China finance

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

1 Comment / May 7, 2015

 

China Law & Practice

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

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Date: 05 May 2015

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What is China First Capital?

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

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

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

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

Read complete interview

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Foreign Investors Unfazed by Kaisa’s Default –South China Morning Post

Leave a Comment / December 15, 2015

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SCMP

Foreign investors unfazed by Kaisa’s default

No increase in costs as mainland developers Jingrui and Landsea tap bond market
PUBLISHED : Saturday, 25 April, 2015, 12:38am

Langi Chiang langi.chiang@scmp.com

PE challenges and opportunities in 2015 — Financier Magazine

Leave a Comment / April 25, 2015
Financier  
May 2015 Issue

PE challenges and opportunities in 2015

May 2015  |  COVER STORY  |  PRIVATE EQUITY

Financier Worldwide Magazine

May 2015 Issue

Like many other facets of the financial services industry, the private equity (PE) asset class has endured a turbulent and difficult period since the onset of the financial crisis. Critics of the industry were quick to colour the PE space as a den of iniquity, a place for vultures and destroyers of jobs. In recent years, the sector has been required to comply with an increasingly tight set of regulatory requirements.

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Chinese PE activity, by contrast, was rather more subdued. “In 2014, the gap between the performance of the private equity industry in China and the US opened wide,” says Peter Fuhrman, chairman and founder of China First Capital, a China-focused global investment bank. “The US had a record-breaking year, with 10-year net annualised return hitting 14.6 percent. Final data is still coming in, but it appears certain US PE raised more capital more quickly and returned more profits to LPs than any year previously. China, on the other hand, had another so-so year. Exits picked up over 2013, but still remain significantly below highs reached in 2011. As a result, profit distributions to LPs and closing of new China-focused funds are also well down on previous highs. While IPO exits for Chinese companies in the US, Hong Kong and China reached 221, compared to only 66 in 2013, the ultimate measure of success in PE investing is not the number of IPOs; it’s the amount of capital and profits paid back to LP investors. This is China PE’s greatest weakness.”

Read complete article

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

Leave a Comment / April 21, 2015

China High Yield Investing -- China First Capital research report

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

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

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

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

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

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

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

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

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

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

 

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

Leave a Comment / March 31, 2015

caijing

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

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

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

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

The Chinese article can be downloaded by clicking here.

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

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

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

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

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

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

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

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

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

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

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

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

Leave a Comment / March 23, 2015

Kaisa bonds

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

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

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

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

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

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

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

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

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

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China’s loan shark economy — Nikkei Asian Review

Leave a Comment / June 25, 2016

Nikkei2

China loan sharking

China’s loan shark economy

PF

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

 

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

Download PDF version.

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US Private Equity Soars While China Stalls

1 Comment / February 9, 2015

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

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

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

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

China private equity distributions to LPs

 

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

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

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

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

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

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

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

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

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

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

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

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

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

 

China still lacking in innovation — Nikkei Asian Review

1 Comment / June 25, 2016

Nikkei2

blueprint China

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China still lacking in innovation

January 23, 2015 1:00 pm JST

By Peter Fuhrman

China’s economy suffers from an acute case of “not invented here” syndrome. Everything can be, and increasingly is, manufactured in China, but almost nothing of value is invented here.

The result is an economy still centered on low-pay, low-margin drudge work manufacturing products designed, patented and marketed by others. This is as true for advanced medical diagnostic equipment from General Electric as it is for Apple’s iPhones and tablets.

While manufacturing accounts for almost 50% of China’s gross domestic product and keeps 100 million people employed, China has few if any domestic companies selling sophisticated, premium-priced manufactured products to the world. As long as this remains the case and China remains a huge economy with only the tiniest sliver of consequential and profitable innovation, it will grow harder each year for the country to sustain high economic growth rates and big increases in living standards.

The government is increasingly anxious. “China is now standing at a critical stage in that its economic growth must be driven by innovation,” warned the State Council, China’s cabinet, in May.

With the talk comes money. Lots of it. Billions of dollars are being allocated to government-backed research projects and venture capital. But for all the rhetoric, government policies and cash, China remains a high-tech disappointment, more dud than ascending rocket. As an investment banker living and running a business in China, I very much wish it were otherwise. But I still see no concrete evidence of a major change underway.

On others’ shoulders

Indeed, the flagship products of China’s advanced manufacturing sector are still built largely on foreign components, technologies and systems, with Chinese factories serving as the assembly point.

Consider Xiaomi, which achieved great success in China’s mobile phone market last year and began getting some traction overseas. The company now has a market valuation of $45 billion, far higher than Sony, Toshiba, Philips, Ericsson and many more of the world’s most famous innovators.

Xiaomi’s handsets rely on components and software from a group of mainly U.S. companies, including Broadcom, Qualcomm and Google. They, along with U.K. chipmaker ARM Holdings and foreign screen manufacturers, are the ones making the real money on Android phones like Xiaomi’s.

Many of Xiaomi’s phones, like those of Apple and other leading brands, are assembled in China by Hon Hai Precision Industry, a Taiwanese company better known as Foxconn. As of now, Foxconn has no Chinese competitor that can match its production quality at a comparable low cost. Its superior management systems for high-volume production underscore another critical area where China’s domestic technology industry is weak.

The picture is similar with products such as computers, cars and aircraft. China’s military and commercial jet development programs have relied on foreign engines because of the country’s continuing failure to design and produce its own. Compare this with the Soviet Union, which, though an economic also-ran all the way up to its extinction in 1991, was producing jet engines as early as the 1950s; Russia still supplies advanced military engines for Chinese military jets. The picture is little better with jet brakes and advanced radar systems.

Stumbling blocks in China’s jet engine development continue at the manufacturing level with difficulties in serial production of minute-tolerance machinery, at the materials level with a lack of special alloys, and at the industrial level where a state-owned monopoly producer faces no local competitor to drive innovation as has been seen in the dynamic in the U.S. between GE and Pratt & Whitney.

China’s inability to make its own advanced jet engines casts light on problems China has, and likely will continue to have, developing a globally competitive indigenous technology base. This challenge, to bring all the parts together in a high-tech manufacturing project, is also evident in China’s failure, up to now, to develop and sell domestically developed advanced integrated circuits, pharmaceuticals and new materials globally.

China has, by some estimates, spent more than $10 billion on pharmaceutical research, but it has had only one domestically developed drug accepted in the global market, the modestly successful anti-malarial treatment artemisinin, or qinghaosu. Interestingly, it is derived from an herbal medicine used for 2,000 years in China to treat malaria; the drug was first synthesized by Chinese researchers in 1972.

Missing pieces

It’s simply not enough to count Chinese engineers and patents, or to rely on the content of the government’s technology-promoting policies. China still lacks so many of the basic building blocks of high-tech development, such as a mature, experienced venture capital industry staffed by professional entrepreneurs and technologists. A transparent judicial system is also essential, not only for protecting patents and other intellectual property, but for managing the contractual process that allows companies to put money at risk over long periods to achieve a return. Nondisclosure and noncompete agreements, a backbone of the technology industry in the U.S. and elsewhere, are basically unenforceable in China.

Tencent Holdings’ WeChat mobile messaging service is an example frequently cited by those who claim to see a dawning of innovation in China. An impressive 400 million phone users have signed up for the service. The basic application, though, is similar to that of Facebook’s WhatsApp, Japan’s Line and others.

WeChat’s real technological strength is in its back end, in building and managing the servers to store all the content that is sent across the network, including a huge amount of video and audio files. Tencent does this because it’s required to do so by Chinese internet rules and government policies on monitoring Internet content. Tencent might be able to commercialize and sell its backend storage architecture globally, but it’s not clear anyone would be interested in buying it. It’s a technology that evolved from specific Chinese requirements, not market demand.

China’s record of invention is the stuff of history: gunpowder, the compass, paper, oil wells, porcelain, even alcoholic beverages, kites and the fishing reel. All that occurred over 1,000 years ago. China’s greatest modern invention has been its singular pathway out of poverty as the economy expanded 200-fold over the last 35 years. But growth is now slowing, costs are rising sharply and profit margins are shrinking. To go on prospering, China needs to invent a new path and discover a new wellspring of breakthrough innovation, and it needs to do so in a hurry.

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

 

http://asia.nikkei.com/Viewpoints/Perspectives/China-still-lacking-in-innovation

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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General’s Mills’ Stunning Success in China

3 Comments / December 16, 2014

Wanzai Matou 湾仔码头

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Leave a Comment / December 11, 2014

Chinese banking loan approval process

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

 

 

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

Leave a Comment / December 5, 2014

globatimes

 

Govt calls for progress in IPO reform to help small firms

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

 

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

 

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

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

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

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

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

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

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

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

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

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

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

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

Equal access

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

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

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

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

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

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

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

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China High-Tech: giant ambitions can’t disguise a disappointing record of achievement

Leave a Comment / October 8, 2014

–China innovation

China high-tech achievements

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“China, the innovation nation. With nine times more engineering graduates and more patents filed each year than in the US, China is transitioning quickly away from its roots as a copycat, knockoff economy to become a potent new high-tech power.” By now, we’ve all read the headlines, heard the hype. China’s high-tech ambitions were part of the sales pitch used in Alibaba’s successful US IPO last month.

No story about China, no prediction about China’s future gets more attention or more traction from consultants, authors, policy analysts. It encapsulates the unanimous hopes of China’s leadership, and the fears of America’s. “China is now standing at a critical stage in that its economic growth must be driven by innovation,” declared China’s ruling State Council in May this year.

While China is certainly making strides the reality is sobering. For all the hype, the government policies and cash, China remains a high-tech disappointment, more dud than ascending rocket. As a banker living and running a business in China, I very much wish it were otherwise. But, I see no concrete evidence of a major change underway. The best the many boosters can offer is, “give it more time and it’s bound to happen”. In other words, they make their case unfalsifiable, by saying today’s China’s tech famine will turn into a feast, if only we are prepared to stand by the empty banquet table long enough.

Unlike a lot of those forecasting China’s inevitable rise to technology superpowerdom, I’ve actually met and talked with hundreds of Chinese tech companies, and before that run a California venture capital firm with investments in the US, Israel and Europe. I’ve also run a high-tech enterprise software company in the US that used proprietary technology to gain leading market position and ultimately a high price from an acquirer when we sold the business. So, I’ve been around the tech world a fair bit, both in China and elsewhere. Rule number one: deal with the facts in front of you, not wishful thinking. Rule number two: a high-tech economy is not a quotient of national IQ, national will, national urgency or national subsidies. If it were, China might well by now be at the epicenter of global innovation.

High-tech is meant to be a savior of China’s economy, delivering higher levels of affluence in the future and an escape from the so-called “middle income trap” that has slowed growth elsewhere in Asia. But saviors have a nasty habit of never arriving.

Let’s start with perhaps the most glaring weakness: China’s failed efforts, despite momentous efforts across more than a decade, to reach even the first rung of high-tech engineering competence by designing and serially producing jet engines.

Military power both requires and underpins high-tech success.  Any doubt about this was eliminated by the collapse of USSR. I was fortunate to have a front-row seat for that event. During the 1980s and 1990s, as a Forbes journalist, I spent a lot of time in the USSR surveying both its military and civilian industries, its indigenous technology base. I was one of the few who got to spend time, for example, inside the secret Soviet rocket program, including visiting main factories where its rockets and space station were built. The rocket program was for decades the pinnacle of Soviet tech achievement.

But, it proved to have little overall spinoff benefit for USSR economy. It was a dead-end. Note: the Soviet Union then, like China now, had far more engineers and engineering graduates than the US.

As I wrote back in the 1990s, US’s military supremacy rests as much on Intel and Broadcom as it does on Lockheed Martin fighter jets and GD nuclear submarines. The US has a huge fast-adopter civilian technology market with strong competitive dynamics, something China is without. This means US military then and now can procure the best chips, best integrated software and systems cheaply and quickly from companies that are mainly serving the civilian market. The Soviet Union had no civilian high-tech industry, no market forces. The Soviet military was exposed as a technology pauper by the 1989 Iraq War.

China is different and better off in so many ways. It now manufactures a lot of the world’s most advanced civilian high-tech electronics products. This gives China huge advantages USSR never had. All the same, the USSR by the mid-1950s was producing jet engines for military and civilian use. To this day, China relies on Russia, using Soviet-successor technologies, for its advanced military jet engines. Russian jet engines are generally considered a generation at least behind the best ones manufactured now in the US, France, UK.

China’s inability to make its own advanced jet engines casts light on problems China has, and likely will continue to have, developing a globally-competitive indigenous technology base.  In the case of jet engines, the problems are at manufacturing level (difficulty to serially produce minute-tolerance machinery), at the materials level (lack of special alloys) at the industrial level (only one designated monopoly aircraft engine producer in China, so no competitive dynamic as in the US between GE and P&W).

A recent report on China’s jet engine industry puts the technology gap in stark terms.  “In some areas,” it concludes, “Chinese engine makers are roughly three decades behind their U.S. peers.”

This challenge, to bring all the parts together in a high-technology manufacturing project, is also evident in China’s failure, up to now, to develop and sell globally domestically-developed advanced integrated circuits, pharmaceuticals, new materials. In drug development, China by some estimates has spent over $10 billion on pharmaceutical research and up to now has had only one domestically-developed drug accepted in the global market, the modestly-successful anti-malarial treatment Qinghaosu (artemisinin). Interestingly, it is derived from an herbal medicine used for two thousand years in China to treat malaria. The drug was first synthesized by Chinese researchers in 1972.

It’s simply not enough to count engineers and patents, or the content of government technology-promotion policies. China lacks so many of the basic building blocks of high-tech development. Included here is a mature, experienced venture capital industry staffed by professional entrepreneurs and technologists, not MBAs. A transparent judicial system is also essential, not only for protecting IP, but managing the contractual process that allows companies to put money at risk over long-periods to achieve a return. Non-Disclosure and Non-Compete agreements, a backbone of the technology industry in the US, are basically unenforceable in China. Not just here in China, but anywhere this is the case you can about kiss goodbye big-time technology innovation.

While ignoring the troubling lessons of China’s failure to produce a jet engine (as well as jet brakes and advanced radar systems) the boosters of China’s bright tech future these days most often cite two mobile phone-related businesses as signs of China’s innovation. The two are Xiaomi mobile phones, and Tencent‘s WeChat service. Both have had great success in the last year, including getting some traction in markets outside China. Look a little deeper and there’s less to be positive about.

Xiaomi is a handset manufacturer that now has a market valuation of over $10 billion, higher than just about any other mobile phone manufacturer. It relies, though, on the same group of mainly-US companies (Broadcom, Qualcomm, Google) for its phones. They, along with UK chip-maker ARM and non-Chinese screen manufacturers, are the ones making the real money on all Android phones. In addition, Xiaomi’s phones as are many cases manufactured by Taiwanese company Foxconn. As of now, China has no domestic company that can achieve Foxconn’s levels of quality at low manufacturing cost. Foxconn does this from factories in China. Its superior management systems for high-volume high-quality production also underscore another critical area where China’s domestic technology industry is weak.

With WeChat, it’s done some impressive things, in signing up over 300 million users. The basic application is similar to that of Facebook‘s WhatsApp and others. Its real technology strength is in its back end, in building and managing the servers to store all the content that is sent across WeChat, including a huge amount of video and audio files.

Whatsapp doesn’t have similar capacity. In fact, it points with pride to the fact it doesn’t backup for storage any Whatsapp customers’ conversations. Tencent does this because it’s required to do so by Chinese internet rules and government’s policies to monitor internet content. Tencent might be able to commercialize and sell globally its backend storage architecture, but it’s not clear anyone would be interested to own it. It’s a technology that evolved from specific Chinese requirements, not market demand.

Earlier this year I spoke on a panel at a conference in Shanghai of the global bio-manufacturing industry. This is precisely the sort of area where China most needs to up its game. Bio-manufacturing relies on a combination of first-rate science, cutting-edge manufacturing techniques and far-sighted management. After all the talk and the establishment of dozens of government-funded high-tech pharmaceutical science parks across China, the simple verdict was China has yet to achieve any real success in this industry.

China is not alone, of course, in having its difficulties nurturing a globally-competitive indigenous technology industry. In their time, most of the world’s advanced major economies have all tried — Germany, France, Japan, UK. All lavished government subsidies to foster domestic innovation. All made technology a policy priority. Yet, all have basically failed. If anything, the US is now more dominant in high-technology than it was at any earlier time in history. The US is home to most of the companies earning high margins, market shares and license fees for their proprietary technology.

China has already achieved what no other country has: in the course of a single generation, it has achieved the highest-ever sustained rate of growth, and so lifted hundreds of millions of its citizens out of poverty. This achievement shows the capabilities of the Chinese people, the far-sighted and pragmatic skills of its policy-makers. Both will continue to deliver benefits for China for decades to come.

For China, becoming a tech power is neither certain nor impossible. Progress can be hurt more than helped by those who engage more in hype, in predicting certain outcomes, rather than critically assess the impediments, and learn lessons from the failed efforts so many other countries have had in developing a technology industry. New thinking about innovation, and how to encourage it in China, is still lacking.

 

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

4 Comments / October 3, 2014

Amazon China & Alibaba

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

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

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

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

online shopping China

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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