China venture 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

 

 

 

 

 


Will Bad Money Drive Out Good in Chinese Private Equity?

2 Comments / December 1, 2009

Qing Dynasty jade boulder, from China First Capital blog post

The financial rule first postulated by Sir Thomas Gresham 500 years ago famously holds that “bad money drives out good”. In other words, if two different currencies are circulating together, the “bad” one will be used more frequently. By “bad”, what Gresham meant was a currency of equal face value but lower real value than its competitor. A simple way to understand it: if you had two $100 bills in your wallet, and suspected one is counterfeit and the other genuine, you’d likely try to spend the counterfeit $100 bill first, hoping you can pass it off at its nominal value. 

While it’s a bit of a stretch from Sir Thomas’s original precept, it’s possible to see a modified version of Gresham’s Law beginning to emerge in the private equity industry in China. How so? Money from some of “bad” PE investors may drive out money from “good” PE investors. If this happens, it could result in companies growing less strongly, less solidly and, ultimately, having less successful IPOs. 

Good money belongs to the PE investors who have the experience, temperament, patience, connections, managerial knowledge and financial techniques to help a company after it receives investment. Bad money, on the other hand, comes from private equity and other investment firms that either cannot or will not do much to help the companies it invests in. Instead, it pushes for the earliest possible IPO. 

Good money can be transformational for a company, putting it on a better pathway financially, operationally and strategically. We see it all the time in our work: a good PE investor will usually lift a company’s performance, and help implement long-term improvements. They do it by having operational experience of their own, running companies, and also knowing who to bring in to tighten up things like financial controls and inventory management. 

You only need to look at some of China’s most successful private businesses, before and after they received pre-IPO PE finance, to see how effective this “good money” can be. Baidu, Suntech, Focus Media, Belle and a host of the other most successful fully-private companies on the stock market had pre-IPO PE investment. After the PE firms invested, up to the time of IPO, these companies showed significant improvements in operating and financial performance. 

The problem the “good money” PEs face in China is that they are being squeezed out by other investors who will invest at higher valuations, more quickly and with less time and money spent on due diligence. All money spends the same, of course. So, from the perspective of many company bosses, these firms offering “bad money” have a lot going for them. They pay more, intrude less, demand little. Sure, they don’t have the experience or inclination to get involved improving a company’s operations. But, many bosses see that also as a plus. They are usually, rightly or wrongly,  pretty sure of themselves and the direction they are moving. The “good money” PE firms can be seen as nosy and meddlesome. The “bad money” guys as trusting and fully-supportive. 

Every week, new private equity companies are being formed to invest in China – with billions of renminbi in capital from government departments, banks, state-owned companies, rich individuals. “Stampede” isn’t too strong a word. The reason is simple: investing in private Chinese companies, ahead of their eventual IPOs, can be a very good way to make money. It also looks (deceptively) easy: you find a decent company, buy their shares at ten times this year’s earnings, hold for a few years while profits increase, and then sell your shares in an IPO on the Shanghai or Shenzhen stock markets for thirty times earnings. 

The management of these firms often have very different backgrounds (and pay structures) than the partners at the global PE firms. Many are former stockbrokers or accountants, have never run companies, nor do they know what to do to turn around an investment that goes wrong. They do know how to ride a favorable wave – and that wave is China’s booming domestic economy, and high profit growth at lots of private Chinese companies. 

Having both served on boards and run companies with outside directors and investors, I am a big believer in their importance. Having a smart, experienced, active, hands-on minority investor is often a real boon. In the best cases, the minority investors can more than make up for any value they extract (by driving a hard bargain when buying the shares) by introducing more rigorous financial controls, strategic planning and corporate governance. The best proof of this: private companies with pre-IPO investment from a “good money” PE firm tend to get higher valuations, and better underwriters, at the time of their initial public offering. 

But, the precise dollar value of “good money” investment is hard to measure. It’s easy enough for a “bad money” PE firm to claim it’s very knowledgeable about the best way to structure the company ahead of an IPO.  So, then it comes back to: who is willing to pay the highest price, act the quickest, do the most perfunctory due diligence and attach the fewest punitive terms (no ratchets or anti-dilution measures) in their investment contracts. In PE in China, bad money drives out the good, because it drives faster and looser.

No Preference: Disallowing Preferred Shares for Private Companies is Hobbling China’s Venture Capital and Private Equity Industry

Leave a Comment / October 31, 2009

 

Ming Dynasty mother-of-pearl from China First Capital blog post

Chinese securities regulations do not allow private domestic companies to issue preferred shares.  It does not sound particularly problematic, since preferred shares are not all that common anywhere. And yet, this regulatory quirk has serious unintended consequences. It is holding back the flow of private equity and venture capital investment into promising Chinese companies, particularly those with more than one shareholder. 

Preferred shares earn their name for a reason. These shares enjoy certain preferences over common shares, most often greater voting power and better protection in the event of bankruptcy. Preferred shares are the main mechanism through which venture capital and private equity firms invest in private companies. In general, when a PE or VC firm invests, the company receiving the investment creates a special class of preferred shares for the PE or VC. These preferred shares will have a raft of special privileges, above and beyond voting rights and liquidation preference. The theory is, the preferred shares level the playing field, giving the PE or VC firm more power to control the actions of the company, particularly how it uses the VC money,  and so protect its illiquid investment. 

Take away the ability to issue preferred, as is the case in China, and things begin to get much trickier for PE and VC investment. PE and VC firms are loathe to invest in ordinary common shares, since this gives them little of the protection they need to fulfill properly their fiduciary duty to their Limited Partners. There are, of course, all kinds of clever solutions that can be and often are employed to get around this problem in China. For example, the PE or VC firm can ask their very clever lawyers to craft a special shareholders agreement, to be signed by the company it’s investing in, that gives the PE or VC firm the same special treatment conferred by preferred shares. 

The problem here, though, is the legal enforceability of a shareholder agreement is not cut-and-dried.  A basis of most securities law, in China and elsewhere, is that all shareholders holding the same class of shares must be treated equally. In other words, if a PE or VC firm has ordinary common shares, it can’t get better treatment and more rights than any other common shareholder. 

What happens if a PE or VC firm’s shareholder agreement conflicts with this principle of equal treatment? China’s legal system is evolving, and precedent is not unequivocally clear. But, in general, the law takes precedence over any contract. In other words, if it comes down to a court fight, the PE or VC firm might find its shareholders agreement invalidated. 

This is not some remote likelihood, particularly if the company has more than just the founder and the PE or VC firm as shareholders. The “unpreferred” common shareholders have every right and many reasons to feel disadvantaged if they are deprived the same rights enjoyed by a VC firm also holding common shares.

There are many scenarios when this could lead to litigation, not just if the company runs into trouble, and shareholders end up fighting over how to divide whatever assets remain There’s also a big chance of legal mischief if the company does splendidly well. Let’s say the company is preparing for an IPO, and a shareholders agreement gives the VC firm special rights to have their shares registered and fully tradeable. This is a fairly common element in shareholders agreements. Other common shareholders would have ample reason to object, if their shares can’t be liquidated at the same time.  

Sometimes in business, legal uncertainty can be useful In this case, though, there are no clear winners. Anything that makes PE or VC firms less likely to invest disrupts the flow of capital to worthy businesses. That’s the situation now in China, with preferred shares disallowed and much uncertainty surrounding the legality of shareholders agreements. 

I have no special insight into why Chinese regulators have outlawed preferred shares for private domestic companies, or whether they are contemplating a change. But, a change would be beneficial. Most likely, the prohibition of preferred shares was designed to stop private companies from fleecing their unsuspecting equity-holders. In other words, the motive is sound. But, if the result is less growth capital available for successful young Chinese companies, the medicine ends up occasionally killing the patient. That doesn’t serve anyone’s interests: not entrepreneurs, nor investors, nor the country as a whole. 

 There are ways to give common shareholders some protection while still allowing private companies to create preferred shares. Ultimately, these common shareholders will likely benefit from the injection of PE or VC money into a company they’ve also invested in.  A shortage of capital is always a problem for growing companies, but it’s a particularly acute one in China. The PE or VC firm will also usually play a much more active role than other shareholders in building value, giving these other shareholders a free ride. 

Like most, I invest to make money, not exercise voting rights. So, my preference as a common shareholder will be to let the preferred have whatever rights they deem important – as long as they are doing the heavy lifting and pushing hard to build profits. They bring the capital, track record and expertise that often makes all the difference between a successful company and a has-been. I prefer to invest for success, and that often means preferring the presence of preferred investors.

China Zigs While the Rest of the PE and VC World Zags

Leave a Comment / September 10, 2009

Tang vase from China First Capital blog post

This is a time of darkness and despair for most private equity and venture capital guys. Their world came crumbling down last year, as credit and stock markets collapsed and IPO activity came to a halt everywhere —  everywhere that is, except China.  

If ever there were an example of a counter-cyclical trend, it is the private equity industry in China. It is poised now for the most active period, over the next 12 months, in its young history. There are many reasons to explain why China should be so insulated from the deep freeze that’s gripping the industry elsewhere. For one thing, it has always relied less on leverage, and more on plain vanilla equity investing. 

This mattered crucially, since as credit markets seized up last year, PE firms were still able to do deals in China, by putting their own equity to work. Of course, PE firms in the US could have done the same thing. After all, most have very large piles of equity capital raised from limited partners. But, they have habituated themselves to a different form of investing, involving tiny slivers of equity and very large slabs of bank debt. Like any leveraged transaction, it can produce phenomenal results, on a return-on-equity basis. But, without access to the debt component, many PE firms seem adrift. It’s as if they’ve forgotten, or lost the knack of how to properly evaluate a company, to look at cash flows not in relation to potential debt service, but as a telltale sign of overall operating performance. 

Many PE firms these days seem to resemble a hedge fund gone bad:  they once had a formula for making great piles of money. Then, markets changed, the formula stopped working, and the firms are at a loss as to how to proceed. 

China looks very different. Beyond the lack of leverage, there are other, larger factors at work that are the envy of the rest of the PE world. Most importantly, China’s economy remains robust. It’s done a remarkable pirouette, while the rest of the world was falling flat on its face. An economy dependent until recently on exports is now chugging along based on domestic demand. And no, it’s not simply — or even mainly —  because of China’s huge +$600 billion stimulus package. The growth is also fueled by Chinese consumers, who are continuing to spend. 

There’s one other key factor, in my opinion, that sets China apart and makes it the most dynamic and desirable market for PE investing in the world: the rise of world-class private companies, of a sufficient scale and market presence to grow into billion-dollar companies. In other words, PE investing in China is not an exercise in financial engineering. It’s straight-up equity investing into very solid businesses, with very bright futures. 

One common characteristic of PE investing in China, all but absent in the US, is that the first round of equity investment going into a company is smaller than trailing revenues. So, in a typical deal, $10mn will be invested into a company with $50 million of last year’s revenues, and profits of around $5 million. Risk mitigation doesn’t get much better than this: investing into established, profitable companies that are often already market leaders — and doing so at reasonable price-earnings multiples. 

China has other things going for it, from the perspective of PE investors: the IPO window is open; dollar-based investors have the likely prospect of upping their gains through Renminbi appreciation; management and financial systems both have significant room for improvement with a little coaching from a good PE firm. 

It all adds up to a unique set of circumstances for PE investors in China.  It’s a highly positive picture all but unrecognizable to PE and VC firms in the US and elsewhere. Opportunities abound. Risk-adjusted returns in China are higher, I’d argue, than anywhere else in the world. A +300% return over three to five years is a realistic target for most PE investment in China. The PE firms invest at eight times last year’s earnings, and should exit at IPO at 15 times, at a minimum. Pick the right company (and it’s not all that difficult to do so), and the capital will be used efficiently enough to double profits over  the term, between the PE investment and the IPO.  Couple these two forces together — valuation differentials and decent rates of return on invested capital — and the 300% return should becomes a modest target as well as reasonably commonplace occurrence. 

It’s  the kind of return some US PE firms were able to earn during the good years, but only by layering in a lot of bank debt on top of smaller amounts of equity. That model may still work, at some future time when banks again start lending at modest interest rates on deals like this. But, there’s an inherent instability in this highly-leveraged approach: cash flows are stretched to the limit to make debt payments. A bad quarter or two leads to missed repayments, and the whole elaborate structure crumbles: just think of Cerberus’s $7.5 billion purchase of 80% of Chrysler. 

China is in a world of its own, when it comes to PE investing. My best guess is that it remains the world’s best market for PE investment over the next ten years at least. Little wonder that many of the world’s under- or unemployed PE staff members are taking crash courses in Chinese. 

Here’s one of the slides from the PPT that accompanied a recent talk I gave  in Shanghai called “Trends in Global Private Equity: China as Number One”.

Private Equity in China  中国的私募股权投资: 

—Strong present, stronger future—  今天不差钱，明天更美好

—PE firms continue to raise money for investment in China, over $10 billion in committed   capital and growing —  私募股权基金仍在继续募集资金投资国内，规模已经为100亿美元并将继续增长

—Next 12 months : most active in history ; IPO window open; finding and financing China’s next national champions —  未来的一年：历史上最蓬勃发展的时期，IPO 重启，发现并投资中国下一批的企业明星

 

For whole presentation, please click: 私募股权投资：中国成为第一 

 


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Chinese Language Report on Private Equity in China 2009: 中国的私募股权投资与战略并购

Leave a Comment / March 24, 2009

Following on from the publication of the China First Capital report, “2009 Private Equity and Strategic M&A Transactions in China — A Preview“ , the Chinese version is now completed. It’s more than just a change in language.

It incorporates a different but complimentary perspective to the English report, one enriched by the deep knowledge, insights and experience of my China First Capital colleague, Amy Bai. 谢谢白海鹰。

Here’s the first section. 

China First Capital Chinese language report on Private Equity, Venture Capital in China 2009

 

 

概  览chinese-balance

 

危机创造机遇

2008 年对于中国是不平凡的一年。2008年带给我们骄傲和欢乐，也带给我们挫折和悲伤。北京奥运会使我们感到前所未有的骄傲和自豪。刚刚战胜了冰冻灾害的我们又遭遇了汶川大地震。

从经济领域来看，2008年同样也是不平凡的一年。在年初，上海、深圳和香港的股市都出现了长势良好的喜人景象。IPO形势大好。然而，在2008年夏，股市开始暴跌 ，IPO也开始枯竭。到年底，上海、深圳和香港的股市均下跌了60%左右。 

中国的私募股权投资和风险投资出现了与股市涨跌相应的波动变化。在年初，投资活动非常活跃。上半年，私募股权投资和风险投资在中国的投资总额超过了100多亿美元。随着金融风暴的影响，私募股权投资和风险投资也放缓了在中国的投资步伐。到去年底的时候，基本上已经停止了所有投资活动。 

中国，美国和全球其他国家均以前所未有的方式采取了一系列干预措施，以期稳定经济。然而， 

当我们跨入2009年时，全球经济进入衰退期已成为不争的事实。 

大家所关心的问题是，经济复苏期何时来临？何时开始新一轮的投资比较合适？我公司愿与您们分享就上述问题的一些观点和想法。 

作为中国首创投资的董事长，凭借在资本市场，私募股权投资和商业领域20余年的经验，我经历过数次商业周期，并且成功地带领我的企业幸存了下来。例如，我曾经担任美国加州一家风险投资公司的首席执行官，目睹了网络泡沫的破灭， 当时的情形和现在类似，所有的私募股权投资活动几乎都停止了。 但是，仅仅两年以后，交易活动和企业估值又呈现回升趋势。 

所以，我们认为，就整体投资环境而言，2008年的金融风暴将会继续影响中国经济的发展，中国目前仍旧会经受各种考验。但是，对于私募股权投资、风险投资和兼并收购而言，2009年是个充满着无限机会的一年。机会与风险并存。只要你抓住了机会，成功就近在咫尺。 

2009年，企业所有人和私募股权投资公司可以期待商业主题中的下列几点。 

行业整合与“质的飞跃”

在2009年新年伊始，我们就感受到了中国经济所面临的严峻局面。经济增长速度减慢，成千的工厂倒闭和数以万计的人失业。中国许多经济领域已经出现了一种所谓“超饱和”状态，也就是很多企业在一个经济领域竞争，但是每个企业的市场份额都很小。这种情况下，中国企业进行合并的时机已经成熟。

在市场经济的自由竞争规律下，缺乏竞争力的企业会逐渐被淘汰。然而，具有竞争力的企业会不断赢取市场份额。并且，在良性循环下会不断发展壮大。产量不断提高，成本继续降低，从而，提高利润。企业将所赚取的盈余再度投到生产中以降低成本，进而形成一个良性循环。 

从消费者的角度来说，一个优秀的企业，由于其管理完善、生产效率高和销售策略适当，吸引着无数消费者。除此之外，强有力的主导品牌将会适时并购其他品牌。在这种状况下，企业间的合并已经成为不可避免的趋势。 

在中国，这种合并的势头刚刚开始。中国拥有仅次于美国的巨大的国内市场。在中国的许多纵向市场（包括金融服务，消费品，分销和物流，零售，时尚等），只要多争取一分的市场份额，销售收入就能增加上千万美元。 

通常，相对于企业所处行业，中国企业的规模都相对较小。在一些国营企业和半国营企业不占主导地位的区域，优秀民营企业抢先出击，兼并和收购其他区域内的竞争者，进而成为国内行业的领军企业。

对于投资者来说，这种帮助企业进行并购活动的机会将是空前的。企业在并购后的兴盛是投资者和企业共同期待的。即使在经济衰退期，并购案中 的优胜企业也会呈现销售收入和利润长期持续增长的现象。 

利润增长为IPO的

重现提供了平台

 

在过去的五年里，对于投资中国市场的私募股权投资者和风险投资者来说，IPO无疑是最可靠的退出途径。 

下面的图显示，IPO交易量在2007年达到了高峰。在2008年初，IPO交易量继续呈现高增长趋势。然而，到2008年的下半年，IPO交易量急转直下，直到2009 年年初。

 chart-1

 

 

众所周知， IPO市场与股票市场紧密相连。当股票市场整体表现不好时，企业发行新股票的欲望也会相应减弱。所以，只要中国股票市场和香港股票市场继续呈现薄弱趋势，IPO活动就不会呈现上升趋势。 

对于私募股权投资者和风险投资者来说，这意味着他们需要做出巨大的改变。 

为适应当前形势，私募股权投资公司和风险投资公司需要改变他们的投资方向。较之前而言，企业IPO前的短期投资机会已大大减少。换言之，私募股权投资公司或风险投资公司以18倍的估值投资于中国企业， 18个月后，再以20倍的价值发行上市的简单套利的机会已经一去不复返了。 

取而代之的是，在中国进行投资活动的私募股权投资公司应该从价值投资者的角度考虑他们在中国的投资，而不是从套利的角度去衡量他们在中国的投资。这说明了，私募股权投资公司在中国寻找目标企业时，应以企业的长远高回报为目标注入投资基金。 

企业的利润增长为中国市场的IPO重现提供了平台。具体而言，私募股权投资的重点应该集中在帮助企业提高运作效率和利润率上。 

这是一个值得强调的财务理念，尤其是在现今中国。企业估值归根结底是一个与公司盈利能力相关的函数，而不是一个投资者愿意为公司盈利能力而支付的价格函数。在市盈率倍数的公式中，“收益”部分是关键，而不是“价格”部分。在过去的五年时间里，IPO股票价格市盈率可谓差距巨大。IPO股票价格市盈率高至超过100， 低至少于5。 

对于中国市场来讲，情况可以瞬息万变。IPO股票价格市盈率很有可能出现回升趋势。什么时候会发生？我们无法给您一个准确的答案。但是我们可以确定的是，一个优秀的私募股权投资者想要投资于有明确目标和有能力实现目标的中国优秀企业。

 换言之，企业有计划和具体步骤去提升利润和利润率。那么，选择正确的中国企业进行投资，选择适当的额度进行投资和帮助企业提升整体价值，是私募股权投资公司和风险投资公司在未来几年内成功的关键所在。

 私募股权投资公司和风险投资公司提升企业价值的方式有很多。可以通过向企业提供市场营销，业务发展，金融工程，运营效率，企业治理，审计，战略兼并和收购等方面专业人才，来帮助企业迅速提高企业价值。

无论通过上述哪种方式，企业的收益都有可能被大大提高。关键点是，帮助企业保持强劲的利润增长态势。这样，在股市复苏的时候，IPO的时机再一次到来时，我们的客户企业会从中脱颖而出，赢得最高收益。 

2009年，一个有着投资重点和帮助企业成长的私募股权投资公司会脱颖而出。

 

 


American and Chinese entrepreneurs: they are very different, but the best are equally good at making their investors rich

Leave a Comment / March 27, 2009

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Held each year in Los Angeles, the technology conference organized by the investment bank Montgomery & Co. is one of the best of its kind, anywhere. It brings together about 1,000 people from the top American venture capital and private equity firms along with senior management at some of the most accomplished privately-owned technology companies in the US. It provides a very focused snapshot of some of the strongest new tech business models and where venture capital and private equity firms are looking to invest this year.  

I was at the conference from start to finish, in meetings and panels. It was a great gathering in every respect, with a level of optimism that runs counter to much of the economic gloom that dominates the headlines. One reason: good technology can thrive in bad times. Corporate budgets are getting squeezed and each purchase is more tightly scrutinized. This means that many new tech solutions, offering good or better performance at lower price, have a great opportunity to gain market share against more lumbering competitors. 

I saw some interesting companies with interesting business models, in particular several that were focused on SaaS (“Software-as-a-Service”) solutions that can dramatically lower for businesses large and small the cost (both hardware and software) of implementing enterprise software. SaaS makes so much sense because companies can switch to a powerful software solution, but without the need to buy and install any of the software or hardware to run it. It’s all done using an internet browser as the main interface. The software is hosted and managed on a central server by the company that developed it. Users pay a monthly or annual fee to use the software. 

SaaS is an area where I have a special interest. I’m lucky enough to be CEO of Awareness Technologies (www.awarenesstechnologies.com), which develops and sells SaaS-based corporate security software. Awareness also has as its founders two of the best entrepreneurs I’ve ever met, Ron and Mike. They are superstars.

Great entrepreneurs are rare, even in a conference of hot technology companies. Of the 100 tech companies at the Montgomery conference, very few – by my very unscientific study — seemed to have a great entrepreneur at the controls. Most are venture-backed, and so tend to have very experienced professional managers at the top. Often, the founding entrepreneurs have been pushed out, or given different roles, after the venture capital money arrives. One obvious reason for this: the venture capital and private equity partners are usually from similar backgrounds as the professional managerial class, with gold-plated resumes and MBA degrees from the best universities in the US.  Institutional investors often look for a safe pair of hands, and not a visionary, to run a company once their money is committed. This is sometimes the right choice.

That’s the usual pattern in the US. I was struck, not surprisingly, by the differences in China. Great entrepreneurs are no less rare, but it’s almost impossible for me to imagine a situation where the founder of a Chinese company is pushed aside by the venture capital or private equity firm after its put its money in. That would, in most cases, be sheer madness. First, there is no large “professional managerial class” in China at this point, with experienced managers who have run successful businesses previously, and then either sold them or led them to IPO.

Second, and perhaps even more important, good Chinese companies, in my experience and to an extent rarely seen in the US, are one-man shows. There is usually as boss and owner one superbly talented, charismatic, driven and shrewd individual, who saw a market opportunity and seized it. Against unimaginable odds – including the severe ack of capital, continually changing regulations, predatory officials, the primitive market economy of ten years ago in China, and the fiercest competitors – these successful Chinese business owners managed to build large and thriving companies. Single-handedly. There is usually no “management team” to speak of — just one man of outsized abilities and an equally outsized will to succeed.

Another difference with the US: the best entrepreneurs in China, and so the best investment opportunities for venture capital and private equity firms,  aren’t likely in the technology business. They most often are in what are considered, in the US, old-line, low-growth businesses like manufacturing, retailing, branded consumer goods. In the US, companies in these sectors find it nearly impossible to raise money from venture capital and private equity companies. In China, it’s where most of the VC and PE investment goes.

It’s what makes China such an interesting place to be for venture capital and private equity, and why I feel so lucky to have a business there in that field. China has both the most sophisticated global investors and the most well-run, entrepreneurial smokestack industries.

Of the 100 companies at the Montgomery conference, I can’t think of a single one that runs a factory and manufactures a tangible product. The guys who run these companies are almost certainly all college graduates, often with advanced degrees, looking for money to complete or market a website, a software application, an internet advertising platform. In China, conversely, a conference filled with some of the better, more promising private companies would have 100 men, most with only a high-school education, looking for money to expand their factories, fulfill more customer orders and so double their revenues and profits in the next year or  two.

As someone who has spent a big part of his life managing technology and venture capital businesses, I see great opportunities to make money investing in both China and the US. The big difference is that in the US, the biggest risks for venture capital and early stage private equity investors tend to be technological, that the company you’ve invested in may not succeed because its product or service doesn’t work as planned, or isn’t as good as a competitor’s. In China, technology risk is usually minimal. The big risk for venture and private equity firms is that the rules may change, and the company you’ve invested will not be able to freely operate in the domestic market in China.

How do I manage risk personally? I try to eliminate it, by working with the best entrepreneurs. I’m confident Awareness Technologies will widen its technological lead, become the dominant SaaS-based security software company and make its investors a ton of money. Equally, I’m confident the Chinese companies we work with at China First Capital will become dominant in their industries in China and make their investors a ton of money. Along the way, the men running these Chinese businesses will continue to do what they’ve always done: find ingenious ways to stay one step ahead of competitors and any changes in the country as a whole.

AltAssets writes on China First Capital’s Report on Private Equity in China 2009

Leave a Comment / March 14, 2009

AltAssets is among the world’s leading sources for news and analysis on the global private equity industry. They just published a summary of my firm‘s report, “2009 Private Equity and Strategic M&A Transactions in China — A Preview“. 

AltAssets is based in London, and provides news and research to more than 1,000 institutional investors and 2,000 private equity and venture capital firms worldwide.

Here is what they wrote about the China First Capital report:

 

altassets_logo

“CHINA THE MOST ROBUST EMERGING MARKET FOR PRIVATE EQUITY AND VENTURE CAPITAL SAYS REPORT”

China continues to be the world’s most robust emerging market for private equity and venture capital finance, even in a difficult global economic environment, according to the Private Equity and Strategic M&A Transactions in China 2009 report just released by China First Capital, a boutique investment bank with offices in China, Hong Kong and the USA.

Peter Fuhrman, China First Capital’s chairman and the report’s author, said, “While the overall investment environment remains challenging and the effects of 2008’s turbulence are still being felt, 2009 will be a year of unique opportunity for private equity, venture capital and M&As in China.” 

China’s economy continues to grow, powered largely by successful small and medium private businesses, many of which are among the fastest-growing companies in the world. Private equity and venture capital investment in China will likely reach record levels in 2009, the report projects, with over $1bn in new investment into high-growth Chinese SMEs with strong focus on China’s booming domestic market. 

“In 2009, China should rightly be among the most attractive and active private equity investment markets in the world,” the China First Capital report predicts. “Many of the international private equity firms we work with are expecting to invest more in Chinese SMEs in 2009 than in 2008. Chinese companies raising capital this year will enjoy significant financial advantages over competitors, improving market share and profitability.” 

The report identifies five central trends that will drive the growth in private equity and venture capital investment in China’s SMEs in 2009. They are: the drive for industrial consolidation; profit growth helping to reignite the IPO markets for Chinese companies in China, Hong Kong and the USA; increased importance of convertible debt and other hybrid financings; opportunities for strategic M&As; well-financed businesses with strong balance sheets will enjoy sustainable competitive advantage in China’s domestic market. 

“The pathways to success in China are fewer and narrower than in recent years. But, for the entrepreneurs and private equity investors that can navigate their way in 2009, this will be a year of abundant opportunity,” Fuhrman added. 

Copyright © 2009 AltAssets

Private Equity and Strategic M&A Transactions in China 2009: A New Dawn

Leave a Comment / March 8, 2009

China First Capital, a boutique investment bank, releases comprehensive analysis of five key trends for 2009 in Private Equity, Venture Capital and M&A markets in China.jpg

My firm, China First Capital, just completed our annual report on Private Equity, Venture Capital and Strategic Mergers and Acquisitions in China. I had the biggest hand in writing it, so the opinions expressed are my own. My view, overall, is one of realistic optimism. China will continue to be the world’s most robust emerging market for private equity and venture capital finance, even in a very difficult global economic environment. A big reason for this is the continuing strong performance of many private SME companies in China, especially those focused on the domestic market, rather than exports. 

China First Capital has a special affinity for these strong private SMEs. They are the only companies we choose to work with. There a few reasons for this. A big one is my personal conviction that the most important predictor of a success in private equity investing is putting money into a company with a truly outstanding boss. Ideally, the boss will also be the entrepreneur who founded the company. 

You can do all the spreadsheet modeling and projections you want, but nothing else matters quite as much as the quality and drive of the leadership at the top. In many of the good Chinese SMEs, the boss is a first-class business strategist and opportunity-seeker. Give him a dollar and he’ll bring you back five. In many of China’s larger state-owned, or partially state-owned companies in China, the boss is often more a political animal, appointed to the job as much for skills as a bureaucratic infighter as for talents at managing a business. Give him a dollar and he’ll come back in a while and ask you to lend him another three. 

SMEs, no surprise, usually run circles around their state-owned competitors in China. That’s a big reason we choose to work exclusively for SMEs. Another reason: we prefer long-term partnerships with our clients rather than one-off deal-making of larger investment banks. We act as a financial and strategic advisor to Chinese SMEs in a long-term process that often begins at early stages of corporate development and continues through the capital raising process from private equity to a successful IPO and beyond to global leadership. 

Thanks to these Chinese SMEs,  China should be among the most attractive – and active – private equity investment markets in the world in 2009. Many of the international private equity firms we work with are expecting to invest more in Chinese SMEs in 2009 than in 2008. Indeed, private equity and venture capital investment in China will likely reach record levels in 2009, the report projects, with over $1 billion in new investment into high-growth Chinese SMEs with strong focus on China’s booming domestic market.

Chinese companies raising capital this year will enjoy significant financial advantages over competitors, improving market share and profitability.

The report, titled “Private Equity and Strategic M&A Transactions in China 2009”, identifies five central trends that will drive the growth in private equity and venture capital investment in China’s SMEs in 2009. They are:

  1. the drive for industrial consolidation;
  2. profit growth helping to reignite the IPO markets for Chinese companies in China, Hong Kong and the USA;
  3. increased importance of Convertible Debt and other hybrid financings;
  4. opportunities for strategic mergers and acquisitions;
  5. well-financed businesses with strong balance sheets will enjoy sustainable competitive advantage in China’s domestic market.

Here’s the report’s first section. I’ll add more of it in later posts.

 

 Overview  chinese-balance

       

Turbulence creates opportunity

2008 was a year of extremes in China. Extremes of joy and pride, during the Beijing Olympics. Extremes of sadness and shock following the Sichuan earthquake. Even the climate reached extremes, during China’s crippling winter storms early in 2008. 

Financially, 2008 was also a year of extremes. The stock markets in Hong Kong, Shanghai and Shenzhen rose strongly in the first months of the year, and IPOs were plentiful. By mid-year, the markets began plunging, and IPOs dried up. By year-end, Shenzhen, Shanghai and Hong Kong were all down 60% for the year. 

China’s private equity and venture capital investments followed a similar turbulent course, beginning strongly, with over $10 billion invested in Chinese companies in the first half of the years, and then the pace of new investments slowed to a crawl.   

Governments in China, the USA and around the world intervened in an unprecedented fashion to stabilize the economy and the credit markets. As we enter 2009, there is no longer any doubt that the world economy is in recession. 

The question now is when will the recovery begin and when will be a good time to begin investing again? I want to offer a personal perspective to our valued relationships, both clients and the private equity firms we work with. As Chairman of China First Capital,  Ltd, with over 20 years of experience in the capital markets, private equity and business analytics, I’ve survived my share of business cycles. One example, I was CEO of a California venture capital company during the Dot-Bust years, the last time private equity investing came to a similar standstill. Within two years, deal activity and valuations resumed their upward momentum. 

My view: the overall investment environment in China remains challenging and the effects of 2008’s turbulence are still being felt. But, 2009 will be a year of unique opportunity for private equity, venture capital and mergers and acquisitions in China. Tough times can be the best time to make money. 

Consolidation and “flight to quality”

 

 

The Chinese economy is under significant strain as 2009 begins, with growth decelerating, factories closing by the thousands and unemployment rising. Many areas of China’s domestic economy are “over-saturated”, with too many companies competing with small market shares. China is ripe for consolidation. 

In the freely competitive markets, the weakest companies will perish. The stronger competitors will be able to add market share and enjoy the virtuous cycle of increasing volumes lowering unit costs, thus boosting profits that can be re-invested to lower still further costs of production.

Chinese consumers will respond as well, and reward with more of their money the better managed companies with the most efficient manufacturing and distribution. Out of this, stronger dominant brands will emerge, and this too will push for greater consolidation.

This process is just beginning in China. China’s domestic market is huge, second only to the US. In many vertical markets (including financial services, consumer goods, distribution and logistics, retailing, fashion), each point of additional market share in China can equate to tens of millions of dollars in additional revenue.

Chinese companies are still, most often, small-in-scale relative to the size of the industries they serve, particularly in areas where private companies, rather than those with partial or complete state-ownership, predominate Strong regional companies will acquire competitors elsewhere in China to become national powerhouses.   

For investors, the opportunities will be unparalleled to back the Chinese companies that will thrive during this process of consolidation.  The winners will be able to increase revenues and profits strongly and sustainably, even in a weak economy.

 

 

 

 

 

 

 

 

 

 

 

China M&A: 2008 Is A Record Year, And The Strong Growth Will Continue

Leave a Comment / March 8, 2009

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Even as IPO activity all but came to a standstill in 2008, China’s M&A market reached an all-time high in 2008, with almost USD$160 billion in deals completed, according to Thomson Reuters. This makes China the biggest M&A market in Asia, for the first time ever. 

This is an important development, and I expect China’s role as Asia’s largest M&A market will continue into the future, despite the current economic slowdown. The reasons: M&A deals in China will continue to make business and financial sense. China’s M&A activity in 2008 was almost equally split between purely domestic deals – where one Chinese company buys or merges with another – and the cross-border acquisitions where Chinese and foreign firms join together – either with the Chinese firm buying into the overseas business, or the foreign firm taking a stake in a Chinese one.  

I see huge scope for growth in both areas. China’s economy, though growing more slowly now than in recent years, is still expanding. Despite its vase size (China is now the world’s third-largest economy, trailing only Japan and the US) Chinese companies are still, most often, small-in-scale relative to the size of the industries they serve, particularly in areas where private companies, rather than those with partial or complete state-ownership, predominate. China’s private sector is filled with minnows, not whales. 

The result: there is ample room for consolidation in virtually every industry. Smaller firms will continue to merge, to gain both market share and scale economies. Strong regional companies will acquire competitors elsewhere in China to become national powerhouses. 

The M&A market, more than IPO activity, tends to holds up well even during sour economic times, or when stock markets fall. As share prices drop, the lower valuations make it cheaper for acquirers to act. We had evidence of this recently in the US, where one of the biggest M&A deals of all-time was recently announced: Pfizer’s planned acquisition of Wyeth Labs. 

In China, valuations for both quoted and private companies are lower than they were a year ago. That lowers the cost of acquiring a competitor. The cheapest way to build market share, at this point in China, will often be to buy it. 

All M&A transactions have risk. Very often, the planned-for gains in efficiency never materialize from combining two similar businesses. In China, the complexities go above and beyond this. There is due diligence risk – the difficulty of getting accurate financial information about an acquisition target – and management risk as well.  Good Chinese companies are  usually owned and run by a single strong Chairman, with scarce management talent around him. In a merger, the boss of the acquired company will often step aside, leaving a big hole in that company’s management, and so making it harder for the acquiring company to integrate its new acquisition. 

How to do M&A right in China? Good deal-structure and good advice are crucial. Structure can anticipate and resolve some of the larger post-acquisition headaches. Advice is important to make sure that the price and strategic fit are right. Just as China’s SMB’s need specialized merchant banks to serve their needs in raising capital, these SMBs, as they grow, will also need competent M&A advisors to identify target companies, manage the DD, do the valuation work, help negotiate the price, and assist with post-acquisition integration. 

Last year was a strong one for M&A in China. But, the future should be even brighter, once current economic uncertainty begins to abate.  Looking ahead, I see a real possibility that China’s M&A market will overtake America’s as the world’s largest. I’m planning for my company to play a part in this. 

A New Year of Challenges and Opportunities in China’ Private Equity Industry

Leave a Comment / March 9, 2009

chin-amulet-wanli-taichang

Looking purely at the economic news from China of late, this has not been the happiest of Chinese New Years. The Chinese government is estimating that 16% of the huge migrant labor force of 200 million will have no job to return to after the New Year.  Factories are continuing to close, or cut employment, across the country. Guangdong province, where China First Capital has its base in China, is particularly hard hit, because it’s still the primary production base for much of China’s better private factories. While factories are being moved out of Guangdong to less expensive, inland locations like Jiangxi, overall industrial employment in factories in Guangdong is still huge, and hugely reliant on migrant labor. There’s no solid date, but ten million or more workers may have lost their jobs in Guangdong over the last six months. 

The picture is no less bleak in terms of projections for corporate profits in China in 2009. Larger companies are reporting profit falls of over 50% in 2008, and forecasting even worse results this year. This matters crucially in China. Over 40% of total economic output is generated by business investment. This, in turn,  is intimately tied to corporate profits, since most of that business investment is financed out of retained profits. According to a recent report in the Wall Street Journal, “official statistics show that 63% of investment in China last year was financed by what are called “internally generated” funds, which include retained profits. That’s up from just below 50% a decade ago.” 

In other words, as corporate profits decline, they take Chinese GDP growth with them. This falling economic output, in turn, influences consumer sentiment, and so takes personal spending down with it. 

Good economic news is a scarce commodity this Chinese New Year. But, I see one bright glimmer of hope here. Chinese companies have been excessively reliant on retained earnings and expensive bank debt to finance their growth, rather than equity capital. The difficult economic environment, in China and indeed worldwide, provides a good opportunity for better Chinese companies to reorient their method of financing capital investment and growth. It’s the right time to take on equity capital, and use it as a platform to continue to invest and grow, even if corporate profits are in cyclical decline. 

The Chinese companies that can raise equity finance will enjoy a significant financial advantage over competitors, and so be able to gain market share. Adding equity finance lets a company both lower its overall cost of capital, and also increase the amount of capital it can put to work in its business. Both of these factors equate to a very real competitive advantage. 

Equity investors, principally PE firms, will need to change their orientation as well. The opportunities to do shorter-term “pre-IPO” financing are far fewer than they were, because stock market valuations are way down and IPO activity has slowed to a crawl. So, the simple arbitrage of a PE firm buying into a Chinese company at a valuation, say, of 10x and selling out 18 months later in an IPO at 20x are gone. 

Instead, PE investors in China need to think more like value investors, and less like arbitrageurs. This means looking for opportunities to deploy capital into good businesses offering high rates of return on that invested capital. Equity investment is then used to expand output, lower unit costs, gain market share, and so expand both profits and profit margins. Build profits and valuation will take care of itself. If a Chinese company can put equity capital to work well, and accelerate profits in 2009 and beyond, that business will be worth a lot more money when the IPO market revives than if it simply cut back on investing to ride out the bad times. 

This year is going to be difficult, challenging, but also potentially highly rewarding for all of us participating in the financing of private companies in China. It’s a year when good companies should be able to get even better. And smart-money PE firms will make far more, over the medium-term, than fast-money valuation arbitrageurs ever did. 

 

IPO Market in China — Down in 2008, But Not By As Much as in the USA

Leave a Comment / March 8, 2009

song-vase

 

Looking for confirmation of how much more vibrant China’s IPO market — and therefore private equity market — is than the US? Well, the numbers are in. China’s IPO market has stumbled. America’s is in a coma.  

As reported in the Shanghai Daily, the number of IPOs in 2008 on China’s domestic stock exchanges fell, both in number and amount of capital raised. The totals were 76 IPOs, compared to 118 in 2007. The total capital raised was US$15 billion (RMB 103.4 billion) on the Shanghai and Shenzhen stock exchanges, down 77% from a year earlier.

While hardly a banner year for IPOs in China, the situation in the IPO market in the US was nothing short of cataclysmic. IPO activity was basically at a standstill, touching lows not seen for a generation. The last two quarters of the year, there wasn’t a single IPO by a venture capital or private equity-backed business. The IPO window in China may have closed somewhat. In the US, it seems welded shut.

What does this mean? Well, for one thing, it’s not a predictor of future activity. The US markets are highly cyclical. IPO activity ceased, in large part, because of more general weakness in the stock market, which was down over 33% in 2008. As the stock market begins to recover, so will IPO activity. Meantime, however, many venture capital and private equity firms in the US are going to suffer. Badly. 

In China, stock markets fell more steeply than in the US, but that didn’t entirely undermine the public appetite for new issues. There are a lot of cultural factors at work here. But, one fact that’s often overlooked is that most shares in China are owned by individuals. In the US, over two-thirds (by valuation) are owned by institutions. Individuals tend to have a higher appetite for risk than institutions, whose managers are constrained by fiduciary responsibilities and a competitive need to outperform their peers.

So, when it comes to the IPO market, China enjoys a structural advantage over the US, at this point in history. Equally important, China’s continued high economic growth of over 8% underpins corporate profit growth that is among the fastest in the world. 

Each $1 of profit in China can still be sold for $15 or more at IPO. That’s why China looks even more attractive, comparatively, than it did before for many of the world’s private equity firms. 

In the global competition for capital, China now ranks as a genuine superpower. 

Distressing Times — China’s Weak PE Firms Look to Sell Out

Leave a Comment / March 8, 2009

Ming Dynasty Ivory Luohan

 

Look up. Those are vultures circling over China’s Private Equity market. The vultures, in this case, are distress investors, including AIG and GE Capital. They have quietly begun shopping for the investment portfolios of hard-up private equity and venture capital firms who spent the last three to five years investing in China. The price they are offering: as little as five to ten cents on the dollar. In other words, a PE fund that invested $100mn in Chinese private companies could liquidate those investments for as little as $10mn in cash.

Who would be crazy enough to sell at that price?

Good question. It’s hard to see why any PE or VC fund would want out at that sort of price. After all, their investors (aka LPs) are locked in for the long haul, about 7-10 years on average. This is the signal difference PE and VC firms enjoy compared to hedge funds, whose investors usually can redeem either quarterly or annually. A PE or VC fund has better balance of assets and liabilities: its illiquid investments are matched by liabilities to its investors that are similarly long-term. 

This means a PE or VC firm can ride out any market turbulence, even one as severe as what we’re experiencing now. China’s stock markets are off 60% over the last 12 months, and IPO activity (the usual exit route for PE and VC investments in China) has all but dried up.   

And yet, you can be sure there are PE and VC firms that will sell out in coming months to distress investors. Why? It’s not because these funds will be legally or contractually or even morally obliged to sell. It’s more a matter of confidence – or lack thereof. While LPs can’t withdraw their money, they can make life very tough for PE or VC partners whose investments are in deep trouble. 

Another reason, PE or VC partners don’t much like the prospect of nursing investments for many years, during a difficult period, with no strong likelihood of a successful exit. VC and PE partners like to say they’re long-term investors. But, the reality is, they like to get in and out within two to three years, collect their share of profits, use this success as a selling point to raise more money from which they can collect even higher management fees. And so the wheel spins. At least in good times. 

Well, the good times are over. 

I’ve run a VC firm through the last down-cycle following the crash of the internet bubble in 2000. It takes a different kind of mindset than that of many PE and VC investors, especially ones who had a relatively easy time during the boom years, when some very mediocre companies can achieve successful exits. 

China’s PE market today is quite reminiscent of Silicon Valley venture capital after the 2000 crash. A lot of Silicon Valley VC firms (generally those with the weakest ability to make winning investments) sold out to distress investors back then. A similar pattern is emerging in China – the weakest will perish.   

The good firms know how to keep the vultures at bay. They are the ones who know how to manage in lean times, and how to work harder, faster and smarter with their portfolio companies to improve operations and cash flow. 

 

Coming Soon — A Stock Market for High-Tech Companies in Shenzhen

Leave a Comment / March 8, 2009

Zhou Dynasty Horse Fittings

Despite delays and continuing uncertainty, 2009 should see the opening of China’s first stock market for smaller, high-growth technology companies. Modeled on the NASDAQ in the US and AIM in London, this new market will be headquartered in Shenzhen, as part of the Shenzhen Stock Exchange, the smaller of the two stock markets in China.

Overall, this is a positive development for China’s financial industry, and the private equity and venture capital communities. Since China’s Prime Minister, Wen Jiabao announced in March 2008 the planned establishment of this new stock market, after almost a decade of internal discussion, the date for the launch has steadily slid back, a casualty of the 60% fall in China’s main stock markets this year.  

The final details have not been announced, but what seems clear at this point is that this new market will have significantly lower qualifying thresholds for companies seeking a stock market listing, compared to the main boards in Shenzhen and Shanghai. The numbers talked about are net assets above RMB 20 million (US$2.8mn) and revenues above RMB 10mn (US$1.5mn). There seems to be no requirement, as of now, for companies to be profitable at the time of listing. It’s possible, therefore, that companies listed on the new exchange will have market caps that barely exceed $10mn. 

 

Here’s my thinking. The largest quoted companies on the Shanghai market are trading at a price-earnings multiple of under 12. This is down, like the broader market, by almost 60% from recent highs. Put those kind of multiples on a small company with revenues under US$2mn and profits below $1mn, and you have the possibility of market caps in that very low range. True, high-tech companies tend to enjoy higher p/e multiples than more traditional large-caps. But, even so, this new stock market will be operating in some unchartered territory for China’s financial markets — companies with comparatively thin floats, low total market value, and so, most likely, higher price volatility. 

 

This could help explain why the Chinese government has repeatedly delayed plans to launch this stock market for high-growth companies. The regulators have probably seen this year all the volatility they care to see for a long time. 

 

Of course, the key factor won’t be earnings multiples or volatility, but the quality of the underlying high-tech businesses to be quoted on this exchange. Here’s where I see bigger problems. China, like its richer neighbors in Asia, as well as Western Europe, would very much like to rival the USA in nurturing successful high-tech companies in industries like software and chip technology. Across China, there are high-tech business parks where early-stage technology companies are concentrated. By one count, there are over 5,000 across the country. But, so far, there haven’t been many big break-out successes. 

 

The simple truth is that, as other countries have learned over the last decade, it’s hard to duplicate the particular success the US has in developing successful high-tech businesses. Having a stock market for high-tech companies is certainly not much of a factor. If so, Germany, which started its own high-tech company stock market, the NeuerMarkt ten years ago, would today be awash with leading technology firms. Instead, there are few, if any good tech companies in Germany and the Neuer Markt eventually was shut down. Britain’s AIM market has also failed to produce many successes in that country. 

 

In my mind, China does have a better shot than Germany, or Britain, or Japan. The main reason: Chinese are more entrepreneurial, and there’s more a culture of prudent risk-taking than elsewhere. If any country has a shot to achieve some of the same success the US has enjoyed building great technology companies, it’s got to be China. 

 

So, I hope this new stock market gets started early in 2009. It will provide more motivation – not that much is needed – to China’s budding technology leaders, and also provide another viable exit route for venture capital investors in China

 

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