China’s growth is not in decline: here’s why

In 2010 China was the place of choice for foreign investment in the tech sector. Fast forward to today and it’s an IPO ghost town, with less money and deals than a mid-level casino. At the heart of this “decline” in foreign interest are a number of factors.

The Next Web states that political unrest, audit checks and internet censorship are but a few reasons for investor hesitation while Bloomberg pips rising employee and land costs as lowering China’s “attractiveness as a destination for foreign investors.” The proof is in the IPO-pudding and number of deals.

In 2010, China saw US$6.1 billion invested into the country across 365 deals. This peaked in 2011 with US$6.3 billion spread out across 362 deals. Last year though, those figures drastically dropped to US$3.4 billion in investment over 202 deals.

The number of IPOs dropped off too. In 2012 there were only two, compared to 15 in 2011 and 38 in 2010. Even IPOs on Chinese exchanges have dropped The Next Web reports, from 150 in 2011 down 45% in 2012. Was this sudden drop in deals, IPOs and dollars invested, the worst since 2008/2009’s financial crisis, just due to the aforementioned factors?

Jeff Richards of GGV Capital, a specialty firm based in Shanghai and Menlo Park, California had this to say on the IPO decline.

“In 2010, investors were paying a premium for Chinese IPOs… Some of those IPOs have not performed well, and there’s not much enthusiasm right now on the part of some of the momentum funds to invest in more startups there.”

Mercury News added that Andrew Chung, who leads China efforts for Menlo Park-based Khosla Ventures, stated that VC investment has “cooled” because of uncertainties about the Chinese economy, the death of initial public offerings and the rise of ‘copycat’ companies (specifically clones of Western companies).

So that’s it right? China’s days as a tech-haven for investments are over due to political and economic instability, rising wages and operation costs. Simple as that, dust it off and move on. The country’s GDP, after all, has slowed to 7.7% on a steady decline from first quarter 2011 when it was just about 10%. Well I’d like to propose that it isn’t that simple, and that China’s growth is not in decline, and actually has the potential for incredible growth.

A shift

Dr. Dan Steinbock, Research Director of International Business in India, China and America Institute, wrote an interesting analysis on the foreign investment situation in China in which he argues that foreign direct investment (FDI) is not in decline, but rather being relocated or shifted to other parts of China and the greater region. FDI coming into mainland China — mostly rural — is shifting to the west and coastlines where the bigger cities are. In short, FDI coming into China is enjoying a “geo-recomposition.”

This correlates with an increase in Chinese urbanisation.

Theodure Qi Shou, Chief Investment Officer of investment house and global fund management business Skybound Capital, speaking from their Hong Kong office, sent comments to Ventureburn on the situation.

“Currently, over 51% of the Chinese population live in urban areas and it is estimated that by 2020 over 70% of Chinese will be in cities. We believe that “living in cities” does not equal to living a city life. Millions of migrant workers moved to cities for low-paying jobs / heavy labour jobs that city dwellers are no longer willing to do (though still a lot more attractive than the income in rural areas). The low-income prohibits such migrant workers to live a real “city life”. They squeeze themselves into tiny shared apartments, eat cheap (maybe unsafe) food, and remit a big part of their income back home (in the countryside). Therefore, our estimate of China’s “actual urbanisation” (defined by “living a city life”) is slightly more than 35%. Expanding the social safety net (including pension, healthcare and education subsidies) to the migrant workers and a convergence in income gap will significantly improve the lives of these migrant workers and mix them into a real city life. This is what the government is advocating and implementing. Therefore, the potential that can be stimulated from urbanisation comes from two aspects, the nominal increase in urbanisation rate (from 50% to 70%) and the actual increase in urbanisation rate (maybe from 35% to 60%). Sectors like infrastructure (yes, again), property (some of the “ghost towns/shopping malls” will be filled soon), medical services, education, and normal domestic consumption will definitely benefit.”

These figures indicate that there is a growing consumer-market in China – and given its population size, China has the potential to become the largest consumer-market in the world. Historically, China’s growth has relied on an export-driven economy, but now it is shifting towards a consumer-based economy. This change is potentially what is scaring off investors because it’s a whole new ball game when thinking about China. Yet it seems like investors are not looking towards the future, and what a consumer-based economy means for China’s growth.

“Significant increase in disposal income in the past decade allows Chinese to spend more on discretionary items, like movies, auto or luxury goods (China is a top sales destination for most luxury brands today),” Qi Shou continued, “Chinese youth are not big savers like their fathers. They are happy to spend every single dollar they make (still not so much on credit though). Hence, online gaming giants like Tencent are making easy bucks.”

With an increase in urbanisation and an increasingly empowered consumer-market, China’s growth will be driven by its large base of people in the coming years rather than rely on foreign investment. It’s not a decline, it’s a maturation. China’s economy is changing, it’s becoming more independent.

So what does this mean for the tech industry? Well with a maturing economy, I would think that maturing technologies are what would become the next big thing for investors.

Already markets such as cleantech have been identified, as well as mobile – growing consumer base anyone? – by powerhouse firms such as GGV, GSR Ventures and Khosla.

“You can’t ignore the kind of opportunity in China,” Andrew Chung continued, “In cleantech, for example, the government plans to invest US$80 billion per year for the next 10 years.”

Unsurprisingly, some investors are seeing opportunity within the lowered interest in the region. GGV’s Richards said that there is less competition now that many “tourist investors” have pulled out. This provides investors time as well as room to find and make the best deals, and perhaps establish themselves as powerhouses within the region.

At the end of the day it comes down to what investors want from their foreign investment. If they want low-cost efficiencies they might be better off looking at Southeast Asia and the surrounds, but China can still offer infrastructure, logistics, opportunity for expansion and soon, potentially the largest consumer-market in the world. Investors should not view China’s growth as in decline, they should look to the future, and acknowledge China’s growing consumer-market, and target the sectors that can enjoy profits from that internal growth.

The local startups should take notice too, and refocus their efforts away from foreign funding towards the local funding ecosystem, which comes with its own set of benefits and challenges as Qi Shou comments:

On one hand, like India, China produces more than a million engineers (or graduates in engineering) a year, let alone the hundreds of MIT/CalTech graduates coming back home. And many Chinese are born to be entrepreneurial. Therefore, it’s a fertile land for new tech start-ups. Success stories like Tencent/Baidu in capital markets, together with abundant venture capital funds supporting these start-ups, further stimulate the surge of more new tech players.

On the other hand, competition is very fierce and there are so many copycats around (very often the copycats could even overtake the originals). Big internet conglomerates like Tencent and Shanda often either buy out the promising start-ups in their early stage or launch competing products and knock out the small players. It’s quite difficult for many of the start-ups to survive and thrive.