On September 23, Gridsum (GSUM) debuted on NASDAQ as the third new listing of a Chinese tech stock in the United States in 2016. An early investor in Gridsum, NGP has now realized successful exits in each of its first five investments in China, including two U.S. IPOs. Of the three companies that were acquired, UCWeb and Ganji are among the largest tech acquisitions in China to date.
Much has changed since NGP began investing in China. In fifteen short years, China has moved from a technology laggard to global leader. Alibaba, Tencent, Baidu and Huawei have emerged as global technology titans vying for global leadership in their respective fields. Yet beneath the sheen of these emerging heavyweights, China tech is undergoing growing pains. Like a gangly teenager lumbering with newfound height, China tech is tentatively flexing new muscles.
China no longer looks to the West for innovative inspiration. However, before China can assume an appropriate role as a technology peer, its tech market must mature to full adulthood.
China Tech – A Thriving, Rapidly Developing Ecosystem
For context, it is instructive to see how much the China tech market has changed over the past 15 years. In 2001, China’s big three (“BAT”) Internet companies – Baidu, Alibaba, Tencent were fledgling, unprofitable startups founded in 1998-2000 and still several years away from public listings. In 2001, Naspers, a South African media company, acquired a 47 percent stake in a struggling Tencent to help expand QQ, the foundation for their now ubiquitous messaging platform WeChat. Alibaba turned profitable in December 2001, two years after its founding and still three years away from taking over Yahoo operations in China. Founded in 2000, Baidu had yet to develop its search engine that would one day overtake Google in China. Today, China’s BAT have a combined market cap of over $550 billion, about 40 percent that of Amazon, Apple and Google combined.
Beyond the emergence of these tech giants, China tech has blossomed into a thriving industry driven by an ever deepening ecosystem of successful companies, investors and partners. This ecosystem is spawning increasingly sophisticated entrepreneurs. When we began investing in China, a common entrepreneurial refrain was: “We are the Chinese equivalent of XYZ company in the United States.” Within months of a new technology or service getting traction in the Unites States, we would predictably see fast followers developing analogs of these businesses in China. But indigenous innovation has replaced copycat entrepreneurship. It has been years since we have heard the once common comparison to a Western counterpart. With the world’s largest Internet and mobile user base, Chinese entrepreneurs now look to their own market rather than the West for new ideas and pockets of opportunity. Many new services emerging in the West – messaging, social and gaming are examples – are now inspired implicitly or explicitly from services first launched in Asia.
The pace of innovation is faster in China than anywhere in the world, including Silicon Valley, driven by intense competition and a willingness to innovate incrementally. Rapid prototyping was commonly practiced in China long before it became popular in the West. Daily iterations of A/B testing for new website offerings have long been standard practice in China. The pace of innovation is particularly striking in the combination of consumer electronics, software and services. On factory tours, we are occasionally invited to design our own consumer electronic device featuring various form factors, color preferences (or skins) packaged with our personalized services of choice. At the end of the tour, we receive our customized device neatly packaged as if ready for sale in stores.
Exit opportunities have also expanded. When we began investing in China, the only viable exit was through an IPO in the United States or Hong Kong. This constrained the range of investable businesses to those that could achieve substantial scale and led to systemic overfunding in an effort to achieve market leadership required for listing. Some debated whether mergers were possible in China, but we held that the acquisition market would develop when economic forces required consolidation. And while the M&A market is still nascent, this is what we have seen. Alibaba delisted in May 2012 and used its 28 months as a private company before relisting in September 2014 to consolidate its market position through significant investment and acquisitions. One company it quietly acquired during this period was UCWeb, an NGP portfolio company. Ganji, another NGP portfolio company, agreed to merge with 58.com in a $3.6 billion deal to consolidate the online classifieds market in 2015. Similar logic prevailed this year when Uber China agreed to merge with Didi Chuxing in a deal valued at $35 billion to consolidate the online taxi market.
China Tech – Assuming a Leading Role in the Global Tech Community
While China tech has come a long way in the past 15 years, three areas must be addressed to realize its full potential.
Companies from small markets must think globally from the outset. Chinese entrepreneurs focus domestically as the market is massive and local competition intense. But China tech forfeits opportunity by foregoing global markets; China’s BAT would not be trading at 40 percent of their U.S. counterparts if they had a comparable global presence. When domestic markets are protected, expanding internationally also ensures products meet global standards. NGP encouraged UCWeb to expand globally early and helped them identify partners and recruit executives in several key markets. When Alibaba acquired UCWeb, they had over 500 million users in 150 countries and were leaders in most markets across Southeast Asia. We have played similar roles with several other companies in our China tech portfolio with positive results. We fully expect China tech to be much more aggressive in international expansion in the coming decade, and we hope to play a key role in this effort.
Building World Class Teams
A startup typically reaches the height and breadth of the shadow cast by its leader. Nowhere is this truer than in China where tech founders generally remain in control until retirement. The same could be said until recently of U.S. tech companies where leadership succession and assembling complete executive teams was not widely practiced until the 1990s. Much as a heightened competitive environment and threats from incumbents required change in the Unites States, similar forces are at work in China today. Fortunately, a deepening talent pool allows founders to recruit experienced executives early. UCWeb was a rare example in China where the technical founders recruited an outside CEO to help build the business. UCWeb could not have achieved its level of success nor expanded globally without the leadership of CEO Yu Yongfu.
Modernizing Capital Markets
China has a bifurcated capital market with investment denominated either in domestic or foreign currency. Entrepreneurs’ preference for domestic or foreign investment predicates companies’ organizational structure, investor pool and potential exit outcomes. China has long had a closed currency system enabling greater control of its domestic economy and protection for local companies. But a flexible currency regime would attract more investment to China lowering overall cost of capital. More flexibility would also facilitate global expansion of its leading companies. Loosening currency controls is likely as China seeks to build its local stock markets and augment its role in global financial markets while maintaining oversight on domestic development.
We are enthusiastic about the prospects for China tech and look forward to continued active investment there in the years ahead.