trudges off to a nearby restaurant, and talk switches to everyone’s favorite topic: “what should we order?” Soon, the food begins to pile up on the table. Laughter and toasts to friendship and shared success are the most common sounds. The host gets the additional satisfaction and “face” of providing abundant hospitality to his guests.  

And yet, there are some modern business people in China that can and do conceive of meetings taking precedence over mealtime. Thankfully, they are quite few in number, probably no more than a handful among the 1.4 billion of us in China. I just happen to know more of them than most people. 

In my experience, those with this heterodox view that meals can be delayed or even skipped are mainly Chinese who’ve spent time at top universities in the US. There, they learn that in the US it’s a sign of serious intent to work through mealtimes. It’s a particularly American form of business machismo, and one I never much liked in my years in businesses there. Americans will readily keep talking, rather than break for food. Or, as common, someone will order takeout food, and the meeting will continue, unbroken, as pizza or sandwiches are spread out on the conference room table. 

Heaven help the fool who tries to change the subject, as the takeout food is passed around, to something not strictly related to the business matters under discussion. If as Americans will often remind you, “time is money”, the time spent eating is often regarded as uncompensated, devoid of value and anything but the most utilitarian of purposes. 

Is it any wonder I’m so happy working in China? I love food generally, and Chinese food above all else. It’s been that way since I was a kid. These days, I often tell Chinese that adjusting to life in China has had its challenges for me, but I know that every day I will have at least two opportunities for transcendent happiness: lunch and dinner. 

So, not only do I accept that business meetings will usually include a break for a nice meal, I consider it one of the primary perks of my job. But, I do meet occasionally these US-educated Chinese who don’t share my view. They will ask if meetings can be scheduled so there won’t be the need to break for a meal, or if not, to make the mealtime as short and functional as possible, so “work can resume quickly”. 

This is misguided on so many levels that I worry how these folks, who I otherwise usually like and admire, will ever achieve real career success in China. The meals are often the most valuable and important part of a business meeting – precisely because they are unrushed, convivial and free of any intense discussion of business. 

Trust is a particularly vital component of business in China. Without it, most business transactions will never succeed, be it a private equity investment, a joint venture, a vendor-supplier relationship. Contracts are generally unenforceable. The most certain way to build that trust is to share a meal together — or, preferably, many meals together. 

To propose skipping a meal is a little like proposing to use sign language as the primary form of negotiation for a complex business deal: it’s possible, but likely to lead to first to misunderstanding, frustration and then, inevitably, to failure.


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.


 

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.  


How & Where to IPO: Research Article by CFC Published in Chinese Magazine

Leave a Comment / October 31, 2009

 

Cover 

The current issue of “Corporate Finance Magazine” has a Chinese-language research report written by the China First Capital management team. It’s the cover story. The title of the report is: “如何选择上市的时机和地点”. It examines some of the right  and wrong ways for a Chinese SME to IPO. 

The article begins on page 10. Download report here

We are very happy about the planned opening of trading later this month on the new Growth Enterprise Market (创业板 ) here in Shenzhen. We hope it will give many successful SME new opportunities to go public properly and efficiently.

Our goal is that the report in Corporate Finance will contribute towards a successful future for the Growth Enterprise Market and for all of China’s best-performing SME. 

 


Shenzhen’s New Growth Enterprise Market: Getting it Right, Right From the Start

1 Comment / October 31, 2009

 

China First Capital blog post -- Ming Dynasty jade bowl

 

“Manage people’s expectations. Then, exceed them.” That’s not a bad rule to live by, or management principle to apply in regulating China’s fast-moving capital markets. This past week, China Regulatory Securities Commission, the nation’s stock market regulator, moved one step closer to opening trading in the new, Shenzhen-based, Growth Enterprise Market. It’s been ten years in the planning. The names were finally announced of the first companies that will list on the new market when trading begins later in October. All are private SME, and several had pre-IPO private equity funding.

The total amount of capital this first crop of IPOs will raise is well above most earlier estimates. The original stated plan was for smaller companies to list on the GEM, which, in turn, suggested the GEM market would be only a marginal contributor of growth capital for private SME. The minimum requirement was set at just $1.5mn in aggregate profits over the last two years. Even at high Chinese multiples, firms of that size would struggle to raise more than $10mn in an IPO.

But, in something of a surprise, CSRC chose larger companies to be in the first group to list. It now looks like that the ten companies will raise a total of over $400mn when their IPOs close, or an average of $40mn each. This, in turn, points to a cumulative market capitalization for this first group of around $2 billion. That bodes well for the market’s long-term future. A larger market capitalization means more liquidity and so less volatility in the share price. This will help attract more capital to the new Shenzhen market, and to subsequent future IPOs there.

Bravo, I say! The CSRC may well get the formula right, and so prove that these smaller-capitalization “growth stock markets” can work, both for companies and investors.

Elsewhere, these growth stock markets have mainly failed in their stated purpose to create an efficient platform for smaller companies to attract investors and raise capital. Germany’s Neuer Markt shut down soon after it was created. The small-cap markets in Singapore and Hong Kong have been disappointments. Small-cap companies stayed small-cap companies, which is entirely contrary to the purpose of a “growth board” like this. The granddaddy of them all, America’s OTC Bulletin Board, has become an all-purpose dumping ground for shady American firms, stock manipulators, and, sadly, several hundred once-strong Chinese SME who listed there after taking very bad advice from self-interested advisors and brokers looking to make a quick buck.

It’s anybody’s guess how many companies will list on Shenzhen’s GEM this year, or next. There is a backlog of at least 100 that have applied, and been provisionally accepted by CSRC. One thing we know: each IPO in China will get its final approval as part of an orderly process that takes into account the performance of companies already listed on GEM, and stock prices trends overall.

The Shenzhen GEM shows every sign of beginning to fill a very large, very important funding gap in China. Assuming, as I hope, that CSRC continues its preference for companies able to raise at least $30mn-$40mn in a public listing, these IPOs will channel capital to companies who would otherwise find it very hard to come by. Most of the private equity and venture firms that we work with don’t write checks that large. They generally invest around $10mn-$25mn in pre-IPO equity capital to own 20%-30% of a private Chinese SME. These investments are done at valuations of around eight times last year’s profits. So, a GEM listing could become the best source of growth capital for an SME that already has achieved some success, has profits of over $10mn-$20mn a year, but is still too small for a main board listing, in China or outside.

The public markets have two big advantages over private equity financing: they offer much higher price-earnings valuations, and give shareholders a liquid market to trade their shares. On the other hand, for Chinese SME, staging an IPO in China always has a level of deep unpredictability. The CSRC makes all the decisions about which companies can IPO and when. So, SME can wait two years or more to apply, get approval, and then put the IPO proceeds in the bank. If that SME is now growing quickly, has outsized opportunities near-to-hand with a high rate of return, but can’t finance its growth internally or with bank debt, a round of private equity will almost certainly be the best route to follow.

Done right (see my earlier blog post, on Foshan Saturday ‘s IPO) a company’s market capitalization, when it eventually completes its IPO, can be at least three times larger than it is at present. That means the laoban gets richer (nothing wrong with that), and investors are happier, too, because of the increased liquidity and stability from the higher market cap at IPO.

I’m extremely positive about the role the GEM will play in helping to build even stronger private Chinese SME. The CSRC and Chinese government have taken over ten years to plan this new stock market, and learn from the mistakes of others. All signs now are that they have done so, and the GEM will gradually create a group of publicly-traded private companies that will go on to achieve far more impressive results in the future.