China Stock Turmoil 2015

Stock market turmoil widens gap between haves and have-nots in China's tech sector

PUBLISHED : Tuesday, 14 July, 2015, 9:44am
UPDATED : Wednesday, 15 July, 2015, 2:22am

Investments in Chinese technology start-ups could get squeezed this year as Beijing continues to wrestle with the country's stock market crisis, dealing a blow to the government’s plan to foster more innovative entrepreneurial activity.

In contrast, spending by major Chinese technology companies on mergers and acquisitions will likely be left unscathed by the turmoil in the world's second-largest economy.

“These are completely different stories amid the [stock market] crunch that happened so quickly,” said Paul Haswell, a partner at Pinsent Masons, an international law firm focused on technology, media and telecommunications transactions.

Government authorities, led by the People’s Bank of China and margin financing lender China Securities Finance, have responded to the rout suffered by thousands of companies in the Shenzhen and Shanghai bourses over the past four weeks with a series of support measures.

Those included the setting up of a US$19.3 billion fund to buy stocks, suspending initial public offerings, cutting interest rates, allowing insurance firms to raise their stock investments, and barring state-owned enterprises from selling shares in their listed subsidiaries.

It was hoped that the aggressive intervention would end the massive sell-off that erased almost US$4 trillion from locally listed companies’ share valuations — more than the combined market cap of London's FTSE 100 index. The Shanghai and Shenzhen markets have fallen about 30 per cent and 40 per cent, respectively, since June 12.

Shenzhen's highly speculative ChiNext, the Nasdaq-style board dominated by small-cap technology firms and emerging start-ups, has been hit particularly hard. On July 8, about 267 companies — representing 56 per cent of all stocks in the ChiNext index — requested that trading in their shares be halted to escape the bear run.

As of the close of trading on Monday, Beijing's rescue efforts had appeared to yield their desired effect, bringing back some degree of confidence for the third straight trading day to the country's battered stock markets. Hundreds of companies resumed trading on Monday, after government authorities started an investigation into possible stock market manipulation by some securities firms.

The country's benchmark Shanghai Composite Index increased 2.4 per cent to close at 3,970.39, but that was still a long way from the peak of 5,178.19 it reached on June 12.

The smaller Shenzhen Composite Index rose 4.2 per cent points to finish at 2,120.25. This was the second straight trading day that the index was back over the 2,000-level mark.

The ChiNext index gained 5.8 per cent to reach 2,683.07. But that remains well below its all-time high of 3,982.25 set on June 3.

China's stock market plunge has created a deep-seated uncertainty that could make investors wary. The likely result is a significant reduction of venture capital funding for Chinese technology start-ups, according to entrepreneur Leo Zhang.

Zhang is the co-founder of TT-Kuaiche, a mobile carwash app operator that raised nearly US$10 million in its first round of financing from the China arm of California-based venture capital firm Sequoia Capital.

“If the situation in the stock markets gets worse, the size of the available capital pool for Chinese start-ups would be affected since many new technology innovation projects are funded by listed companies that raise proceeds in the capital market,” Zhang said.

“We are lucky because our first and second rounds of financing were based on the US dollar and funded by overseas venture capital investors.”

He said competition for venture capital this year felt more fierce compared with 2014. As such, he expected that “a big number of start-ups that have raised their first round of financing will fail because of the lack of second-round financing”.

A report released last week by investment database, which is run by Zero2IPO Research in Beijing, showed that the number of new Chinese venture capital funds and their funding size have dropped sharply in the first half of this year.

A total of 105 new funds were set up in China's venture capital market in the first six months of this year, down 16 per cent from the same period in 2014. among these funds, 82 publicly disclosed the amount of fresh capital geared for the domestic market. That total sum reached US$6.31 billion, down 41 per cent from the amount made available last year.

The report partly attributed that decline to the many so-called high-net worth domestic investors who increased their investments in the stock market during the short-sighted bull run in the first half of this year. Individual investors account for more than 80 per cent of the trading turnover in China's A-share market, which comprises about 2,800 listed companies.

Zhu Bo, the founder of angel investor Guangzhou Innovalley Incubation, said there was no official statistics to show how fierce the competition for funds had become for Chinese technology start-ups.

But by his own estimate, Zhu said only about 1 per cent of the hundreds of technology start-ups in mainland China can successfully raise seed funding from angel investors at any given time.

He added that only 5 per cent of those start-ups would go on to generate their first round of financing from established investors. About half of these firms would be able to reach their third round of financing.

“This year will mark the winter of China’s venture capital industry. There is more money leaving the pool [of funds] than going in”, Zhu said.

“I believe many venture capital investors will slow down and remain cautious.”

That would create another set of problems, exacerbating the widening gap among the haves and have-nots in China’s technology start-up scene. While many small firms feel the pinch, there are those that have become or are on their way to becoming “unicorns” — the investment industry's term for a start-up with a valuation of more than US$1 billion.

Popular smartphone maker Xiaomi easily raised US$1.1 billion in one go last December, when the start-up received a valuation of US$45 billion from investors.

Didi Kuaidi, China’s largest ride-hailing app operator, topped that amount last week when it raised US$2 billion in its latest fundraising, breaking Facebook's record for the most lucrative single round of fundraising achieved by a privately held company.

Zhu said the latest boom-and-bust cycle in China’s stock markets has only made the situation worse for smaller-cap firms.

Zhou Liang, securities affairs representative at Shenzhen-listed O-film Tech Company, which makes touch-panel fingerprint sensors, said having a stable capital market is vital when it comes to helping his company and others like it to grow.

Despite the current market uncertainty, Zhu said his company still managed to make investments of about 3 million yuan each in about 30 Chinese technology companies in the first half of this year. He said his company was optimistic in making bets on “fast-growing technology start-ups that already show potential of having steady cash flow”.

To balance the risk, Zhu said he plans to invest in at least 20 US start-ups based in California's Silicon Valley.

The lingering market uncertainty also undermines the central government’s plan to promote the development of a new generation of innovative, young enterprises, following the much-vaunted lead of Chinese internet giant Alibaba Group, Tencent and Baidu.

The State Council, China’s cabinet, issued a call in March for ministries and local governments at “all levels” to support innovation and start-ups. In a statement published online, the State Council said China should catch up with other countries and “encourage the general public to start their own businesses”.

It vowed to “promote financing for technology start-ups, and improve the funding and investment exit system of venture capital funds and angel investors”. The cabinet statement added that Beijing would also make relevant approval processes more efficient and reduce red tape.

This year, one of the government's key economic targets is employment, with the country aiming to create a minimum of 10 million new jobs. This followed Beijing’s decision to cut the country's 2015 economic growth target to 7 per cent, the lowest rate in more than two decades. There will be 7.49 million university students graduating this year, a record high.

Meanwhile, the more-established Chinese technology companies which are listed in Hong Kong or the US are rather insulated from any serious damage caused by the crash because of their businesses’ size and distance from the troubles on the mainland market.

“The mergers and acquisitions plans of the major Chinese technology companies will continue and won’t be impacted by what’s happening in the country’s stock markets,” Pinsent Masons' Haswell said.

“It will be business as usual for the likes of Lenovo, Huawei, Alibaba, Baidu and Tencent.”

Haswell claimed that those large companies have already drawn up their mergers and acquisitions strategy, and have sufficiently large businesses and operating models to weather the storm. “By following through with their plans, they can increase their stock price anyway,” he said.

E-commerce giant Alibaba, for example, continued to strengthen its international e-commerce capabilities, unfazed by all the volatility in China’s stock markets. The company last Wednesday said it will buy an additional 5 per cent stake in Singapore Post for US$138.6 million, as well as invest US$67.85 million in the national mail carrier’s logistics arm Quantium Solutions International.

Its announcement was made on the same day the Shanghai Composite Index closed at 3,507.19, the lowest it had reached in nearly four months.

Haswell said the situation is all-too different for China’s small-cap technology companies, which are expected to put their mergers and acquisitions efforts on hold. “These smaller firms will just have to wait and see what happens next in China’s stock markets,” he said.

The shares of Hong Kong-listed Lenovo and Tencent, as well as those of Nasdaq-traded Baidu and New York-listed Alibaba have all resisted any sharp falls amid the turmoil in China's bourses. Their share prices, however, are still down from recent highs.

Shares of Baidu, the leading online search provider in China, finished trading on July 10 at US$187.75, down 11.4 per cent from a high of US$211.98 on June 23. Alibaba's shares closed at US$80.30 on July 10, 14.5 per cent below its recent peak of US$93.88 on May 21.

Tencent, China's largest online games operator and social messaging services provider, saw its share price rise 1.07 per cent on Monday to HK$150.50. It marked an 8 per cent decrease from the stock’s high of HK$163.70 on June 24.

Lenovo, the world’s largest supplier of personal computers, finished up 1.02 per cent to HK$9.86 on Monday. That was down 27.4 per cent from its recent peak of HK$13.58 on May 11.

Haswell said China’s larger, cash-rich private-sector technology companies are expected to drive outbound acquisitions in the second half of this year for relevant intellectual property, especially those from European technology firms.

“The acquisition and incorporation of European tech is viewed as making Chinese technology brands more competitive and more attractive in the world stage,” he said.

The most recent example of such an outbound acquisition was Huawei Technologies’ US$25 million purchase of British firm Neul last September.

Data from PricewaterhouseCoopers showed that China mergers and acquisitions activity reached record highs last year in terms of number of deals, which reached 6,899, and the value involved, which totalled US$407 billion.

Technology and consumer-related deals accounted for more than half of those transactions, reflecting investment plans that aim to be in tune with the strategic direction of the country’s economy.