China venture capital

Are US and China Decoupling? Guest Lecture at University of Michigan Ross School of Business

I was honored and delighted to teach a class via video lecture at the University of Michigan Ross School of Business for third year, this time on the potential decoupling between the US and China, the competitive realignments as well as investment opportunities.

The lecture’s title: “Chimerica No More: Are China and the US Decoupling? How Will This Alter World Economics and Commerce?”

Thanks to Professor David Brophy and his class on Global Private Equity for the invitation an incisive questions.

This is a video link to the presentation. (Click here.)

This is a video link to the full two hour class. (Click here.)

This is the PDF of the presentation — without the animations. (Click here.)

China Merchants Steams in to Compete with SoftBank’s Vision Fund — Financial Times

 

China Merchants Group has been adopting new technology to resist foreign competitors for nearly 150 years. Founded in the 19th century, the company brought steam shipping to China so it could compete with western traders.

Now an arm of the Chinese state, CMG has been enlisted once again to buy up technology at a time when global private equity is vying for a share of China’s burgeoning tech market.

The country’s largest and oldest state-owned enterprise, CMG said this month it would partner with a London-based firm to raise a Rmb100bn ($15bn) fund mainly focused on investing in Chinese start-ups.

The China New Era Technology Fund will be launched into direct competition with the likes of SoftBank’s $100bn Vision Fund, as well as other huge investment vehicles raised by top global private equity houses such as Sequoia Capital, Carlyle, KKR and Hillhouse Capital Management.

“They have been very important to China in the past, especially in reform,” said Li Wei, a professor of economics at Cheung Kong Graduate School of Business in Beijing. “But you haven’t heard much about them in technology . . . It’s not too surprising to see them moving into this area, upgrading themselves once again.”

CMG is already one of the world’s largest investors. Since the start of 2015 its investment arm China Merchants Capital, which will oversee the New Era fund, has launched 31 funds aiming to raise a combined total of at least $52bn, according to publicly disclosed information.

But experts say little is known about the returns of those funds, most of which have been launched in co-operation with other local governments or state companies.

Before New Era, China Merchants Capital’s largest fund was a Rmb60bn vehicle launched with China Construction Bank in 2016. While almost no information is available on its investment activity, the fund said it would focus on high-tech, manufacturing and medical tech.

CMG’s experience investing directly into Chinese tech groups is limited, although it has taken part in the fundraising of several high-profile companies. In 2015 China Merchants Bank joined Apple, Tencent and Ant Financial to invest a combined $2.5bn into ride-hailing service Didi Chuxing, a company that now touts an $80bn valuation. It also invested in ecommerce logistics provider SF Express in 2013.

Success in Chinese tech investing is set to become increasingly difficult as more capital pours into the sector.

“Fifteen billion dollars can seem like a droplet in China,” said Peter Fuhrman, chairman and chief executive of tech-focused investment banking group China First Capital, based in Shenzhen. “We’re all bobbing in an ocean of risk capital. Still, one can’t but wonder, given the quite so-so cash returns from China high-tech investing, if all this money will find investable opportunities, and if there weren’t more productive uses for at least some of all this bounty.”

CMG, however, has always set itself apart from the rest of the country’s state groups. It is unlike any other company under the control of the Chinese government as it was founded before the Chinese Communist party and is based in Hong Kong, outside mainland China. Recommended Banks China Merchants Bank accused of US discrimination

The business was launched in 1872 as China Merchants Steam Navigation Company, a logistics and shipping joint-stock company formed between Chinese merchants based in China’s bustling port cities and the Qing dynasty court.

Mirroring its New Era fund today, it was designed to compete for technology with foreign rivals. At that time it was focused on obtaining steam transport technology to “counter the inroads of western steam shipping in Chinese coastal trade”, according to research by University of Queensland professor Chi-Kong Lai.

Nearly a century later, after falling under the control of the Chinese government, CMG became the single most important company in the early development of the city of Shenzhen, China’s so-called “window to the world” as it opened to the west.

Then led by former intelligence officer and guerrilla soldier Yuan Geng, the company used its base in Hong Kong to attract some of the first investors from the British-controlled city into the small Chinese town of Shenzhen, which has since grown into one of the world’s largest manufacturing hubs.

Its work in opening China to global investment gained CMG and Yuan, who led the company until the early 1990s, status as leading figures in the country’s reform era.

Today the company is a sprawling state conglomerate with $1.1tn in assets and holdings in real estate, ports, shipping, banking, asset management, toll roads and even healthcare. The company has 46 ports in 18 countries, according to the state-run People’s Daily, with deals last year in the sector including the controversial takeover of the Hambantota terminal in Sri Lanka and the $924m acquisition of Brazilian operator TCP Participações.

CMG did not respond to requests for comment. But one person who has advised it on overseas investments said the Chinese government was using it in the same way the company opened up Shenzhen to the outside world, helping “unlock foreign markets”.

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University of Michigan Ross School of Business — Guest Lecture on China Investment, the Perils & Attractions

 

 

I was in Ann Arbor this past week to guest lecture at the University of Michigan Ross Business School. The full video can be accessed by clicking here.

I was invited to speak at the business school by Professor David Brophy, who introduces me at the start. Professor Brophy teaches a winter semester class in Global Private Equity. He began researching and teaching PE at Michigan in the mid-1970s, not long after the field was invented by firms like KKR.

Along with speaking in person to students at the school, my talk was also streamed live to the Michigan Venture Capital Association.

 

Maurice Greenberg, Wall Street Journal.

 

China’s Technology Future and What It Means for Silicon Valley — Bay Area Council Research Report

 

The Bay Area Council Economic Institute, the leading think tank and public policy organization in the Silicon Valley, has just published a comprehensive and timely research report on Chinese innovation, titled “China’s Technology Future and What It Means for Silicon Valley“. The author is Sean Randolph, Senior Director at the Institute.

You can download a copy of the complete report by clicking here.

Sean was kind enough to seek out my views on this topic and we shared a lively dialogue, both in person here in China, and by email once he returned to San Francisco.

The report does an excellent job contrasting China’s overarching future goals in technology and innovation with the current state of affairs. It takes a balanced view: “While recognizing China’s advances, it would be a mistake to think of China as a remorseless juggernaut sweeping everything in its path. Having a plan doesn’t guarantee success, and not everything works.”

The report looks deeply both at some of China’s leading technology companies — including the “BAT” along with Huawei and car-maker Geely — and more broadly at how Chinese companies, both state-owned and private, regions and universities all align themselves with broader national goals to upgrade the level of China’s indigenous innovation.

What does all this mean for Silicon Valley, the world’s most important and successful breeding ground for high-value innovation? It’s here, in offering answers and perspective, that the report achieves its greatest value.

Here are some particularly insightful passages:

“China’s relationship with the Silicon Valley/San Francisco Bay Area is unique, in part due to the deep historical and demographic ties between the Bay Area and China, but also because the region’s technology sector—the world’s largest—most highly concentrates the assets of technology, investment and expertise that relate to China’s goals to accelerate its own technological development.

Bay Area technology companies, such as Intel, Apple, and Cisco, and venture firms, such as Sequoia Capital, DFJ (Draper Fisher Jurvetson), and Kleiner Perkins, have been active investors in China for decades. Now, reversing the historic trend in which virtually all investment flowed from the Bay Area to China, Chinese companies have started sending investment capital and other resources to the Bay Area through mergers and acquisitions, equity investments, and the establishment of research and innovation centers and accelerator programs.”

The attraction of China’s market can be compelling, but [Silicon Valley] companies also must consider whether their core technology can be protected, and whether their position in the Chinese market can be sustained if that technology is compromised by competitors.While few US companies are leaving China, government policies and weak IP protection have caused many to keep their best technology at home and others to stay away.”

The report appears at an especially critical time in the development of US-China technology policy and investment. Congress is moving to tighten the CFIUS controls on Chinese technology investment in the US. China, meanwhile, is pushing ahead with new and more restrictive policies at home, leading to companies like Amazon selling off assets in China.

Let’s hope the tide reverses. A more open and reciprocal trade and investment relationship between China and the US would benefit both, benefit the world.

 

 

 

In Today’s China, Paradoxes Still Abound. But So Do Opportunities — Site Selection Magazine

 

In September, China First Capital Chairman and CEO Peter Fuhrman, familiar to attendees at the World Forum for FDI in Shanghai last year, delivered a talk from China to Harvard Business School alumni. Here, with Mr. Fuhrman’s permission, we present excerpts from his remarks.

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GDP growth has never and will never absolutely correlate with investment returns.

Any questions? No? Great. Thanks for your time.

Of course I’m joking. But that key reality of successful investing is all too often overlooked, and China has provided all of us over these last 30-some-odd years with a vivid reminder that IRR and GDP are by no means the same animal.

China is, was and will likely long remain a phenomenal economy. The growth that’s taken place here since I first set foot in China in 1981 has been something almost beyond human reckoning. Since I first came to China as a postgrad in 1981, per-capita GDP (PPP) has risen 43X, from $352 to $15,417. China achieved so much more than anyone dare hope, a billion people lifted out of poverty, freed to pursue their dreams, to make and spend a bundle.

China this year will add about $1 trillion of new GDP. Just to put that in context, $1 trillion is not a lot less than the entire GDP of Russia. So who is making all this newly minted money? And how can any of us hope to get a piece of it? Another question: Why, if China is such a great economy, has it proved such a disaster area for so many of the world’s largest, most sophisticated global institutional investors, private equity firms and Fortune 500s?

Turning Inward

Let’s start with the fact that China is a part of the World Trade Organization, but not entirely of it — not fully subscribed in any way to the notion that reciprocity, openness, free trade, level playing fields and equal treatment are positive ends unto themselves. As China has gotten richer it has seen even less and less need to attract foreign capital and foreign investment. That’s a tendency we see in other countries, including obviously some of the rhetoric we now hear in the U.S. — that more of the gains of the national economy should belong to its citizens. But China’s way is different.

The renminbi is a closed non-tradable currency, so getting US dollars into and out of China has always been difficult. China now has the world’s second-largest stock and bond markets, but those markets are largely closed to any investors other than Chinese domestic ones. But China also continues to provide companies going public with by far the highest multiples anywhere in the world.

When I first came to China 36 years ago China was a 100-percent state-owned economy. Twenty years ago the first rules were put in place to allow a private sector to function. Today, according to anyone’s best estimate, it’s about 70 percent private and 30 percent state, and most of the value creation is being provided by that private-sector economy. So in theory there should be very interesting M&A opportunities. But it’s been exceedingly difficult to get successful transactions done. One of the core reasons is that by and large all private-sector companies in China, large and small, are family-owned.

The other thing important to consider is a Mandarin term: guifan. It’s the Chinese way of explaining the extent to which a company in China is abiding by all the rules of the road — the taxes you should pay, the environmental and labor laws you should follow. It’s not at all uncommon that successful private-sector companies in China are successful by virtue of having negotiated to pay little or no corporate tax on profits.

For foreign-owned companies in China it’s an entirely different story. They are by and large 100-percent compliant with the written rules. This has an enormous impact on the operating performance of any company, so you can imagine how potentially skewed the competitive environment becomes. And keep in mind that corporate taxation in China in the aggregate is, if not the highest in the developed world, then among the highest, and the environmental and labor laws are every bit as difficult, rigorous, tough and expensive to implement as they are in the U.S.

China is a country where local government officials are scored on the measurable success of their time in office, and success is overwhelmingly attributed to GDP growth. So it should be no surprise if what they’re trying to do is optimize GDP growth, the percentage of a company’s income that goes back to the government in taxation can have an adverse effect on that. Instead the government will continue to urge its local companies to take the money and, rather than pay tax, continue to invest, expand and therefore build local GDP.

The Hum of Consumerism

The reasons to stay engaged and find a viable investment angle include GDP growth. China’s GDP is likely to continue to grow by at least 6 percent a year. Second, across my 25 years of involvement in China, every one of the predictions of imminent collapse — financial catastrophe, local government debt, bad bank loans, real estate bubbles — have proved to be false. It appears China has some resiliency, and it’s certainly the case that the government has the tools and financial resources to ride out most challenges.

Third has been how effortlessly it’s made the transition that still bedevils lots of Europe, from a smokestack economy to a consumer-spending paradise. At this moment every major consumer market in China is booming both online and offline. Alibaba, Baidu and Tencent are now operating as three of the most profitable companies in the world.

How does China have a robust, booming consumer economy and an enormous appetite for luxury brands, yet on average salary levels that are still one-fifth or one-sixth the levels in the US? The simple answer is that almost all the Chinese now living in urban China — about half the population, compared to about 15 percent when I first got here — owns at least a single apartment if not multiple, which is more and more common. The single best-performing asset in history has probably been Chinese urban real estate over the last 30 years. It’s fair to say the average appreciation over the last 10 years is at least 300 percent.

Though China has a population whose incomes on paper look like those of people flipping burgers at McDonald’s, they seem to have the spending power and love of luxury goods like the people summering in East Hampton. Even Apple itself has no idea how big its market is here in China. It’s likely that at least 100 million iPhone 8s will be sold to Chinese over the next year. The retail price here in China is at least 30 to 40 percent higher than in the US, with most phones bought for cash, without a carrier subsidy.

‘You’ll Be Older Too’

So where is it possible to make money in China? One message above all: Active investing beats passive investing every time. What you need to do is either be the owner-operator or be a close strategic partner with one, and stay actively engaged.

There are four major areas of opportunity: Tech, health-care services, leisure and education (see graphic below). The potential for building out a chronic care business in China is enormous. Looking ahead 25 to 30 years, sadly China will likely suffer a demographic disaster. This country will become a very old society very quickly. That’s the inevitable product of 30 years of a one-child-per-family policy. By 2040 or 2050, 25 percent of China will be over the age of 65.

The overall rate of GDP growth is unlikely to ever rival that of a few years ago at 10 to 12 percent a year, but overall what we have is higher-quality growth. People in China are living well. Things should continue to motor along very smoothly at least for one more generation — a generation whose members are better educated, more skilled, ambitious and globalized than their parents.

There’s no denying the reality of what a better, happier, freer, richer country China has become since I first set foot here. I marvel every day at the China that I now live in, even while I occasionally curse some of the unwanted byproducts like heavy pollution in most parts of the country, overcrowding at tourist attractions, bad traffic, and a pushy culture that’s lost touch with some of China’s ancient glories.

China will continue to amaze, inspire and stupefy the world. The Chinese have done very well and will do better. At the same time, those of us investing in China may do a little better in years to come than we have up to now. More of the newly minted trillions in China just may end up sticking to our palms.

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Amazon Sells Hardware to Cloud Partner in China — The Wall Street Journal

Amazon Web Services is selling computing equipment used for its cloud services in China for as much as $300.8 million.
Amazon Web Services is selling computing equipment used for its cloud services in China for as much as $300.8 million.

Amazon.com Inc. AMZN 0.68% on Tuesday said it has sold computing equipment used for its cloud services in China to its local partner, Beijing Sinnet Technology Co., in a move analysts said underscores the increasingly chilly atmosphere for foreign companies in the country.

Amazon Web Services said it took the step to meet new Chinese regulations.

”Chinese law forbids non-Chinese companies from owning or operating certain technology for the provision of cloud services,” AWS said. “As a result, in order to comply with Chinese law, AWS sold certain physical infrastructure assets to Sinnet, its longtime Chinese partner.”

The company said it remains committed to China and that customers would continue to receive AWS cloud services. It also said the deal didn’t involve any transfer of intellectual property.

Peter Fuhrman, chairman of technology investment bank China First Capital, said Amazon’s decision illustrates China’s tightened grip on companies providing internet services.

”The key policy brickwork is now done,” Mr. Fuhrman said. “The Chinese internet, in its broad entirety, will become even more comprehensively managed by the Chinese state.”

Mr. Fuhrman added that such protectionist moves will ultimately limit China’s access to the latest technology and could hurt its competitiveness over the long term.

Jim McGregor, chairman of the Greater China region for public-affairs consultancy APCO Worldwide, said the move should be viewed in light of China’s Made in China 2025 plan to promote domestic enterprises and technologies. ”China has a different plan and it has the power,” he said.

U.S. tech companies in China are dealing with a different world “and it would be corporate suicide not to acknowledge it,” he added.

Beijing Sinnet, in a regulatory filing late Monday, said it was paying up to 2 billion yuan ($300.8 million) for the assets to “comply with our country’s laws and rules and further improve the security and the service quality of the AWS cloud-computing service operated by the company.”

Early this year, China’s Ministry of Industry and Information Technology informed foreign companies with cloud ventures that new operating licenses would be applied by year-end. Amazon’s deal with Sinnet could clear the final obstacles for AWS to get such licenses, analysts from Citic Securities said in a note Tuesday.

Late last year, China’s MIIT also issued draft measures calling for tighter technical cooperation between foreign cloud operators and their local partners. The proposed rule change triggered complaints from more than 50 U.S. lawmakers, who in March protested in a letter to China’s ambassador to the U.S., Cui Tiankai, that the change would force U.S. companies to essentially transfer ownership and operations of their cloud systems to Chinese partners.

Officials with the MIIT had no immediate comment.

Amazon and other U.S. companies, including Apple Inc., have faced increased pressure in the country in recent months in the face of the Chinese government’s desire to control cyberspace.

In July, Apple said it would begin storing cloud data for its Chinese customers on a server run by a government-owned company, to comply with Chinese law. The data include photos, documents, messages and videos uploaded by mainland China users of Apple’s iCloud service.

Since a new cybersecurity law came into effect in June, U.S. tech companies have been constrained in their efforts to operate as they normally would globally, and this has led to inefficiency and a higher risk of cyberthreats, said the U.S.-China Business Council in a statement Tuesday.

In August, AWS was caught up in a Chinese government clampdown on tools that allow internet users to circumvent the country’s vast system of internet filters. In that instance, AWS customers were sent emails by Beijing Sinnet asking them to delete tools enabling them to bypass the filters. Some of the tools that clients use include virtual private networks, or VPNs.

Cloud platforms provide their users with data storage, computing and networking resources over the internet, reducing the need for on-site servers. China’s $2 billion public cloud market is set to grow to a $16 billion by 2020, according to estimates by Morgan Stanley analysts. A government policy push for enterprises to migrate to the cloud, better vendor offerings and falling costs will boost demand for such services, Morgan Stanley said.

In China, AWS faces strong local competition in the form of Alibaba Group Holding Ltd. and China Telecom Corp. Alibaba’s cloud unit held 40% of the country’s cloud infrastructure-as-a-service market, according to International Data Corp. research. Microsoft Corp. , the largest foreign provider in China, had 5%, while AWS has 3.8%.

Still, China’s market is in its nascent stage, and it is too early to crown industry champions, said Kevin Ji, a research director at Gartner, an industry research firm. With their strong product offerings, AWS and Microsoft are likely to prove formidable competitors to Alibaba in the longer run, he said.

As published in The Wall Street Journal.

China Investing, The Pain and the Perks — Harvard Business School Global Alumni Lecture

 

It was a delight and a privilege to give a talk on China investing to Harvard Business School’s global alumni organization. If you’d like to see the slide deck, please click here. The audio version of the lecture, done by worldwide webcast,  is also up on YouTube.

The topic was a big one — why have China investment returns so often failed to keep pace with the phenomenal growth in the country’s economy, and can investors do anything to improve the odds of success? Given an hour to discuss, I could only really scratch the surface.

A key takeaway: the past needn’t be prologue. Investing in China may prove less vexatious in the future. In part, that’s because of the growth of a mass affluent consumer market in China, a shift that plays to the strengths of many US, European and East Asian companies and institutional investors. Second, of course, everyone now can learn from past mistakes and misperceptions.

As I said in closing, “China will continue to amaze, inspire and stupefy the world. Chinese have done very well and will do better. At same time, those of us investing in China may do a little better here in years to come than we have up to now. More of the newly minted trillions in China just may end up sticking to our palms.”

 

 

 

Venture Fundraising in Yuan Soars as Investors Target Chinese Tech Firms — The New York Times

 

HONG KONG (Reuters) – China-focused venture capital funds are increasing their bets on local technology companies and a further opening of Chinese domestic capital markets, raising money in the yuan at the fastest pace in five years.

Fund managers have raised 95.8 billion yuan ($14.54 billion) this year through late September in funds denominated in the Chinese currency, which is also known as the renminbi, compared with 56.7 billion yuan in all of 2016. That puts 2017 on pace to be the biggest year since 2012, when 145.8 billion yuan was raised, according to data provider Preqin.

There are currently 78 funds looking to raise as much as another 1.15 trillion yuan over the next couple of years, Preqin said, most of it coming from mammoth-sized state-owned entities and so-called government guidance funds, which seek to foster domestic innovation in different industries from advanced engineering and robotics to biotechnology and clean energy.

 Those include the 350 billion yuan sought by the China Structural Reform Fund, 200 billion yuan targeted by the China State-Owned Capital Venture Investment Fund and a proposed 150 billion yuan for the state-owned Enterprise National Innovation Fund.

The enormous size of the fundraising ambitions of the Chinese state-backed funds means it may take some time before they reach their final goals. The China Structural Reform Fund, which was launched in 2016, has raised 20 percent of its registered capital and its president said in an interview with Caixin Global that funding will be completed by the end of 2018.

“We’re at the all-time highest of capital-raising high water marks, with a tsunami of government-backed entities seeding incubators, VC funds, locally, provincially, nationally,” said Peter Fuhrman, CEO of China-focused investment bank China First Capital. “China has a lot of money in its government apparatus. It wants to seed innovation and entrepreneurship and this is how it’s doing it.”

The surge contrasts with the slowdown in seed financing for start ups in the United States, which is down for the past two years. It also compares with flat growth expected for U.S. venture capital fundraising in 2017, according to estimates from the National Venture Capital Association (NVCA).

CATCHING ENTREPRENEURS

Firms such as Lightspeed China Partners, Morningside Venture Capital, GGV Capital and investment and merchant bank Ion Pacific that previously only had U.S. dollar funds are launching their first funds in yuan. Others like Hillhouse Capital, Sequoia Capital China and China Renaissance that have raised funds in both currencies are adding to their yuan cash pile with new funds.

Key to those firms is to not lose potential investment opportunities in sectors closed to foreign investors or miss out on investing with the Chinese entrepreneurs who now want to list their companies locally instead of in the United States.

“Catching the right entrepreneurs in the ecosystem is our number one priority, so currencies to us are just tools, those are the tools that I need to catch these entrepreneurs,” said Harry Man, partner at Matrix Partners China, which has funds in both currencies. “That’s why if you don’t have RMB in your hand, ultimately you’ll be missing 50 percent of the deals. Then you’ll be forced to raise an RMB fund and that’s why everybody is doing it.”

Sequoia Capital China, which backed top Chinese technology firms such as Alibaba Group (BABA.N), is looking to raise at least 10 billion yuan for a new fund, while Hillhouse Capital, an early investor in companies including Tencent Holdings Ltd (0700.HK), Baidu Inc (BIDU.O) and JD.com Inc (JD.O), is targeting about 8 billion yuan for its fund, sources told Reuters.

The investment management arm of securities firm China Renaissance is also adding to its yuan reserves with a new fund worth about 6 billion yuan, according to a person familiar with the plans who couldn’t be named because details of the fundraising aren’t yet public. Ion Pacific is raising 1 billion yuan for its debut fund in the Chinese currency, while GGV Capital is about to close fundraising for its first yuan-denominated fund.

“Some sectors don’t allow foreign investors, so for example, in the culture and media industry you need to apply for certain licenses like video licenses and you need to be a local investor,” said Helen Wong, a partner at Qiming Venture Partners.

“Now the IPO window is open for the local stock market, so that encourages a lot of companies to go for a local listing,” she added, in reference to the increase in IPO approvals by regulators in 2017 that is prompting more companies to start preparations to go public. Previously, a slow approval process and long line of companies waiting for clearance dissuaded many from those plans.

The shift would give an added boost to the Shenzhen and Shanghai bourses. China has had 322 new listings this year, raising a combined $22.9 billion, Thomson Reuters data showed. This already surpasses the 252 for all of 2016, even after the country’s securities regulator slowed the number of weekly IPO approvals in May.

It could also reduce the influence of the Nasdaq and New York stock exchanges, where many Chinese technology companies previously flocked when they went public.

“For the RMB side, you see more companies in restricted sectors like healthcare and media and certain parts of cleantech that needs government support to get started,” said Hans Tung, managing partner at GGV Capital. “You also see companies in the fintech space and a lot of them need a license to operate a business in the financial services industry, so they tend to want to list in China.”

As published in The New York Times.

Why Has China’s GDP So Outpaced IRR?

It’s the paradox at the core of China investing: why has such a phenomenal economy proved such a disappointing investment destination for so many global institutional investors, PE firms and Fortune 500s.

Financial theory provides a conceptual explanation. Investment returns are not absolutely correlated to GDP growth. China will likely go down in history as the best proof of this theorem. China as certainly delivered exceptional GDP growth. In per capita PPP terms, China is 43 times larger than in 1981, when I first set foot in China as a grad student. No other country has ever grown so fast, for so long and lifted so many people out of poverty and into the consumer middle class.

Commensurate investment returns, however, have been far harder to lock in. Harvard Business School’s global alumni organization invited me to give an hour-long talk on this topic this week. It required a quick gallop through some recent and not always happy history to arrive at the key question — does the future hold m0re promise for global institutional investors looking to deploy capital in China.

 For more detailed look at some reasons for the big disconnect between China’s national GPD growth and investment IRR, and some suggestions how to improve matters, please have a look by clicking here at the HBS talk slide deck.

Publicly-quoted shares in Chinese companies have failed by far and away to keep pace with the growth in overall national income. In the alternative investment arena, global PE and VC firms enjoyed some huge early success in late 1990s and first part of the 2000s. Since then, the situation has worsened, as measured in cash returns paid out to Limited Partners. One major reason — the explosion within China of Renminbi investment funds, now numbering at least 1,000. They’ve bid up valuations, gotten first access to better opportunities, and left the major global PE and VC firms often sitting on the sidelines. With tens of billions in dry powder, these global firms look more and more like deposed financial royalty — rich, nostalgic, melancholy and idle.

China this year will add approximately $1 trillion of new gdp this year – that’s not a lot less than the entire gdp of Russia. Indeed, China gdp growth in 2017 is larger than the entire gdp of all but 15 countries. Who is making all this money? Are all the spoils reserved for local investors and entrepreneurs? Can global investors find a way at last to get a bigger piece of all this new wealth?

Overall, I’m moderately sanguine that lessons have been learned, especially about the large risks of following the Renminbi fund herd into what are meant to be sure-thing “Pre-Ipo” minority deals. Active investment strategies have generally done better. With China’s economy well along in its high-speed transition away from smokestack industries and OEM exports to one powered by consumer spending, there are new, larger and ripe opportunities for global investors. In virtually all major, growing categories of consumer spending, Western brands are doing well, and will likely do better, as Chinese consumers preferences move upmarket to embrace high-quality, well-established global household brand names.

Harvard, its alumni and benefactors have a two hundred year history of investing and operating in China. So, there’s some deep institutional memory and fascination, not least with the risks and moral quandaries that come with the territory. The Cabot family, at one time among America’s richest, provided huge grants to Harvard funded in part by profits made opium running into China.

Harvard Management Company, the university’s $35 billion endowment, was an early and enthusiastic LP investor in China as well as large investor in Chinese quoted companies including Sinopec. Their enthusiasm seems to be waning. Harvard Management is apparently considering selling off many of its LP positions, including those in PE and VC funds investing in China.

This looks to be an acknowledgment that the GP/LP model of China investing has not regularly delivered the kind of risk-adjusted cash-on-cash returns sophisticated, diversified institutional investors demand. While China’s economy is doing great, it’s never been harder to achieve a successful private equity or venture capital investment exit. True, the number of Chinese IPOs has ratcheted up this year, but there are still thousands of unexited deals, especially inside upstart Renminbi funds.

While decent returns on committed capital have been scarce, the Chinese government continues to pour billions of Renminbi into establishing new funds in China. There’s hardly a government department, at local, provincial or national level that isn’t now in the fund creation business. Diversification isn’t a priority. Instead, two investment themes all but monopolize the Chinese government’s time and money — one is to stimulate startups and high-tech industry (with a special focus on voguish sectors like Big Data, robotics, artificial intelligence, biotech) the other is to support the country’s major geostrategic initiative, the One Belt One Road policy.

One would need to be visionary, reckless or brave to add one’s own money to this cash tsunami. Never before has so much government money poured into private equity and venture capital, mainly not in search of returns, but to further policy and employment aims. It’s a first in financial history. The distortions are profound. Valuations and deal activity are high, while returns in the aggregate from China investing will likely plummet, from already rather low levels.

Where should a disciplined investor seek opportunity in China? First, as always, one should follow the money — not all the government capital, but the even larger pools of cash being spent by Chinese consumers.

In China, every major consumer market is in play, and growing fast. This plays to the strengths of foreign capital and foreign operating companies. There are almost unlimited opportunities to bring new and better consumer products and services to China. Let the Chinese government focus on investing in China’s future. High-tech companies in China, ones with globally competitive technology, market share and margins are still extraordinarily rare, as are cash gains from investing here.

Meantime, as I reminded the HBS alumni, plenty of foreign companies and investors are doing well today in China’s consumer market. Not just the well-known ones like Apple and Starbucks. Smaller ventures helping Chinese spend money while traveling globally, or obtain better-quality health care and education options, are building defendable, high-margin niches in China. One company started by an HBS alumnus, a native New Yorker like me, is among the leading non-bank small lending companies in China. It provides small loans to small-scale entrepreneurs, mainly in the consumer market. Few in China know much about Zhongan Credit, and fewer still that it’s started and run by a Caucasian American HBS grad. But, it’s among the most impressive success stories of foreign investment in China.

Of course, such success investing in China is far from guaranteed. Consumer markets in China are tricky, fast-changing, and sometimes skewed to disadvantage foreign investors. For over two hundred years, most foreign investors have seen their fond dreams of a big China payday crash on the rocks of Chinese reality.

The rewards from China’s 35 years of remarkable economic growth has mainly — and rightly — gone to the hard-working people of China. But, there’s reason to believe that in the future, more of the new wealth created each year in China will be captured by smart, pragmatic investors from HBS and elsewhere.

 

As published by China Money Network

As published by SuperReturn

YouTube video of the full lecture to Harvard Business School alumni organization

 

 

 

China’s New Plan for Silicon Valley Partnerships — Global Times

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The once-sizzling romance between China and Silicon Valley has cooled rather dramatically. This has some potentially serious consequences for both sides, but especially for China, which desires to invest in and gain access to some of the hottest new ideas from this cradle of innovation. A new strategy is needed.

Until recently, Chinese investment funds and companies were investing hundreds of millions of dollars every year into promising Silicon Valley start-ups, as part of a strategy to forge closer ties between the US high-technology sector and the large Chinese market. But the flow of funds has largely dried up.

There are two main reasons. First, Chinese regulators imposed new restrictions on large overseas investments. Second, the US government began to take a less friendly attitude toward Chinese technology investment in the US, killing several proposed deals and holding up approval on many others.

There is every sign that things in the US are going to get more restrictive rather than less. As someone convinced of mutual benefits from Chinese investment in US technology, it all seems highly counterproductive. The world needs more deep and extensive ties between the Chinese and the US high-technology world, not just in start-up investing but also in university research and scientific conferences, shared research and development (R&D) labs, and partnerships among large companies working in hot fields like semiconductors, robotics, artificial intelligence and clean energy.

What can China do? Rather than sending money out, it can encourage more US high-technology start-ups to relocate to China. There is a huge amount to be gained, both for China’s continuing industrial upgrading and for innovative US technology companies looking to grow into giants.

China has in abundance the most vital ingredients for technology start-up success:  capital, a market and talented managers and engineers. In many industries, for example advanced manufacturing, robotics and new battery technologies, China often has more to offer technology companies than the US.

China already has lured a lot of Chinese-born scientists and technologists back from Silicon Valley to open start-ups. The next step is to lure some of the best early-stage US technology companies to China. This addresses a big weakness in the US high-technology scene: companies there tend to view the China market as an after-thought. In reality, it is often the market most worth prioritizing.

I’m seeing how well all this can work on the ground. We’re helping a promising US robotics company build its future in China. It is establishing a Chinese company as its main asset and moving some of its core team to China. It expects to add many more staff in China. The breakthrough product it’s now perfecting has a huge potential market in China’s manufacturing industry.

Originally, this company was aiming to find investors in China to help it grow in Ohio. We helped explain why bringing the company to China would make a lot more sense. The company is applying for R&D grants as well as venture capital in China. Within a 100-kilometer radius of its future base in Shenzhen, South China’s Guangdong Province is the largest concentration of potential customers and partners in the world.

We foresee big mutual gains if China can attract many more exciting early-stage technology companies. They  will create jobs, pay taxes and invest in local R&D. The benefits to China should be far larger than just buying some shares in a technology company based in Silicon Valley.

The objective isn’t to evade US rules but to bring start-ups early in their growth stage to the market where the demand is greatest. Technology companies do best when they sit close to the biggest concentration of customers.

The Chinese government has already said it wants to make the country more of a magnet for global technology talent. Shenzhen is a great city for US start-ups to grow big.

The steep drop in Chinese investment in Silicon Valley may actually prove a blessing in disguise. It’s smart to keep more of that capital at home to invest in great technology companies in China. Many US technology start-ups will achieve far more, and far more quickly, if they make China their future home.

The author is Chairman and CEO of China First Capital.

http://www.globaltimes.cn/content/1061519.shtml

China’s Millions of Alzheimer’s Patients Cannot Wait Any Longer for Specialised Care — South China Morning Post

No health care problem looms larger in China than Alzheimer’s disease. It is the fastest-growing major disease on the mainland, with at least 9.5 million ­sufferers and perhaps as many undiagnosed cases. Almost a million Chinese are diagnosed every year with Alzheimer’s, with the number of new cases expected to rise sharply by around 2030.

Of the major diseases in China, Alzheimer’s also has the greatest mismatch between the number of patients and amount of specialised care available. The US has about half the number of Alzheimer’s patients, and 73,000 beds in specialist treatment centres. China has fewer than 200 beds. Alzheimer’s care is a US$250 billion industry in the US. In China, it has barely even begun.

By 2050, the number of Alzheimer’s patients in China is expected to reach 45 million, about half the number worldwide

The reason for this mismatch is clear. China’s health care system is already under strain to improve the quality of care overall, especially for diseases like cancer and hepatitis. Alzheimer’s is not a top priority, either for government policy or health care companies and investors.

But, over the coming decades, no disease will possibly impact more lives in China or possibly cost the country more to treat. By 2050, the number of Alzheimer’s patients in China is expected to reach 45 million, about half the number worldwide.

The total cost of treating all of them is impossible to estimate. Alzheimer’s is already the most expensive disease to treat in the US. With the number of cases there expected to double in the next 20 years, US government spending on Alzheimer’s care is on course to become the single most expensive part of the national budget, topping even military spending.

China is likely to take a different path, with more spending done by patients and their families, rather than through national health ­insurance. But the near-total lack of ­Alzheimer’s treatment centres, and trained nurses and doctors, is one of the most significant market failures in China’s health care industry.

 While the government, SOEs and private sector have been making significant investments in old age care, most of it has gone towards flats in retirement communities, for older people fundamentally still healthy and active. There has been little investment in elderly care. The urgent need is to provide specialist centres for people with Alzheimer’s and other chronic diseases that afflict the elderly, like Parkinson’s, arthritis, and post-stroke conditions.
In China, Alzheimer’s is still often seen not as a disease but as an inevitable and natural part of ageing

In China, Alzheimer’s is still often seen not as a disease but as an inevitable and natural part of ageing, a sad side effect of enjoying a long life. The national broadcaster, CCTV, has of late been airing public service advertisements to raise awareness about Alzheimer’s as a disease. This is the same education process the US and Europe began over 40 years ago.

Alzheimer’s, like diabetes, obesity or colorectal cancer, is a disease of economic success. As a country becomes richer and health care standards improve, people live longer. Nowhere has this transformation happened more quickly than in China, meaning an explosive growth in the number of Alzheimer’s cases as has never been seen before.

The average life expectancy in China has ­increased more in the past 30 years than in the previous 3,000. China’s life expectancy is still growing faster than that of developed countries.

The facts: Alzheimer’s is an incurable disease that afflicts a large number of older people, but not the majority. About 3 per cent of people aged 65 to 74, and 17 per cent of those between 75 and 85, will develop the disease. Those over 85 have a 30 per cent chance of getting it. It is a mystery why some old people get Alzheimer’s and most do not.

One interesting correlation: people with higher education levels are less likely to get the disease. The more you use your brain in complex ways, the more you may inoculate yourself against Alzheimer’s.

Rural people are more susceptible than city-dwellers. With a larger percentage of Chinese living in rural areas, the percentage of over-80s with the disease may end up higher than in the US, Europe or other more urbanised Asian societies of Japan, Korea, Taiwan or Singapore. Women are more likely to get Alzheimer’s, as they live longer on average.

Despite billions of dollars spent on scientific and pharmaceutical research in the West, there are no drug or surgical treatments for Alzheimer’s. Brain chemistry and biology make developing a drug for Alzheimer’s difficult.

Brain chemistry and biology make developing a drug for Alzheimer’s difficult

Despite this, there have been remarkable successes in Europe and the US, especially in the past 10 years, at care facilities managed by specially trained nurses and doctors. They work together to slow the progress of the disease in patients, through physical therapy, psychological counselling, special equipment to improve memory and mobility, one-on-one assistance, and a safe living environment designed for the care of people gradually losing their ability to think, speak and function.

The result: Alzheimer’s patients in Europe and the US now live twice as long after diagnosis than 30 years ago, an average of eight to 10 years.

Dozens of US and European-listed companies are focused on research and specialist Alzheimer’s care in nursing homes and clinics. China has none.

Traditionally in China, more money has been spent on children’s education than on medical care for older people. But, as Chinese live longer, the way money is spent across three generations is likely to change. The grandchildren of people in their 80s will have usually already been through college and are working. That leaves more money, both in the hands of older people and their children, to provide more high-quality care for those at the end of their lives.

Alzheimer’s care will also ­become a huge source of new employment in China

How should China build its Alzheimer’s treatment infrastructure and bring it quickly up to global standards? The biggest need will be providing care to those with average family income and savings levels.

If there’s one advantage to getting a late start, it’s that China can learn from the mistakes of, and adopt the best ideas developed in, the US, Europe and Asia. Japan, for example, is not only building specialist nursing homes for Alzheimer’s patients in the final years of their lives, but also community centres for those still living at home or with relatives.

Home nursing care is expanding in the West, ­improving and lengthening the lives of Alzheimer’s patients. Home nursing is still at a very early stage in China, but it is the fastest growing industry and largest source of new jobs in the US.

From little spending now on specialised Alzheimer’s care, China will certainly grow into the world’s largest market for it. Alzheimer’s care will also ­become a huge source of new employment in China.

It’s hard to think of a business opportunity in China with better long-term investment fundamentals than specialised Alzheimer’s care. But the greatest return on investment would be in limiting the suffering of Alzheimer’s patients and their families.

Peter Fuhrman is CEO and Dr Wang Yansong, is COO, respectively, of China First Capital. This article is adapted from a version originally published in The Week In China

http://www.scmp.com/comment/insight-opinion/article/2098539/chinas-millions-alzheimers-patients-cannot-wait-any-longer

 

Goldman, Lazard China Dealmakers Decamp for Upstart Funds — Bloomberg

(Bloomberg) — Veteran China dealmakers at Wall Street banks and Western buyout firms are heading for the exits, in search of the more lucrative deals and higher remuneration offered by smaller funds.

Three senior merger advisory bankers from Goldman Sachs Group Inc., Bank of America Corp. and Lazard Ltd. have resigned within the past month for senior roles at fledgling investment funds, according to people familiar with their departures, who asked not to be identified discussing private information. Carlyle Group LP Managing Director Alex Ying left the firm in January after two decades to set up Rivendell Partners, which focuses on mid-sized buyouts in Greater China and Vietnam, other people said.

The moves highlight the increasing challenges big banks face in retaining their top dealmakers in an environment of tighter regulations and shrinking fees. Revenue from investment banking in the Asia Pacific region fell 8 percent in 2016 to the lowest in at least five years, according to data from research firm Coalition. Merger advisory revenue dropped 4 percent, the figures show.

“Deal flow from China has come down considerably — those flows are severely curtailed relative to where they were,” said Henry Tillman, chairman of London-based advisory firm Grisons Peak LLP. “With investment banking revenue declining, people are going to look at their options.”

Imminent departures include Andrew Huang, a managing director advising on Greater China mergers and acquisitions at Goldman Sachs who has resigned to join Chinese private equity firm FountainVest Partners, according to the people. Peter Kuo, a China M&A banker at Lazard, is leaving to help run a technology fund backed by Chinese investors called Canyon Bridge Capital Partners, the investment firm confirmed in response to Bloomberg queries.

Higher Returns

Ellis Chu, head of China M&A at Bank of America, has also resigned and will be joining an Asia-focused fund, the people said.

Spokesmen for Bank of America, Goldman Sachs and Rivendell declined to comment on the departures. A representative for Carlyle confirmed Ying’s departure, declining to comment further. FountainVest Chief Executive Officer Frank Tang didn’t answer calls to his mobile phone seeking comment.

Running or working for a smaller, Asia-based fund can offer managers greater independence in decision-making on deals and give them a bigger share of fees and profits from exiting investments. Senior executives at global buyout funds in Asia typically have to share 40 percent to 60 percent of deal fees generated in the region with U.S. and European counterparts, people familiar with the practice said.

Smaller funds are also making more money. Private funds in Asia with assets of $500 million or less had a median internal rate of return of 16.1 percent over a three-year timeframe, compared with 11.5 percent at peers with more than $1 billion of assets, according to data compiled by research firm Preqin Ltd.

High Turnover

“A reason these guys are leaving likely also includes the fact those big firms have been having a challenging time of late in China, which leads to higher work pressure and unusually high turnover,” said Peter Fuhrman, chairman of Shenzhen-based China First Capital. “You can then try to set up on your own, make some deals, hope for success.”

The exits follow other recent moves to smaller outfits. KKR & Co.’s two most senior China executives left in December to form a China-focused investment firm. Richard Wong, an M&A veteran at Morgan Stanley, resigned this month after 16 years to help set up Nexus Point Partners, a China-focused buyout fund started by MBK Partners Ltd. co-founder Kuo-Chuan Kung.

The bankers and their new funds will face challenges when it comes to sourcing China deals. The government is clamping down on money outflows, which augurs poorly for outbound acquisitions. What’s more, competition is increasing from Chinese securities firms. Three Chinese banks ranked in the top 10 advisers on offshore acquisitions by mainland companies since the beginning of 2016, according to data compiled by Bloomberg.

Among the first buyout specialists to make the leap from big outfits were KY Tang, who left UBS AG’s private equity fund in 2004 to start Affinity Equity Partners, and Michael Kim, who set up MBK in 2005 with five other senior Asian executives from Carlyle. In 2010, TPG Capital lost Shan Weijian, who left to found PAG Asia Capital. The next year, Mary Ma departed to help start Boyu Capital.

https://www.bloombergquint.com/markets/2017/03/30/veteran-china-dealmakers-leave-wall-street-for-upstart-funds

Turbulence and Paralysis: the Year Ahead in US-China Relations — Financial Times

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trumpxi

A month before his official inauguration, Donald Trump is already tossing diplomatic grenades in China’s direction. It is a sign of things to come. 2017 is shaping up to be a highly eventful, taut and precarious year for China-US relations. This is partly due to a simple scheduling coincidence.

2017 will be the first time ever when both the US and the PRC in the same year will usher in new governments. The US will kick things off on January 20th by swearing in Donald Trump as President. China, meanwhile, will undertake its own large political upheaval, its five-yearly change in political leadership, culminating in the 19th Communist Party Congress sometime late in the year. Virtually the entire government hierarchy, from local mayors on up, will be changed in a monumental job-swapping exercise orchestrated by Xi Jinping, China’s president.

The US under Mr Trump, with a Republican Congress at his back, seems intent to challenge China more assertively in trade, investment and as a currency manipulator while intensifying the military rivalry. China’s leadership, meantime, will become deeply absorbed in its own highly secretive, inward-looking and internecine political maneuvering. While Mr Xi tries to further consolidate his power, Mr Trump will likely be asserting his, leading to a globally ambitious US and an introspective China. This would represent something of a role reversal from recent precedent.

With the chess pieces all in motion, businesses should be plotting their moves in China with caution. The proposed Trans Pacific Partnership (TPP) trade deal is dead, leaving China’s still-evolving “One Belt,One Road” initiative as the main impetus for new trade flows in Asia. Donald Trump says he will push for what he claims to be more “more fair” bilateral trade deals. China, with its $365bn trade surplus with the US and high barriers to much inward investment, is clearly in his sights.

How will China react? The only certainty is that as the year progresses, China’s government apparatus will slow, and with it decision-making at policy-making bodies and many State-owned enterprises (SoEs). All will wait to hear what new tunes to march to, once the new ruling Politburo is revealed to the public in the fourth quarter.

Chinese officials at all levels are already jockeying for promotion. That means falling into line with Mr Xi’s anti-corruption campaign. The Party Secretary in Jiangsu province, one of China’s wealthiest, got an early head start. He instituted his own form of localized prohibition, ordering that government officials could no longer drink alcohol at any time, in any kind of setting, anywhere in Jiangsu.

The booze embargo did include one loophole. If senior foreign guests are present, alcohol can flow as before, like an undammed torrent.

As the Party Congress approaches, it will be even harder to get a deal with a Chinese SoE lined up and closed within any kind of reasonable time frame. Even after the Party Congress ends, it will likely take more months for any real deal momentum to return. Investment banking bonuses along with billings at global law, accounting and consulting firms are all likely to take a hit.

One other certainty: the renminbi will come under increasing pressure as the US ratchets up its moves to apply tariffs to Chinese exports and China’s own economy remains, relatively speaking, in the doldrums. How much pressure, though, is another question.

Anyone making predictions about the speed and degree of the renminbi’s decline is playing with a loaded weapon. A year ago some of the world’s biggest and loudest hedge fund bosses, including Kyle Bass, David Tepper and Bill Ackman, were proclaiming the imminent collapse of the renminbi. The renminbi, despite slipping by about 6 per cent during 2016, has yet to behave as the money guys predicted.

The Chinese government uses non-market mechanisms to slow the renminbi’s decline. A recent example: its abrupt move in November to tightly control outbound investment and M&A. But shoring up the currency will undercut one of China’s larger economic imperatives, the need to upgrade the country’s industrial and technological base. That will require a prodigious volume of dollars to acquire US and European technology companies such as recent Chinese deals to acquire German robot-maker Kuka and US semiconductor company Omnivision.

Chinese investors and acquirers not only face tighter controls on the outflow of US dollars. The US is also becoming more antagonistic toward Chinese acquisitions in the US and globally. Deals of any significant size need to pass a national security review overseen by a shadowy interagency body known as the Committee on Foreign Investment in the United States, or CFIUS.

CFIUS works in secret. In recent months, it has blocked Chinese investment in everything from a San Diego hotel, to Dutch LED light bulbs as well as US and European companies more explicitly involved in high-tech industry including semiconductor design and manufacturing. The strong likelihood is CFIUS will become even more restrictive once Mr Trump takes over.

Unlike most areas of bilateral tension between the US and China, this is one area where the Chinese have no room to retaliate in kind. China already has a blanket prohibition on investment by US, indeed all foreign companies, into multiple sectors of the Chinese economy, from tech industries like the internet and e-commerce all the way to innocuous ones like movies, cigarettes and steel smelting. So, for now, China quietly seethes as the US intensifies moves to prevent China investment deals from being concluded.

China will probably need to regroup and start playing the long game. That means investing more in earlier stage tech companies, especially in the Silicon Valley, and hoping some then strike it big. These venture capital investments generally fall outside the tightening CFIUS net. China wants to spend big and spend fast, but will find it often impossible to do so.

Even as political and military tensions rise between the US and China in 2017, one ironic certainty will be that a record number of Chinese are likely to go to the US as tourists, home buyers or students and spend ever more there. China’s ardour for all things American – its clean air, high-tech, good universities, relatively cheap housing, and retail therapy – is all but unbounded.

If informal online surveys are to be believed, ordinary Chinese seem to like and admire Mr Trump, especially for his business acumen. Mr Xi, understandably, may view the new US President in a harsher light. Xi faces cascading complexities as well as factional opposition within China. He could most use a US leader cast in the previous mold, committed to constructive cooperation with China. Instead, he’s likely to contend with an unpredictable, disapproving and distrustful adversary.

https://www.ft.com/content/b1801637-4219-3222-9f45-658740aa1187

China Inc.’s Investment Bank Dives Into Troubled Retail Market — Bloomberg

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headline

China International Capital Corp., the investment bank ex-Premier Zhu Rongji set up two decades ago to help restructure the Chinese economy, is again taking on a role that fits with the government’s agenda.

CICC’s $2.5 billion acquisition of China Investment Securities Corp. will plunge the firm into the retail investor market, a segment it had long shunned because of thin margins and a traditional focus on institutional clients. The deal is part of Chief Executive Officer Bi Mingjian’s push to lessen dependence on volatile investment banking fees.

Yet the transaction also ties in with a key objective of the government, which will become CICC’s largest shareholder as a result of the purchase. Having used CICC to take some of the largest state companies public since the late 1990s, China is now looking for assistance in its quest to reform a retail-driven equities market that’s prone to speculative booms and busts.

In the wake of the latest such episode, a stock market meltdown last year, the government launched an unprecedented crackdown on the securities industry and arrested several high-ranking executives.

“CICC will once again play this civilizing and globalizing role, only with the more far-reaching aim of helping to professionalize the often-shambolic Chinese stock market,” said Peter Fuhrman, chairman of China First Capital, a Shenzhen-based advisory firm. “Its reputation is still unsullied in China, unlike other banks whose leaders have been marched out in handcuffs and whose market practices are widely blamed for the rampant speculative fever that often afflicts China’s domestic capital markets.”

Reforming Role

In announcing the takeover on Friday, CICC hinted at a reforming role by saying the two firms will “work together to improve the quality and efficiency of mass market services” through training and by upgrading technology systems at China Investment Securities’ 192 branches across the country that serve retail clients.

CICC is buying China Investment Securities from state-owned Central Huijin Investment Ltd. It will issue shares to Central Huijin, more than doubling the entity’s stake in CICC to 58.7 percent. CICC had to get a waiver from the Hong Kong Stock Exchange for the transaction, so that Central Huijin’s controlling stake wouldn’t be classified as a reverse takeover.

An additional rationale for the deal is Huijin’s push to consolidate the securities industry by combining institutional and retail brokerage businesses, said Zhang Chunxin, an analyst at CMB International Capital Holdings Corp. She cautioned that “the reform process will be long and gradual.”

China Investment Securities ranked 17th among Chinese securities firms by revenue last year, while CICC was 23rd, according to official data. Bi’s overhaul has the support of the firm’s foreign shareholders, who had already been pushing CICC to diversify into areas such as asset and wealth management, a person with knowledge of the matter said.

Sherry Tan, spokeswoman at CICC, declined to comment.

Shareholder Backing

The combined stakes of CICC’s main foreign backers — private equity firms TPG Capital and KKR & Co., and Singapore sovereign wealth fund GIC Pte — will drop to 15.3 percent as a result of the takeover. However, the foreign firms may buy additional stakes from Central Huijin in future, people familiar with the matter said.

When former premier Zhu Rongji created CICC in 1995, China was launching a shakeup of its state-run industrial sector, leading to the closure of some 60,000 firms and loss of 40 million jobs. Since then, CICC has worked on some of the biggest listings of state enterprises, such as China Construction Bank Corp. and China Mobile Ltd. It was the top adviser on mergers involving Chinese companies in 2014, 2015 and so far this year.

Buying China Investment Securities is a departure from former CEO Levin Zhu’s strategy. The son of the former premier, who ran the firm until two years ago, had long resisted expanding into retail broking, fearing it would erode margins and its differentiation from other Chinese securities firms, according to people familiar with the matter.

Last year’s leverage-fueled equities rally and the subsequent implosion brought worldwide attention to the shortcomings of China’s markets. The government responded with an effort that included enlisting securities firms in supporting the stock market as well as jailing senior brokerage executives for alleged wrongdoing. CICC wasn’t among the firms that took part in the stock-market rescue, but China Investment Securities was.

Market Manias

China’s 114 million individual investors account for the bulk of equities trading. That makes them a hard-to-ignore segment, but also one that tends to be susceptible to market manias. Critics contend that the government’s efforts to restore market calm last year only served to hurt investor confidence further.

The Shanghai Composite Index remains 39 percent below its June 2015 peak. Xiao Gang, who was removed from his post as chairman of China’s securities regulator this year, in January acknowledged loopholes and ineptitude within the regulatory system.

Some analysts aren’t convinced the deal is in CICC’s best interest. The stock fell 2.1 percent on Monday after a trading halt was lifted.

The transaction makes the firm “more like a state-owned company, which could compromise CICC’s corporate governance, operational autonomy” and its ability to retain top talent, said Fred Hu, Goldman Sachs Group Inc.’s former Greater China chairman.

http://www.bloomberg.com/news/articles/2016-11-07/china-inc-s-investment-bank-dives-into-troubled-retail-market

PAG Said to Pay About $250 Million for Chinese School Operator — Bloomberg

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By Cathy Chan

(Bloomberg) — PAG Asia Capital has paid about $250 million for Golden Apple Education Group, a Chinese company that’s been embroiled in legal action brought by creditors of its former owner, according to people familiar with the matter.

The Hong Kong-based private equity firm acquired Golden Apple from Sichuan Harmony Group, a Chengdu-based property developer, the people said, requesting anonymity because the details of the transaction are private. Golden Apple became involved in legal cases brought since 2014 by Sichuan Harmony’s creditors because it guaranteed some of the property developer’s loans, the people added.

The sale of Golden Apple helped resolve legal claims from about 60 individuals and money lenders, some of which had foreclosed on Sichuan Harmony assets, according to an official at Sichuan Financial Assets Exchange, the state-backed entity which was appointed to lead the Sichuan Harmony debt restructuring together with PAG.

“It’s highly unusual for a foreign private equity firm to buy a Chinese company undergoing court-supervised administration,” said Peter Fuhrman, the chairman of China First Capital, a Shenzhen-based investment banking and advisory firm.

The unwillingness of many Chinese creditors to write off part of their loans, a concession needed to restructure debt and give a company a new start, makes such deals “worlds away both in complexity and investment appeal” from other private equity transactions, Fuhrman said.

 One-Child Policy

A spokesman for PAG declined to comment. A spokeswoman for Golden Apple referred to an Aug. 25 media interview posted on the company’s website which said it is partnering with PAG and plans to invest 2 billion yuan ($295 million) in its facilities over the next two to three years. She declined to comment further on the PAG acquisition or on the company’s legal issues.

PAG, co-founded by former TPG Capital veteran Shan Weijian, is buying Golden Apple partly because China’s move to repeal its decades-old one-child policy has bolstered the prospects of the education industry, according to the people. The Chinese government has estimated that the change is likely to add three million newborns each year. Investors have taken note, with venture capital companies conducting 10 fundraising rounds in the first half for startups in the maternity and pediatric market, according to VC Beat Research, which tracks internet health-related investment and fundraising.

   Kindergartens

Golden Apple operates 33 kindergartens and two primary schools, mostly based in Chengdu, with more than 12,000 students, the people said. PAG plans to expand the number of primary schools and develop secondary schooling after acquiring the business, according to the people.

Sichuan Harmony has reduced its outstanding loans from state-backed lenders from 2.5 billion yuan to 1.9 billion yuan, according to the Sichuan Financial Exchange official, who asked not to be identified by name. The company has 4.5 billion yuan of assets and will focus on its medical and community nursing- home businesses, the official added.

The market for online education services in China has also attracted overseas interest. KKR & Co. last year agreed to invest $70 million in Tarena International Inc., which offers in-person and online classes in information technology, marketing and accounting. GIC Pte and Goldman Sachs Group Inc.

were among investors putting $200 million into TutorGroup, a Chinese online education platform, in its third round of financing in November. CVC Capital Partners in May sold its stake in Education International Corp., China’s biggest overseas educational counselling service provider, to a consortium led by Chinese private equity fund NLD Investment LLP.