Venture capitalists continue pushing for deals in China, upping investment in the country to take advantage of the growing base of urban consumers. But a global slowdown in consumption during 2009 will hit Chinese factory workers right in the pocketbook and could chill investor interest in consumer startups.
VCs invested $3.3 billion as of Dec. 3, up about 20% from the amount invested in all of 2007, according to preliminary data from Thomson Reuters (publisher of VCJ).
The biggest deals look, in many cases, more like private equity than pure venture capital. This is, in part, because of the evolving nature of opportunities in the country. Venture capitalists have been diversifying away from pure technology plays for some time. The biggest financings through the first nine months of the year went to a mining company, an aluminum products manufacturer, a vehicle maker, an outdoor advertising company, and an information technology company (see table for details).
“We believe China is a bit more resistant, not immune, but resistant to what else is going on in the world,” says Steve Hyndman, CFO of GGV Capital, which makes expansion stage venture investments in the United States and Asia. “The theme that we’re investing on is urban growth and consumer growth. With the continuing migration Chinese populace from primarily rural communities to urban centers, there’s tremendous demand for a whole variety of goods and services.”
Sequoia Capital, a firm with a long track record of technology investing, has been active in a wider variety of industries in China. The firm invested in nine companies during the first three quarters of 2008, only four of which were IT-focused companies, according to Thomson Reuters. Of its non-tech deals, the firm backed outdoor advertising business Skyflying Media Group, agricultural products company China LiNong International, test-prep company Universal Education Group, biotechnology company China Nuokang Bio-pharmaceutical and talk show producer JinTV.
Kleiner Perkins Caufield & Byers took a similar approach to the China market during the first three quarters of 2008. Only half of the six companies it backed were information technology-oriented. The firm’s non-tech deals include investments in pesticide company Jiangxi Tianren Zoology Int’l, plastics maker Tianjin Green BioScience and vocational education business Beijing GAMFE Tech Co.
The increasing diversification away from information technology deals has been focused on servicing an ever-growing base of middle class Chinese. That’s helped some firms duck the financial downturn in the United States. “There’s no question that the decline in consumer spending in North America and Europe is hitting the export sector very hard,” says Hyndman. “We’re really focused on the domestic demand for Chinese goods and services and companies that address that demand.”
China-focused firms, especially those affiliated with U.S.-based venture firms, managed to raise large new funds during the first half of the year. The bigger funds are the product of investors pleased with the first generation of affiliated funds and an increasing necessity to address large consumer-oriented opportunities.
DT Ventures, a China-based firm—formed as a partnership between Lightspeed Venture Partners, Madrone Capital Partners and Pantheon Capital—raised about $283 million toward a proposed $350 million growth fund in March. The fund came less than a year after the firm closed its second early stage fund at $122 million.
The growth fund does not signal any shift in strategy or focus for DT Ventures, which will continue to make early stage deals in China, says General Partner Greg Penner, an early stage investor with Madrone. “In China, venture firms tend to have more growth stage funds than early stage,” he told VCJ earlier this year. “I wouldn’t say that there are no early stage deal opportunities in China. That’s just the nature of the business over there.”
Northern Light, the collaborative effort between New Enterprise Associates and Greylock Partners, closed a $350 million second fund targeted at China in May. It dwarfs the $125 million predecessor fund closed in December 2005.
Qiming Venture Partners closed a $320 million second fund to make early stage investments in health care, technology, media and consumer startups in June. The new fund is substantially bigger than the $200 million first fund Qiming raised in 2006. The firm began in 2006 as a partnership with Bellevue, Wash.-based Ignition Partners when Ignition’s John Zagula and Richard Tong partnered with former Mobius Venture Capital Managing Director Gary Rieschel and others to launch the Qiming team.
China has slowed since summer, with fewer funds getting raised and fewer companies receiving financing. By October, the Hang Seng Index, an index of the biggest companies trading on the Hong Kong Stock Exchange, was trading at half the value it had during the same month in 2007.
PE players of all sizes started to pull back as the Chinese markets fell. In October, the head of General Electric’s private equity unit told Reuters it would focus on its existing investment portfolio and wouldn’t be making new investments for the next two to three years.
The falling public markets have hurt IPOs, too. Sequoia Capital managed to get one of its Chinese portfolio companies out the door in October. Renhe Commercial Holdings (HKG: 1387), a builder of underground shopping malls, had hoped to raise as much as $658 million with its IPO, but the offering was chronically under-subscribed and ended up collecting $435 million. More than six weeks after the IPO, the stock was trading about 9% lower than its first-day close.
There’s little reason for optimism in the coming year. Indexes that track manufacturing in China show at least a 10% decrease in production from October to November. If such decreases continue, the country’s base of emerging consumers will suffer job losses and a general spending slowdown. That will hit VC-backed consumer-oriented companies of all stripes.
Still, VC investment may maintain a steady pace in 2009 thanks to the slew of successful fund closes during the beginning of the year.