Chinese SME

After Wanda Deal, Chinese Property Developer Faces Debt Risk — The New York Times

Leave a Comment / August 11, 2020

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A Dalian Wanda property in Nanchang, China.

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BEIJING — The Chinese property developer Sunac China Holdings has turned into one of the country’s biggest white knights, swooping in to help troubled companies with too much debt. The risk: Sunac is amassing its own large pile of debt in the process.

Sunac has more than doubled its debt load in a year to $38 billion. Its deal this week to buy a portfolio of theme parks and hotels from the Dalian Wanda Group, the heavily indebted Chinese conglomerate, will add to the tab. At $9.3 billion, the acquisition is larger than the market value of Sunac.

“The problem for Sunac is twofold,” said Peter Fuhrman, chairman of China First Capital, an investment bank. “They themselves are already rather overleveraged and they are not paying distressed prices.”

Sunac is offering a much-needed lifeline.

For years, China fueled growth by providing easy credit. Chinese companies borrowed heavily, using the money to fund aggressive expansions.

As the economy now slows, companies are increasingly running into financial trouble, with some having to borrow even more to pay their debts. Policy makers are worried that the country’s Passover level of corporate debt could threaten the broader financial system.

Sunac, China’s seventh-largest property developer in terms of sales, has been able to tap into its financial strength to help companies under pressure. Since 2012, Sunac’s property sales have grown at double-digit rates nearly every year, giving it the firepower to scoop up assets and land plots.

Before the Wanda deal, Sunac in January pumped $2.2 billion into LeEco, a tech firm struggling to pay off its creditors. This May, it paid $1.5 billion for an 80 percent stake in Tianjin Xingyao, a property firm known for leaving its projects uncompleted.

In 2015, Sunac made a play to rescue Kaisa, pledging $1.2 billion to take over the troubled property company; it later pulled out after Kaisa did not meet certain conditions for the deal. That same year, it announced a partnership with the cash-poor Yurun Holding Group, which ran a business empire ranging from sausage making to property and finance.

It is a remarkable turnabout for the company’s founder, Sun Hongbin.

Mr. Sun started his career at the Lenovo Group, where he was promoted to run enterprise development. But he had a falling out with Liu Chuanzhi, the founder of Lenovo, over a business dispute. Related to the dispute, Mr. Sun was sentenced in 1992 to five years in jail for misappropriation of public funds.

After his release in 1994, he met with the founder of Lenovo and apologized, according to the website of The People’s Daily, the ruling Communist Party’s official newspaper. The Lenovo founder eventually lent Mr. Sun about $74,000, which he used to start a predecessor real estate firm to Sunac.

Lenovo did not immediately respond to a request for comment.

When Mr. Sun started Sunac in 2003, he focused on the cities of Wuxi and Chongqing and then moved on to China’s most developed cities, among them Beijing, Shanghai, Tianjin and Hangzhou, building apartments with names like Beijing Fontainebleau Chateau. Sunac built its residential projects in good locations near city centers and was aggressive in acquiring land plots — with higher debt.

 Sun Hongbin, the founder and chairman of Sunac China Holdings.

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“People who have failed are those who have been defeated by themselves,” Mr. Sun told a newspaper, China Business News, in 2013. “But I often tell others: After you fail, you can start again.”

With the Wanda deal, Sunac is extending its reach into tourism, paying $9.3 billion for 76 hotels and a major chunk of its 13 tourism projects, in the country’s largest property acquisition ever. The purchase will help Sunac diversify its business, which is hurting from government restrictions on home sales as Beijing seeks to cool a frothy property market. It also strengthens the company’s hand in an industry dominated by bigwigs like the China Vanke Group and Country Garden.

“Within the housing industry, the powerhouses are really strong,” said Lu Wenxi, an analyst for Centaline Properties who is based in Shanghai. “If you don’t gobble up the fat ones, it is easy to be eaten up by others. Taking on more projects will prevent you from being eaten.”

Investors have rewarded Sunac for the deal. Shares of Sunac rose 14 percent in Hong Kong on Tuesday after they resumed trading after the deal announcement.

But the deal will add to an already significant debt load. In 2016, the company’s net gearing ratio — a measure of total debt to shareholders’ equity — rose to 121.5 percent, from to 75.9 percent in 2015. Fitch Ratings recently downgraded the company’s credit rating to BB-, saying Sunac’s acquisitive approach had made its financial profile “more volatile.”

Wanda is helping finance the acquisition. Sunac, in a statement to the Hong Kong Stock Exchange on Monday, said Wanda would procure a loan for the company worth about $4.4 billion.

Seller financing is not uncommon, both in China and the West. But Wanda’s role means that Sunac doesn’t have all the money upfront.

“In my experience, I’ve never seen it anywhere,” said Lester Ross, a Beijing-based partner with the law firm WilmerHale, who has advised deals in China for the last 20 years. “No client that I represent would accept a deal like that where you’re responsible for raising the money to pay for somebody else.”

Sunac did not return multiple calls for comment. The company said in a statement to the Hong Kong Stock Exchange on Tuesday that the deal with Wanda “will add a large number of prime land reserves and property assets for the company at a reasonable cost.”

The LeEco deal is also prompting concern.

Sunac invested $2.2 billion in LeEco, buying minority stakes in three of the conglomerate’s more stable businesses, including the smart TV affiliate Leshi Zhixin, Le Vision Pictures, and Leshi Internet. The two companies don’t have many overlapping interests, and LeEco’s finances have continued to sour. Before the Wanda deal, shares of Sunac were falling on fears that LeEco’s problems would spread.

In a January news conference, Mr. Sun said many people had tried to dissuade him from investing in LeEco, adding that several were “resolutely opposed” to it.

“I seriously considered their views, but I don’t think their opinions are sufficient to change my mind,” he said.

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Article as published in the New York Times

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China’s Healthcare Sector a Big Draw for Private Equity Investors — South China Morning Post

Leave a Comment / January 19, 2017

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China’s healthcare sector a big draw for private equity investors

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PUBLISHED : Wednesday, 18 January, 2017
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Private equity firms and hedge funds are investing heavily into China’s healthcare industry in a bet on the sector’s upbeat growth potential, fund managers told a Hong Kong forum.

Private hospitals and drug makers are among the bright spots for investors focusing on China, where rising income and an ageing population are boosting the demand for quality medical services.

Private hospitals are set to attract large amounts of capital in the coming decade amid an underdeveloped private medical industry and a shortage of doctors, said investment professionals.

“Healthcare has been the single area that probably everyone can foresee globally an enormous amount of capital and investment,” Peter Fuhrman, chairman of China First Capital told the Asia Private Equity Forum in Hong Kong on Wednesday.

China’s population of individuals aged 60 or older is set to rise 90 per cent to 240 million by 2020, according to the World Health Organisation.

Meanwhile, one consequence of the nation’s one-child policy, introduced in 1979 and officially phased out in 2015, is that the burden of caring for ageing parents will put tremendous pressures on the young generations.

The healthcare sector in China will become a US$1 trillion a year business by 2020, according to a report by consulting firm McKinsey & Company.

Among healthcare institutions, private hospitals are set to become the best investment for this sector, said Li Bin, chief executive of Ally Bridge LB Healthcare Fund, a hedge fund that focuses on investing in China and Asia healthcare companies.

However, he said there are problems that will likely hinder the industry’s growth.

Among barriers, Li cited a shortage of quality doctors, the lack of an ecosystem to support the development of private hospitals, as well as the long time frame needed to build up a trusted reputation.

Although about half of the hospitals in the country are private, more than 80 per cent of medical professionals work in the public sector, which offer higher salaries and better career prospects, according to a recent report by Citi.

“Five years ago I said it would take 10 years for private hospitals to mature in China, now I think it would take another 10 years,” he said.

Alice Au Miu Hing from SpencerStuart, an executive search consultancy, said it remains extremely difficult to find experienced private hospital executives with China experience who can speak Putonghua.

“The common approach now is to bring someone from the industry from outside and see if the person can survive in the mainland market,” said Au.

Meanwhile, pharmaceutical and biotech start-ups will flourish with China’s emerging middle class seeking better healthcare services.

Judith Li, partner at the life science-focused Lilly Asia Ventures, told the forum that China spends about 6 per cent of its GDP on healthcare, versus an Organization for Economic Cooperation and Development average of 10 per cent.

“China has so many white spaces where there is nothing exists, and it’s very compelling,” she said.

“If you can bring it [a drug] from the US, you can then avoid the fundamental scientific risk of developing something that’s completely unavailable.”

http://www.scmp.com/business/article/2063273/chinas-healthcare-sector-big-draw-private-equity-investors

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The Big Sort — The Economist

Leave a Comment / August 11, 2020

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“THE vultures all start circling, they’re whispering, ‘You’re out of time’…but I still rise!” Those lyrics, from a song by Katy Perry, an American pop star, sounded often at Hillary Clinton’s campaign rallies but will shortly ring out over a less serious event: a late-night party in Shenzhen to kick off “Singles’ Day”, an online shopping extravaganza that takes place in China on November 11th every year.

The event was not dreamt up by Alibaba, but the e-commerce giant dominates it. Shoppers spent $14.3bn through its portals during last year’s event. That figure, a rise of 60% on a year earlier, was over double the sales racked up on America’s two main retail dates, Black Friday and Cyber Monday, put together. Chinese consumers are still confident, so sales on this Singles’ Day should again break records.

It points to an intriguing question: how will all of those purchases get to consumers? Around 540m delivery orders were generated during the 24-hour spree last year. That is nearly ten times the average daily volume, but even a slow shopping day in China generates an enormous number. By the reckoning of the State Post Bureau, 21bn parcels were delivered during the first three quarters of this year.

The country’s express-delivery sector, accordingly, is doing well. In spite of a cooling economy, revenues rose by 43% year on year in the first eight months of 2016, to 234bn yuan ($36bn). And although the state’s grip on China’s economy is tightening, the private sector’s share of this market is actually growing. The state-run postal carrier once had a monopoly on all post and parcels. Now far more parcels are delivered than letters, and the share of the market that is commanded by the country’s private express-delivery firms far exceeds that of Express Mail Service, the state-owned courier.

China’s very biggest couriers have been rushing to go public on the back of the strong growth. Most of them started life as scrappy startups, and are privately held. But because of regulatory delays, which mean a big backlog of initial public offerings, many companies have resorted to other means. Last month, two of them, YTO Express and STO Express, used “reverse mergers”, in which a private company goes public by combining with a listed shell company, to list on local exchanges. In what looks to be the largest public flotation in America so far this year, another, ZTO Express, raised $1.4bn in New York on October 27th. Yet another, SF Express, China’s biggest courier, recently won approval to use a reverse merger too.

But investors could be in for a rocky ride. Shares in ZTO, for example, have plunged sharply since its flotation. That is because the breakneck growth of courier companies masks structural problems. For now, the industry is highly fragmented, with some 8,000 domestic competitors, and it is inefficient.

One reason is that regulation, inspired by a sort of regional protectionism, obliges delivery firms to maintain multiple local licences and offices. Cargoes are unpacked and repacked numerous times as they cross the country to satisfy local regulations. Firms therefore find it hard to build up national networks with scale and pricing power. All the competition has led to prices falling by over a third since 2011. The average freight rate for two-day ground delivery between distant cities in America is roughly $15 per kg, whereas in China it is a measly 60 cents, according to research by Peter Fuhrman of China First Capital, an advisory firm.

A handful of the biggest companies now aim to modernise the industry. Some are spending on advanced technology: SF Express’s new package-handling hub in Shanghai is thought to have greatly increased efficiency by replacing labour with expensive European sorting equipment. A semi-automated warehouse in nearby Suzhou run by Alog, a smaller courier in which Alibaba has a stake, seems behind by comparison but in fact Alog is a partner in Alibaba’s logistics coalition, which is known as Cainiao. The e-commerce firm has helped member companies to co-ordinate routes and to improve efficiency through big data.

Other investments are also under way. Yu Weijiao, the chairman of YTO, recalls visiting FedEx, a giant American courier, in Memphis at its so-called “aerotropolis” (an urban centre around an airport) in 2007. He was awed by the firm’s embrace of advanced technology. He returned to China and sought advice from IBM on how his company could follow suit. YTO is using the proceeds of its recent reverse merger to expand its fleet of aircraft, buy automatic parcel-sorting kit and introduce heavy-logistics capabilities for packages over 50kg.

There is as yet little sign that China’s regions will begin allowing packages to move freely, so regulation will remain a brake on the industry. More ominously, labour costs are rising. There are fewer migrant labourers today who are willing to work for a pittance delivering parcels. This week China Daily, a state-owned newspaper, reported that ahead of Singles’ Day, courier firms were offering salaries on the level of university graduates.

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http://www.economist.com/news/business/21710004-chinas-express-delivery-sector-needs-consolidation-and-modernisation-big-sort

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ZTO Spurns Huge China Valuations For Benefits of U.S. Listing — Reuters

Leave a Comment / August 12, 2020

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By Elzio Barreto and Julie Zhu | HONG KONG

Chinese logistics company ZTO Express is turning up the chance of a much more lucrative share listing at home in favor of an overseas IPO that lets its founder retain control and its investors cash out more easily.

To steal a march on its rivals in the world’s largest express delivery market, it is taking the quicker U.S. route to raise $1.3 billion for new warehouses and long-haul trucks to ride breakneck growth fueled by China’s e-commerce boom.

Its competitors SF Express, YTO Express, STO Express and Yunda Express all unveiled plans several months ago for backdoor listings in Shenzhen and Shanghai, but ZTO’s head start could prove crucial, analysts and investors said.

“ZTO will have a clear, certain route to raise additional capital via U.S. markets, which their competitors, assuming they all end up quoted in China, will not,” said Peter Fuhrman, CEO of China-focused investment bank China First Capital.

With a backlog of about 800 companies waiting for approval to go public in China and frequent changes to the listing rules by regulators, a New York listing is generally a quicker and more predictable way of raising funds and taps a broader mix of investors, bankers and investors said.

“ZTO will have a built-in long-term competitive advantage – more reliable access to equity capital,” Fuhrman added.

U.S. rules that allow founder Meisong Lai to retain control over the company and make it easier for ZTO’s private equity investors to sell their shares were some of the main reasons to go for an overseas listing, according to four people close to the company. U.S. markets allow a dual-class share structure that will give Lai 80 percent voting power in the company, even though he will only hold 28 percent of the stock after the IPO.

Most of Lai’s shares are Class B ordinary shares carrying 10 votes, while Class A shares, including the new U.S. shares, have one vote. China’s markets do not allow shares with different voting power.

ZTO’s existing shareholders, including private equity firms Warburg Pincus, Hillhouse Capital and venture capital firm Sequoia Capital will also get much more leeway and flexibility to exit their investment under U.S. market rules. In China, they would be locked in for one to three years after the IPO.

As concerns grow about a weakening Chinese currency, the New York IPO also gives it more stable dollar-denominated shares it can use for international acquisitions, the people close to the company said.

IN DEMAND

Demand for the IPO, the biggest by a Chinese company in the United States since e-commerce giant Alibaba Group’s $25 billion record in 2014, already exceeds the shares on offer multiple times, two of the people said.

That underscores the appeal of the fast-growing company to global investors, despite a valuation that places it above household names United Parcel Service Inc and FedEx Corp.

The shares will be priced on Oct. 26 and start trading the following day.

ZTO is selling 72.1 million new American Depositary Shares (ADS), equivalent to about 10 percent of its outstanding stock, in the range $16.50 to $18.50 each. The range is equal to 23.4-26.3 times its expected 2017 earnings per share, according to people familiar with the matter.

By comparison, Chinese rivals SF Express, YTO Express, STO Express and Yunda shares trade between 43 and 106 times earnings, according to Haitong Securities estimates.

UPS and FedEx, which are growing at a much slower pace, trade at multiples of 17.8 and 13.4 times.

“The A-share market (in China) does give you a higher valuation, but the U.S. market can help improve your transparency and corporate governance,” said one of the people close to ZTO. “Becoming a New York-listed company will also benefit the company in the long-term if it plans to conduct M&A overseas and seek more capital from the international market.”

China’s express delivery firms handled 20.7 billion parcels in 2015, shifting 1.5 times the volume in the United States, according to consulting firm iResearch data cited in the ZTO prospectus.

The market will grow an average 23.7 percent a year through 2020 and reach 60 billion parcels, iResearch forecasts.

Domestic rivals STO Express and YTO Express have unveiled plans to go public with reverse takeovers worth $2.5 billion and $2.6 billion, while the country’s biggest player, SF Express, is working on a $6.4 billion deal and Yunda Express on a $2.7 billion listing.

ZTO plans to use $720 million of the IPO proceeds to purchase land and invest in new facilities to expand its packaged sorting capacity, according to the listing prospectus.

The rest will be used to expand its truck fleet, invest in new technology and for potential acquisitions.

“It’s a competitive industry and you do need fresh capital for your expansion, in particular when all your rivals are doing so or plan to do so,” said one of the people close to the company.

http://www.reuters.com/article/us-zto-express-ipo-idUSKCN12L0QH

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Quietly But Successfully, US Companies Are Buying Chinese Businesses

1 Comment / August 12, 2020

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--FILE--RMB (renminbi) yuan and US dollar bills are pictured at a bank in Huaibei city, east Chinas Anhui province, 16 September 2011. Chinas yuan edged down versus the dollar on Tuesday (11 October 2011), consolidating its biggest single-day gain a day earlier, brushing aside a record central bank mid-point as US lawmakers prepare to vote on a bill aimed at punishing Beijing for alleged currency manipulation. The Peoples Bank of China, the countrys central bank, set the yuan central parity rate at 6.3483 against the dollar, compared with 6.3586 on Monday.

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Is China really buying up America? Or is it the opposite?

Chinese investments in the US draw lots of headlines and occasional handwringing about China’s growing influence and ownership. It is true that Chinese investors, especially SOE, have been throwing billions of dollars around, mostly for US real estate.

Far more quietly, and perhaps with better overall results, US investors have been buying businesses in China. The US acquirers do their utmost to stay out of the headlines. They prefer to shop quietly, without competitors finding out. This does a lot to keep prices down and give these US buyers maximum negotiating leverage. A lot of these US acquisitions in China stay secret long after they close.

Contrast this style with that of Chinese investors in the US. Most end up bidding against one another for the same assets. Overpaying has become a hallmark of Chinese purchases in the US.

Compared to the huge number of Chinese companies shopping for assets in the US, not nearly as many US companies are sizing up deals and kicking tires in China. Partly this stems from some misunderstandings among less-experienced US acquirers about what kinds of Chinese businesses can be targeted. Topping the list of sweeping generalizations: Chinese companies, especially privately-owned ones, are said to have owners who rarely wish to sell. Those that do, want to sell their deeply troubled companies at Neiman Marcus prices.

There is some truth to this arm-chair analysis. But, equally, there are good deals being done. I’ve written before about the most successful US acquisition in China, by food giant General Mills. (Click here to read.) It’s a textbook case of how to do M&A in China and also how to build a billion dollar business there without anyone really noticing.

Why buy rather than build in China? For one thing, China has huge and fast-growing markets in almost all industries except the smoke-stack ones. For buyers that choose and execute well, the China market is proving lucrative ground to do M&A. It’s a truth that remains a known to a select group of smart buyers.

Lifting the veil a bit, here are some of the largely-unpublicized acquisitions done by smart American buyers in China.

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In April 2015, 3D Systems, a New York Stock Exchange-quoted manufacturer of 3D printers, purchased 65% of a Chinese 3D printing sales and service company Wuxi Easyway. The Chinese company’s customers in China include VW, Nissan, Philips, Omron, Black & Decker, Panasonic and Honeywell. 3D Systems has an option to purchase the remainder of the business within five years.

Along with acquiring a developed sales network and increased distribution in China, another key aspect of the deal was to make the founder of Easyway, a Western-educated Chinese, the CEO of a newly-formed subsidiary,  3D Systems China.  The plan is to make the Chinese founder the king of a larger kingdom, a carrot frequently dangled by American companies to persuade Chinese founders to sell to them.

Since the deal closed, 3D Systems also accelerated the build-out of its operational infrastructure in China. What lies behind the deal? 3D Systems acquired a local management team as well sales channels, customer relationships.  It did not acquire manufacturing capability.

3D Systems manufactures high-quality 3D printers that sells at significantly higher prices than Chinese domestic competitors. Owning a Chinese business with established customer relationships in China will make it easier for 3D Systems to penetrate more deeply what should become the world’s largest market for 3D printers. The shift is particularly strong among Chinese private sector manufacturing companies making products for China’s consumer market.

Prior to the acquisition, Easyway was not a major client or partner of 3D Systems. As the integration moves forward, Easyway will likely expand its product offerings in China beyond relatively commoditized business of producing 3D prototypes. 3D Systems’ printers have broader capabilities, including the production of end-use parts, molds for advanced tool production, medical and surgical supplies.

The dual-track strategy is for Easyway to maintain its existing comparatively low-end service business in China while adding two new sources of revenue: the sale of 3D Systems’ 3D printers in China and an enhanced/upgraded service business of using 3D Systems printers to produce higher-quality and more complex parts to order for Chinese customers.  Both should positively impact 3D Systems’ P&L.

3D Systems used a deal structure that often works well in China. They bought a majority of Easyway, while leaving the target company founder/owner with a 35% minority stake in an illiquid subsidiary of 3D Systems. 3D Systems has the option to buy out the remaining shares and assume 100% control. But, the option may never be exercised. 3D Systems now enjoys the benefits of holding corporate control, including consolidation, while also keeping the previous owner aligned and incentivized.

The deal isn’t without its risks, of course. 3D Systems previously had no corporate presence in China. It therefore did not have its own management team in place and on-the-ground in China to manage the integration of Easyway and monitor the business going forward.

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In July 2013, Illinois Tool Works (“ITW”), a huge and hugely-successful US industrial conglomerate, purchased 100% of a Chinese kitchen supply manufacturer Gold Pattern Holdings, based in Guangzhou, from global private equity firm Actis.

The acquisition fits well with the expansion strategy of ITW of looking to make tuck-in acquisitions in their core business segments. ITW has a large food equipment business with over $2 billion in annual revenue, 15% of ITW’s total.  Gold Pattern’s business is selling Western-style kitchen equipment to restaurants and hotels in China.

From discussions we’ve had with ITW since the acquisition, the deal is considered a solid success within ITW. The company says it has a strengthened appetite to make more such acquisitions in China, a key market for the company going forward.

ITW owns some of the most well-known brands in the food equipment industry, including Hobart mixers and Vulcan ranges. Buying Gold Pattern was part of a strategy to increase sales and distribution of these ITW brands in the fast-growing China market. Gold Pattern’s own commercial kitchen equipment is lower-priced and generally considered lower-quality.  But, the domestic sales channels used to sell Gold Pattern’s equipment is also suitable to distribute ITW’s US brands.

ITW expects that as China continues to grow more affluent, the demand among the Chinese middle class for European and American food will expand significantly. This will create a long-term market opportunity for ITW to sell Western style commercial kitchen equipment. More and more four-and-five star hotels in China are being equipped with Western kitchens as well as Chinese ones.

ITW mitigated its deal risk by buying Gold Pattern from a well-regarded international PE fund. As a result, Gold Pattern already had fully-compliant GAAP accounting, established corporate governance structures, and a professional management team. No less important, ITW knew from the outset that Gold Pattern had already successfully undergone the forensic due diligence process that preceded Actis buying control of the company. This significantly lower due diligence risk, a prime reason many deals in China – both minority and control – fail to close.

ITW has significant experience buying and integrating businesses globally. They had operations in China for twenty years prior to this acquisition.  ITW and another diversified Midwestern industrial company, Dover Corporation, are both actively, but ever-so-quietly seeking more acquisitions in China, aimed primarily at expanding their sales and distribution in China’s growing domestic market.

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This deal happened a long time ago, but continues to pay dividends for Amazon. In August 2004, they bought 100% of Chinese e-commerce company Joyo, paying a total of $75mn including an earn-out.  At the time, e-commerce in China was in its infancy, while Amazon was less than one-tenth its current size. The purchase of Joyo was a calculated gamble that China’s online shopping industry, despite huge impediments at the time including no established online payment systems would eventually achieve meaningful scale.

The gamble has paid off handsomely for Amazon. The e-commerce industry in China is now at least 50X larger than in 2004, with revenues last year of over $700bn. E-commerce revenues are projected to double in China by 2020. Amazon is the only non-Chinese company with meaningful market share and revenues in this hot sector. That said, Amazon is dwarfed by Alibaba’s Taobao, which has a market share in China estimated at 75%.

But, Amazon in 2012 spotted an opportunity to use its China-based business to establish a highly-lucrative cross-border business facilitating direct export sales by Chinese manufacturers and individual traders on Amazon’s main US and UK websites.  This is a business Alibaba has tried and so far failed to enter.  As a result, Amazon’s senior management, if they know no one is listening, will tell you the Joyo acquisition is a big success. It generates meaningful revenue in China (approx. $3bn), while supporting the infrastructure to build out the cross-border exports.  Amazon continues to invest aggressively in China, with enormous warehouse facilities (800,000 total sqm) and wholly-owned logistics business.

When Amazon bought Joyo, it knew full well that Chinese law, as written, forbids foreign companies from owning a domestic internet company. The Chinese government views the internet and e-commerce as “strategic national industries”. At the time, Amazon got around this by using an ownership structure for its China business called a “Variable Interest Entity” (“VIE”) also used by some domestic Chinese e-commerce companies that listed on the US stock market. The Chinese government, if they chose to, could probably shut Amazon down in China, because it’s using this loophole to operate in China. That could leave Amazon scrambling to find a way to stay in business in a country in which it now has hundreds of millions of dollars in assets.

The boards of many other large US companies would blanch at approving a deal where the assets are owned indirectly and control could be so easily forfeited by Chinese regulatory action. But, Amazon, with founder Jeff Bezos firmly in control, has shown itself time and again to be comfortable with making rather bold bets. Success in China often requires that mindset.

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Of course, US buyers have also slipped on their share of Chinese banana peels. Three well-known Silicon Valley technology companies tried and mainly failed to do M&A successfully in China. All three followed a similar strategy to acquire domestic Chinese technology companies started and owned by Chinese who had previously studied and worked in the tech field in the US. The acquisitions followed the general strategic logic of most tech M&A within the US: to identify and acquire companies with complimentary proprietary IP. But, the results in China fell well short of expectations.

The three deals were:

  1. Cirrus Logic acquired Caretta Integrated Circuits in 2007. By 2008, the acquired company was shut down and Cirrus recorded a $12mn loss.
  2. Netgear acquired CP Secure in 2008. There is now no trace of the original CP Secure business, nor any indication it is ongoing concern.
  3. Aruba Networks acquired Azalea Networks in 2010, a Chinese wireless LAN provider.

Over the last five years, no similar M&A deals in China were announced by larger Silicon Valley companies. The strategy has shifted from acquiring companies for their IP to targeting companies for their domestic Chinese distribution and sales channels.  This reflects the fact that indigenous innovation in China has not made much of a global impact. IP protection in China is still inadequate by US standards. China is also a late adopter market, which further impedes the development of globally-competitive domestic technology companies.

The successful US acquisitions in China were all rooted in a different, more viable strategy: to buy one’s way directly or indirectly into China’s burgeoning consumer market.

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Abridged version as published in Nikkei Asian Review

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Reworking a formula for economic success — China Daily Commentary

Leave a Comment / August 12, 2020

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Reworking a formula for economic success

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By PETER FUHRMAN (China Daily) Updated: 2016-04-08

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Reworking a formula for economic success
An assembly line of a Daimler AG venture in Minhou, Fujian province.

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My on-the-ground experience in China stretches back to the beginnings of the reform era in 1981. Yet I cannot recall a time when so much pessimism, especially in English-language media, has surrounded the Chinese economy. Yes, it is a time of large, perhaps unprecedented transition and challenge.

But the negative outlook is overdone, and starts from a false premise. China does not need to search for a new economic model to generate further prosperity. Instead, what is happening now is a return to a simple formula that has previously worked extraordinarily well: applying pressure on China’s State-owned enterprises to improve their efficiency and profitability, while also doing more to tap China’s most abundant and valuable “natural resource”－the entrepreneurial spirit of the Chinese people, the talent to start a company, provide new jobs and build a successful new business.

These two together provided the impetus for the economic growth since the 1990s. In the 1990s, SOEs accounted for perhaps as much as 90 percent of China’s total economic output. Today, the SOEs’ share has fallen to below 40 percent by most counts. Once the main engine of growth, SOEs are now more like an anchor. Profits across the SOEs have been sinking, while their debt has risen sharply.

Arresting that slide of SOEs is now vital. SOE reform has long been on the agenda of the Chinese government. But such a reform has become more urgent than ever, as well as more difficult. There are fewer SOEs today than in 1991 when serious SOE reform was first undertaken. Among those that remain, many are now extremely big and rank among the biggest companies in the world. The restructuring of any such large company is always difficult.

China, however, has taken some key first steps in that direction. The Chinese government has divided SOEs into those that will operate entirely based on market principles and those that perform a social function. It is downsizing the coal and steel industries, two of the largest red-ink sectors. Senior managers of some large SOEs have been dismissed or are under investigation for corruption, and experiments linking SOEs’ salaries more directly with profitability are underway.

Less noticed, but in my opinion, as important is a strong push now at some SOEs and SOE-affiliated companies to become not better but among the best in the world at what they do. Tsinghua Unigroup in semiconductors, China National Nuclear Corporation and China General Nuclear Power in building and operating nuclear power plants, and CITIC Group in eldercare are seeking global glory. They are trying to sprint while most other SOEs are limping.

Luckily for China, the overall situation in the entrepreneurial sector is far rosier. All it needs is a more level playing field. Important steps to further free up the private sector are now underway－taxes are being cut, banks pushed to lend more, and markets long closed to protect SOE monopolies are being pried open. Healthcare is a good example in this regard.

All these moves are part of what the government calls its new “supply side” policy. The aim is to demolish barriers to competition and efficiency. Chinese entrepreneurs have shown time and again they have world-class aptitude to spot and seize opportunities. They are leading the charge now into China’s underdeveloped service sector. This, more than manufacturing or exports, is where new jobs, profits and growth will come from.

Opportunities also await smart entrepreneurs in less efficient industries like agriculture, in getting food products to market quickly, cheaply and safely. In cities, traditional retail has been hit hard by online shopping. Struggling shopping malls are becoming giant laboratories where entrepreneurs are incubating new ideas on how Chinese consumers will shop, play, eat and be entertained.

China’s economy is now 30 times larger than what it was in 1991, and far more complex. The private sector 25 years ago was then truly in its infancy. But, there is still huge scope today for China to gain from its original policy prescription: prodding SOEs to get in line for reform while letting entrepreneurs meet the needs of Chinese consumers.

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The author is chairman and CEO of China First Capital.

http://www.chinadaily.com.cn/opinion/2016-04/08/content_24364851.htm

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New Year gambling hints at Chinese entrepreneurial vigour — The Financial Times

Leave a Comment / August 12, 2020

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FT beyondbrics

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With about every major leading economic indicator in a tailspin, it’s easy, even obvious, to be bearish about China. But, one sign of economic activity could hardly seem more robust: the crowds and cash at gambling tables during this year’s Chinese New Year.

The two-week long lunar New Year celebration finally drew to a close on Monday with the Lantern Festival. Here in Shenzhen, China’s richest city per capita, no sooner do the shops all shut down for the long break than the gambling tables spill out onto the street, like the cork flying out of a bottle.

Gambling, especially in public places with large sums being wagered, is illegal everywhere in China. All the same, the New Year is ready-made for gamblers and street-corner croupiers to gather. For one thing, most police and urban street patrols are also away from their jobs with family.

Along with over-eating and giving cash-stuffed red envelopes, gambling is the other main popular indulgence during the New Year. Most of it happens behind closed doors with families gathered around the mahjong and card table. But parts of Shenzhen soon take on the appearance of an al fresco Macau (see photo).

 

 

 

 

 

 

 

 

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This year, from what I could see, the number of punters and sums being wagered was far higher than years past. This matters not only as a statement of consumer optimism here but also as affirmation of the love of risk-taking that helps make China such a hotbed of entrepreneurial activity.

The two forces operating together – not only at street corner casinos — are perhaps the best reason to be optimistic that China’s economy may yet avoid a “hard landing” and continue to thrive.

In my neighborhood, the favorite game on the street is a form of craps where people bet on which of six auspicious animals and lucky symbols will turn up. Hundreds of renminbi change hands with each roll. No small bets allowed. The gambling goes on from morning until late at night.

It’s a game that requires no skill and one that also gives the house a huge advantage, since winning bets only make four times the sum wagered. This puts it in a somewhat similar league with punto banco baccarat, the casino game Chinese seem to like the most. It’s also game of pure chance, where the house has a built-in edge.

In China, gamblers’ capital flows to games with unfair odds, where dumb luck counts for more than smarts. In this there is cogent parallel with the investment culture in China. China is simply awash in risk-loving risk capital.

Street-side gambling is popular during the New Year break in part because the other more organised mainstream forms of taking a punt are shut down. Top of the list, of course, is the Chinese domestic stock market. It’s rightly called the world’s largest gambling den. Shares bob up and down in unison, prices decoupled from underlying economic factors, a company’s own prospects or comparable valuations elsewhere.

The simple reason is that almost all shares are owned by individual traders. Fed on rumors and goaded by state-owned brokerage houses, they seem to give no more thought to which shares to buy than my neighbors do before betting Rmb200 on which dice will land on the lucky crab.

The housing market, too, traces a similar erratic arc, driven far more by short-term speculation than the need to put a roof over one’s head. Billions pour in, bidding up local housing prices in many Chinese cities to a per-square-foot level higher than just about anywhere in the West except London, Paris, New York and San Francisco. Eventually prices do begin to moderate or even fall, as happened in most smaller cities this past twelve months.

The other big pool of risk capital in China goes into direct investment in entrepreneurial ventures of all sizes and calibers. Nowhere in the world is it easier to raise money to start or grow a business than China. In part, because Chinese have a marked preference for being their own boss, so the number of new companies started each year is high. The other big factor, call it the demand side, is that there is both a lot of money available and a great enthusiasm for investing in the new, the untried, the risky.

Before coming here, I used to work in the venture capital industry in California. VCs there are occasionally accused of turning a blind eye toward risk. Compared to venture investing in China, however, even the most starry-eyed venture investor in Silicon Valley looks like a Swiss money manager.

Just about any idea here seems to attract funding, a lot of it institutional. China now almost certainly has more venture firms than the rest of the world combined. No one can keep proper count. Along with all the big global names like Sequoia and Kleiner Perkins, there are thousands of other China-only venture firms operating, along with at least as many angel groups. In addition, just about every Chinese town, city and province, along with most listed companies, have their own venture funds.

I marvel at the ease with which early-stage businesses get funded, the valuations they command and the less than diligent due diligence that takes sometimes place before money moves. Of course, a few of these venture-backed companies hit the jackpot.

Alibaba or Tencent are two that come to mind. But, initial public offering (IPO) exits for Chinese startups remain rare, and so taken as a whole, venture investing returns in China have proved meager. But, activity never seems to wane. Fad follows fad. From group shopping, to what’s known in China as “O2O” (offline-to-online) thousands of companies get started, funded and then often within less than 18 months, go pffft.

With the New Year celebrations winding down, the outdoor gambling tables in my neighborhood are being put away for another year. Work schedules are returning to normal. For all the headwinds China’s economy now faces, Chinese household savings are still apparently growing faster than GDP. This means Chinese will likely go on year-after-year amassing more money to invest, to gamble or to speculate.

 

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http://blogs.ft.com/beyond-brics/2016/02/22/new-year-gambling-hints-at-chinese-entrepreneurial-vigour/

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Xiaomi’s $45 Billion Valuation Seen `Unfeasible’ as Growth Cools — Bloomberg

Leave a Comment / June 24, 2016

Bloomberg

Xiaomi’s $45 Billion Valuation Seen `Unfeasible’ as Growth Cools

By Tim Culpan

November 25, 2015 — 7:00 PM HKT

Things were going so well for Xiaomi Corp. Customers were lining up, investors were swooning and the Beijing-based startup closed funding at a $45 billion valuation. That was last year.

Now the high-flying smartphone maker is stumbling. Founder Lei Jun’s latest business, one of China’s most exciting startup stories of the past few years, is likely to miss its own goal of selling 80 million smartphones this year, according to two people with knowledge of its production plans. Suppliers also cut their internal targets for Xiaomi in anticipation of the shortfall, they said.
Xiaomi’s falter shows the startup’s challenge in trying to maintain momentum after a meteoric ascent past Apple Inc. and Samsung Electronics Co. in China. Investors bought into the company’s story of youthful disruption and online sales, yet the subsequent lowering of China’s growth target and the copying of its sales strategy by rivals have neutralized Xiaomi’s first-mover advantage, putting its high price tag in doubt.

“All those expectations of growth aren’t being realized, which now makes that $45 billion valuation unfeasible,” said Alberto Moel, an analyst at Sanford C Bernstein in Hong Kong. “The argument was that their business is kind of like Apple and they’re growing very fast, but they’re no longer growing so fast and they’re not as good as Apple.”
Shipments Drop

Xiaomi doesn’t provide exact shipment targets to its suppliers, instead working on a real-time basis with orders fulfilled as they come in on Xiaomi’s website. Yet the companies tasked with preparing the components and capacity to meet Xiaomi’s needs have started scaling back production and diverting resources elsewhere, said the people, who have knowledge of the supply chain and asked not to be identified because the details are private.

Domestic shipments of Xiaomi smartphones, including its premium Mi 4 and more economical Redmi series, dropped 8 percent in the third quarter from a year earlier, its first-ever decline, according to researcher Canalys. IHS, another research firm, estimates that Xiaomi shipments dropped 3.9 percent, barely maintaining the lead over Huawei Technologies Co.

That’s a big change from the bold growth projections used to justify Xiaomi’s tag as one of the world’s most-valuable technology startups. In March of last year, Lei predicted selling 100 million smartphones in 2015. Through the first nine months of this year, Xiaomi shipped about 53 million smartphones.

With its optimistic forecast, Xiaomi secured $1.1 billion in December from investors including GIC Pte., All-Stars Investment Ltd. and DST. Xiaomi drew comparisons to Alibaba Group Holding Ltd., the Chinese e-commerce company that months earlier held the largest initial public offering ever.

‘Hype, Hope’

At 3.75 times last year’s $12 billion in revenue, Xiaomi’s fundraising gave it a price-to-sales ratio exceeding that of Apple, which currently trades at 2.9.

That pricing of Xiaomi does not seem to have been based on any known or accepted valuation methodology, said Peter Fuhrman, chairman and CEO of China First Capital. “Hype and hope seem to have been the two key drivers,” he said.

In March, after that round of funding and after China set its lowest growth target in 15 years, Lei trimmed his earlier prediction to “80 million to 100 million” units for the year.

Its first year-on-year decline came during a quarter when Xiaomi released its Redmi Note 2, a lower-priced handset that sold for an average of 801 yuan ($125) each. On Tuesday it unveiled a metallic version of that phone with a fingerprint sensor, as well as a new tablet computer and air purifier.

‘Substantial’ Market

Growth might be reignited in the fourth quarter by China’s Nov. 11 Singles’ Day shopping promotions and the latest version of the Redmi Note. The company, which traditionally unveils an update to its marquee Mi smartphones during the third quarter, hasn’t yet announced a Mi 5 after last year’s Mi 4.

“I am not concerned about the valuation because, over time, their market is substantial,” said Hans Tung, managing partner at Xiaomi investor GGV Capital in Menlo Park, Calif. “Over the next 12 months, it’ll become increasingly obvious what Xiaomi is doing in the smart home and services space.”

Hugo Barra, a Xiaomi vice president, declined to comment on shipment targets or valuations and referred questions to Chief Financial Officer Shou Zi Chew, who didn’t reply to an e-mail seeking comment.

Xiaomi eschews the label of smartphone maker, claiming instead to be an “Internet company” furnishing a range of devices and online services. Xiaomi and its affiliates sell TVs, air filters, battery packs, action cameras, fitness trackers and even a self-balancing scooter. Its non-hardware offerings include games, payments, mobile-phone services and cloud storage.

No Loyalty

It’s those other products, such as the Mi Air Purifier 2 released this week, which Tung sees helping Xiaomi expand its sales and keeping consumers coming back to an ecosystem that connects home devices to the Internet and through mobile apps.

The ancillary businesses are still relatively small, with the company expecting the services units to account for just $1 billion of its $16 billion in projected revenue this year, Barra said in a July interview. Sales of smartphones outside China accounted for just 7 percent of its total in the third quarter, according to Strategy Analytics.

Xiaomi has struggled partly because competitors Huawei, Lenovo Group Ltd. and Gionee — among others — quickly copied its business model with ultra-thin devices, glossy websites and lower prices, allowing consumers to easily switch to the hippest new phone.

“Xiaomi was very popular because it was the first brand that marketed its phones as being limited edition,” said Chen Si, a 25-year-old real estate worker in Beijing who bought the Mi 3 after its 2013 release, citing its cool design. “I wouldn’t say I am loyal to Xiaomi, I just think that a phone should be affordable and easy to use. If not, then I’ll just change.”

A year later, she switched to the iPhone 6.

 

http://www.bloomberg.com/news/articles/2015-11-25/xiaomi-s-45-billion-valuation-seen-unfeasible-as-growth-cools

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Shining lights brighten future of SOEs — China Daily Commentary

Leave a Comment / December 8, 2015

 

China Daily

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Shining lights brighten future of SOEs

By PETER FUHRMAN (China Daily) Updated: 2015-10-23 07:29

Shining lights brighten future of SOEs
While the need for SOE reform is great and too many SOEs still fight to maintain the troubled status quo, there are also some Chinese SOEs leading by example.

As China’s leadership prepares its 13th Five-Year Plan (2016-20), it confronts multiple economic challenges, reform of State-owned enterprises being one of them.

Shining lights brighten future of SOEs

SOEs account for at least 30 percent of China’s total GDP. Some estimates put the share as high as 45 percent. But there are two worrying signs of the worsening situation for China’s SOEs: Their profits are dropping and indebtedness is rising sharply. According to the Ministry of Finance on Wednesday, the profits of the SOEs from January to August decreased by 8.2 percent year-on-year, while the total debt of SOEs from January to September has surpassed 77 trillion yuan, a 20 percent year-on-year increase.

Last month, the government introduced its guidelines for the next stage of SOE reform, including more outside capital. The guidelines are in the right direction, but, there is also some enormous potential within the SOE sector in China that, if unleashed, would also help contribute to the overall turnaround.

There are centers of research excellence, especially in applied engineering, on par with the best in the US and Europe. One example is the China Iron and Steel Research Institute Group in Beijing. It employs 2,000 staff with doctorates along with other experienced research scientists. Every visit, I leave impressed not only by the commitment of the large staff, but also the level of the research institute’s globally-important innovation.

If there is an area that needs improving－one not uncommon for SOE research institutes－it is in how to commercialize their many technologies and how to initiate and structure profitable licensing deals, both with other SOEs in China and global steel and new materials companies. The Institute, based in Beijing’s Haidian district, is making great strides, but, a greater focus as well as a stronger push from the government to get technologies out of the lab and into factories would be helpful.

SOEs too often focus excessively on increasing gross output rather than on pleasing customers and accumulating profits. One positive mold-breaker here is Yangzhou’s AVIC Baosheng Group, which makes steel and copper cable. Though operating in a brutally-competitive market with lots of competitors, Baosheng holds its own. Also in Yangzhou are two examples of how SOEs can take a valuable traditional brand name and rejuvenate it. Restaurant chain Yechun Teahouse and cosmetic manufacturer Xiefuchun have both been around since the Qing Dynasty (1644-1911) and became SOEs in the 1950s.

Yechun is now opening beautiful restaurants both inside and outside China that maintain consistently high quality. Xiefuchun is more of a jewel-in-the-making, with great all-natural products in tune with buying trends in China and abroad. However, Xiefuchun is not as good as it could be on branding, packaging and retail, areas where SOEs often tend to do poorly. Xiefuchun, against all commercial logic, is now stuck inside a large SOE chemicals holding company.

Meanwhile, China Huadian Corporation stands out for its success doing something few SOEs have mastered－investing to build from the ground up and then running profitable large-scale projects outside China. All SOEs know about the central government’s “Go Global” policy. Huadian is getting it right and so has much to teach other globally-ambitious SOEs.

Then there’s my choice for most exceptional high-tech SOE in China, Sichuan Aerospace Tuoxin Basalt Industrial. Though little known, it could be a model for how SOEs might develop in the future. Based in Chengdu, 90 percent of the company is owned by the giant centrally-managed SOE, China Aerospace Group. Tuoxin internally developed a revolutionary process for using ordinary quarried stone to produce a lightweight waterproof, heat-resistant material with broad applications in everything from auto parts to wind-energy. It is on track to become a billion-dollar company within the next five years. Tuoxin suggests what more SOEs could be capable of.

But to get to where it is, Tuoxin needed an owner with long-term vision and patient capital, as well as a senior management team that wants to break out of the cocoon of supplying mainly other SOEs by partnering extensively with China’s private sector companies.

While the need for SOE reform is great and too many SOEs still fight to maintain the troubled status quo, there are also some Chinese SOEs leading by example. They are blazing a path toward a more productive and profitable SOE sector all Chinese can take pride in.

The author is chairman and chief executive officer of China First Capital

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http://www.chinadaily.com.cn/opinion/2015-10/23/content_22260934.htm

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“A lot hasn’t gone to plan”: SuperReturn Interview

Leave a Comment / December 14, 2015

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Does [China’s] shift from a manufacturing-driven economy to a service-driven one make macroeconomic shocks like those seen this summer inevitable?

Peter Fuhrman: China has enjoyed something of a worldwide monopoly on hair-raising economic news of late: a stock market collapse followed by a klutzy bail-out, then a devaluation followed by a catastrophic explosion and finally near-hourly reports of sinking economic indicators. As someone who first set foot in China 34 years ago, my view is we’re in an unprecedented time of economic and financial uncertainty . Consumers and corporates are noticeably wobbling. For a Chinese government long used to ordering “Jump!” and the economy shouting back “How high?” this is not the China they thought they were commanding.  Everyone is looking for a bannister to grab.

And yet, China still has some powerful fundamentals working in its favour. Urbanization is a big one. It alone should add at least 3-4% to annual GDP a year for many years to come. The shift towards services and domestic growth as opposed to exports are two others. For now, these forces are strong enough to keep China propelling forward even as it tows heavy anchors like an ageing population, and a cohort of monopolistic state-owned enterprises (SOEs) that suck up too much of China’s capital and often achieve appalling results with it.

Look, the Chinese stock market had no business in the first place almost tripling from June last year to June of this. The correction was long, long overdue. It’s often overlooked that China’s domestic stock market has a pronounced negative selection bias. Heavily represented among the 3,000 listed companies are quite a number of China’s very worst companies, with the balance made up of lethargic, low-growth, often loss-making SOEs. The good companies, like Tencent or Baidu, predominantly expatriate themselves when it comes time to IPO. To my way of thinking, China’s domestic market still seems overpriced. The dead cats are, for now, still bouncing.

 

Given this overall picture, do you expect to see greater or fewer opportunities [in China] for alternative investments and why? 

Peter Fuhrman: The environment in China has been challenging, to say the least, for alternative investment firms not just in the last year, but for the better part of the last decade. A lot hasn’t gone to plan. China’s growth and opportunities proved alluring to both GPs and LPs. And yet too often, almost systematically, the big money has slipped between their fingers. Partly it’s because of too much competition, and with it ballooning valuations, from over 500 newly-launched domestic Chinese PE and VC firms. The fault also sits with home-grown mistakes, with errors by private equity firms in investment approach. This includes an excessive reliance on a single source of deal exit, the IPO, all but unheard-of in other major alternative investment environments.

Overall PE returns have been lacklustre in China, especially distributions, before the economy began to slip off the rails. In the current environment, challenges multiply. A certain rare set of investing skills should prove well-adapted: firms that can do control deals, including industry consolidating roll-ups. In other words, a whole different set of prey than China PE investors have up to now mainly stalked. These are not pre-IPO deals, not ones predicated on valuation arbitrage or the predilections of Chinese young online shoppers. There’s money to be made in China’s own Rust Belt, backing solid well-managed manufacturers, a la Berkshire Hathaway. There’s too much fragmentation across the industrial board. China will remain the manufacturing locus for the world, as well as for its own gigantic domestic market.

Another anomaly that needs correcting: Global alternative investing has been overwhelmingly skewed in China towards equity not debt. The ratio could be as high as 99:1. This imbalance looks even more freakish when you consider real lending rates to credit-worthy corporates in China are probably the highest anywhere in the advanced world, even a lot higher than in less developed places like India and Indonesia. Regulation is one reason why global capital hasn’t poured in in search of these fat yields. Another is the fact PE firms on the ground in China have few if any team members with the requisite background and experience to source, qualify, diligence and execute China securitized debt deals. There’s a bit of action in the China NPL and distress world. But, straight up direct collateralized lending to China’s AA-and-up corporates and municipalities remains an opportunity global capital has yet to seize. Meanwhile, China’s shadow banking sector has exploded in size, with over $2.5 trillion in credit outstanding, almost all of which is current. There’s big money being made in China’s securitized high-yield debt, just not by dollar investors.

 

What’s the overall story of alternative investors engaging with central planning? How would you characterise the regulatory environment?

Peter Fuhrman: China has had a state regulatory and administrative apparatus since Europeans were running around in pelts and throwing spears at one another. So, yes, there is a large regulatory system in China overseen by a powerful government that is very deeply involved in economic and financial planning and rule-making. One must tread carefully here. Rules are numerous, occasionally contradictory, oft-time opaque and liable to sudden change.

Less observed, however, and less harrowing for foreign investors is the core fact that the planning and regulatory system in China has a strong inbuilt bias towards the goal of lifting GDP growth and employment. Other governments talk this talk. But it’s actually China that walks the walk. The days of anything-goes, rip-roaring, pollute-as-you-go development are about done with. But, still the compass needle remains fixed in the direction of encouraging strong rates of growth.

The Chinese government has also gotten more and more comfortable with the fact that most of the growth is now coming from the highly-competitive, generally lightly-regulated private sector. Along with a fair degree of deregulation lately in industries like banking and transport, China also often pursues a policy of benign neglect, of letting entrepreneurs duke it out, and only imposing rules-of-the-game where it looks like a lot of innocents’ money may be lost or conned. To be sure, foreign investors in most cases cannot and should not operate in these more free-form areas of China’s economy. They often seem to be the first as well as the fattest targets when the clamps come down. Just ask some larger Western pharmaceutical companies about this.

 

In the long view, how long can the parallel USD-RMB system run? Do you expect to see the experiments in Shanghai’s Pilot Free Trade Zone (FTZ) replicated and extended? 

Peter Fuhrman: Unravelling China’s rigged exchange rate system will not happen quickly. Every baby step — and the steps are coming more fast of late — is one in the direction of a more open capital account, of greater liberalization. But, big change will all unfold with a kind of stately sluggishness in my view. Not because policy-makers are particularly wed to the notion of an unconvertible currency. There’s the deadweight problem of nearly $4 trillion in foreign exchange reserves. What’s the market equilibrium rate of the Dollar-Renminbi? Ask someone facing competition from a Chinese exporter and they’re likely to say three-to-one, or an almost 100% appreciation. Ask 1.4 billion Chinese consumers and they will, with eminent good reason, say it should be more like 12-to-one. Prices of just about everything sold to consumers in China is higher, often markedly higher, than in the US where I’m from. This runs from fruit, to supermarket staples, to housing, brand-name clothing up to ladder to cars and the fuel that powers them.

I think the irrational exuberance about Shanghai’s FTZ has slammed into the wall of actual central government policy of late.  It will not, cannot, act like a free market pathogen.

 

Reform of China’s state-owned enterprises has been piecemeal, and private equity has had patchy success with SOEs. Do you expect this to change, and why?

Peter Fuhrman: For those keeping score, reform of SOEs has yet to really put any points on the board. The SOE economy-within-an-economy remains substantially the same today as it was three years ago. Senior managers continue to be appointed not by competence, vision and experience, but by rotation. The major shareholder of all these SOEs, both at centrally-administered level as for well as those at provincial and local level, act like indifferent absentee proprietors, demanding little by way of dividends and showing scant concern as margins and return-on-investment droop year-by-year at the companies they own.

There are good deals to be done for PE firms in the SOE patch. The dirty little secret is that the government uses a net asset value system for state-owned assets that is often out-of-kilter with market valuations. Choose right and there’s scope to make money from this. But, if you’re a junior partner behind a state owner who cares more about jobs-for-the-boys than maximizing (or even earning) profits then no asset however cheaply bought will ever really be in the money.

 

TPP has been described as ‘a club with China left out’. If it comes to pass, how do you expect China to respond?

Peter Fuhrman: China has responded. Along with its rather clumsy-sounding “One Belt, One Road” initiative it also has its Asia Infrastructure Investment Bank. The logic isn’t alien to me. When American Jews were barred from joining WASP country clubs, they tried to build better clubs of their own. When Chase Manhattan, JP Morgan and America’s largest commercial banks wouldn’t hire Jews, they went instead into investment banking, where there was more money to be made anyway.

But, China may not so easily and successfully shrug off their exclusion from TPP. It increases their aggrieved sense of being ganged-up upon. The US understands this and now frets more about China’s military power. The partners China are turning to instead – especially the countries transected by the “One Belt, One Road” – look more like a cast of economic misfits, not dynamic free traders like the TPP nations and China itself. I don’t think anyone in Beijing seriously believes that increased trading with the Central Asian -stans is a credible substitute. Even so, China will not soon be invited to join the TPP. China has hardly acted like a cozy neighbour of late to the countries with the markets and with the money. Being feared may have its strategic dividends. But the neighbourhood bully rarely if ever gets invited to the block party.

 

Peter Fuhrman will be speaking at SuperReturn Asia 2015, 21-24 September 2015, JW Marriott, Hong Kong.

 

http://www.superreturnasia.com/blog/super-return-private-equity-conference/post/id/7653_A-lot-hasnt-gone-to-plan-Peter-Fuhrman-China-First-Capital-on-alternative-investments-in-the-PRC?xtssot=0

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The Economist Survey on China Business

Leave a Comment / June 25, 2016

Econ

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With a timing that can only be described as exquisite, the Economist today publishes their in-depth survey of business in China. It appears at a time when the media is brimming with stories, often in my view overblown,  about China’s economic problems and challenges. The Economist survey provides light where there’s been way too much heat of late. I couldn’t recommend more highly taking the time to read it in full.

Please click here to go direct to the survey on the Economist website. It includes nine separate articles, each offering a banquet of analysis, ideas and insights on where China’s economy, both private sector and SOE, is heading.

The author of the survey is Vijay Vaitheeswaran, the China business and finance editor. This is the first Economist China business survey in many years. It was certainly no small undertaking. China’s size, complexity and ever-morphing business environment make a comprehensive future-looking summary of this kind difficult in the extreme to do well.

I got to meet Vijay during his research phase. I took him for Tibetan food in Shenzhen. He ended up quoting me briefly in one of the articles in the survey.

Vijay paid particular attention to accelerating innovation cycles in China’s hardware industry. He spent a few days in Shenzhen including attending a kind of hacker forum for hardware geeks. He calls Shenzhen “the world’s best place to start a hardware firm” and visited my favorite exemplar of this, 18-month-old mobile phone brand OnePlus.

Quick aside, since the launch of its new model, the OnePlus 2 six weeks ago, the waiting list to buy one has grown to over five million people. If OnePlus’s factories can keep pace with the exploding demand, the company is on track to sell over $2 billion of phones in coming twelve months.

While overall highly positive about China’s economic prospects and the ambitions of its vast pool of private sector entrepreneurs, the survey sounds a note of caution. It argues that the less efficient state-owned sector appears more and more like an unevolved creature from a foregone era.  They are, the survey warns, sucking up too much of China’s capital and achieving too little with it, all the while fighting to maintain the cozy monopolies that keep the far more dynamic and efficient private sector shut out.

How much market? How much government control and ownership? All countries struggle to find a balance. China stands out because the private sector has come so far so fast. Thirty years ago when I first set foot in China there was no private sector to speak of. Now, in all but the so-called “commanding heights” of China’s economy, entrepreneurs run rampant. 1.4 billion Chinese benefit from this fact every day.

 

Download PDF version.

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Trials and tribulations: China’s shifting business landscape highlighted in new report — Financier Worldwide

Leave a Comment / July 23, 2015

Financier–

Trials and tribulations: China’s shifting business landscape highlighted in new report

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BY Fraser Tennant

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The deeper trends reshaping the business and investment environment in China today are the focus of a new report – ‘China 2015: China’s shifting landscape’ – by the boutique investment bank and advisory firm, China First Capital.

As well as highlighting slowing growth and a gyrating stock market as the two most obvious sources of turbulence in China at the midway point of 2015, the report also delves into the deeper trends radically reshaping the country’s overall business environment.

Chief among these trends is the steady erosion in margins and competitiveness among many, if not most, companies operating in China’s industrial and service economy. As the report makes abundantly clear, there are few sectors and few companies enjoying growth and profit expansion to match that seen in previous years.

The China First Capital report, quite simply, paints a none too rosy picture of China’s long-term development prospects.

“China’s consumer market, while healthy overall, is also becoming a more difficult place for businesses to earn decent returns,” explains Peter Fuhrman, China First Capital’s chairman and chief executive. “Relentless competition is one part, as are problematic rising costs and inefficient poorly-evolved management systems.”

To read complete article, click here.

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China 2015 — China’s Shifting Landscape — China First Capital new research report published

Leave a Comment / July 20, 2015

China First Capital research report

 

Slowing growth and a gyrating stock market are the two most obvious sources of turbulence in China at the midway point of 2015. Less noticed, perhaps, but certainly no less important for China’s long-term development are deeper trends radically reshaping the overall business environment. Among these are a steady erosion in margins and competitiveness in many, if not most, of China’s industrial and service economy. There are few sectors and few companies that are enjoying growth and profit expansion to match last year and the years before.

China’s consumer market, while healthy overall, is also becoming a more difficult place for businesses to earn decent returns. Relentless competition is one part. As problematic are rising costs and inefficient poorly-evolved management systems.  From a producer economy dominated by large SOEs, China is shifting fast to one where consumers enjoy vastly more choice, more pricing leverage and more opportunities to buy better and buy cheaper. Online shopping is one helpful factor, since it allows Chinese to escape from the poor service and high prices that characterize so much of the traditional bricks-and-mortar retail sector. It’s hard to find anything positive to say about either the current state or future prospects for China’s “offline economy”.

Meanwhile, more Chinese are taking their spending money elsewhere, traveling and buying abroad in record numbers. They have the money to buy premium products, both at home and abroad. But, too much of what’s made and sold within China, belongs to an earlier age. Too many domestic Chinese companies are left manufacturing products no longer quite meet current demands. Adapting and changing is difficult because so many companies gorged themselves previously on bank loans. Declining margins mean that debt service every year swallows up more and more available cash flow. When the economy was still purring along, it was easier for companies and their banks to pretend debt levels were manageable. In 2015, across much of the industrial economy, the strained position of many corporate borrowers has become brutally obvious.

These are a few of the broad themes discussed in our latest research report, “China 2015 — China’s Shifting Landscape”. To download a copy click here.

Inside, you will not find much discussion of GDP growth or the stock market. Instead, we try here to illuminate some less-seen, but relevant, aspects of China’s changing business and investment environment.

For those interested in the stock market’s current woes, I can recommend this article (click here) published in The New York Times, with a good summary of how and why the Chinese stock market arrived at its current difficult state. I’m quoted about the preference among many of China’s better, bigger and more dynamic private sector companies to IPO outside China.

In our new report, I can point to a few articles that may be of special interest, for the signals they provide about future opportunities for growth and profit in China:

  1. China’s most successful cross-border M&A ever, General Mills of the USA acquisition and development of dumpling brand Wanchai Ferry (湾仔码头), using a strategy also favored by Nestle in China
  2. China’s new rules and rationale for domestic M&A – “buy first and pay later”
  3. China’s most successful, if little known, recent start-up, mobile phone brand OnePlus – in its first full year of operations, 2015 worldwide revenues should reach $1 billion, while redefining positively the way Chinese brand manufacturers are viewed in the US and Europe
  4. Shale gas – by shutting out most private sector investment, will China fail to create conditions to exploit the vast reserves, larger than America’s, buried under its soil?
  5. Nanjing – left behind during the early years of Chinese economic reform and development, it is emerging as a core of China’s “inland economy”, linking prosperous Jiangsu and Shanghai with less developed heavily-populated Hubei, Anhui, Sichuan

We’re at a fascinating moment in China’s story of 35 years of rapid and remarkable economic transformation. The report’s conclusion: for businesses and investors both global and China-based, it will take ever more insight, guts and focus to outsmart the competition and succeed.

 

The Shenzhen Unicorn — Week in China Magazine

Leave a Comment / December 8, 2015

week-in-china

 

OnePlus Two

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A sizeable quotient of the techno-hip crowd in the US and Europe is counting down the days to the launch next week of the newest Android mobile phone by China’s OnePlus. It’s called the OnePlus Two and follows a little more than a year after the 18-month-old company’s first phone, the OnePlue One, went on sale in the US and Europe. With barely a nickel to spend on marketing and promotion, OnePlus insouciantly dubbed its OnePlus One a “flagship killer” claiming it delivered similar or better performance than Samsung, LG and HTC Android phones costing twice as much.

The tech media swooned, and buyers formed long online queues to buy one from the OnePlus website, www.oneplus.net, the only place the phones are sold. In little more than six months last year, OnePlus sold over one million phones.

The new OnePlus model is rumored to be built around a new top-of-the-line Qualcomm processor, and features a larger screen, an upgraded in-house version of Android software, fingerprint recognition. Price? Around $300. It will be available, as was the OnePlus One for most of the last year, on an “invitation-only cash-upfront” basis to prospective buyers. How to get a coveted invitation remains something of a dark art. New OnePlus owners are given a certain number of invitations to send to whoever they please.

The July 27th launch will be an online event broadcast in virtual reality. OnePlus manufactured and is giving away a cardboard virtual reality viewer said to be as good or better than the ones sold by Google for $20. The viewers have been flying out the door for the last month.

To read complete article, click here.

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