Bullish on China –

If you’re itching to invest in China, you might be wondering if it’s too late to scratch. After all, everyone is abuzz about the investment activity that’s taking place in the communist nation. Some speculate that the country will be home to one of the biggest economic trends over the next two decades as active investors already there step up their efforts and as new players continue to go to China in droves.

To find out what’s going on in the China venture capital community, Venture Capital Journal gathered together a roundtable of business leaders at the Park Hyatt Hotel in San Francisco on May 31. Jerry Borrell, who covers Asia for VCJ, moderated the panel discussion.

The participants included:

  • Peter Chu, managing partner of AsiaTech Ventures;
  • Bob Grady, managing director, The Carlyle Group;
  • David Chao, managing general partner, DCM-Doll Capital Management;
  • Andrew Kau, managing director, Walden International;
  • Steven Toronto, Beijing managing partner, Morrison & Foerster.

The speakers discussed current investment trends and the cultural differences of managing portfolio companies in China, among other topics. Of course, the hottest topic for each participant was what airline has the most comfortable seats. That question was left unanswered. But the panelists did speak up about a number of other pressing issues.

The Big Picture

VCJ: What’s the overall outlook of investing in China?

Grady: You see so much media coverage these days to the effect that the change going on in China is not good for Main Street America. That is wrong. And it is emblematic of how at a very large level, with apologies to the Fourth Estate, the American press has missed the story.

Months ago Business Week had a cover story that said, The China Price,’ as if the only thing going on in China that is relevant to Americans is that goods are produced more cheaply there. In fact, China’s a net importer of goods and services.

Also, the big story is that China has the greatest rise in living standards for the largest number of people in human history-if you take 1990 GDP as an index of 100. That is the story. Today, the United States is at 150 and China is at 400. Admittedly, that six times growth is over a smaller base. But the point is that change took place in a period of what most would say was excellent U.S. economic performance.

Firing CEOs

VCJ: Why is it that making management changes with a portfolio company is so difficult in China?

Kau: There are lots of reasons. But getting fired is a huge personal loss of face in China. And it’s sometimes very difficult for the CEOs to recover from that experience.

However, in the United States, if a CEO can show they learned from the experience, getting fired can be a positive mark.

Plus, a lot of homegrown, bootstrapped businesses in China are owned by the founders and their families. If investors try to remove a founder or CEO and bring in professional management, they’re changing the culture of a company that it was founded upon. You risk losing the rest of the team if you try to force that.

Chao: What also makes it difficult is that it’s hard to find other CEOs. So without the founder or the CEO, an investor’s ability to manage a portfolio company on the ground would just go away-it would be very difficult.

In fact, one of the hardest parts of operating a portfolio company comes when one of your key management people leaves, opens a shop next door and takes half the customers with them.

Kau: Well, very often investors don’t own a majority of the portfolio companies.

So there may be a lot of negative governance rights, but it’s not like investor control 80% of the stock and can do whatever we want with the company.

Chips Ahoy

VCJ: What’s the market for investing in Chinese semiconductor companies?

Kau: The domestic consumption of semiconductors in China is more than 90% foreign chips. These chips are going into electronic goods that are being made in China. By 2008 or 2009, China will consume a third of the world’s semiconductors.

So, you can imagine that there is now an effort for the substitution of domestically produced semiconductors for foreign products. Walden is trying to help form startups that are going to be the next Broadcom’s for the Chinese market.

VCJ: What’s Walden’s investment pace in semiconductors?

Kau: We’ll be at around the same pace as last year, around a dozen semiconductor investments.

The semiconductor market for cell phones will be a combination of local companies as well as U.S. or international companies.

But we have a Chinese portfolio company developing an applications co-processor, the chip in phones that enable games, video, pictures, and all the stuff except for voice. There’s a large need in China for a lower-cost domestic supplier of these applications co-processors that will tailor their product to the local market. It’s very difficult to get a Broadcom or an Intel to tailor their international product to the Chinese market, even at the volumes that exist today.

Chao: I see many tiers of excitement to what’s going on with semiconductors in China. One area centers around local Chinese established semiconductor deals, which are tailoring their product to the domestic needs.

For those that are buying foreign chips today, their biggest frustration is that they can’t get decent customer service. “I don’t have a person speaking Chinese to me.” They’re saying, “Man, if you even just produced a product that’s the same price as the one Infineon is giving me, if I can find a local vendor, I’d buy it off the spot.”


VCJ: 2004 was a good year for IPOs as 10 China-based, venture-backed companies went public on a U.S. exchange last year. Given regulation changes and other factors, what is the outlook for IPOs in China for 2005?

Toronto: There has been one IPO since Circular 29 came out: China TechFaith Wireless (Nasdaq: CNTF). We hear that IPOs are slowing down for the second and third quarter.

Grady: The bigger issue for the IPO market is not necessarily new regulations, as it is how well the new issues that come out trade in the aftermarket. A lot of them have traded poorly since their debuts.

Only Ctrip.com International and Shanda Interactive, that I can think of, have traded pretty well, and a lot of other stuff that’s traded has been choppy.

Semiconductor Manufacturing International Corp. traded way off after it became public last year. I hope it recovers because I own some shares. But I think the window for new issues going out on the Nasdaq is probably shutdown to a certain extent.

Chao: The general economic slowdown is partly from government regulation and partly from the shrinking window for IPOs. But some of the IPOs that are in the pipeline are companies that were supposed to go out three quarters ago, based on their hitting a certain number in their revenue projections. But those IPOs still haven’t happened yet.

We may have one come out in the next quarter, but it’s shaky. And all the ones that were supposed to go out this year are now talking about going out mid-2006, because of the slowdown of the overall market.

The problem is that when it takes a long time for a company to go public, it allows other companies to encroach the market and get funded. And they’re becoming well funded. So it gets to be a tougher and tougher competitive environment, as a result of the IPO slowdown.

Toronto: I also think that we’ve already seen the cream of the crop of the investments go IPO. So the next group of companies that go out will not be the leading companies in their respective industries.