China wine plays: oversaturation?

China's fast-growing wine sector looks set for a period of stiff competition and consolidation over the next 2-3 years as too much investment flows into the sector.

PUBLISHED : Friday, 07 December, 2012, 12:51pm
UPDATED : Friday, 07 December, 2012, 12:52pm

Two news bits from the wine sector are making headlines, shining a spotlight on this hot industry whose fast growth is being fueled by millions of new middle class Chinese who are willing to pay big money for premium products like wine and coffee. But these latest two deals also reflect intensifying competition in a sector that could easily become the next bloody battlefield for over-eager Chinese start-ups, resulting in big losses and ultimately an ugly consolidation.

This kind of "me too" rush into hot new sectors is all too common for Chinese companies, and usually results in cycles of huge investment, followed by an explosion in companies in the space. That leads to rampant competition, followed by extensive closures and consolidation before the sector enters a more sustainable phase. Unfortunately, these cycles can often take up to a decade to reach their conclusion due to the big amount of investment capital in the market, making it difficult for investors to identify the best managed players with the greatest chances for longer term success.

All of that said, let's take a look at the latest news involving two young wine sellers, one called Jiumei and the other called Jiuxian. We'll start with Jiumei, which has announced it has received a new round of venture funding although it isn't giving any details on the investors or actual amount of funds raised. Media reported back in September that Jiumei had raised a new round of funding totaling around 100 million yuan, or about US$16 million, and I suspect this new announcement could be the same deal. 

Despite the relatively small amount, I previously said this funding looked like a positive sign because it happened at all. By comparison, new funding has virtually disappeared for other companies in the overheated e-commerce sector, which has been plagued by rampant competition and losses by most players for more than a year. So the fact that an online wine-selling company could still get funding seemed like a positive sign.

Meantime, media are also reporting that Jiuxian will notch more than 300 per cent revenue growth this year as demand for wine grows.  But perhaps more significantly, the company's CEO also said Jiuxian wouldn't meet its target of generating 2 billion yuan in sales this year. The executive didn't say just how short Jiuxian would fall of its target, but the fact that he was discussing the subject at all probably indicates the company's revenue will fall well short of the figure, perhaps reaching just 1.5 billion yuan or less.

His public discussion of the shortfall also probably reflects the growing competition in a space that has seen competition rapidly heat up from both start-ups and other more established companies entering the field over the last two years. All of those companies are chasing a market that grew some 60 per cent last year and should post similar growth in 2012, fueled both by imports and increasingly high quality wines produced in China.

Over the last year alone, major e-commerce players including Jingdong Mall and (Shenzhen: 002024) have both announced new wine-selling initiatives; and Bright Food, one of China's leading food groups, also made headlines earlier this year with its purchase of a French winemaker.

I've been in China long enough to know that all of this activity means that price wars and rampant competition are probably already starting to hit this up-and-coming industry. That means start-ups that were hoping to quickly become profitable may soon be facing a cash crunch if investors lose their appetite for the sector.

We could still see 1 or 2 companies make an IPO in the next year before the situation becomes too overheated, perhaps providing a good chance for investors to buy into this promising sector. But the potential for any big returns might have to wait at least 2-3 years until this current wave of investment euphoria passes and a more sustainable situation takes shape.

Bottom line: China's fast-growing wine sector looks set for a period of stiff competition and consolidation over the next 2-3 years as too much investment flows into the sector.