Venture capital still finds Chinese entrepreneurs a difficult proposition to beat. There is little doubt that funds will continue to flood the country in 2008, but there will be new hot sectors and new strategies in the struggle to evade Beijing’s capital controls.
Yuan-denominated venture capital (VC) and private equity (PE) funds will be big players this year, according to the Center for Asia Private Equity Research, a consultancy in Hong Kong. In 2006, yuan funds totaled US$916 million; by November 2007, they already reached US$891 million.
One reason for the increase is tougher rules – implemented in 2006 and clarified in 2007 – that make it harder for foreign investors to enter and exit the China market. Since foreign funds tend to be US dollar-denominated, the rules have shrunk the supply of US funds available.
Beijing has simultaneously encouraged local, yuan-denominated PE funds to be more active. The net result will be a tussle between yuan and dollar funds for dominance, according to Kathleen Ng, the center’s managing director.
“Certainly it’s a defining period, where it’s going to be a contest between the yuan-denominated funds and the foreign funds,” she said.
Nevertheless, funding continues to increase. According to third-quarter figures compiled by research firm Dow Jones VentureOne and Ernst & Young, overall VC investment in China rose 5% year-on-year to reach US$677 million. Funding for the year is on track to exceed the US$2.4 billion raised in 2006.
The VentureOne report also noted that nearly half of the capital raised in the third quarter went to non-technology enterprises, specifically in the consumer and business services sector. That sector accounted for US$333.5 million, up 242% on the third quarter of 2006.
This newfound consumer focus comes in part from a desire to cash in on China’s rising middle class. According to Brian Lee, a vice president at the venture firm United Capital Investment in Shanghai, tech firms can suffer from weak cashflows and low exposure to middle-class habits.
“Money flows into [consumer] businesses much faster than in IT firms,” he said. “IT is more behavior-based; education [of the consumer] is involved.”
Indeed, tech companies may be doing too well, which is why less VC money is going to them, according to Matt Comyns, a managing partner at research firm JL McGregor. Tech firms can now get by with less funding, thanks to lower hardware and software costs, and China’s maturing internet market means valuations are getting higher, giving VCs less investment opportunities.
That’s not to say tech firms aren’t attracting any capital. According to VentureOne, IT firms received US$217 million in the third quarter of 2007. Lee and Comyns tip social networking sites in the mold of Facebook and MySpace to be hot property next year.
“Suddenly everybody is thinking that social networking is getting more interesting again,” Lee said. “[Because of] the fact that it’s darn successful in the US, [and] there’s not one successful one here that we can name.”
Another area might be e-commerce. As Chinese consumers become comfortable with online transactions, the sales volumes of sites like online book retailer Dangdang are likely to rise, Comyns said. Alibaba.com’s huge US$1.7 billion IPO has also boosted the visibility of e-commerce to investors and consumers alike.
Then there’s cleantech. Lee’s firm has invested in a biofuels company called Gushan Environmental Energy which has filed to list on the New York Stock Exchange. Naturally, he’s bullish about biofuel’s prospects next year.
“With the oil prices the way they are … the government will, I believe, strongly encourage [alternative fuels] because they are the ones losing money on every single barrel [of oil] they are buying,” he said.
From online bookstores to biofuels, China’s entrepreneurs won’t be short of funding any time soon.
“More money’s coming,” Comyns said. “Just when you think it’s a bubble or too frothy, the bottom line is that the growth in China is so broad and so deep that it can absorb a lot of capital.”