Overview of China’s Venture Capital Industry
Investment Network www.merar.com
George Iliev October 25, 2010
(Photo: West Looks at East, Hong Kong Island, Nov 2009) 1
Contents About Merar ..................................................................................... 3 About the author .............................................................................. 3 Tributes ........................................................................................... 3 Executive Summary .......................................................................... 4 1. Introduction to China’s VC industry ................................................ 5 2. Number and value of VC deals in 2009 and Q2 2010 ........................ 5 3. Average size of deals ................................................................... 7 4. Breakdown by Industry (tech, media, telecoms vs. traditional) .......... 9 5. Breakdown by stage (development, expansion, profitability) ........... 11 6. Breakdown by round (A,B,C,D,E) ................................................. 11 7. Breakdown by geographical region ............................................... 12 8. Breakdown by source of funding (Chinese, foreign, joint-venture) ... 14 9. Global Trends in PE/VC in the West .............................................. 15 10. Global Trends in PE/VC in Emerging Markets .............................. 16 11. Conclusion ............................................................................. 16 APPENDIX I ................................................................................... 18 APPENDIX II.................................................................................. 19 APPENDIX III ................................................................................ 20
2
About Merar Merar Investment Network (www.merar.com) is a global web-based investment network focused on the emerging markets of Asia, Central and Eastern Europe and Africa. Merar operates in English, Russian, Chinese and Turkish and helps investors establish the initial contact with entrepreneurs in need of capital. The web-based platform serves as the meeting place where VC/PE funds, investment intermediaries, angels and strategic investors from across the world find emerging-market projects, entrepreneurs and companies in which to invest. Merar is a membership service. About the author George Iliev is the China Business Development Manager of Merar Investment Network. He speaks Mandarin Chinese and holds an MBA degree from Emory University (Atlanta), where he attended on a Fulbright scholarship awarded by the US State Department. He also has a master’s degree on China from the London School of Economics and a bachelor’s degree in Chinese Studies from Sofia University. Before joining Merar, George was the Managing Editor of a Chinese business news service published on Reuters Business Briefing and Factiva/Dow Jones. He has also taught Economy of China at Sofia University and attended an MBA semester at the Hong Kong University of Science and Technology.
Tributes Merar Investment Network would like to extend its special gratitude to ChinaVenture (www.chinaventure.com.cn) for all statistical and graphical data used in this report.
3
Executive Summary China’s venture capital and private equity industry was until recently dominated by foreign currency offshore funds run by international investors. However, in 2009 Chinese-yuan funds for the first time took the lead over foreign-currency funds in terms of amount of new capital raised and number of deals. Domestic funds in China are smaller but nimbler as they face fewer regulatory hurdles. A total 428 VC investments in China were reported in 2009 according to ChinaVenture, down 20% year-on-year. The total value of these deals stood at USD $3.77 billion, down 24.8% year-on-year. The number and value of the 2009 deals were the second-highest on record after the peak results posted for 2008. The average size of the deals conducted in China by Chinese funds was USD $3.6 million in 2009 while foreign funds posted an average deal size of USD $18.1 million. The average size of deals for the whole country was USD $8.8 million in 2009, a slight decline from 2008, but up more than twofold compared with 2002-2005. The technology, media and telecommunications sectors account for roughly half of all deals. China displays the characteristics of an emerging market as the investments in all development-stage projects are more numerous and represent a larger investment value than all expansion-, profitability- and early-stage deals combined. Almost 3/4 of all VC deals occur in China’s coastal provinces, with the cities of Beijing and Shanghai alone accounting for over one-third in both number of deals and invested value. Global trends show that VC firms in China, India and Brazil are very optimistic about growth prospects in their home region. The number of VC firms in these countries is expected to increase by 2015 and the opportunities that exist there are increasingly attracting the attention of western and eastern funds alike.
4
1.Introduction to China’s VC industry China’s venture capital and private equity (VC/PE) industry was until recently dominated by foreign currency offshore funds run by international investors. In recent years China has been relaxing restrictions in the private equity field and has since 2009 allowed foreign firms to raise funds denominated in Chinese yuan (RMB). In 2009 Chinese-yuan funds for the first time took the lead over foreign-currency funds in terms of amount of new capital raised and number of deals. The year 2009 also marked the launch of China’s third stock exchange, ChiNext in Shenzhen, which provides an alternative exit for those PE acquisitions which are not sold on to a strategic investor. Competition is increasing from the smaller but nimbler domestic funds which enjoy protection and encouragement from the Chinese government. The local funds are quicker to win deals due to fewer regulatory constraints. Restrictions on the size of stake purchases in Chinese companies to below the majority control threshold still exist for the yuandenominated foreign-run funds. Statistics for 2009 from ChinaVenture, a VC research and consulting firm, tell a story of a “Chinese David and western Goliath”: • 105 Chinese-yuan funds raised USD $12.3 bn in 2009 • 19 foreign-currency funds raised USD $6.52 bn in 2009 An interesting characteristic of Chinese limited partners is the fact that they expect returns in three years, while investors in developed markets typically sign up for up to a ten-year time horizon, according to the Wall Street Journal (Will Private Equity Play China Rules, May 29, 2010). Chinese investors also tend to expect to be more involved in investment decisions and the day-to-day management of the fund than western VC/PE firms are used to.
2.Number and value of VC deals in 2009 and Q2 2010 A total of 428 VC investments were disclosed in 2009, according to ChinaVenture. This figure marks a 20% decline year-on-year, but is still the second highest number on record. The decline comes naturally as the 2008 results came at the peak of the cycle, right before the global impact of the recession was felt.
5
The total amount of VC investments of USD 3.767 billion in 2009 was similarly 24.8% lower year-on-year but was still the second highest annual value on record (see graph). 1 Graph 1
As the quarterly graph below shows, a robust recovery in the VC industry was underway in the second half of 2009. However, the trend was later derailed by two important trends in the economy: a) The on-going phasing-out of economic stimulus policies by the Chinese government. This was recently underscored by a 25 basis point interest-rate rise to check inflationary pressures resulting from overheating industries and the growth of real estate bubbles. b) The crash of the domestic stock markets in 2008 and the timid recent recovery of the Shanghai Stock Exchange Composite Index to levels recorded in early 2007.
1
Unless otherwise stated, all graphs and tables in this report are provided by ChinaVenture (www.chinaventure.com.cn)
6
Graph 2
3.Average size of deals The average deal size in China fell to USD $8.8 million in 2009, from USD $9.36 million in 2008. Still, the level in recent years has hovered around the USD $8-$9 million mark, which shows a growing appetite for larger deals by the funds. In comparison, the first half of the decade saw average deal sizes of around USD $3-$5 million.
7
Graph 3
Quarterly statistics until the second half of 2010 roughly follow the annual trend, except for a few large deals which skew the statistics for the first months of the year.
8
Graph 4
4.Breakdown by Industry telecoms vs. traditional)
(tech,
media,
The IT industry (mostly hardware and software) led in terms of number of deals in 2009 with 75 purchases worth USD $706 million and an average amount of USD $9.4 million per deal. However, the IT sector was outpaced by the Internet sector in terms of value and deal size, as the 65 Internet deals were worth USD $948 million in 2009 and had an average value of USD $14.6 million per deal. Overall, the Technology-Media-Telecoms (TMT) sectors in China attracted 44% of all deals and 51% of the invested value in 2009.
9
Graphs 5, 6
The share of TMT deals as a percent of the whole number of deals has declined since 2006. However, the larger value of individual TMT deals in 2009 makes the decline in value smaller than the decline in number. Graph 7
A breakdown of all sectors and detailed figures for 2009 and Q2-2010 are available in the appendices. 10
5.Breakdown by stage (development, expansion, profitability) Out of all 428 VC deals struck in China in 2009, 243 deals worth USD $2.453 billion were in development-stage companies/projects, accounting for 57% of the number and 65% of the invested amount for the year. This is typical of emerging markets where development- and expansion-stage deals vastly outnumber profitability-stage deals. Graphs 8, 9
Table 1
6.Breakdown by round (A,B,C,D,E) The vast majority of deals in 2009 were A-round deals, that is these were the first VC investment in the given company. A-round deals accounted for 71% of the number and 63% of the value for the year.
11
Graphs 10, 11
Table 2
7.Breakdown by geographical region There are no surprises here: the developed coastal provinces of China account for well over 2/3 of all VC activity. Beijing, the Yangtze River Delta around Shanghai (including Jiangsu and Zhejiang provinces) and the Pearl River Delta (excluding Hong Kong in this report, but including Shenzhen and all of Guangdong province) led the way in 2009. The only non-coastal areas to find a place in the top ranking were the east-central populous provinces of Hubei and Hunan.
12
Graphs 12, 13
Table 3
13
8.Breakdown by source of funding (Chinese, foreign, joint-venture) Chinese institutions were more active in the number of deals in 2009 for the first time, clinching 267 deals worth USD $949 million, but the average investment amounts were fivefold smaller than the average for the foreign-funded deals. Table 4
The decline in the number of foreign-funded deals comes in stark contrast to the relatively constant share of overall investments. This shows that the nimbler Chinese funds have entered the market with an increasing number of smaller deals while foreign funds have maintained a focus on large-value acquisitions.
14
Graph 14
9.Global Trends in PE/VC in the West The 2010 Global Venture Capital Survey 2 of Deloitte and the National Venture Capital Association (NVCA) projects a lackluster performance for the VC industry in the West. The survey, which measures the opinions of over 500 venture capitalists worldwide, shows that 92% of US VC firms expect the number of venture firms in the States to fall in the next five years. Respondents in France (83%), Israel (80%), the UK (70%) and Canada also expect a similar outcome for their countries by 2015. 2
2010 Global Venture Capital Survey by Deloitte and National Venture Capital Association
http://www.deloitte.com/view/en_US/us/Insights/browse-by-role/mediarole/a8e40f2f800d9210VgnVCM200000bb42f00aRCRD.htm
15
The main reasons for the lack of optimism among US venture capitalists is the weak IPO market and difficult exits in recent years (88% of respondents), unfavourable tax policies (59%) and the unstable US regulatory environment (53%). A total of 56% of US VCs expect that their limited partners will be less willing to invest in US venture capital funds in the future. The same expectations about investing in their home country are shared by 89% of respondents in France, 61% in the UK, and 44% in Germany.
10. Global Markets
Trends
in
PE/VC
in
Emerging
In stark contrast to the gloomy sentiment of western VC firms, investors in the rapidly growing emerging economies of Asia and Latin America are markedly optimistic about their markets, according to the 2010 Global Venture Capital Survey of Deloitte and NVCA. A vast majority of venture capitalists in China, India and Brazil expect the number of venture firms in their country to grow: 99% of respondents in China, 97% in Brazil and 85% in India. Yet, 62% of respondents in China point out that the unstable regulatory environment in the country may present a challenge. Emerging market VCs are also becoming more inward-looking as the investment opportunities within their countries become more and more numerous. Only 34% of all respondents expect to increase their investment activity outside their own country in the future, but the figure for the BRIC countries is three times lower than the average for developed economies: 11% in China, 15% in India and 19% in Brazil, as opposed to 49% in the UK, 50% in Israel and 56% in France. The limited partners of emerging market VCs are showing distinct optimism about their home countries and a willingness to invest domestically: 92% of respondents in Brazil, 91% in China and 76 % in India.
11.
Conclusion
The 2010 VC survey of Deloitte and NVCA confirms the overall trend that investment opportunities are moving from North & West to South & East. The robust growth of China, India and Brazil, even though some of it is catch-up growth resulting from a lower starting point, shows that the 16
centre of gravity of global capital markets and the entire world economic order are shifting. Positive demographic trends in India and Brazil, sound macroeconomic policies in China and an abundance of natural resources in Brazil (and Russia) augur well for the development of the BRIC economies. The BRICs are already establishing their role and gaining confidence in the VC industry, but they will continue to rely for decades on the West’s “mortar�, in the form of capital and expertise. Thus, western VCs will keep providing structure and knowledge to this mutually beneficial BRIC-andmortar model in which opportunities lie in the East while expertise comes from the West.
17
APPENDIX I VC Investments in 2009 by Sector (Details) Table 5
18
APPENDIX II VC Investments in Q2-2010 by Sector (Details and Graphs) Table 6
19
APPENDIX III Graph 15
Graph 16
20