The January 8th Financial Times reports
that Patricia Hewitt, the U.K. secretary of state
for trade and industry, stated "The China bandwagon
is accelerating very fast and it is time to jump on
it". Ms. Hewitt's concern is that an historic reshaping
of the global economy and capital market is taking
place and U.K.
business is not recognizing how fundamental this restructuring
is. The same is, in some ways, less true of Canada,
where a substantial portion of Canadian business in
Vancouver and Calgary
has seen Canada
as an Asia-Pacific economy. However, we remain with
the same set of challenges.
If
this is a restructuring of historic proportions, then
what are the optimal investment strategies for Canadian
businesses and investors? Right now, the global
economy is in a process of reconfiguration to reflect
the enormous growth potential of the Chinese market
and the impact of Chinese growth on global consumption,
already evident in the increasing demand for fossil
fuels as a result of China's
consumption needs.
Chinese
innovations like silk and gunpowder helped to transform
earlier global economies. The future commercialization
of China's
knowledge base and the development of an indigenous
private equity and venture capital capability have
obvious significance for global capital markets.
This represents an opportunity for Canadian investors
and private equity strategists to play a role of increasing
significance.
For
most Canadian fund managers in 2004, China
is a play on Manulife, or Nortel, or any oil and gas
technology with reasonable times to PetroChina.
While there are a few specific China-focused plays,
including educational technologies and rare-earth
mining, on the whole, the China
story to date has been largely about exporting Canadian
products.
What
I intend to do today is (i) discuss some of the
trends which are shaping China's participation in
global capital markets, (ii) assess whether there
is a private equity / venture capital play for Canadians,
and (iii) sketch out a way that a Canadian centre
to explore venture capital and private equity strategies
in China can contribute to the Canadian financial
community's understanding of China, becoming in effect
Bay Street's (a pan-Canadian Bay Street's) window
on China.
I. Trends
Shaping China's
Participation in Global Capital Markets
Let
us start with three case studies:
- CHINA
GREEN BECOMES THE MOST OVERSUBSCRIBED OFFER IN HONG
KONG HISTORY (http://fpeng.peopledaily.com.cn/200401/14/eng20040114_132534.shtml
) (January 2004). China Green shows the market
appeal of a small vegetable growing concern from
Fujian and has raised
a number of questions about whether or not the current
pattern of investment in China
is leading to a bubble.
- CHENGWEI
VENTURES (www.chengwei.com)
DEVELOPS A PORTFOLIO OF BEST PRACTICES INTERNET
AND E-COMMERCE. The Chengwei and New Margin portfolios
(www.newmargin.com)
show the opportunities of applying learned best
practices from internet era venture capital strategies
in Europe and North America
to the emerging Chinese marketplace. (e.g. OVAL
TECHNOLOGIES www.oval-tech.com
)
- CARLYLE
BUYS INTO BOTO (www.thecarlylegroup.com,
www.boto.com.hk
) Carlyle's investment in Boto shows the appeal
of Chinese manufacturing and the strategy for participating
in the manufacturing based boom in China.
Boto is an interesting Chinese leisure goods (recreational
furniture) play growing from the manufacture of
artificial Christmas trees.
As
2004 begins, there are four lessons we should take
from cases like these.
First,
avoid the frenzy and the overheating and, like Chinese
business for centuries, focus on the longterm. This
is a major economic restructuring not only of China
but of roles in the global economy and the financial
engineering of new players for these roles. This
is one of the attractive features of private equity
and venture capital as opposed to the public equity
markets in areas where overheating can easily occur.
From the dotcom era, however, we know that overheated
markets can lead to disastrously short-sighted investing
strategies on the private equity side; nevertheless,
in a market that is oriented towards stable financial
engineering and longterm strategic thinking, private
equity can be an attractive avenue for investing..
Second, understand the enormous strengths of China
as a society and pool of intellectual capital. The
talent-pool which goes into the management of the
Chengwei investee companies is easily a management
talent pool that matches what investors could finds
in any advanced economy in Europe.
The next wave of the global restructuring will
see the creation of the Chinese equivalents of Nokia,
Bombardier and Samsung, companies commercializing
the Chinese knowledge-base as it innovates. The
question is how to discover and facilitate the development
of these companies.
Third,
learn to appreciate the regional strengths and diversity
of the Chinese economy. China
is no more a single market than Canada,
India
or Russia
and in understanding the economic geography and regional
political economies of China,
there is a potential to create investment strategies
which are differentiated and avoid the "me-too" pattern
of some private equity or the overheating which can
lead to a bubble. (See the superb piece by Keith
Bradsher in the New York Times of January 18, 2004
"Is China the Next Bubble?", where he points out
the economic risk of a round of U.S. protectionism
limiting China's growth opportunities). The regional
characteristics of China
are shown in the different locations of value-creation.
Fourth, the existing pattern of red-chip investments
reveals a pattern familiar to veterans of earlier
"emerging" markets, e.g. Russia
in the early 1990s, Thailand
in the mid-1990s.
The
public capital markets focus on privatization and
large holding companies. There is nothing wrong
with this as an investment strategy. It leads to both
the development of acquisition currency for an emerging
market multinational (the evolution of Chaeron Pokphand
(www.cpthailand.com)
is an example of this). But this is precisely where
markets like China
can become overheated, and, for a variety of uniquely
Canadian reasons, it is also a market where we are
just figuring out how to play.
There are a couple of generalizations about doing
business in China
which are always worth repeating: (i)one needs to
know the local historical networks (the same is true
about international business everywhere) and (ii)
long-term relationships matter (although the same
is true in Switzerland
and almost everywhere outside of a gold rush market-frenzy
driven economy).
There
are also some other characteristics of contemporary
China
which are worth exploring as we start to formulate
and assess investment strategies in China.
These will enable the identification of key trends
in the development of the Chinese economy from which
we can learn and with which we can define an investment
strategy:
- China
is, like every country a nation of regions, just
much more so. The economic geography band political
economy of the rustbelt states of Liaoning,
Jilin and Heilongjiang
has different growth opportunities than the entrepreneurial
characteristic of Anhui
or the commercial globalization of Guangdong.
- The
commercialization of knowledge is a global opportunity.
The Soviet science base in advanced industrial materials,
rare-earth based metals for the Soyuz and MIGS proved
a real technological advantage, but one which was
difficult to commercialize except as part of a global
manufacturing strategy. The search for a diagnostic
of the Chinese technology base is a first step toward
venture capital strategies being customized for
the Chinese market.
- Venture
capital in an overheated market or an emerging market
(China
is both) requires the backing of individual management
teams. A portfolio strategy for China
which seems to be followed by the major venture
capital firms in China
or with a Chinese presence is to back individual
entrepreneurs and let them develop their ideas.
Investors in Canada
are, essentially, talent scouts.
- The
current business and investment models in both public
and private equity for China
are broadly a combination of:
- Beer
& Cement: traditional emerging markets
portfolio ("beer and cement" consumer products
and infrastructure). From previous knowledge
of emerging markets portfolio strategy (and
China
is both an emerging market like Brazil
or South Africa)
and a burgeoning economic superpower, like Japan
in the 1970s, or Germany
in the 1960s), there is a portfolio strategy
which is based on infrastructure + consumer
products. This fits the "standard" rapid growth
formula for fund managers who look for some
mixture of these formulas in Russia,
Thailand,
and Mexico
in previous periods of hyper-growth;
- Maquiladora:
the maquiladora strategies similar to the post-NAFTA
investment strategies in Mexico
(privatized companies with manufacturing capabilities,
financial infrastructure to manage manufacturing
in the new global economy); and
- Best
practices Internet business models: venture
capital strategies applying best practices e-commerce
and enterprise management to the Chinese information
infrastructure).
II.
IN SEARCH OF THE NEXT SILK: A PRIVATE EQUITY/VENTURE
CAPITAL PLAY FOR CANADIAN INVESTORS?
The best way to start is to look at some best practices
investment strategies in the venture capital and private
equity markets in China.
I used a Chengwei portfolio company as an example
earlier. Chengwei focuses on replicating successful
information technology, enterprise software and e-commerce
models from the playbook of U.S.
and European venture capital during the Internet boom
period. Other Chengwei companies (www.chengwei.com)
like www.onewaveinc.com
build the architecture of the Chinese web.
W.I Harper (www.wiharper.com)
has a mixture of internet infrastructure (e.g. www.leyou.com,
www.bookoo.com
on Chinese-language book publishing), gaming plays
(www.youle.com)
and "beer-and-cement" investments like Beijing development
(restaurant chains).
In the Hambrecht and Quist Asia portfolio,
there are examples of maquiladora manufacturing (www.smics.com
and a battery-manufacturing to complement the development
of a semiconductor industry in www.atlbattery.com).
It also invests in the Beijing Starbucks and Sinogen,
an attempt to become a lead biopharmaceuticals firm
for China.
Intel Capital has a number of content plays, including
www.asiacontent.com,
www.asiainfoholdings.com
, and computer infrastructure and manufacturing plays
like Beijing Golden Human Computer Company.
The following is an attempt
to organize the discussion regarding a potential private
equity/venture capital play for Canadians by outlining
some possible investment strategies:
1.
The Chengwei and New Margin approach is one that imports
best practices of e-commerce and information economy
business models for the Chinese marketplace.
Chinese venture capital firms are adapting the expertise
of European and North American trained MBAs to the
experience of contemporary
China. Arguably, this is what most of the venture
capital strategies to date have been.
2.
To the extent that generalities can be applied to
a market as complex, sophisticated, regionally and
sectorally diversified as China,
the "beer and cement" rule for rapid development
in emerging markets still applies. Financing
infrastructure plays and financing consumer brand
building in China then becomes a significant approach
to the way in which growth can be anticipated, facilitated
and invested in the Chinese market. Investment bankers
looking for opportunities for IPOs will congregate
on this strategy. China Green is such a play and
exemplifies the building of a Chinese private sector
in consumer products, export-oriented agriculture
and primary resources and the construction of industrial
infrastructure.
3.
The pattern of Chinese growth is, however, different
from the conventional new market "beer and cement"
days. Given the global restructuring of manufacturing,
another appropriate strategy is to focus on the supply-chain
that facilitates the Intel, Nokia, Lucent, Motorola
capacity to operate in China or builds on it to create
Chinese plays within this expertise by developing
brands in China to do the manufacturing of cell phones,
component parts and automotive products for the global
export market. This is a unique Chinese strategy,
borrowing from the economic geography of the Mexican
post-NAFTA maquiladora days, but dramatically
different in the capital market strategies which underlie
it. As Chinese manufacturing develops a greater
financial and organizational sophistication, companies
will emerge in an opening market that can grow to
develop strategies that are autonomous from the functional
role that they play within a Nokia, Intel, Motorola,
cost-efficient manufacturing strategy. This might
mean that China's automotive industry emphasizes a
productive efficiency in manufacturing eco-cars, either
with hybrid fuels or other innovations.
Two
additional approaches are made possible by the degree
of social networking which has emerged in the new
private equities world, lubricated by millions of
emails between MBAs from major world business schools.
The first flows directly from this new reality:
4.
The talent-scout approach to investing is another
approach. Find 100 entrepreneurs in China
with global networks and ask them to invest in start-up
opportunities. This approach is, in reality, what
other investors have done in less significant markets
than China. It means betting on the entrepreneur's
local knowledge, local networks, and local market
intelligence. If a local entrepreneur's judgment
is that value can be created in food-processing, then
that diagnostic of the economy is more appropriate
than any general theory or "comparative" investment
strategy. If a skilled entrepreneur with global
knowledge sees a market opportunity in restructuring
a machine tools company in the northeast of China,
then the same logic applies. This is a venture
capital strategy for entrepreneurial growth in a rapidly-changing
economy.
5.
Another new strategy is to look at Chinese inventive
sources and attempt to commercialize
them. This builds on a diagnostic of Chinese excellence
and competence in science, medicine and engineering
to design a venture capital strategy that would be
similar to that of any knowledge-rich expanding economy
with a smaller domestic base (e.g. Switzerland
or Finland)
and see how that knowledge can be commercialized as
in any strategic venture capital model. Where
are the Chinese Nokias or Bombardiers of the year
2014?
III. CANADA-CHINA ECONOMIC PARTNERSHIPS AND THE ROLE
FOR A NEW CANADIAN CENTER
FOR PRIVATE EQUITY IN CHINA
Canadians looking for investment opportunities in China
have usually asked what blue-chip and red-chip investment
strategies exist for Canadian fund managers wanting
to position their portfolio for the expansion of the
Chinese marketplace. This leads to the accumulation
of a public portfolio of Chinese stocks like China Green
or the red chips in the U.S.China Index (see Appendix
2). Or we can look for "China
plays", Canadian companies with significant room for
growth because of their local knowledge of China.
We can continue the China
play concept of following Manulife, Nortel, Husky
and Canadian blue chips with expansion strategies
that target Chinese accelerated growth. On a limited
scale, the Chinese market can be accessed by Canadian
entrepreneurs who convince our venture public markets
that their activities are worth some higher-risk financial
engineering. That has happened in the educational
services cluster (www.zicorp.com,
www.tengtu.com,
www.chinaventuresinc.com,
www.lingomedia.com)
and one can argue that this is a case study of the
entrepreneurial Canadian capitol market functioning
well.
Beyond these approaches, how should Canadian investors
and business schools approach the growing China
marketplace? A Canadian Centre for Private Equity
in China
would be a first step, both as a window for Canadian
investors on China,
but also to extend the Canada-China economic partnership.
Questions to be addressed include:
§
Is
there a strategy for rust-belt investing which involves
partnerships between Canadian manufacturing companies
and investors and the Chinese northeast states?
§
What
is the state or original research in, e.g., biosciences
in China
and how can that be commercialized more effectively?
Can Canadian venture capital firms help prospect
for the leading technologies in China?
- Are
there sectoral collaborations (e.g. environmental
technologies) in which Canada-China investing consortia
make sense?
- What
kind of investment strategies exist in China today
to capitalize on the explosive pattern of growth
and the concentration of intellectual capital which
exists in the Chinese economy today and how can
this be translated into a public or private equity
investment strategy for China?
- How
does one create an entrepreneurial financial engineering
strategy for the emerging China
market, given our global experience with venture
capital portfolios in periods of rapidly-growing
economies?
The
immediate proposal is that CIPEC do two things.
1. Case
Studies: We need a series of case studies for teaching
in China
and about China
the way private equity and venture capital work.
The case/course package attached here as Appendix 1
constitutes a potential framework for looking at private
equity in China.
The case studies include new innovation areas like biosciences
and computerized gaming, and business models and investment
portfolios of the maquiladora and beer-and-cement
strategies discussed above. They cover the themes
discussed above and as a package represent a coherent
pattern of story-lines both to inform Chinese investors
of how market opportunities in China could develop and
be a "course" (in the broadest sense of the term) to
inform Europeans, Latin Americans and North Americans
of investment opportunities in China and how they might
be accessed.
2.
Commercialization of Innovation: We need to address
the question of innovation in China and to identify
where the financial engineering exists to create the
Chinese version of Lego, Bombardier, Bausch or Sony,
commercializing appropriate innovative skills in engineering
and research to create a global multinational.
This is where the next stage of venture capital and
private equity strategies for China
become the most exciting and where Canadian experiences
and knowledge can be the most valuable. It begins
with a diagnostic of the Chinese technology and research
base to see, as any national venture capital strategy
must, which areas are closest to commercialization.
As such, it would mirror many of the activities which
have taken place in recent experience in Canada
and Europe, by attempting
to identity scientific competitive advantage.
APPENDIX
1--CASE STUDIES IN CHINESE NEW GROWTH
PORTFOLIO
ANALYSIS OF CHINESE PRIVATE EQUITY / VENTURE CAPITAL
FIRMS
Softbank
portfolio www.sbcvc.com
H&Q
Asia new maquiladora investing www.smics.com
www.atlbattery.com
HD
Biosciences www.hdbiosciences.com
What is the structure of the Chinese biosciences
research base?
What are the linkages with financial investors
(global life sciences investment firms?
How does the scientific research fit into the
global structure of research in life sciences?
What
alliances produce the most benefit for the Chinese inventive
sources?
How does one create global market reach for these areas
of Chinese science as they are
commercialized? New
Margin portfolio www.rfwaves.com
(short-range wireless connectivity), www.landsystem.com
(Laijing multimedia, broadband content), www.mwcards.com.cn
(smart card manufacturing), www.hjsoft.com.cn
(ERP solutions), www.redflag-linux.com
(Linux applications for Chinese companies), www.rongshu.com
(e-versions of Chinese literature)
CASE
STUDIES OF SUCCESSFUL COMPANIES BUILT FROM ENTREPRENEURIAL
ENGINEERING Ningbo
Bird - commercializing Chinese technology and exporting
to SE Asia
www.chinabird.com
Ctrip
- IPO (www.ctrip.com)
first of 87 Chinese IPOs offered in U.S.
markets. W.I.
Harper and Youle www.wiharper.com
www.youle.com
CRITICAL
CASE STUDIES REGARDING THE ECONOMIC GEOGRAPHY AND
POLITICAL ECONOMY OF PRIVATE EQUITY IN CHINA
AMR
Technologies - a Canadian case study (www.amr-ltd.com
) Carlyle
and Boto - private equity strategies for China.
(www.boto.com )
Stimul
- Chinese investing in Central Asian and Russian oil.
( STIMUL joint venture producing oil in Russia
near Kazakhstan)
http://www.moscowtimes.ru/stories/2003/12/30/045.html
. FINDING
THE NEW SILK-- COMMERCIALIZING THE CHINESE CREATIVE
BASE Zhuing
Guan Cao - Tsinghua Silicon
Valley
http://www.entrust.com/partners/profiles/beijing_venus_information_technology_inc.htm
Huayan
- Silicon Valley Entrepreneurs www.huayuan.org
Silicon Valley backed Chinese entrepreneurs networked
and leading to NASDAQ IPOs or venture-backed financing:
Viador www.viador.com,
GRIC www.gric.com
Webex www.webex.com,
SINA www.sina.com,
Oplink (www.oplink.com)
APPENDIX
2: CHINESE PUBLIC EQUITY STOCK PERFORMANCE:
1.USX China Index http://www.usxchinaindex.com
