Neil Nanpeng Shen is one of the hottest properties in China’s venture capital industry. Ranked 252nd in the 2006 Forbes China rich list, Shen made his name, and his fortune, as co-founder and president of internet travel company Ctrip.com. He followed that up in late October with the successful US$109 million NASDAQ listing of budget hotel chain Home Inns. As founding managing partner of Sequoia Capital’s China operations, Shen is looking to lend his Midas touch to Sequoia’s investors. CHINA ECONOMIC REVIEW caught up with Shen shortly before the Home Inns listing to talk about China’s outlook for venture capital funds.
Q: Sequoia Capital has done pretty well worldwide. How do you recreate that success in China?
A: I think it’s the same approach, i.e. the capability of identifying – in the early stage and in the growth stage – the promising companies before other people find them. It is certainly not easy but Sequoia has done that extremely well in the US and I see the same dynamic here. We’ve got an economy that is doing very well. Just like in the US the TMT (telecom, media and technology) sector is growing very fast.
Q: Chinese companies are renowned for poor transparency. Does this create difficulties identifying companies with potential?
A: This is what makes venture capital so worthwhile, if you are able to find five fast growing companies. It’s a very important aspect of being a venture capitalist.
Q: China-dedicated VC funds raised US$4 billion in committed capital last year. Where is it all going to go? Is the market big enough to absorb that much capital, or are we approaching a sellers market?
A: I think overall there are still a lot of opportunities in China and the economy is able to accommodate or absorb the money. If you look at Israel, for example, the venture capital market is very big given that there have been a lot of entrepreneurs founding new companies. In China we see the same entrepreneurship and on top of that very strong economic growth. And it is across the board, not just in the internet area or technology area but also in some traditional areas. So, I am not surprised we are seeing a lot of funds being established to try and enter the market. If you ask me if there is any sort of issue, there might be some over-investment in certain areas but overall it is a pretty healthy market.
Q: According to Ernst & Young research, venture capital investment in the IT sector reached US$313.6 million in the second quarter this year, representing 65% of total VC investment in China? Is this level of investment healthy?
A: I am not surprised because scalability for successful tech companies is very good and we have seen examples of some internet companies listing and growing from small to very big multi-billion dollar companies. Again, it is a very natural phenomenon that a lot of people are very interested in the sector.
Q: While Ctrip is an IT company, you could say it is a service company, working off an IT platform. You also founded budget hotel chain Home Inns and Sequoia China has backed restaurant-chain Chatea, which attracted a lot of VC money. Is this a China-specific thing where venture capitalists are starting to back a lot of service sector industries?
A: Yes. I think the service industry grows when the economy grows and they will probably benefit a lot as we see an increase in service and product demand from ordinary citizens. Naturally, those sectors benefit tremendously as GDP and disposable income grows, no matter whether it is dining or whether it is travel.
Q: Is this unique to China or has it happened before in other places?
A: I think it happened in the US 40 years ago, but obviously the US was not growing as fast as China as far as percentage growth is concerned. China is coming from a small base so from that end we are just in the early stage of the formation of those industries. In the US that probably happened 40 years ago and now it is more stable and more mature.
Q: But you didn’t really have VC funds 40 years ago like you do today?
A: Exactly. Obviously in the US they probably used personal savings and bank loans but in China they are lucky venture capital also looks into the market and helps the fastest growing of those companies. Without venture capital they would probably still grow, but with venture capital they can probably grow faster, particularly with the very strong underlying demand.
Q: For VCs who are used to dealing in IT, is it difficult to get your head around the service sector? Do you have to change the way you operate as a VC company?
A: I was not an IT guy to start with. Again, first of all there are a lot of common characteristics like management sophistication. It is also similar in the sense that you need innovation, you need to come up with creative ideas and innovative business models. Whether you are in the internet/search space or whether it is the consumer space, ultimately you are looking for a sophisticated management style as well as innovative business models.
Q: Fast growing companies need a fast growing exchange. How important is it in China to develop a NASDAQ style exchange?
A: I think it is very important. I think it is always nice to have a local exchange that is strong and able to provide exits and liquidity. China is moving in that direction. We see fully liquid share IPOs on domestic stock exchanges and I think this needs a little more time but it is definitely moving in that direction.
Q: What do you make of the rumors circulating regarding the government’s intention to develop Shenzhen into a NASDAQ style exchange? Do you think this is happening?
A: I think overall there will be more room for small and medium companies listing on domestic exchanges.
Q: The state-controlled banking sector, which dominates lending in China, is an inefficient allocator of capital so there are a lot cash-starved private companies. Does this make it easier for you guys to get good deals?
A: There is lot of venture capital coming from overseas and we see domestic capital on the equity side trying to tap into that too, so I don’t think it is that easy or that obvious. Ultimately it takes a lot of effort to become a leader as an investor, and I think you really need to be the top. If you are not, you will probably not do so well, even though you are sitting in a nice industry.
Q: So any advantage there may have been because of this situation is now gone because of the amount of money chasing deals?
A: I don’t know whether we can say there is too much money now but at least there is a decent amount of money looking for investment in China.
Q: A number of high profile M&A deals have hit regulatory hurdles lately. Do you think there is backlash against foreign investment? Does it affect Sequoia?
A: I don’t think so. First of all, we are not an active player in that space. We are more or less in the venture capital space and we typically seek minority [stakes]. I see a pretty open mind from the government side to encourage foreign investment so I don’t see things going that way. You always have to look at the local rules and regulations but overall there is room for investors as long as they invest properly.
Q: What impact will the new M&A rules concerning offshore shell companies have on VCs exiting investments? In particular, can you see it being used to block offshore listings?
A: In the past 10-plus years that I have had experience in business in China, whether at an investment bank or as a venture capitalist or as an entrepreneur, I have seen new laws, new regulations come into play. But the overall trend is to have more transparency, more international standards.
Q: For Sequoia Capital, what are you looking at next, what is big on your agenda?
A: There are a lot of opportunities. Obviously we will look at the TMT area but we will also look at traditional industries. We have been very disciplined in capital but we are also very excited by the great opportunities.
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