Venture Capital Rides a Comeback Trail

(Caixin Online) Overseas and domestic venture capital (VC) is warming up to China again after a stagnant period that began in late 2008 with the onset of the global financial crisis.

According to incomplete statistics from financial services provider Zero2IPO, more than 10 Chinese firms have received major investments from more than 20 VC firms so far this year.

The largest investment involved a third round of fund-raising for the e-commerce enterprise Jingdong Mall that totaled US$ 150 million – a record for an e-commerce enterprise in China.
     
An investment arena that includes telecommunications, media and technology is still the most attractive for VC in China.

And according to industry insiders, publicly disclosed investments are just a fraction of the total funneled into these sectors, which rely on innovation and low entry barriers. Start-up telecom and technology firms prefer staying quiet about initiatives since they often begin by copying ideas from other companies.

VC promoters are now more optimistic -- and inviting investors to think ahead of the curve.

"Investment activity reflects optimism for the future; you want to get in early to avoid missing out," said Tu Hongchuan, general manager of the U.S. Highland Capital Partners. "Investment really comes in when things start to pick up, but it can be difficult to notice when that turning point comes."

Bouncing Back

VC investment activity was at a virtual standstill just one year ago. Enterprises that had pulled back were not seeking capital injections. Moreover, market transaction prices had fallen quickly in China's second-tier cities, prompting VCs to scale back buy offers.

Furthermore, foreign-backed funds were hit hard by the economic crisis. Some big limited partnerships tried to draw back from investing funds, or double back on previous funding commitments to ease cash flow pressures.

However, by the fourth quarter 2009, a number of VC portfolios were starting to perform well again, increasing investor confidence.

"Many companies went better than expected in the fourth quarter" and into 2010, said Tu. "We may see some Internet companies in our portfolio listed in the latter half of this year."

Aside from improved fundamentals, the good performance of the China's new Growth Enterprise Market (GEM) has done a lot to warm the VC scene.

According to Zero2IPO, GEM yielded an average seven-fold return for private equity and VCs in 2009, far exceeding the double return on overseas markets, although these gains have yet to be realized due to share sale restrictions of one to three years in China, compared with six months abroad.

Compared with those in the United States and Europe, the price-to-earnings ratios for companies listed on China's A-share and GEM boards is high, making China ideal for IPO activity. However, due to regulatory restrictions on foreign investment, most overseas VCs operate outside China and rarely participate in GEM activity.
  
"No matter how the good returns on GEM are, we're not going to change project selection criteria or price thresholds," said a managers of a fund that's invested in a GEM enterprise. "You have to wait until the investment projects are wrapping up to know what GEM will be like."

But the case of Jingdong Mall highlights VC's interest in competitive fields. The Chinese VC Capital Today channeled US$ 10 million to Jingdong in 2007, and joined Bull Capital and Hong Kong investment banker Francis Leung Pak-to in a US$ 21 million injection in 2008.
  
So far Jingdong's growth rate has been significant but its profits are meager. CEO Liu Qiangdong said e-commerce enterprises rely on scale to secure profits, adding that revenues in the billions of yuan should generate considerable earnings.

Liu said most funds raised by his company have been used to expand the company's business in second- and third-tier cities in central and western China. For example, a Chengdu subsidiary launched operations in March 2009.

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