Private Equity China

Can Xiaomi Reverse Its Slide in China? — CNBC Interview

 

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From King-of-Mobile to possible also-ran in two short years, China’s Xiaomi is struggling to reclaim its spot at the top of China’s domestic phone market. Here’s my interview on CNBC on the tough challenges Xiaomi faces. Nerves are starting to fray among investors who put money into the company less than two years ago at a $45 billion valuation.

To watch the interview, please click here.

 

Fresh Ideas For Making Money in China Private Equity and Venture Capital

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2016 is looking like it may be another year to forget for PE and VC in China.  The problem, as always, is with exits. For years, IPOs in China for PE-backed deals have been too few and far between.  There was initially a lot of  hope for improvement this year. But, prospects unexpectedly turned bleak when the Chinese securities regulator, the CSRC, suddenly reversed course. Not only did they put on hold previously-announced plans to liberalize IPOs by opening a new “strategic board” in Shanghai and to shift to a registration-based IPO system, they also began clamping down hard on the two main exit alternatives, backdoor shell listings and trade sales to Chinese listed companies.

IPO multiples remain sky-high in China. The IPO queue sits at 830 companies, with at least another 700 now lined up to get provincial approval to join the main waiting list. The CSRC did finally announce one liberalization of the IPO regime in China, but it will likely be of little help to the hundreds of PE and VC firms with thousands of unexited deals. Companies based in China’s poorest, most backward areas, the CSRC announced earlier this month, will now get to jump to the head of the queue.

Not for the first time, it looks like PE and VC portfolios may be mismatched with IPO regulatory policy in China. PE and VC firms have of late invested overwhelmingly in two areas. First is healthcare. The industry in China is growing and reforming. But, entry valuations have been bid up to astronomical levels.

In terms of number of deals closed, Chinese tech startups are getting the lion’s share of the attention. China’s online and smartphone population as well as e-commerce industry, after all, are the world’s largest. What’s missing at most of the funded startups are profits or a high-probability path to making money one day soon. Many are using PE money as part of a “last man standing” strategy to win customers by subsidizing purchases. Loss-making companies are still barred from having an IPO in China.

The main building blocks of China’s corporate sector, manufacturing companies and bricks-and-mortar businesses, are both highly out of favor with PE firms.

Amid so much misfortune, where should the PE and VC industry look next to invest profitably in China? What seems most clear is that any strategy linked to short-term IPO exit-chasing, or seeking to intuit the next flux in CSRC policy, has proved fundamentally risky. Some fresh approaches may be in order.

One priority should be on backing companies that can deliver sustainably high margins and positive cash flow over time to support regular dividend payments. Invest more for yield and less for capital gains.

There are such investment opportunities in China. I want to share six here. There are certainly many others. Looking outside the current China PE investment mainstream has other pluses. A troubling term has entered the Chinese financial vocabulary in the last two years, called “2VC”. It means a Chinese company started and run primarily for the purpose of attracting PE and VC money and less about making money from customers. 2VC deserves a detailed analysis of its own, how much it may be warping the investment landscape in China.

GPs and LPs looking for durable margins, scaleability, and a dearth of competition in China could start their search here:

  1. Robotics gearbox. China’s robot industry is hot. By now, about everyone has read the stories suggesting China’s robotics market, already the largest in the world, will boom for decades to come. For now, the investment money in China has gone overwhelmingly into companies that are making simple robots, rather than the robot industry supply chain. This overlooks perhaps the best opportunity of all. Robots rely on sophisticated gearboxes to make parts move. Making and selling gearboxes, rather than the final robot, is where the big margins and demand are. The technology has been around for a while, but the industry is dominated by two big foreign manufacturers, ABB of Switzerland and Rexnord of the US. They make a ton doing it. A Chinese robotics gearbox maker, assuming they get the product right, could immediately roll up sales in the hundreds of millions of dollars, both to Chinese robot makers as well as US, European and Japanese ones. From conversations I’ve had with C Level execs at both ABB and Rexnord, this is the Chinese competition they fear most, but which to their surprise has yet to materialize.  —————————————————————————–
  2. Hospice and specialized late stage care. PE investment in healthcare, especially into biosimilar pharma companies, hospitals and clinics for plastic surgery and dental care has been abundant, averaging well over a billion dollars a year in China. Competition is rampant in all these areas. Late stage critical care, however, has largely gone unfunded. The unmet need in China is almost unfathomably large. There are basically no hospices in China, though some 10 million Chinese die every year, including a surging number from cancers and long-term chronic diseases. There are also 30 million Chinese with Alzheimers and virtually no places offering specialized care. The number of Alzheimers sufferers is rising fast as Chinese longevity surges. Make no mistake, it’s harder to provide this kind of medical care than to do Botox injections. But, anywhere money is easily made in China, it’s getting harder to make any money at all. The biggest provider of specialized high-end late stage care in China is the French company, Orpea. They are doing a great job. I’ve had a close look at their business in China. They too are awed by the scale of the untapped market in China. A big plus: pricing freedom. The business doesn’t rely, as most conventional hospitals and drug companies in China do, on state reimbursement. —————————————————————————————————————————
  3. Dog food and other pet items. When I first came to China in 1981, it was basically illegal to keep a dog or cat as a pet. There was barely enough food to feed the human population and food was rationed. To say the growth in pet ownership since then has been explosive would risk understating things. China is now the third largest dog-owning market globally, with 27.4 million dogs (behind the US with 55.3 million dogs and Brazil with 35.7 million), and the second largest cat-owning country with 58.1 million cats, behind only the US with 80.6 million. China’s pet market will soon blow past that of the US. Everywhere this is presenting great opportunities in pet care, pet food, pet hotels. The US pet food giant Mars has a large chunk of the dog food market here. But, there are still many opportunities to carve out a niche in pet food, both via sales at veterinary clinics and online. The other vast uncharted market: pet insurance.   ——————————————————————————————–
  4. Server storage. Chinese law mandates that the country now has and will continue to have the largest ongoing demand for high-end servers, as well as the software that powers them. The reason: all the major sources of online traffic — Alibaba, Tencent, JD.com, Baidu — must permanently store virtually everything that runs across their network. In the case of Tencent’s Wechat business, that means keeping billions of text, audio, video and photo messages generated every day by its 600 million users. Tencent’s ongoing investment in servers is almost certainly larger than any other company in the world, with the other big Chinese internet companies following closely behind. The growth rate is dizzying. This has created a wonderful profit-center for otherwise troubled chip giant Intel. Its Xeon chips power virtually all high-end servers. No single domestic company has yet emerged to build a sizeable business in storage software, maintenance and integration tailored to the regulatory needs in China. In parallel, there’s also a large market for similar made-at-home software solutions to sell to the Chinese government. They are the reason all this server storage demand exists.   ————————————————————————————————————————————————
  5. Mall-based attractions. Shopping malls in China are in a fight for survival. Clothing retailers, which just two to three years ago took at least half the floor space in Chinese malls, are disappearing. They can’t compete with online merchants offering the same products for one-third to one-half less. The going has proved especially hard for Chinese domestic retail brands, quite a few got PE money back when this sector was hot. Chinese malls need to change, and fast. Their main strategy so far is increasing the floor space allocated to restaurants and movie theaters. Another area with huge potential, but so far little concrete activity, is “edu-tainment” attractions. A prime example is a mall-based aquarium. I was recently shown around one-such mall aquarium in a major Chinese city by its owners, a large Chinese real estate developer. Though they initially knew nothing about aquariums, their design and selection of fish are mediocre, the owner is coining money with over 45% margins. Tickets sell days in advance, not just on weekends, for average of $15 for adults and less for kids. It’s been open and thriving for three years. Every mall they are building now will have a similar attraction. A better operator should be able to push margins higher and roll out nationwide. On average, 55 million Chinese go to the mall each week. —————————————————————————–
  6. Indoor LED vegetable growing.  China has a big appetite for vegetables, about 100 kilos per person per year, or seventy billion tons. Many Chinese, especially the 55% living in cities, have concerns about where and how the vegetables are grown and how they get to market. The worry rises in lock step with per capita income.  Catering to worried Chinese consumers could keep a company in profit for decades. One good idea that’s not yet in China but should be: growing vegetables indoors, using LED lights.The cost of LED lighting has fallen by over 90% since 2010 and will continue to decline, thanks in large part to over-investment in this sector in China. LED efficiency has also nearly doubled over that time. It now costs about the same to grow vegetables indoors with LEDs as it does in well-irrigated farmland. Supplying vegetables to urban China this way has a lot of other advantages, including the ability to provide a secure chain of custody, from the place where the food is picked all the way to the customer’s hands. Lots of models would work in China — large growing areas inside abandoned urban factories to supply better Chinese supermarket chains like Walmart, Carrefour and China Resources, or smaller-scale packages home-delivered or sold through vending machines placed inside high-end residential complexes in China. Organic or non-organic, catering to Chinese picky consumers could keep a company in profit for decades.

Since PE first took off in China in 2005,  China’s economy has grown by almost four-fold. Few GPs in China have done as well in DPI terms. It’s likely not going to get any easier to make or raise money, nor to rack up IPO exits. More than ever, PE firms need to back or incubate ideas to catch and hold some of the new wealth that’s getting created every day in China.

As published by SuperReturn

Chinese Firms Are Reinventing Private Equity — Nikkei Asian Review

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Pudong

July 26, 2016  Commentary

Chinese firms are reinventing private equity

Henry Kravis, his cousin George Roberts and his mentor Jerry Kohlberg are generally credited with having invented private equity buyouts after forming KKR 40 years ago. Even after other firms like Blackstone and Carlyle piled in and deals reached mammoth scale, the rules of the buyout game changed little: Select an underperforming company, buy it with lots of borrowed money, cut costs and kick it into shape, then sell out at a big markup, either in an initial public offering or to a strategic buyer.

This has proved a lucrative business that lots of small private equity firms worldwide have sought to copy. China’s domestic buyout funds, however, are trying to reinvent the PE buyout in ways that Kravis would barely recognize. Instead of using fancy financial engineering, leverage and tight operational efficiencies to earn a return, the Chinese firms are counting on Chinese consumers to turn their buyout deals into moneymakers.

Compared to KKR and other global giants, Chinese buyout firms are tiny, new to the game and little known inside China or out. Firms such as AGIC, Golden Brick, PAG, JAC and Hua Capital have billions of dollars at their disposal to buy international companies. Within the last year, these five have successfully led deals to acquire large technology and computer hardware companies in the U.S. and Europe, including the makers of Lexmark printers, OmniVision semiconductors and the Opera web browser.

So what’s up here? The Chinese government is urgently seeking to upgrade the country’s manufacturing and technology base. The goal is to sustain manufacturing profits as domestic costs rise and sales slow worldwide for made-in-China industrial products. The government is pouring money into supporting more research and development. It is also spreading its bets by providing encouragement and sometimes cash to Chinese investment companies to buy U.S. and European companies with global brands and valuable intellectual property.

While the hope is that acquired companies will help China move out of the basement of the global supply chain, the buyout funds have a more immediate goal in sight, namely a huge expansion of the acquired companies’ sales within China.

This is where the Chinese buyout firms differ so fundamentally from their global counterparts. They aren’t focusing much on streamlining acquired operations, shaving costs and improving margins. Instead, they plan to leave things more or less unchanged at each target company’s headquarters while seeking to bolt on a major new source of revenues that was either ignored or poorly managed.

So for example, now that the Lexmark printer business is Chinese-owned, the plan will be to push growth in China and capture market share from domestic manufacturers that lack a well-known global brand and proprietary technologies. With OmniVision Technologies, the plan will be to aggressively build sales to China’s domestic mobile phone producers such as Huawei Technologies, Oppo Electronics and Xiaomi.

The China Android phone market is the biggest in the world.  Omnivision used to be the main supplier of mobile phone camera sensor chips to the Apple iPhone, but lost much of the business to Sony.

In launching last year the $1.8bn takeover of then then Nasdaq-quoted Omnivision, Hua Capital took on significant and unhedgeable risk. The deal needed the approval of the US Committee for Foreign Investment in the United States, also known as CFIUS. This somewhat-shadowy interagency body vets foreign takeovers of US companies to decide if US national security might be compromised. CFIUS has occasionally blocked deals by Chinese acquirers where the target had patents and other know-how that might potentially have non-civilian applications.

CFIUS also arrogates to itself approval rights over takeovers by Chinese companies of non-US businesses, if the target has some presence in the US. It used this justification to block the $2.8 billion takeover by Chinese buyout fund GO Scale Capital of 80% of the LED business of Netherlands-based Philips. CFIUS acted almost a year after GO Scale and Philips first agreed to the deal. All the time and money spent by GO Scale with US and Dutch lawyers, consultants and accountants to conclude the deal went down the drain. CFIUS rulings cannot be readily appealed.

Worrying about CFIUS approval isn’t something KKR or Blackstone need do, but it’s a core part of the workload at Chinese buyout funds. Hua Capital ultimately got the okay to buy Omnivision five months after announcing the deal to the US stock exchange.

The Chinese buyout firms see their role as encouraging and assisting acquired companies to build their business in China. This often boils down to business development and market access consulting. Global buyout firms say they also do some similar work on behalf of acquired companies, but it is never their primary strategy for making a buyout financially successful.

Chinese buyout funds count on two things happening to make a decent return on their overseas deals. First is a boost in revenues and profits from China. Second, the funds have to sell down their stake for a higher price than they paid. The favored route on paper has been to seek an IPO in China where valuations can be the highest in the world. This path always had its complications since it generally required a minimum three-year waiting period before submitting an application to join what is now a 900-company-long IPO waiting list.

The IPO route has gotten far more difficult this year. The Chinese government delivered a one-two punch, first scrapping its previous plan to open a new stock exchange board in Shanghai for Chinese-owned international companies, then moving to shut down backdoor market listings through reverse mergers.

The main hope for buyout funds seeking deal exits now is to sell to Chinese listed companies. In some cases, the buyout funds have enlisted such companies from the start as minority partners in their company takeovers. This isn’t a deal structure one commonly runs across outside China, but may prove a brilliant strategy to prepare for eventual exits.

There is one other important way in which the new Chinese buyout funds differ from their global peers. They don’t know the meaning of the term “hostile takeover.” Chinese buyout funds seek to position themselves as loyal friends and generous partners of a business’s current owners. A lot of sellers, especially among family-controlled companies in Europe, say they prefer to sell to a gentle pair of hands — someone who promises to build on rather than gut what they have put together. Chinese buyout funds sing precisely this soothing tune, opening up some deal-making opportunities that may be closed to KKR, Blackstone, Carlyle and other global buyout giants.

The global firms are also finding it harder to compete with Chinese buyout funds for deals within China, even though they have raised more than $10 billion in new funds over the last six years to put into investments in the country. They have basically been shut out of the game lately because they can’t and won’t bid up valuations to the levels to which domestic funds are willing to go.

The global buyout giants won’t be too concerned that they face an existential threat from their new Chinese competitors. It is also unlikely that they will adopt similar deal strategies. Instead, they are getting busy now prettying up companies they have previously bought in the U.S. and Europe. They will hope to sell some to Chinese buyers. Along with offering genial negotiations and a big potential market in China, the Chinese buyout funds are also gaining renown for paying large premiums on every deal. No one ever said that about Henry Kravis.

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

Abridged version as published in Nikkei Asian Review

Chinese Private Equity Funds Are Taking on the World’s Giants — Bloomberg

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Cathy Chan 

July 21, 2016 — 12:00 AM HKT

  • PE firms from China pursue overseas deals at record pace
  • One Italian target says China links are what matter most

Giuseppe Bellandi never imagined that his company, a 30-year-old maker of industrial automation components in the foothills of the Italian Alps, would end up in the hands of a private-equity fund from China.

But when the chief executive officer of Gimatic Srl realized that Asia’s largest economy was key to his firm’s future, and that Chinese PE executives had the expertise to help him grow there, Bellandi jumped at the chance to partner up. Last month, Gimatic turned down bids from Europe and the U.S. in favor of selling a majority stake to AGIC Capital, the PE firm founded by Chinese banker Henry Cai with backing from the nation’s sovereign wealth fund.

“I was really surprised when I realized how strong Chinese private equity firms are,” Bellandi said by e-mail.

China’s PE industry is expanding globally at an unprecedented pace, putting firms like AGIC, Legend Capital and Golden Brick Capital in competition with European and U.S. counterparts like never before. Fueled by China’s growing wealth, investor sophistication and desire to gain exposure to overseas assets, homegrown funds have taken part in at least $16.4 billion of cross-border deals so far this year, exceeding the previous annual record of $11 billion in 2012, according to Asian Venture Capital Journal.

The overseas push marks a coming of age for an industry that just a few years ago was better known for “buy-and-flip” investments in local companies already primed to go public. The approach was so pervasive that Chinese regulators asked KKR & Co.’s Henry Kravis, a private equity pioneer, to lecture domestic players on how to add more value.

This year, Chinese PE firms have participated in the $3.6 billion takeover of U.S. printer company Lexmark International Inc., the $2.75 billion purchase of Dutch chipmaker NXP Semiconductors NV’s standard products unit and the $600 million acquisition of Oslo-based Opera Software ASA’s web browser business. The sum of overseas transactions so far in 2016 is higher than Asian deals by foreign PE firms for the first time, according to AVCJ.

“These Chinese funds are already beginning to alter the calculus for buyout deals worldwide,” said Peter Fuhrman, the chairman and CEO of China First Capital, a Shenzhen-based investment banking and advisory firm. “It’s about buying companies that, once they have Chinese owners, can start making really big money selling products in China.”

For a QuickTake explainer China’s outbound M&A, click here.

The firepower to pull off such deals comes in part from China’s growing army of high-net worth individuals, whose ranks expanded at the fastest pace worldwide last year despite the country’s weakest economic growth in a quarter century, according to Capgemini SA. Rich Chinese investors are increasingly keen to diversify overseas after last year’s devaluation of the yuan spurred concern of more weakness to come.

“There’s a lot of domestic capital available, obviously looking for a home, and that’s fueling the emergence of these funds,” said Michael Thorneman, a partner at Bain & Co., a Boston-based consulting firm.

It’s no coincidence that the increased focus on international deals comes amid a record overseas shopping spree by Chinese companies, who have announced about $149 billion of outbound acquisitions so far this year. In some cases, PE funds are working with Chinese corporates and financial firms to help structure the deals and amplify their buying power.

For the Lexmark purchase, Legend Capital partnered with PAG Asia Capital and Apex Technology Co., a Chinese maker of ink cartridge chips. On the $9.3 billion takeover of U.S.-listed Qihoo 360 Technology Co., Golden Brick Capital teamed up with Chinese investors including Ping An Insurance (Group) Co.

Domestic Players

“PE funds like us have very experienced teams, who can do the whole thing from deal sourcing to negotiation to due diligence to deal structure,” said Parker Wang, the CEO of Beijing-based Golden Brick, which has invested about $2 billion since it opened in 2014 and also led the purchase of Opera Software’s browser unit.

It hasn’t always been smooth sailing. The Opera Software deal, for example, was originally supposed to be a takeover of the entire company, but suitors including Golden Brick failed to secure government approval.

Chinese funds are also becoming more active in their home market. They’ve been helped by a regulatory bottleneck for initial public offerings — which encouraged companies to turn to PE firms for financing — and the rise of China’s Internet industry, a business that the government shields from foreign ownership.

Local funds participated in domestic investments worth $48 billion last year, exceeding Chinese deals by foreign PE firms by a record margin, according to AVCJ. The number of active Chinese funds, at 672 during 2013-2015, was the highest in at least five years, according to data compiled by Bain & Co.

For more on one of the latest China PE investments, click here.

Among the most high-profile firms doing domestic deals is Yunfeng Capital, founded by Alibaba Group Holding Ltd. Chairman Jack Ma. The firm has purchased stakes in Citic Securities Co. and smartphone maker Xiaomi, while also participating in offers for U.S.-listed Chinese companies such as iKang Healthcare Group Inc. and WuXi PharmaTech.

Domestic funds typically have a home-field advantage over foreign firms in identifying promising investment targets, according to William Sun, general manager of Beijing Jianguang Asset Management Co., a PE firm that focuses on the technology industry.

“We’re all optimistic about China opportunities, but we probably have a better grasp of them than foreign funds,” Sun said.

To be sure, overseas players aren’t walking away from China. Some have partnered with domestic PE firms on consortium deals, as California-based Sequoia Capital did with Yunfeng on the WuXi PharmaTech takeover.

Growing Competition

Others have identified niches. KKR has spent about $1 billion on five food-related investments in China since 2008, betting that its global track record in the industry will help it thrive in a country that’s faced several food-safety scandals in recent years.

More broadly, foreign firms may be concerned about rising valuations in China, according to Bain & Co.’s Thorneman. The average PE-backed Chinese acquisition target in 2015 had an enterprise value of about 18 times earnings before interest, taxes, depreciation and amortization, up from about 11 in 2013, according to data compiled by Bain.

“There’s just more competition out there,” Thorneman said. “That translates typically into higher valuations, more competitive deals, and more players pushing prices up.”

Most signs point toward a bigger role for Chinese PE firms both at home and abroad. They controlled the largest portion of an estimated $128 billion cash pile in Asia-focused PE funds at the end of 2015, data compiled by Bain show.

Given that China is still growing faster than most major countries, any PE firm with the ability to help companies thrive there will have a leg up on international competitors, said Cai, the former Deutsche Bank AG investment banker who started AGIC last year and calls it an “Asian-European” PE firm. The fund, which counted Chinese insurance companies among its early investors, has offices in Beijing, Shanghai, Hong Kong and Munich.

“Few companies nowadays would care about the money or how much you pay them,” Cai said. “They care if the investor can help them break into the Greater China market.”

http://www.bloomberg.com/news/articles/2016-07-20/chinese-funds-that-kravis-urged-to-grow-up-are-now-kkr-rivals

The Secret to Alibaba’s Success: Dirt Cheap Third-Party Shipping — Nikkei Asian Review

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ZTO

Procter & Gamble’s staple brands – Crest, Tide, Head & Shoulders, Pantene, Pampers — dominate the mass-market premium segment in China just as they do in the US. Buy them at the local Walmart supermarket in China, and just about everything costs more, in dollar terms, than it does at Walmart in the US. Shop online, though, and China wins hands down the P&G low-price battle.

Alibabas Taobao marketplace deserves part of the credit. Its 10 million merchants, most of whom are small traders with their own limited inventory, offer things at prices well-below those at brick-and-mortar shops. But, the biggest savings comes from ridiculously low overnight shipping costs in China. Alibaba doesn’t directly arrange shipping for Taobao merchants. It’s up to each seller to sort things out with one of the country’s big nationwide private courier companies.

There are four giants, market leader Shunfeng and three almost identically named firms, YTO, STO and ZTO. Those three were started and are owned by entrepreneurs from the same small county in Zhejiang, called Tonglu, about 50 miles from. Alibaba’s headquarters in Hangzhou.

So, just how cheap is online shopping for P&G products in China? I ran out of detergent and for the first time decided to buy it on Taobao. I was thinking I might save some money. But, the bigger benefit is not having to shlep the three kilo sack of Tide powder from the supermarket, where it sells for around Rmb 50.

On Taobao, I paid Rmb 20.90, or $3.18, for three kilos of Tide and two-day express ground shipping from Shijiazhuang, a city 1,200 miles away from me in Shenzhen. The same weight of Tide bought online in the US from the cheapest eBay seller and ground-shipped the same distance and time by Fedex would cost $53, at a minimum. Of that, at least $35 goes to shipping.

Yes, Chinese labor costs are much less. But, gasoline costs twice as much in China as the US and highway tolls are exorbitant in China, as much as 60 cents for every mile a truck travels. I bought the bag of Tide on Taobao half-thinking I’d never receive anything. But, the parcel showed up intact and on time. Who, if anyone, made any money on this?

Even if the Tide detergent is completely phony — Taobao does have a reputation for selling lots of counterfeit merchandise — the shipping costs can’t be faked. My detergent was shipped and delivered by ZTO. By some counts, it is now moved ahead of Shunfeng in volume, if not revenue. At year-end last year ZTO was said to be delivering 10 million parcels a day. ZTO is mainly a network of independent local franchisees, with the ZTO parent owning and operating the main warehouses. ZTO is planning to IPO sometime soon in Hong Kong. Warburg Pincus and Sequoia Capital are both investors.

The other three big courier companies are also well along in their IPO planning. Each is saying they need billions in new capital. They can’t be earning much if anything and continue to plow money into infrastructure. Parcel shipping is still growing by about 30% a year. Every week, courier companies deliver about 500 million packages in China.

All four big courier companies are saying they want to buy or lease jets to move things around, to save on gasoline and tolls. They’re also all looking to use drones for the last mile. As of now, parcels in China are delivered by an army, perhaps as many as one million strong, of electric-scooter riding delivery guys. Contrary to what you may think, this isn’t low-paid work in China. You can earn at least double what you’d be paid for factory work. A lot of recent college graduates are taking their first job delivering packages. The career ladder for many is to move up from YTO, STO and ZTO, who get most of their business through Taobao, to work for either JD.com or Amazon in China. Both have their own in-house courier staff, with better pay, hours, equipment and genuine uniforms.

Alibaba doesn’t directly own or control a courier company. So far, that strategy has worked out splendidly. As long as the courier companies are competing furiously, things on Taobao will remain dramatically cheaper than in stores. If the couriers ever decided to seek profits rather than market share, it would certainly put a dent in Taobao’s growth. An Alibaba-backed logistics company called Cainiao just raised $1.5bn, at a $7bn valuation, to better coordinate the deliveries made by ZTO and the other Tonglu firms.

Ecommerce in China works like nowhere else in the world. Sales are still growing at breakneck speed and are on course by 2017 to reach $1 trillion annually, far higher than anywhere else. Cheap delivery makes it a bargain not only to buy P&G products, but even the lowest-priced goods on Taobao.

For years, Chinese law made it illegal for Fedex and UPS to enter the domestic delivery business in China. The Chinese government finally rescinded the law two years ago. The two American giants took one look at the cutthroat competition and ridiculously low prices charged by their Chinese counterparts and chose to stay out of the fray.  In the US, they get paid $15.50 a kilo to move goods by ground in two days between two far-off cities. In China, the going rate is about four Renminbi, or 60 cents.

We’ll likely know soon, once IPO prospectuses appear, if ZTO and the others are making any money at all. An IPO requires a GAAP audit and full compliance with China’s burdensome tax code. This often extinguishes all profit.

Ecommerce in China has so far created only two big beneficiaries. Taobao is one. It earns billions a year in ad fees paid by merchants trying to get noticed. The other is China’s 500 million online shoppers. We save big, and enjoy the luxury of cheap home delivery, on just about everything we care to buy.

As published in Nikkei Asian Review

Investors rush to fund China tech start-ups — Singapore Straits Times

 Straits Times

 Investors rush to fund China tech start-ups

Staff at Beijing-based tech start-up ABD Entertainment. Many such firms have been drawing substantial investments from the government and venture capitalists, even amid China's slowing economy.
Staff at Beijing-based tech start-up ABD Entertainment. Many such firms have been drawing substantial investments from the government and venture capitalists, even amid China’s slowing economy.

Amid flow of money, hopeful entrepreneurs warned that innovation is crucial to success

Former media man Lei Ming has programmers, budding actresses and even an Internet celebrity on staff at his data-driven start-up in Beijing.

His two-year-old firm focuses on using big data and analytics – a relatively new tech sector worldwide – to help consumer brands figure out how to get the best bang for their marketing buck.

“There’s an immense amount of data we can glean from weibo accounts,” said Mr Lei, referring to the Chinese version of Twitter, which now has 261 million monthly active users.

Through data analysis, he aims to help clients find the most cost-effective ways to sell their products – through celebrity endorsement, product placement or other innovative means, especially on online platforms.

Valued at about 100 million yuan (S$20 million), the start-up received nearly 10 million yuan in funding last year.

While Mr Lei, 34, is not anxious about revenue for now, he is very clear that he must focus on making his start-up profitable. “It is important that we must be able to make money on our own instead of relying on investors’ money,” he said.

The next step is to become a major player in entertainment advertising – a market he estimates is worth 100 billion yuan. In three years, he aims to get the firm listed on a stock exchange. Mr Lei’s start-up is one of millions that have sprung up in China in recent years amid a tech startup boom. According to a report on the China.org.cn government website, some 4.9 million new companies were set up between March 2014 and May last year, with more than half being Internet firms.

Despite a slowing economy, tech start-ups of all sizes are attracting billions of dollars in investment funds from the government and venture capitalists.

According to research firm Preqin, private investors had poured around US$26.2 billion (S$35 billion) into 796 Chinese tech firms as of the middle of this month.

And last year, government-backed venture funds targeted at tech start-ups raised about 1.5 trillion yuan, increasing the amount under management to 2.2 trillion yuan, according to a Bloomberg report. However, regulations and market practices have yet to be finalised, and it is unclear how quickly the funds will be deployed, said the report.

Even though many of these 780 government guidance funds have been around for more than 10 years, the tech investment boom started after Chinese Premier Li Keqiang rolled out his “Internet Plus” initiative in 2014, encouraging innovation and entrepreneurship. This comes as China seeks to move away from a reliance on low-end manufacturing and heavy industries.

With labour and living costs on the rise, China can no longer rely on labour-intensive industries to keep its economy humming, said Ms Jenny Lee, a Shanghai-based venture capitalist who has been investing in Chinese tech firms for the past 15 years. “The old way of throwing labour at tasks is over,” she said. “China must change.”

It must adopt firms that leverage on technology, for these will help increase efficiency and sometimes replace labour, she added.

But while there is no shortage of money out there, with billions of dollars being poured into thousands of tech start-ups each year, just as many are going belly-up for shortage of funds or failure to commercialise their products.

This is because investors and consumers are becoming more discerning, and it is no longer enough for entrepreneurial hopefuls to just go and copy someone else’s idea and hope to thrive, investors and entrepreneurs told The Straits Times.

“These firms need to innovate to compete,” said Ms Lee. And innovation can be in terms of the business model, product or technology.

Some venture capitalists, such as Beijing-based James Tan, find Chinese tech firms to be very good at localising new ideas from Silicon Valley and achieving superior results on the mainland.

Still, Mr Peter Fuhrman, the chairman of China First Capital, a Shenzhen-based investment bank and advisory firm, pointed out that while this strategy has helped some of the home-grown tech giants to grow, it is not sustainable.

Successful tech players like Baidu, Alibaba and Tencent benefited greatly from an intellectual property and legal regime that allowed them to copy American business models and intellectual property without punishment, he said.

China’s market is also closed to foreign competitors, so that domestic firms can grow and thrive within a walled garden free from outside competition, he added.

However, he noted, it is harder now for China to shield its domestic firms from competition than in the late 1990s, when the tech giants got started, as China has since become a World Trade Organisation member.

“Walled gardens are basically illegal under WTO,” he said.

Another problem that could make it hard for China to grow the tech sector is the unique and “occasionally dysfunctional” capital market and initial public offering (IPO) regime, he said.

“This has now made it between difficult and impossible for Chinese tech companies to IPO within China,” he said.

Despite the problems, the push towards innovation and entrepreneurship looks set to continue, with more than 1,600 high-tech incubators nurturing start-ups across the nation.

Ms Mao Donghui, the executive director of Tsinghua x-lab, a university-based education platform for start-ups, said China is just beginning to wake up to the need for innovation. For start-ups to succeed, however, being innovative is not good enough – young people also need to know how to do business. For them to have the right combination of innovation and entrepreneurship would “require years of effort, right methods and experience”, said Ms Mao.

“It’s not that easy to just shout about innovation and entrepreneurship for a year or two, and expect to see results blossom, and affect economic growth. There is still a long way to go,” she said.

http://www.straitstimes.com/asia/east-asia/investors-rush-to-fund-china-tech-start-ups

Investing in emerging markets — Financier Worldwide Magazine

 

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 by Richard Summerfield

During the strains and stresses of the financial crisis, the world’s undeveloped nations proved a safe haven for investors. Flush with resources and opportunities, emerging markets such as Brazil, Russia, India, China and others were the ideal destination for beleaguered investors.

For years, the emerging markets experienced astronomical growth and development. Infrastructure projects were announced and completed, financial hubs developed and a consuming middle class emerged. For a while, the emerging markets were posited as the next influential force in global business and economics.

Yet in 2016, the rapid ascent enjoyed by many of the emerging markets is now a thing of the past. Brazil is in the midst of its worst recession in living memory and gripped by a political corruption scandal. Russia is beset by financial and geopolitical difficulties. China is wrestling with a substantial economic shift as its ruling class re-tools the national economy away from manufacturing and production toward a service based economy. Though China’s economy is still growing at a pace that many western leaders would happily accept, it is a shadow of what it was just a few years ago.

Though the stratospheric growth experienced in the emerging markets was never going to be infinite, the scale and speed of the decline has been eye opening. And investors, in recent years, have responded by shunning emerging markets and diverting their capital elsewhere.

This reversal in fortunes experienced is reflected in declining inbound M&A. KPMG International’s Cross-border Deals Tracker recorded a 3 percent decline in developed to emerging market deals last year, including a 50 percent drop in developed to emerging market activity in China. Much of the decline in investment into China from developed markets relates to the difficulties foreign firms encounter when entering the Chinese economy. Although it is a global powerhouse, the growth of the country’s economy does not really translate into viable investment opportunities for overseas investors, according to Peter Fuhrman, chief executive officer of China First Capital. China’s unwillingness to allow foreign investors into its financial markets and currency act as considerable barriers to international investment. “As long as this situation persists, China will likely continue to be rather unfriendly terrain for global capital,” says Mr Fuhrman. “The result is that the non-Chinese world’s investment institutions remain under-allocated to China. Its economy and capital markets are the second-largest in the world. But that size doesn’t translate into genuine global financial clout.”

BRICS and beyond

Given the scale of the opportunities available to investors, it is imperative to think beyond the traditional BRIC nations – Brazil, Russia, India and China – when considering the developing world. Though it is true that the BRICs have dominated the discussion around emerging markets since the acronym was first used in 2001, they have suffered more than most over the last few years and other developing nations have risen to prominence and attracted considerable investment.

Countries like Mexico – which has enacted considerable internal reforms to make it more attractive to investors – have risen out of the ashes of the BRICs. For every Brazil and Russia there is a Mexico and Philippines. While some of the BRICs have stumbled in recent years, a number of non-BRIC nations have driven emerging market growth. ASEAN and GCC countries have made great strides, as have a number of Sub-Saharan African states. Indonesia, Nigeria, Bangladesh, Mexico and Pakistan have also seen considerable activity. Mexico has emerged as a burgeoning Latin American powerhouse. According to a new study by the IE Business School, Mexico is the top investment destination in Latin America, and this optimistic outlook is supported by a recent announcement by Ford Motor Company which will be expanding into Mexico, creating 2800 new jobs by 2020. The country has also attracted considerable attention – and investment – from Asian investors of late.

Chile, too, has seen a rise in foreign investment. Its economic performance has been far from stellar in recent years – the country’s GDP has failed to recover from the steep slowdown seen in 2014-2015 – yet it has remained attractive to foreign investors. For Francisco Ugarte, a partner and co-head of corporate M&A at Carey, there are a number of reasons for the uptick in dealmaking activity in the country. “Among the most relevant reasons is the large currency depreciation that emerging markets have experienced, posing their assets at cheaper prices in dollar terms,” he says. “In Chile, for instance, $1 was 549 pesos about two years ago, whereas today $1 equals 661 pesos. Also, the current lacklustre market conditions make, in-house investing projects look less attractive and as a result industry consolidation cycles are triggered in search of greater operational efficiencies. We have seen this in Chile. A few examples are the US$600m acquisition of Cruz Verde by Mexican Femsa and the US$1bn acquisition of 50 percent of Zaldivar by Antofagasta Minerals.”

Turning the tide

Despite the headwinds prevalent across developing nations, it would seem that investors are slowly returning to emerging markets. In March and April alone, around $10bn of capital entered the emerging markets – a reversal in fortunes when compared with 2013-2015 which, according to research from Bank of America Merrill Lynch, saw $103bn leave emerging market debt.

Much of this resurgence has been predicated on a number of factors, including low valuations, currency movements, diversification and commodity prices which have risen gradually since February following persistent declines over the last two years. Furthermore, investors have been drawn back to emerging markets by expectations that the Federal Reserve will raise US rates in 2016 fewer times than previously thought.

Argentina, too, has contributed to the emerging market resurgence. In April, it issued debt to the international capital markets for the first time since its default in 2001, selling $15bn in the biggest single issuance of debt from an emerging market country, according to Dealogic.

One key stock index for emerging nations, the MSCI, is up 6.5 percent so far in 2016. That is markedly better than European markets, and ahead of the recent turnaround in US markets. “If valuations continue to be attractive relative to overall market conditions, deals will continue to be made,” says Wael Jabsheh, a partner at Akin Gump. “For the time being, as long as global markets remain stable and the cost of capital remains low, investment in emerging markets should not significantly subside.”

According to the Institute for International Finance, foreigners ploughed some $36.8bn into emerging stocks and bonds in March 2016 – the highest inflow of capital in nearly two years and well above monthly averages for the past four years. Investors were especially drawn to by Brazil’s equities, due to attractive valuations and hopes for political change in the wake of the ongoing corruption scandal and potential impeachment of President Dilma Rousseff. Investors also sought out emerging markets as commodity prices slowly began to rebound and confidence grew that the Fed was on a slower path to raise interest rates.

Although there have been fears around the performance of emerging markets of late, there are many reasons why companies should not abandon the developing world yet. By taking a nuanced, measured approach, investors can still benefit. They must adopt a more studied approach, taking into account a number of factors including location, sector and risk-hedging strategies.

Patience will also be key for companies pursuing deals or investments in emerging markets. The rapid decline of prices may serve as a beacon for firms to dive in. Currently, emerging market stocks are trading at lower prices than developed stocks, but may not have bottomed out. Furthermore, prices may not be low enough to offset the high risk of investing in some markets. Nevertheless, the developing nations, with their burgeoning populations and nascent middle classes, are the future of global economic growth.

Local focus

For companies looking to invest in emerging markets, there are a number of precautions they must take. Chief among these is tapping into local knowledge and experience. Without embracing local experts, investors risk misunderstanding local business culture, which may be very different to their own. Equally, by utilising local expertise, investors can speed up processes and improve communications. “Local knowledge for investing in emerging markets is fundamental,” says Mr Ugarte. “Developed economies tend to be alike but each developing economy has its own rules. Several failures have happened when companies from developed markets operate in the developing world assuming certain rules as theirs. Successful deals in developing markets require knowledgeable local advisers, local insiders and usually a mix of local-foreign management capacity. Collaboration is likely to play a vital part in the successes – or failures – of many organisations’ efforts in the emerging markets.” As such, engaging with local talent and drawing on their knowledge and expertise is a step which investors should not overlook. Acknowledging that the cultural gap varies tremendously between countries does also help. “Chile, which has a free market economy and a good political stability index, is impregnated with western business culture, which in turn makes the country much more predictable for investors that relate to similar values. This partially explains the economic success we have seen in past years.”

Local experience can provide investors with an insight into issues which they might not otherwise have taken into consideration. “When investing in new markets, investors can sometimes fail to appreciate some of the intangible factors involved in their deals,” says Mr Jabsheh. “The political and cultural dimensions of the market and the business in which you are investing are just as important to understand as the legal and regulatory dimensions. While clearly there is no substitute for conventional due diligence, investors often overlook these less tangible factors because they are not necessarily top of mind when those investors do deals closer to home,” he adds.

Future prosperity

The end of the commodity boom has dealt a significant blow to the economic prosperity of the developing markets. But all is not lost. Many developing markets will continue to prosper, although that will be relative. “China provides proof that investment returns do not correlate neatly with GDP growth,” says Mr Fuhrman. “While the Chinese economy will add $600bn in new output during 2016 – more than the entire GDP of Taiwan – it remains a place where global investors’ hearts are routinely broken. It’s proven so hard consistently to make money there.”

Yet China is stabilising. Although only 2.8 percent growth was recorded in the Chinese stock market, all is not lost. Since February, the economy has been relatively stable, and with the Chinese economy in the midst of a huge transitional period, moving away from domestic stimulus and infrastructure development toward a more ‘Western’ model of relying on domestic consumers and urbanisation. The fact that China’s financial markets and currency are still out of bounds for non-Chinese investors acts as a roadblock, according to Mr Fuhrman; nevertheless, it makes sense for investors to keep China on their radar.

Emerging market investment will continue to be a risky business. Political and economic risks are a fact of life when operating in certain emerging markets, and investors must be mindful of the risks inherent in pursuing opportunities. But for those investors with the requisite appetite, there may yet be rich rewards.

 

http://www.financierworldwide.com/investing-in-emerging-markets#.V0TwZ-Qc1RI

 

 

China to fine-tune back-door listing policies for US-listed companies — South China Morning Post

 

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China reverse mergers

Mainland China’s securities regulator will fine-tune policies related to back-door listing (reverse merger)attempts by US-listed Chinese companies, industry insiders say, but it is unlikely to ban them or impose other rigid restrictions.

“It is clear that the regulator does not like the recent speculation on the A-share markets triggered by the relisting trend and will do something to curb such conduct, but it seems impossible they would shut good-quality companies out of the domestic market,” Wang Yansong, a senior investment banker based in Shenzhen, said.

The China Securities Regulatory Commission (CSRC) was considering capping valuation multiples for companies seeking relisting on the A-share market after delisting from the US market, Bloomberg reported on Tuesday. Another option being discussed was introducing a quota to limit the number of reverse mergers each year from companies formerly listed on a foreign bourse.

To curb speculation, it is most important to show the authorities have clear and strict standards for approving these deals
Wang Yansong.

However, Wang said the CSRC was more likely to strengthen verification of back-door listing deals on a case-by-case basis.

“To curb speculation, it is most important to show the authorities have clear and strict standards for approving these deals, and won’t allow poor-quality companies to seek premiums through this process,” she said.

US-listed mainland companies have been flocking to relist on the A-share market since early last year, when the domestic market started a bull run, in order to shed depressed valuations in American markets.

The valuations of relisted companies have boomed, and that has triggered a surge in speculation on possible shell companies – poorly performing firms listed on the Shanghai or Shenzhen bourses. In a process called a reverse takeover or back-door listing, a shell can buy a bigger, privately held company through a share exchange that gives the private company’s shareholders control of the merged entity.

The biggest such deal was done by digital advertising company Focus Media. Its valuation jumped more than eightfold to US$7.2 billion after it delisted from America’s Nasdaq in 2013 and relisted in Shenzhen in December last year, with private equity funds involved in the deal reaping lucrative returns.

Peter Fuhrman, chairman of China First Capital, an investment bank and advisory firm, said the trend of delisting and relisting was “one of the biggest wealth transfers ever from China to the US”.

“The money spent by Chinese investors to privatise Chinese companies in New York ended up lining the pockets of rich institutional investors and arbitrageurs in the US,” he said.

However, a tightening or freeze on approval of such deals would threaten not only US-listed Chinese companies in the process of buyouts and shell companies, but also the buyout capital sunk into delistings and relistings.

“The more than US$80 billion of capital spent in the ‘delist-relist’ deals is perhaps the biggest unhedged bet made in recent private equity history … if, as seems true, the route to exit via back-door listing may be bolted shut, this investment strategy could turn into one of the bigger losers of recent times,” he said.

On Friday, CSRC spokesman Zhang Xiaojun sidestepped a question about a rumoured ban on reverse takeover deals by US-listed Chinese companies in the A-share market, saying it had noticed the great price difference in the domestic and the US markets, and the speculation on shell companies, and was studying their influences.

http://www.scmp.com/business/markets/article/1943386/china-fine-tune-back-door-listing-policies-us-listed-companies

For article on a related topic published in “The Deal”, please click here

 

Outbid, outspent and outhustled: How Renminbi funds took over Chinese private equity (Part 1) — SuperReturn Commentary

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SR

Outbid, outspent and outhustled

Renminbi-denominated private equity funds basically didn’t exist until about five years ago. Up until that point, for ten golden years, China’s PE and VC industry was the exclusive province of a hundred or so dollar-based funds: a mix of global heavyweights like Blackstone, KKR, Carlyle and Sequoia, together with pan-Asian firms based in Hong Kong and Singapore and some “China only” dollar general partners like CDH, New Horizon and CITIC Capital. These firms all raised money from much the same group of larger global limited partners (LPs), with a similar sales pitch, to make minority pre-IPO investments in high-growth Chinese private sector companies then take them public in New York or Hong Kong.

All played by pretty much the same set of rules used by PE firms in the US and Europe: valuations would be set at a reasonable price-to-earnings multiple, often single digits, with the usual toolkit of downside protections. Due diligence was to be done according to accepted professional standards, usually by retaining the same Big Four accounting firms and consulting shops doing the same well-paid helper work they perform for PE firms working in the US and Europe. Deals got underwritten to a minimum IRR of about 25%, with an expected hold period of anything up to ten years.

There were some home-run deals done during this time, including investments in companies that grew into some of China’s largest and most profitable: now-familiar names like Baidu, Alibaba, Pingan, Tencent. It was a very good time to be in the China PE and VC game – perhaps a little too good. Chinese government and financial institutions began taking notice of all the money being made in China by these offshore dollar-investing entities. They decided to get in on the action. Rather than relying on raising dollars from LPs outside China, the domestic PE and VC firms chose to raise money in Renminbi (RMB) from investors, often with government connections, in China. Off the bat, this gave these new Renminbi funds one huge advantage. Unlike the dollar funds, the RMB upstarts didn’t need to go through the laborious process of getting official Chinese government approval to convert currency. This meant they could close deals far more quickly.

Stock market liberalization and the birth of a strategy

Helpfully, too, the domestic Chinese stock market was liberalized to allow more private sector companies to go public. Even after last year’s stock market tumble, IPO valuations of 70X previous year’s net income are not unheard of. Yes, RMB firms generally had to wait out a three-year mandated lock-up after IPO. But, the mark-to-market profits from their deals made the earlier gains of the dollar PE and VC firms look like chump change. RMB funds were off to the races.

Almost overnight, China developed a huge, deep pool of institutional money these new RMB funds could tap. The distinction between LP and GP is often blurry. Many of the RMB funds are affiliates of the organizations they raise capital from. Chinese government departments at all levels – local, provincial and national – now play a particularly active role, both committing money and establishing PE and VC funds under their general control.

For these government-backed PE firms, earning money from investing is, at best, only part of their purpose. They are also meant to support the growth of private sector companies by filling a serious financing gap. Bank lending in China is reserved, overwhelmingly, for state-owned companies.

A global LP has fiduciary commitments to honor, and needs to earn a risk-adjusted return. A Chinese government LP, on the other hand, often has no such demand placed on it. PE investing is generally an end-unto-itself, yet another government-funded way to nurture China’s economic development, like building airports and train lines.

Chinese publicly-traded companies also soon got in the act, establishing and funding VC and PE firms of their own using balance sheet cash. They can use these nominally-independent funds to finance M&A deals that would otherwise be either impossible or extremely time-consuming for the listed company to do itself. A Chinese publicly-traded company needs regulatory approval, in most cases, to acquire a company. An RMB fund does not.

The fund buys the company on behalf of the listed company, holding it while the regulatory approvals are sought, including permission to sell new shares to raise cash. When all that’s completed, the fund sells the acquired company at a nice mark-up to its listed company cousin. The listco is happy to pay, since valuations rise like clockwork when M&A deals are announced. It’s called “market cap management” in Chinese. If you’re wondering how the fund and the listco resolve the obvious conflicts of interest, you are raising a question that doesn’t seem to come up often, if at all.

Peter continues his discussion of the growth of Renminbi funds next week. Stay tuned! He also moderates our SuperReturn China 2016 Big Debate: ‘How Do You Best Manage Your Exposure To China?’.

http://www.superreturnlive.com/

China’s Xiaomi Under Pressure to Prove Value to Investors — Wall Street Journal

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Headline

Xiaomi’s Redmi 2 smartphones on display during a launch in Brazil in June, 2015.
Xiaomi’s Redmi 2 smartphones on display during a launch in Brazil in June, 2015. Photo: Reuters

BEIJING—In January 2015, Xiaomi Corp. founder Lei Jun announced to his staff in an open letter that the Chinese smartphone maker was the world’s most valuable technology startup.

“We will journey into the constellations, to places where others haven’t dreamed of,” he wrote.

Living up to those high expectations has been a challenge. Xiaomi missed its 2015 sales target of 80 million smartphones, according to people familiar with the company, and investors are beginning to question its $46 billion valuation, which was based on yet unrealized plans to generate substantial revenue from Internet services.

China’s economic slowdown, coupled with turbulence in the stock market, is prompting investors to take a second look at China’s high startup valuations. Startups such as Xiaomi, which raised vast sums on China’s mobile Internet boom, are now facing growing pressure to live up to expectations.

“With China’s economy slowing, many startups will need to be more cautious in their expansion strategies,” said Nicole Peng, an analyst for market research firm Canalys.

Xiaomi shot to the top of China’s smartphone market in 2014 with the novel idea of selling hardware by gathering a large user base, a business model usually favored by Internet companies, not those selling a physical product. Sales that year tripled to 61 million smartphones, compared with a year earlier. Mr. Lei cultivated fan clubs and used “flash sales” to sell smartphones with iPhone-rivaling hardware at a fraction of the price. He swallowed thin margins, betting he could later sell services to users.

Investors swooned. In December 2014, Xiaomi raised a $1.1 billion round that valued it at $46 billion, topping even ride-sharing startup Uber Technologies Inc. at the time, although Uber has since regained the lead.

But Xiaomi’s smartphones, which once sold out in minutes in limited batches via online flash sales, are now easily available—a shift that analysts say signals slowing demand.

A slowdown in China’s smartphone market has laid bare Xiaomi’s weaknesses.

Xiaomi has lost market share against established competitors with more financial and technological firepower, such as Huawei Technologies Co., which launched a high-end smartphone line and overtook Xiaomi as China’s top handset maker in the third quarter 2015, according to research firm Canalys.

Huawei, which sold more than 100 million mobile devices last year, is beefing up its marketing in overseas markets in a bid to challenge Apple Inc. and Samsung Electronics Co. , the world’s two biggest smartphone makers. Huawei’s engineering strength and brand image built up over decades make it difficult for Xiaomi to compete in China, analysts say.

“The competition in China’s smartphone market has intensified tremendously this year,” said a Xiaomi spokeswoman, who declined to comment on the company’s valuation or say whether it met its 2015 sales target. She said Xiaomi sales were “within expectations” and its flash sales are primarily for new phones when production ramps up.

The lack of its own high-end chip technology also proved to be a competitive disadvantage for Xiaomi in 2015. When early versions of the Qualcomm Inc. ’s Snapdragon 810 processor were reported to overheat, it dampened sales of Xiaomi’s most expensive handset yet, the 2,299 yuan (US$349) Mi Note, analysts said. Xiaomi couldn’t fall back on an in-house developed chip to get around the problem, as Huawei and Samsung did.

Xiaomi and Qualcomm declined to comment on the processor. Analysts say the problems have since been fixed.

Overseas growth has also been slow for Xiaomi, with the percentage of its smartphones sold overseas in the first nine months of 2015 rising to 8%, compared with 7% in the 2014 calendar year, according to Canalys. It faced tough competition overseas, and found consumers unaccustomed to online phone-buying, said Ms. Peng, the analyst from Canalys.

Xiaomi’s thin patent portfolio also became a hurdle as it sought to expand in markets such as India. A lack of patents led to a court ruling that crimped its access to the crucial India market. In December 2014, India’s Delhi High Court ordered Xiaomi to stop selling all smartphones not running on Qualcomm chips due to a patent lawsuit filed by Sweden’s Ericsson. A year later, the injunction remains, which means Xiaomi can’t sell its popular models running chips made by Taiwanese chip maker MediaTek Inc.

Xiaomi said it sold 3 million smartphones in India from July 2014 through August 2015, and 1 million smartphones there in the third quarter. Its average quarter-over-quarter growth is 45%, it said.

The lack of a diversified customer base is another challenge for Xiaomi. It remains “locked in a Chinese demographic ghetto of mainly males 18 to 30,” said Peter Fuhrman, chairman of China-focused boutique investment bank China First Capital. Xiaomi’s focus on low prices has hit its brand image, he said.

Xiaomi’s average smartphone price fell to $122 in the third quarter from $160 a year earlier, despite China’s smartphone sector moving upmarket, according to IDC. The average price of a smartphone in China rose to $240 from $202. Huawei’s rose to $209 from $201. Xiaomi’s best-selling model last year was its cheapest, the $76 Redmi 2A, IDC analyst James Yan said.

Xiaomi’s supporters say the outlook is still bright, as it shifts to building an ecosystem of smart home products. The company has invested in 56 startups so far, ranging from iconic scooter maker Segway to a manufacturer of air purifiers, essential in China’s smog-choked cities.

“Xiaomi’s promise lies in its ecosystem,” said Steven Hu, former partner in Xiaomi investor Qiming Venture Partners.

But others are skeptical.

“Mobile services, e-commerce, branded consumer products—these still are largely just a figment rather than a huge and growing source of profits that could validate last year’s sky-high valuation,” said Mr. Fuhrman.

 

http://www.wsj.com/articles/chinas-xiaomi-under-pressure-to-prove-value-to-investors-1452454204

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

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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An insider’s view of Chinese M&A — Intralinks Deal Flow Predictor

intra

Intralinks Dealflow Predictor

 

Intralinks: The meltdown of China’s equity markets that began in the summer, despite measures by officials in Beijing aimed at calming investors’ nerves, has left many global investors jittery. Is this just a correction of an overheated market or the start of something more serious, and how would you describe the mood in China at the moment?

 

Peter Fuhrman: Never once have I heard of a stock market correction that was greeted with glee by the mass of investors, brokers, regulators or government officials. So too most recently in China. The dive in Chinese domestic share prices, while both overdue and in line with the sour fundamentals of most domestically quoted companies, has caused much unhappiness at home and anxiety abroad. The dour outlook persists, as more evidence surfaces that China’s real economy is indeed in some trouble. I first came to China 34 years ago, and have lived full-time here for the last six years. This is unquestionably the worst economic and financial environment I’ve encountered in China. Unlike in 2008, the Chinese government can’t and won’t light a fiscal bonfire to keep the economy percolating. The enormous state-owned sector is overall on life support, barely eking out enough cash flow to pay interest on its massive debts. Salvation this time around, if it’s to be found, will come from the country’s effervescent private sector. It’s already the source of most job creation and non-pump-primed growth in China. The energy, resourcefulness, pluck and risk-tolerance of China’s entrepreneurs knows no equal anywhere in the world. The private sector has been fully legal in China for less than two decades. It is only beginning to work its economic magic.

 

Intralinks: Much has been made of slowing economic growth in China. What are you seeing on the ground and how reliable do you view the Chinese official growth statistics?

 

Peter Fuhrman: If there’s a less productive pastime than quibbling with China’s official statistics, I don’t know of it. Look, it’s beyond peradventure, beyond guesstimation that China’s economic transformation is without parallel in human history. The transformation of this country over the 34 years since I first set foot here as a graduate student is so rapid, so total, so overwhelmingly positive that it defies numerical capture. That said, we’re at a unique juncture in China. There are more signs of economic worry down at the grassroots consumer level than I can recall ever seeing. China is in an unfamiliar state where nothing whatsoever is booming. Real estate prices? Flat or dropping. Manufacturing? Skidding. Exports? Crawling along. Stock market prices? Hammered down and staying down. The Renminbi? No longer a one-way bet.

 

Intralinks: What impact do you see a slowing Chinese economy having on other economies in the APAC region and elsewhere?

 

Peter Fuhrman: Of course there will be an impact, both regionally and globally. There’s only one certain cure for any country feeling ill effects from slowing exports to China: allow the Chinese to travel visa-free to your country. The one trade flow that is now robust and without doubt will become even more so is the Chinese flocking abroad to travel and spend. Only partly in jest do I suggest that the U.S. trade deficit with China, now running at a record high of about $1.5 billion a day, could be eliminated simply by letting the Chinese travel to the U.S. with the same ease as Taiwanese and Hong Kong residents. Manhattan store shelves would be swept clean.

 

Intralinks: With prolonged record low interest rates and low inflation in most of the advanced economies, many multinational companies have looked to China as a source of growth, including through M&A. Which sectors in China have tended to attract the majority of foreign interest? Do you see that continuing or will the focus and opportunities shift elsewhere? Is China a friendly environment for inbound M&A?

 

Peter Fuhrman: The challenges, risks and headaches remain, of course, but M&A fruit has never been riper in China. This is especially so for U.S. and European companies looking to seize a larger slice of China’s domestic consumer market. The M&A strategy that does work in China is to acquire a thriving Chinese private sector business with revenues in China of at least $25m a year, with its own-brand products, distribution, and a degree of market acceptance. The goal for a foreign acquirer is to use M&A to build out most efficiently a sales, brand and product strategy that is optimized for China, in both today’s market conditions, as well as those likely to pertain in the medium- to long-term.

The botched deals tend to get all the headlines, but almost surreptitiously, some larger Fortune 500 companies have made some stellar acquisitions in China. Among them are Nestle, General Mills, ITW, FedEx and Valspar. They bought solid, successful, entrepreneur-founded and run companies. Those acquired companies are now larger, often by orders of magnitude. The acquirer has also dramatically expanded sales of its own global products in China by utilizing the localized distribution channels it acquired. In Nestle’s case, China is now its second-largest market in revenue-terms after the U.S. Four years ago, it ranked number seven.

Chinese government policy towards M&A is broadly positive to neutral. More consequential but perhaps less well-understood are the negative IPO environment for domestic private sector companies, as well as the enormous overhang of un-exited PE invested deals in China. These have transferred pricing leverage from sellers to buyers in China. Increasingly, the most sought-after exit route for domestic Chinese entrepreneurs is through a trade sale to a large global corporation.

 

Intralinks: After years of being seen mainly as “an interested party”, rather than an actual dealmaker, Chinese players are increasingly frequently the successful bidder in international M&A transactions. What has changed in their approach to dealmaking to ensure such success?

 

Peter Fuhrman: Yes, Chinese buyers are increasingly more willing and able to close international M&A deals. But, the commonly-heard refrain that Chinese buyers will devour everything laid in front of them stands miles apart from reality. It seems like every asset for sale in every locale is seeking a Chinese buyer. The limiting factor isn’t money. Chinese acquirers’ cost of capital is lower than anywhere else, often fractionally above zero. The issue instead is too few Chinese companies have the managerial depth and experience to close global M&A deals. There are some world-class exceptions and world-class Chinese buyers. In the last year, for example, a Chinese PE fund called Hua Capital has led two milestone transactions, the proposed acquisition for a total consideration north of $2.5bn, of two U.S.-quoted semiconductor companies, Omnivision and ISSI. Hua Capital has powerful backers in China’s government, as well as outstanding senior executives. These guys are the real deal.

 

Intralinks: When it comes to doing deals, what are the differences between private/public companies and SOEs?

 

Peter Fuhrman: With rare exceptions, the SOE sector is now paralyzed. No M&A deals can be closed. Every week brings new reports of the arrest of senior SOE management for corruption. In some cases, the charges relate directly to M&A malfeasance, bribes, kickbacks and the like. SOE M&A teams will still go on international tire-kicking junkets, but getting any kind of transaction approved by the higher tiers within the SOE itself and by the government control apparatus is all but impossible for now. That leaves China’s private sector companies, especially quoted ones, as the most likely club of buyers. We work with the chairmen of quite a few of these private companies. The appetite is there, the dexterity often less so.

 

Intralinks: China has long been a fertile dealmaking environment for PE funds – both home-grown and international. In what ways does the Chinese PE model differ from what we see in other markets?

 

Peter Fuhrman: Perhaps too fertile. For all the thousands of deals done, Chinese PE’s great Achilles heel is an anemic rate of return to their limited partner investors, especially when measured by actual cash distributions. Over the last three, five, seven years, Chinese PE as a whole has underperformed U.S. PE by a gaping margin. It’s a fundamental truth too often overlooked. High GDP growth rates do not correlate, and never have, with high investment returns, especially from alternative investment classes like PE. If there is one striking disparity between PE as practiced in China as compared to the U.S. and Europe, it’s the fact that that Chinese general partners, whether they’re from the world’s largest global PE firms or pan-Asian or China-focused funds, too often think and act more like asset managers than investors. The 2 takes precedence over the 20.

Intralinks: What opportunities and challenges are private equity investors facing?

 

Peter Fuhrman: The levels of PE and venture capital (VC) investing activity in China have dropped sharply. What money is being invested is mainly chasing after a bunch of loss-making online shopping and mobile services apps. The hope here is one will emerge as China’s next Alibaba or Tencent, the two giants astride China’s private sector. PE investment in China’s “real economy,” that is manufacturing businesses that create most of the jobs and wealth in China, has all but dried up. Though out of favor, this is where the best deals are likely to be found now. Contrarianism is an investing worldview not often encountered at China-focused PE and VC firms.

 

Intralinks: As in many other markets, PE investors are having to deal with a backlog of portfolio companies ready to be exited. Do you feel that PE’s focus on minority investments in China could prove a challenge when it comes to exiting those investments? What do you see as the primary exit route?

 

Peter Fuhrman: Exits remain both few in number and overwhelmingly concentrated on a single pathway, that of IPO. M&A exits, the main source of profit for U.S. and European PE firms, remain exceedingly rare in China. In part, it’s because PE firms usually hold a minority stake in their Chinese investments. In part, though, the desire for an IPO exit is baked into the PE investment process in China. Price/Earnings (P/E) multiple arbitrage, trying to capture alpha through the observed delta in valuation multiples between private and public markets, remains a much-beloved tactic.

 

Intralinks: Finally, what is your overall outlook on China and advice for foreign companies and investors seeking opportunities to engage in M&A or invest there?

 

Peter Fuhrman: Yes, China’s economy is slowing. But the salient discussion point within boardrooms should be that even at 5% growth, China’s economy this year is getting richer faster in dollar terms than it did in 2007 when GDP growth was 14%. That’s because the economy is now so much larger. This added increment of wealth and purchasing power in China in 2015 is larger than the entire economies of Taiwan, Malaysia, Thailand, and Hong Kong. Much of the annual gain in China, likely to remain impressively large for many long years to come, filters down into increased middle class spending power. This is why China must matter to global businesses with a product or service to sell. M&A in China has a cadence and quirks all its own. But, the business case can often be compelling. The terrain can be mastered.

 

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

Superretrun

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

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.