Venture Capital's Clean Dreams for China

Clean technology has become the third-largest destination for venture capital in China, with $420 million invested in 2006

This summer, the government of the eastern city of Wuxi had to turn the taps off, cutting off water supplies to millions. The reason was that chemical factories had dumped too much untreated effluent into the city's main water source, Lake Tai, feeding a massive algae bloom that choked the water body.

Just half an hour's drive from the lake's shore, however, were three factories where workers in face masks and green jumpsuits were assembling paper-thin, black or dark-blue silicon crystals into panels. The factories, operated by a company called Suntech Power, can make enough panels in a year to generate 325 megawatts of clean solar energy.

The situation in Wuxi - unchecked pollution on one hand, and green industry on the other - embodied the contradictions in China's latest investment opportunity: Cleantech.

Much like information technology, cleantech can be difficult to define. Just as "IT" can mean anything from spreadsheet software to virtual MP3 players, "cleantech" is an umbrella term that covers areas as diverse as energy-generation (solar, wind, biofuels), water treatment and energy efficiency (buildings and monitoring systems).

"Cleantech is not a single industry, it's a very huge universe," said Don Ye, founder of Tsing Capital, one of the country's first venture capitalists to focus on cleantech. "It is not a sector, it's more like a concept."

With the IT-cleantech parallel in mind, maybe it's no surprise then, that venture capitalists (VCs), for so long the kingmakers of the tech world, have been upping their stakes in cleantech investments. China represents perhaps the most lucrative of these opportunities, serving as both a potential manufacturing hub for cleantech exports and as a vast future market.

According to research by the Cleantech Network, cleantech-focused investment in China in 2006 rose 147% year-on-year with US$420 million invested in 26 deals. In the first quarter of 2007, US$154 million was invested. This makes cleantech the third-largest destination for venture capital in China after the IT and telecoms industries.

THE SILICON CONNECTION
Cleantech and IT are linked by more than money. The two are connected by a raw material that most of the world can no longer live without: Silicon.

Semiconductor manufacturing, which turns silicon into the chips that run electronics everywhere, has turned out to be a business model for Chinese solar companies. These companies turn silicon into photovoltaic cells that absorb sunlight and transform it into electricity. Silicon was the perfect bridge between venture capitalists and cleantech entrepreneurs.

Suntech Power's US$396 million share offering on the New York Stock Exchange at the end of 2005 heralded the start of a Chinese solar boom. The company's shares, which first opened at US$15, now stand at about US$40 and its founder, Shi Zhengrong, is one of the richest men in China.

Since Suntech's listing, more than half a dozen Chinese companies involved in the production of solar energy have gone public. The most recent market debutant was LDK, which listed in June.

Ye backed two of those solar plays: China Sunergy, which listed on the NASDAQ on May 17, and LDK.

"We made 5-10x on those companies," he said. "In other words, the [returns] were over 1,000%, so it looks good."

China's cleantech space is clearly profitable, and the smart money is beginning to give chase. But what sparked this Sino solar bull-run? To answer that question, a look at the solar supply chain is needed.

Most of the Chinese solar companies are manufacturers of photovoltaic cells (PVs) or modules, which are sets of mounted cells. These modules are the building blocks of systems that convert sunlight into electricity. These cell-makers must buy their supplies from companies that sell raw polysilicon or microns-thin silicon wafers. The raw materials are assembled in the firms' factories in China and then exported to markets like Germany, Spain and Japan, where government subsidies make solar energy viable.

Many of the world's biggest cell-makers, however, are part of conglomerates.