Venture capitalism with Chinese characteristics
If a big billboard collapses somewhere in Beijing, Shanghai or any other big Chinese cities, it has a good chance of killing at least one venture capitalist, so the saying goes. That may be a bit cruel but the growth of venture capital funds on the mainland is definitely amazing, thanks to a flood of liquidity and relaxed regulation.
By the end of September, there were 571 venture capital funds in the country, holding 150 billion yuan (HK$175 billion) worth of assets. That is a 50 times growth over 2006. The industry employs more than 720,000 people.
In 2008 and 2009, foreign players dominated the pre-listing investment of public offerings in Hong Kong. Now, the local breed has become the key players. They are loaded with money, and are keen to invest. Mind you, in the mainland stock market, the yield of a pre-IPO investment ranges between 300 per cent and 1,700 per cent.
Most important of all, 'they pay within 24 hours and a foreign fund will take at least three months', a foreign venture capitalist said.
The investor list of China New Materials Holdings (CNM), a chemical producer planning a public offering, is a telling case of the new breed.
First, they don't mind a crowded bed. Aiming to raise a maximum of HK$980 million and for a market capitalisation of about HK$4 billion, CNM has four venture capitalists putting in a total of HK$453 million (see table). That is on top of a HK$240 million investment by two individuals, according to its draft prospectus.
It is a small circle where everybody knows everybody. Yam Tak-cheung, a prominent owner of various listed shell companies in Hong Kong, went into CNM first. Qi Kebo, who founded Sun Investment Fund where Yam is an executive director, followed. Qi introduced CNM executive chairman Zhang Kaijun to two other funds, China Angel and Chinaland Investment. Suo Lang Duo Ji, chairman of Lumena Resources where Qi is an investor, was the last to join.
Traditional venture capitalists, who pride themselves on value-adding expertise such as management and marketing advice, will not like the crowdedness because that gives them little influence on the founder. But among the locals, money and guanxi is the most important contribution to any issuer. After all, many of them squeeze into the game at the very last minute and there isn't much value-adding to talk about.
Most investment in CNM arrived after May with some as late as October 29, which was only days before the listing committee vetted the listing application. This is despite an October guideline issued by the committee requiring all pre-IPO investment to be made no less than six months before the listing in order to ensure 'equal treatment' for all shareholders. Why was the investment in CNM allowed? An exchange spokesman would not comment on an individual case. Well, even if the exchange had said no, there are many ways to get around it. Sihuan Pharmaceutical Holdings paid HK$1 billion to New Horizon Fund, set up by a son of Premier Wen Jiabao, to cancel an early equity investment deal though New Horizon has never paid up.
Shifang Holding, a printing and media company, has agreed to turn two US$2.2 million investments by two venture capitalists into a loan. The amount to be repaid will be the market value of 3 per cent in Shifang in 12 months' time.
In a country flooded with liquidity, money alone is not going to get you a seat on the IPO wagon. Venture capitalists compete on terms.
CNM is in a cyclical business. The company has managed to secure a 100 billion yuan bank loan. The company is facing a legal dispute with an early potential investor over a HK$50 million injection. (Its chairman has promised to indemnify the company for any damages.)
But the pricing it has managed to get from the venture capitalists is surprisingly competitive. For instance, it cost Sun Investment HK$2.86 per share to get into CNM. That is about the median of its IPO price range of HK$2.33 to HK$3.33. It is the result of a last-minute 1.5 times price mark-up by the major shareholder. The big puzzle is how is the venture capitalist going to make money from this aggressive pricing, as the shares of pre-IPO investors will be locked up for six months.
Their restriction on the usage of the money is also surprisingly lax. While traditional venture capitalists will make sure their money goes into the company, the CNM investors are more relaxed.
Of their HK$653 million investment, HK$259 million was pocketed by chairman Zhang for 'personal use', according to the prospectus.
Now, you see why foreign venture capitalists are squeezed out. For retail investors, the question is, do you want to dance with this new breed or go somewhere else?