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Venture Capital's New Promised Land


Two years ago, Thomas Tsao had a difficult time raising money for his China venture-capital fund, Gobi Partners. Silicon Valley investors were still smarting from the tech meltdown, the mainland was dealing with the SARS outbreak, and getting cash out of China was proving difficult. "It was like pulling teeth," recalls Tsao. "Nobody was interested."

These days venture capitalists from Silicon Valley to Sydney are trolling for deals in China. "Now everybody wants to come in," says Tsao, who had to turn investors away from a $50 million China fund that closed in October. Among the fund's investors: IBM (IBM), NTT DoCoMo (DCM), and The McGraw-Hill Companies (MHP), the parent of BusinessWeek.

For China funds, the money keeps pouring in. In 2005, they raised some $1.17 billion, up from just $325 million in 2002, according to Hong Kong-based Asian Venture Capital Journal. IDG-Accel China Growth Fund's new China fund raised $150 million, Sequoia Capital China attracted $200 million, and JPMorgan Chase recently launched funds to invest in China. Carlyle Group paid $375 million for an 85% stake in state-owned Xugong Group Construction Machinery, and Warburg Pincus ponied up $115 million for a 22.5% stake in Harbin Pharmaceutical Group. In December, SVB Financial Group (SIVBE), a Santa Clara (Calif.) institution specializing in VC financing for technology, opened a Shanghai office. Says Daniel Quon, SVB senior vice-president: "We will try to be the gateway to connect entrepreneurs with the [VC] ecosystem."

Behind the changed mood have been such private equity success stories as Focus Media Ltd. (FMCN), an operator of elevator and supermarket flat-screen TV advertising signs whose NASDAQ-listed shares are up 112% since the company's July initial public offering. Similarly, Baidu.com Inc. (BIDU), a Chinese-language search engine, is up 145% since its August IPO. And Yahoo! Inc.'s (YHOO) $1 billion purchase of a 40% stake in Alibaba.com Corp., the operator of online marketplaces, has further focused interest on Chinese tech companies. What's more, China's fast-growing private sector is now nimbler and more innovative.

The money is everywhere. Just ask Gary Wang. In April the 32-year-old Fujian native, who earned his undergraduate and masters degrees in engineering in the U.S. before receiving an MBA from INSEAD in France, launched Toodou.com, a video podcasting site that serves up amateur films. Although Wang's Shanghai company doesn't yet have any revenues, he says he spoke to nearly 30 different VC firms. Wang finally agreed to an investment from IDG of several hundred thousand dollars for a minority stake.

TOO EXUBERANT?

But watch out. With so much money sloshing around, there's bound to be trouble. Deals that were passed over by seasoned investors a year ago are now getting resurrected, a sign that the market is overheating. "There's a lot of exuberance in the market," says Wayne Tsou, managing director of the Carlyle Group in Hong Kong, which has been investing in China since the late 1990s. "In our view, in hot sectors like mobile-phone services and Internet gaming there are hyped expectations."

One way to avoid those sky-high prices is to move out of the tech sector, where companies are often run by repatriated mainlanders known as sea turtles, who have applied Western business models to China's Internet and mobile-telephony markets. Outside tech, it's another world. Venture capitalists find themselves dealing with folks who have never left home, speak little or no English, and have never even heard of venture capital, but who have survived the rough-and-tumble local marketplace.

But this group has made big money for the VCs who backed them -- and they may prove to be the China play of 2006 if tech gets too hot to touch.

Corrections and Clarifications

The photo accompanying "Venture capital's new Promised Land" (Global Business, Jan. 16, print edition) was incorrectly captioned. It depicts Marc Verissimo, chief strategy officer of SVB Financial Group (left) and Hua Yuda, chairman of Shanghai Venture Capital (not Daniel Quon, senior vice-president, SVB Global), at the opening of SVB's Shanghai office.

By Frederik Balfour


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