China SME

CFC’s latest research report: 2010 will be record-setting year in China Private Equity

2 Comments / May 8, 2010

China First Capital 2010 research report, from blog post

 

China’s private equity industry is on track to break all records in 2010 for number of deals, number of successful PE-backed IPOs, capital raised and capital invested. This record-setting performance comes at a time when the PE and VC industries are still locked in a long skid in the US and Europe.

According to my firms’s latest research report, (see front cover above)  the best days are still ahead for China’s PE industry. The Chinese-language report has just been published. It can be downloaded by clicking this link: China First Capital 2010 Report on Private Equity in China

We prepare these research reports primarily for our clients and partners in China. There is no English version.

A few of the takeaway points are:

  • China’s continued strong economic growth is only one factor providing fuel for the growth of  private equity in China. Another key factor that sets China apart and makes it the most dynamic and attractive market for PE investing in the world: the rise of world-class private SME. These Chinese SME are already profitable and market leaders in China’s domestic market. Even more important, they are owned and managed by some of the most talented entrepreneurs in the world. As these SME grow, they need additional capital to expand even faster in the future. Private Equity capital is often the best choice
  • As long as the IPO window stays open for Chinese SME, rates of return of 300%-500% will remain common for private equity investors. It’s the kind of return some US PE firms were able to earn during the good years, but only by using a lot of bank debt on top of smaller amounts of equity. That type of private equity deal, relying on bank leverage, is for the most part prohibited in China
  • PE in China got its start ten years ago. The founding era is now drawing to a close.  The result will be a fundamental realignment in the way private equity operates in China. It’s a change few of the original PE firms in China anticipated, or can cope with. What’s changed? These PE firms grew large and successful raising and investing US dollars,  and then taking Chinese companies public in Hong Kong or New York. This worked beautifully for a long time, in large part because China’s own capital markets were relatively underdeveloped. Now, the best profit opportunities are for PE investors using renminbi and exiting on China’s domestic stock markets. Many of the first generation PE firms are stuck holding an inferior currency, and an inferior path to IPO

Our goal is to be a thought leader in our industry, as well as providing the highest-quality information and analysis in Chinese for private entrepreneurs and the investors who finance them.


Kleiner Perkins Adrift in China

1 Comment / May 13, 2010

Gold ornament from China First Capital blog post

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

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

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

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

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

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

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

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

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

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

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

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

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

_________________________

 

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

Kleiner Perkins China website


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

 



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

1 Comment / April 8, 2010

stamp from China First Capital blog post

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

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

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

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

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

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

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

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

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

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

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

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


 

The Harshest Phrase in Chinese Business

Leave a Comment / April 1, 2010

Shou screen from China First Capital blog post

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

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

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

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

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

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

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

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

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

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

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

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

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


Zhejiang Province: Why It’s China’s Richest and Will Be Richer Very Soon

4 Comments / March 26, 2010

QIng Dynasty vase, from China First Capital blog post

Geography is destiny. Nowhere is this more true, of course, than in China. The country is the world’s fourth-largest, in terms of territory. But, much of the country is inhospitable: with deserts, mountains,  loess and other areas less fit for human habitation. In a population of 1.4 billion, over 550 million are peasants and farmers. Yet, only 14.86% of the land in China is well-suited for cultivation. Too many hands with too little land to hoe. That basically sums up China’s vast agricultural economy.    

The most fertile agricultural areas are also the ones that have had the highest rate of industrial and overall economic development in the last 30 years. The three richest provinces in China also have the highest concentrations of fertile land: Guangdong, Zhejiang and Jiangsu. Together, these three coastal provinces have a population of about 230 million, or 17.5% of China’s total. But, their combined share of China’s gdp is almost twice that. 

When economic reform got underway, these provinces were already relatively well-off, because of the high quality and productivity of its farm output. They were not as heavily industrialized as more northern parts of China, which got the major share of government investment and attention during the first 30 years after the 1949 revolution. 

This lack of industrial infrastructure turned out to be a decisive advantage for the three provinces, especially Guangdong and Zhejiang.  As reform took hold, they weren’t weighed down by the bloat of forced industrialization. The rich farmland and relatively high living standards helped create a greater sense of economic security and this, in turn, bred more of an entrepreneurial mindset.

As the Chinese government relaxed controls on private business, Guangdong and Zhejiang were the first to seize the opportunities. Capital from private sources was more readily available because of the profitability of farming in the region. Entrepreneurship flourished. To this day, one can travel around Zhejiang and Guangdong and rarely, if ever, come across a state-owned business. Their economies are almost entirely in the hands of private business, with larger, private SME in the lead. 

Travel north or west and the situation is markedly different. Here, subsistence farming was often the norm. There were no large agricultural surpluses to finance the growth of private business. State-owned companies, often of the “we pretend to work and they pretend to pay us” variety,  have predominated. The private sector still fights for its share of resources in these other regions of China. Those with entrepreneurial flair often emigrate. Shenzhen is particularly full of such transplants, drawn from every corner of China. I’ve met many successful entrepreneurs here from inland provinces, especially Jiangxi, Hunan, Sichuan and Hubei.  

I’m in Zhejiang as I write this, and am stuck struck by the beauty of its scenery as well as the industriousness and wealth of its people. It reminds me most of Northern Italy, where I’ve spent a lot of time, earlier in my life. Northern Italy is one of the world’s most prosperous places, as well as among its most visually stunning.

In both places, mountains are close by nearly everywhere, and over recent decades, much of the rich farmland has been plowed under to build factories. Northern Italy includes most of that country’s (and the world’s) most successful private-sector companies and brands, including Benetton, Luxottica, Armani. The food is also particularly excellent, another trait it shares in common with Zhejiang. 

Northern Italy, statistically, is the richest area, per capita, in Europe – richer even than next-door Switzerland. Zhejiang, similarly, is the richest place in China, per capita. While Zhejiang can’t yet claim its home to any internationally-renowned brands, it does have China’s strongest nucleus of SME businesses. Many of these, in coming decades, will likely grow into large businesses that dominate their markets. One Chinese auto brand, Geely, which is about to complete its purchase of Volvo from Ford, is based in Zhejiang.                                               

Zhejiang is unique among provinces in China. It has three cities that vie for commercial and entrepreneurial supremacy. Wenzhou, Ningpo and Hangzhou act like separate pumps, channeling energy and wealth into the province’s circulatory system. I spent time recently in Fuyang, the area about 30 miles to the south of Hangzhou. We’re now lucky to have an outstanding client SME in that city. Fuyang is mainly mountainous. Thin strips of flat richly-fertile land hold much of the population, transport infrastructure and industry. 

It’s hard to imagine there could be a more productive slice of our planet than this flat land in Fuyang, including in Northern Italy. In a hectic 36 hours, I visited six different companies in Fuyang, each from a different industry, and each already of a scale that puts it in the top flight of all China’s SME. They are a very small sample of the great entrepreneurial output of this area of Zhejiang.  I was very impressed with each company, and with each “laoban” (老板）, Chinese for “boss”. 

These companies, and Zhejiang itself, embody the two most powerful forces that are now reshaping the Chinese economy: the twin reliance on private sector SME, and on producing for China’s domestic market rather than manufacturing OEM products for export.   

Zhejiang started out with a lot of natural advantages that other regions in China could only envy: the fertile land, an abundance of fresh water, inland waterways (including the Grand Canal) and plentiful rainfall, proximity to the coast and the major ports in Ningpo and nearby Shanghai. But, it’s richest blessing is a population of talented, instinctive entrepreneurs. They’ve taken what nature provided and augmented it, building a thriving, vibrant industrial economy in an area that 20 years ago was still mainly farmland and rice paddies. 

Other people’s idea of a perfect holiday is a week on some beach, or a visit to a tourist city like Rome or Paris. Mine is to spend time in a place with great food and great entrepreneurs, visiting their factories, hearing their strategies to conquer new markets and seize new opportunities to make money. 

Zhejiang really is my kind of place.

  

Carlyle Goes Native: Renminbi Investing Gets Big Boost in China

2 Comments / March 1, 2010

 

Qing Dynasty lacquer box from China First Capital blog post

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

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

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

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

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

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

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

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

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

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


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

Leave a Comment / February 16, 2010

Yuan tray


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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

China’s Brand New Brand Names

2 Comments / January 30, 2010

Ming Jiajing jar from China First Capital blog post

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

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

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

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

gdp

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

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

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

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

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

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

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

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

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

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

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

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

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

 

 

New CFC Report on Assessing Risk in PE Investment in China

Leave a Comment / January 25, 2010

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

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

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

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

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

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

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

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

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

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

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

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

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

Some examples:

Yaozhou4
Jun4

Guan6

 

 

 

 

 


PE-backed firms in China make huge contribution to Chinese economy and development

Leave a Comment / January 20, 2010

Yellow snuff bottle from China First Capital blog post

Here’s an excellent article from AltAssets on the contributions of PE-backed companies in China. According to the study, Chinese firms receiving at least $20 million in private equity are leaders in contributing to job creation and economic growth in China.  


Chinese PE-backed companies have more positive social impact than listed firms 

The study compared 100 companies that received at least $20m US private equity investments between 2002 and 2006 with 2,424 publicly listed companies having major operations in China to determine their social impact.

The results of the study show that private equity firms support the development of inland provinces, contribute to foster domestic consumption, transfer management know-how to businesses in their portfolios and improve corporate governance. The study further shows that private equity-backed companies in China had a job creation rate 100 per cent higher and a profit growth rate 56 per cent higher than their publicly-listed peers during the study period of 2002 to 2008.

The survey, conducted by Bain & Company and the PE and Strategic Mergers & Acquisitions Working Group of the European Union Chamber of Commerce, also found that private equity-backed companies spent more than two-and-a-half times that of their publicly-listed counterparts on R&D.

Reflecting on their relatively stronger financial performance, private equity-backed companies yielded tax payments that grew at a 28 per cent rate compounded annually, ten percentage points higher than their benchmark peers in the study. 

Andre Loesekrug-Pietri, chairman of the European Chamber’s PE and Strategic M&A Working Group, said, “China has emerged as one of the leading destinations for private equity capital. This trend is continuing through the current turbulence.”

China is generating lots of interest in the private equity industry, with major firms setting up yuan-denominated funds in the country. Earlier this week Carlyle, the second biggest buy-out house, announced that it has signed a memorandum of understanding with Beijing city authorities to establish a fund there, to be known as the Carlyle Asia Partners RMB Fund.

http://www.altassets.net/private-equity-news/article/nz17691.html

Navigating China’s Treacherous IPO Markets

Leave a Comment / January 11, 2010

Song plate from China First Capital blog post

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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


From China, a Plan to Topple One of America’s Most Dominant Brands

2 Comments / October 31, 2009

China First Capital blog post -- China private equity

Every list of America’s most valuable brands includes the same parade of names, year after year – Coca-Cola, McDonalds, Disney, Google. Every year, these lists also ignore what could be the single most dominant brand of all. This brand is known by everyone in America, enjoys a higher market share than any of those on the list, and is able to charge a price premium as much as 300% above its competitors. The brand? Crayola Crayons. 

That’s right, that most humble and low-tech of children’s toys. No one outside the company knows Crayola’s exact market share. A good estimate is at least 80% of the US crayon market. Maybe higher. In other words, Crayola is dominant enough not just to warrant an anti-trust investigation, but to be broken up as a monopoly. 

Of course, I’m partly joking here – about the anti-trust part, not about the market share. Heaven forbid the US Department of Justice should ever decide to police kids toys. But, Crayola really is astoundingly powerful and dominant in its market. It enjoys, according to the company’s own research, 99% brand recognition in the US. Its name is not only synonymous with crayons, but has more or less shut down any lower-cost competitor from grabbing much of its market share. How it does this is also something of a miracle, since as far as I can tell, they do comparatively little advertising to sustain this. In other words, they are not only the most dominant brand, they are also the thriftiest, in terms of how much is spent each year sustaining that position in parents’ minds and kids’ playrooms. 

We don’t know exactly how big Crayola is, or any other fact about its financial performance, because it’s a private company. In fact, even more impenetrably, it’s a private company inside a private company. Binney & Smith, the original manufacturer, was sold to famously-secretive Hallmark in 1984. It’s all educated guesswork. 

But, I’m lucky to know a Chinese boss whose guesswork is far more educated than most. David Zhan is boss and majority shareholder of Wingart, a manufacturer of children’s art supplies based in Shenzhen. David is one of the smartest, savviest and most delightful businesspeople I know. Wingart is also one of my very favorite companies – though they are not a client, nor an especially large and fast-growing SME. But, Wingart is exceptionally well-run and focused, with well-made and well-designed products, as well as the most kaleidoscopically colorful assembly line I’ve ever seen. 

Wingart makes crayons. They are better than Crayola’s. That’s not David’s pride speaking, but the results of some side-by-side testing done by one of the larger American art supply companies. I personally have no doubt this is true. I’ve seen Wingart’s crayon production. Not only are they better, but they are much cheaper too. 

Still, it’s almost impossible for Wingart to gain any ground on Crayola. Wingart mainly sells under other companies’ brand names in the US, including Palmers, KrazyArt and Elmer’s. They have good distribution for many of their products at Wal-Mart and Target. But, not crayons. Wal-Mart would like to start selling Wingart’s crayons – not just, presumably, because they are better than Crayola. But, Wal-Mart, famously, does not like to be reliant on a single brand, a single supplier, for any of the products it carries. 

For the time being, Wingart’s factory is too small to produce crayons in the quantity Wal-Mart requires. This should change within a year or so, when Wingart moves to a new and larger factory about two hours from Shenzhen. Then, perhaps for the first time ever, Crayola will begin to face some real competition. I can’t wait. I think Wingart has a realistic chance to build a crayon business, worldwide, that will compete in size with Crayola, which is pretty much a US-dependent company. 

I have a lot of admiration for Crayola – not so much the crayons, but the fact that a 106 year-old brand could be so predominant in its market, and enjoy such unrivaled – and largely uncelebrated — supremacy for so long. But, I’d still like to see Wingart knock them down a few notches, or more. Crayola has it too good for too long.  American kids deserve the best crayons – as, for that matter,  do European, Chinese and other kids on the planet.

A Step in The Right Direction – But Capital Allocation Remains Highly Inefficient in China

Leave a Comment / October 31, 2009

Vrard Watch from China First Capital blog post

Capital is not a problem in China. Capital allocation is. 

Expansionary credit policies by the government has created a boom in bank lending. This rising tide of bank credit is also lifting Chinese SMEs. Through the first half of this year, loans to SME have increased by 24.1% , or 2.7 trillion yuan ($400bn).  All that new lending, though, has not substantially altered the fact that bank lending in China is still directed overwhelmingly  towards state-owned companies.  So, while lending to SME rose by nearly a quarter, that equates to only a tiny 1.5% increase in the share of all bank loans going to SME. 

State-owned banks and state-owned companies are locked in a mutual embrace. It’s not very good for either of them, or for the Chinese economy as a whole. Faster-growing, credit-worthy private companies find it much harder and more costly to borrow.  Over-collateralization is common. An SME owner must often put up all this company’s assets for collateral, then throw in his personal bank accounts and property, and finally make a cash deposit equal to 30% to 50% of the loan value. 

China isn’t the only country, of course, with inefficient credit policies. Japan’s banking system still puts too much cheap credit in the hands of favored borrowers.  But, the problem is more damaging in China that elsewhere, for two reasons: first, many of China’s best companies are small and private. They are starved of capital and so can’t grow to meet consumer demand. Second, the continuing deluge of credit for state-owned companies distorts the competitive landscape, keeping tired, often loss-making incumbents in business at the expense of better, nimbler and more efficient competitors. 

In other words, China’s credit allocation policies are actually stifling overall economic growth and inhibiting choice for Chinese consumers and businesses. 

State-owned banks everywhere, not just in China, have the same fatal flaw. They like an easy life, which means lending to companies favored by their controlling shareholder, not those that will earn the greatest return.  They can turn a deaf ear to profit signals because, ultimately, profit isn’t the only purpose of their labors. They allocate credit as part of some larger scheme, in China’s case, maintaining output and employment in the country’s less competitive,  clapped-out industries.  

There’s a regional dimension to this too. China’s richest, most developed areas are in South,  particularly the powerhouse provinces of Guangdong, Zhejiang and Fujian.  The economy here is driven by private, entrepreneurial companies, not the state-owned leviathans of the North. As a result, a credit policy that discriminate against private SME also ends up discriminating against the parts of China with the highest levels of private ownership and per capital wealth. 

That’s not sound banking, or sound policy. The good news is that the situation is changing. SME are gradually taking a larger share of all lending. The change is still too slow, too incremental, as the latest figures show. But, with each cautious step, the private sector, led by entrepreneurial SME, gains potency, gains scale and gains more of the resources it needs to provide the products and services Chinese most want to buy.  


Corporate Finance in China: Often A Well-Oiled Machine for Mangling Good Chinese SME

Leave a Comment / July 31, 2009


China Chop -- From China First Capital Blog Post

 

I’m a pretty even-tempered guy, for the most part. But, those who know me, or read this blog, will by now know that I have a rather lively contempt for the financial advisors who swarm all over China, coaxing Chinese SME to pay them huge sums to arrange an IPO. Most often, the IPO happens as quickly as possible, with maximum fees flowing to the advisors, often on the shabbiest, most illiquid and unregulated of all stock markets, the American Over-the-Counter Bulletin Board (OTCBB). 

So, it was with a mix of surprise and, to be honest, some annoyance that I found myself recently besieged by some of these same “financial advisors”, eager to become my friend and business partner. It happened at the PE Conference I attended in mid-July in Shanghai. I was there to give one of the keynote speeches. Overall, it was a great experience. The organizers were cordial and professional. The other speakers and panel-members were first-class. 

But, I occasionally felt like a bit of bait dangling on hook. At every break, I was approached by well-dressed and well-spoken people, eager to give me their business cards, and talk shop. It just so happened that the shop they wanted to talk about was how to revive their now-troubled business model of doing these quick and lucrative IPOs for Chinese companies. I quickly, and I hope politely, explained that they were anathema, and in my mind, deserved particularly excruciating forms of punishment for ruining so many otherwise-good Chinese businesses by promoting and profiting from these awful IPO deals. Boiling in oil perhaps? ;) 

Now, sure, these people didn’t have any way of knowing how I felt about what they do. They’ve never seen my blog, or heard me hold forth on the subject. So, I guess they must have found my reaction a little extreme. But, it did put a more human face on this whole problem, which I believe to be the single worst aspect of China’s financial system, that unethical and unprincipled advisors run rampant here, and have succeeded in convincing so many Chinese companies to IPO for the wrong reasons, at the wrong time, at grotesque expense with disastrous results.   

To be honest, I was a little surprised at just how nice and professional many of these “financial advisors” at the conference seemed to be. They didn’t conform very well to my stereotype, which admittedly, was formed by a quick meeting with one of these advisors almost two years ago. This was the guy who had tried, and nearly succeeded, to lure a great Chinese company to destruction via a “Form 10 Listing” on the OTCBB. This company later became China First Capital’s first client. 

The advisors I met at the conference were mainly eager to talk about how much they liked and respected CFC’s approach, and how much they had to learn from us. What is it they say about flattery being the food of fools? Anyway, soon after, they usually then started pitching me on some company or other that they were trying to list. One of them explained that they were now trying to get into the business of raising PE capital for Chinese SME. Did I have any tips? 

In this case, my advice was to disclose to these SME their past record of copping fat fees for taking companies public, knowing these clients would likely wither and die after the IPO. 

One thing that did strike me, in talking to these guys, is that they all tended to use the same Chinese phrase to describe their clients: “上市公司”, which I’d translate as “an IPO company”. It’s actually quite apt.  They are in business to arrange IPOs, not generally to raise capital, or act as bankers or trusted long-term advisors. 

We have some similar kinds of organizations in the US, and they often delusionally will call themselves “investment banks”. What they are, more accurately, are IPO bucket shops. In China, they still mainly call themselves “FA”, short for “Financial Advisor”. 

By whatever name, these guys are likely to remain a problem in China for a long time. They will not go out of business just because I hectored them about the damage they’re doing to entrepreneurship in China.  There are too many of them, and too many good SME for them to prey upon. They are like a well-oiled machine for mangling good Chinese companies.



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