Banking & Finance

Venturing forth

Local media tries to grasp how a local VC firm grew so big


“The core competiveness is me” says boss Shan Xiangshuang

In May paleontologists in Argentina uncovered the world’s largest dinosaur: an enormous 80- tonne titanosaur.

Journalists in the venture capital sector in China have been doing some digging of their own, unearthing yet another a mammoth – this time going by the name of China Science & Merchants Capital Management (CSC).

In June CSC made a rare appearance in the headlines, announcing a strategic partnership with BYD Auto in launching an Rmb1.5 billion ($241.8 million) fund to invest in the electric car industry. But it generally lacks much in the way of a public profile, especially overseas. Its founder, Shan Xiangshuang, also failed to make it onto the Forbes’ 2013 list of China’s top 50 venture capital investors.

This is in spite of the fact that CSC had $9.7 billion of investable assets at the end of 2013, making it one of the bigger players locally. Its stellar growth has occurred in tandem with that of China’s VC industry, where domestic groups have been displacing foreign ones in fundraising and investment activity. In 2013, the sector had investable assets of $50.84 billion, of which local VCs controlled 55.2%. As a group, they raised $6.9 billion through 199 funds during the course of the year and executed 1,148 investments amounting to more than $6.6 billion. About one fifth went into internet-related start-ups (this year, internet and mobile-related deals have been even more prominent).

Nearly all these funds were renminbi-denominated, a sea change from the mid-to-late-noughties when US-dollar funds from foreign private equity giants like Carlyle and Newbridge Capital predominated. Despite this transformation, the market mood is down on the glory days of 2011 (the period when the domestic funds started to make their mark – raising a total of $26.5 billion and executing 1,401 transactions).

Figures from research agency Zero2IPO show CSC progressing from eighth to fourth in its rankings for ‘best’ VC house between 2010 to 2012 (the most recently released figures), behind Shenzhen Capital Group and Fortune VC.

Between them is China’s biggest foreign player, IDG, with $2.5 billion in investable assets.

CSC is headed by its founder Shan, a dominant presence who has steered the company since 2o00 when it became the first large-scale, government-approved domestic VC fund.

In an article published by 21CN Business Herald, former employees describe Shan as a strong personality who holds ultimate veto over the group’s projects. He also controls about 51% of CSC’s equity, with the remaining shares split between a group of 26 investors including the chairmen of Sha Steel, Erdos Group, Zhongtian Group and Yonglian.

In an interview with China Daily in 2012, Shan said that he brought in these business leaders because their industry expertise would bolster the group’s investment decisions. (Although he isn’t shy about his own contribution, telling 21CN: “The core competiveness of CSC is me.”)

With its local roots, CSC was one of the pioneers behind the so-called government-guidance funds, which bring together private capital and local governments. Often policy-driven, they help provincial governments direct funds to where they believe they are most needed. Obviously, investors expect a return too. “It’s a win-win strategy because investing more in these areas to promote local economic development makes it easier for us to raise money from local investors and gain government support,” Shan told the China Daily.

Typical of this approach was the launch of the first township fund in 2010 when CSC and 10 entrepreneurs in Jiangsu province raised Rmb250 million for its Shuangying VC Fund.

CSC now manages about 120 funds across 40 different towns and cities. But the strategy also means that it has a huge roster of LPs [limited partners] participating at sub-fund level. Again, this is something that Shan cites as a strength. “We have actively sought out private entrepreneurs as our LPs and given them power to make decisions in the deals in which we invest,” he explains.

Shan says that CSC has 6,000 LPs on its books, an eyebrow-raising number given that Zero2IPO calculates there were 8,622 LPs across the entire industry in 2013.

Critics say that CSC lacks focus, picking investments across too many industries. Both the Economic Observer and 21CN also question how closely CSC is able to monitor the activities of its local funds, although the company counters that its head office maintains control through “five unified principles” that cover risk management, decision-making systems, resource allocation, financial management and personnel assignments.

The provinces source the projects, CSC says, but all of the investment has to go through the same approval and compliance processes.

Shan likens it to an internet business that provides an infrastructure as well as a network that benefits investors and investment targets alike.

Others classify the investment style more as the ‘PE factory’ model on the basis that deals are sourced in a way similar to industrial production. CSC’s overall performance is hard to verify because it doesn’t publish its investment returns. But like many other VC players in China, it was forced to re-examine its approach when the CSRC shut the domestic IPO market in 2012.

This is a trend we have discussed before (see WiC179), The stoppage served as a nuclear winter across much of the industry. In effect, the ban on new listings meant that the ‘PE factories’ suddenly had no way of selling their goods. Companies that had focused on finding cheap assets in the private market and selling them on at huge premiums in market flotations in Shanghai and Shenzhen were suddenly stranded.

Zero2IPO figures from 2011 show that nearly 70% of exits were via an IPO (many of them on ChiNext in Shenzhen) but that the figure had dropped to 11.3% in 2013.

Other investor groups like Jiuding Capital, which have also built business models on late-stage investments and quick IPO turnarounds, have also been forced to think again.

In January regulators reopened the IPO funnel and 52 companies listed in the first half of the year. This will have prompted hopes among many of the renminbi-denominated funds that their own normal business might resume too. (In the past couple of years firms like CSC have had to make their exits via M&A instead of flotations – Zero2IPO data shows that trade sales accounted for 33% of VC exits in 2013 versus 12% in 2011.)

In the meantime many VC firms have been turning back towards international investors for fresh capital in the belief that they are readier to accept longer investment periods and are more prepared to pay annual management and carry fees.

In this respect CSC’s 6,000-strong roster of domestic LPs could even be classed as more of hindrance than a help. Raising money from thousands of rich individuals rather than a smaller number of more staid fiduciary institutions will have created its own set of challenges, especially when so many of CSC’s local backers are demanding characters.

Put simply high-net worth individuals who thought they were making a sure-fire, quick-return bet probably aren’t the kind of people that you’d want holding a grudge against you.

But Shan is sticking with his business model, and it’s clear his ambitions remain lofty. His plans to invest in 1,000 start-ups and sink at least Rmb10 billion into angel investments have, as the Economic Observer concludes, left the rest of the industry speechless. Meanwhile Shan says of the estimated 10,000 VC and private equity firms in China that 90% will fail and only 1% (including CSC) will emerge as winners.

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