China’s consumer upstarts set to enter 10-year golden age: BA Capital’s Michael Zhang

Michael Zhang, partner of Chinese consumer-dedicated venture capital firm BA Capital

BA Capital, a Chinese venture capital firm that exclusively bets on consumer brands and products, is expecting to see the country’s profit-making consumer upstarts become some of the most sought-after portfolios among investors in the next 10 years.

“Our portfolios actually picked up better financial results during the pandemic period,” said Michael Zhang, a partner at BA Capital, in a recent phone interview with DealStreetAsia.

“They have become some sort of ‘risk harbour’ for investment firms as they have high growth [numbers] and positive cash flows. They are more appreciated by investors in the primary market and the secondary market – once they get listed.”

His comments came as Pop Mart, a Chinese designer toy brand backed by BA Capital, has grown into a unicorn at a valuation of over $1 billion. The Beijing-based provider of IP-driven blind box dolls filed for an initial public offering (IPO) in Hong Kong early June, about one month after it raised over $100 million in a round led by Chinese private equity firm Loyal Valley Capital and China Renaissance’s New Economy Fund.

BA Capital first invested in Pop Mart as part of a 40-million-yuan ($6 million) round in 2018.

Besides Pop Mart that is expected to float shares on the city board later this year, the three-year-old venture capital firm also has over a dozen portfolio companies. Earlier this month, BA Capital invested in the 1-billion-yuan ($142 million) Series E round of KK Group, a Guangdong-based online-to-offline new retail unicorn. The transaction made KK Group its fifth unicorn portfolio firm.

In China, consumption was gaining good traction before the COVID-19 pandemic hit the epicentre and threw business activity out of gear. According to the National Bureau of Statistics, China’s Consumer Confidence Index reached a 10-year high in 2019 despite a slowing GDP and its trade friction with the United States.

Meanwhile, consumers in the world’s second-largest economy are proving to be remarkably resilient. Official statistics show that the growth rate of China’s total retail sales of consumer goods is quickly coming around from a record-low negative month-over-month (MoM) growth of 20.5 per cent at the start of 2020. In May, Chinese consumers spent a combined 3.20 trillion yuan ($457 billion), down only 2.8 per cent compared to one month earlier.

Looking forward, Zhang stays upbeat on the consumer industry in what he refers to as the next 10 years of “golden age” for rising consumer brands in China.

The development will be partially powered by domestic operators of major online marketplaces, such as Alibaba and JD.com, who have laid a good marketing and sales foundation for consumer brands. China’s drastically changing consumer landscape and infrastructure will also play a part in it, by giving technology-enabled newcomers an edge to compete with old-fashioned incumbents.

Zhang is a partner and one of the three founding members of BA Capital. Zhang has worked for a decade in early-stage venture capital and private equity investment in the consumer and technology sectors. Prior to BA Capital, he was at Fidelity-backed global venture capital fund Eight Roads Ventures, Asia-focused investment group Orchid Asia, and Deloitte.

Zhang spoke to DealStreetAsia about BA Capital’s investment strategies and how it picked now-unicorns such as KK Group and Pop Mart at an early stage and what he believes is the next entrepreneurial opportunity in China’s drastically shifting consumer space. Below are the edited excerpts of the interview:

Could you please walk us through the funds and assets currently managed by BA capital? And how much of these funds have been deployed so far?

I prefer not to disclose our fund details. But I can briefly introduce our fund history and investment strategies. BA Capital was created in 2017 by three founding partners, including two investment specialists and another partner with an entrepreneurial background. I came into the investment space after joining U.S. dollar fund Orchid Asia, where I met another founding partner David He, who later led the strategic investment department at ByteDance [operator of video-sharing social networking service TikTok] for a period of time. We both have over 10 years of private equity investment experience on a couple of platforms.

Our third founding partner, Allen Chen, is a very successful serial entrepreneur who established Chinese eyewear brands MUJOSH and aojo, as well as contact lenses supplier WAKEUP. We came together in 2017 to build a platform that is strictly focused on early and growth-stage consumer brands.

In around early 2015, we saw a wave of emerging new consumer brands in China. But we didn’t see anyone in the market back then, and even now, that is focused enough to capture the consumer investment opportunities. By “focused,” I mean a structured assessment model for consumer brands, which includes very unique research [methods] and an understanding of the industry and consumer habits, as well as an ecosystem to create value for portfolios to help them grow and improve operational excellence.

Known in the [Chinese venture capital] market for having a very high hit rate, BA Capital has so far invested in 13 companies, including four unicorn companies at a valuation of over $1 billion: Pop Mart [a designer toy brand], HeyTea [a cheese-infused tea brand], Jovo [a light-aroma baijiu brand targeting young adults], and Yuanqi Senlin [a tea and beverage brand].

What about BA Capital’s investment performance and major exits in the previous three years?

Unfortunately, I cannot share specific fund performance numbers. But our portfolio company Pop Mart, which has already filed for an IPO in Hong Kong, is expected to go public later this year. I think this marks a pretty good performance for a fund that has only been in operation for around three years. We believe the Pop Mart listing will be a highly sought-after IPO.

BA Capital first invested in Pop Mart in a round of 40 million yuan ($6 million) in 2018. The Chinese designer toy brand closed over $100 million in a new round in April and is now ready for a Hong Kong IPO. Back to two years ago, what made you think that it was a good investment opportunity and how long did BA Capital take to make the bet?  

Our investment process into Pop Mart is the same as how we usually invest in a new company. We adopt a high bar of assessment because we intend to have a small and selected portfolio.

We have completed multiple investments into Pop Mart and the first transaction decision took about two to three months [to make] since we usually try to take as much time as we can to understand and analyze the business model as well as to get to know the management team.

We conducted a consumer survey with close to 500 Pop Mart toy users and also studied other IP-driven toy businesses to break down their success factors, based on which we built our prediction [of the future development of Pop Mart].

Generally speaking, I think Pop Mart fits into our investment philosophy, which includes two major aspects. Firstly, the company needs to ride on a sustainable or irreversible trend that is happening in consumer landscape (like the premiumization and diversification trend in China’s consumption behaviours), infrastructure (like the shifting distribution or marketing channel), or commerce, instead of a fad-driven trend.

In the case of Pop Mart, it is a trend that – as people’s income rise – they will shift from a functional satisfaction to emotional satisfaction. Younger consumers are going after a more personalized, emotion-driven type of spending, while Pop Mart provides them with a sense of companionship and a sense of emotional bonding that are considered genuine, which was verified through our consumer survey.

Secondly, we identify the entry barrier of [the business] our portfolio companies [are involved in]. Our portfolio companies, such as Pop Mart, HeyTea, and Jovo, have built a high entry barrier in terms of branding, products, and supply chain, among others.

Pop Mart, for example, operates a full value chain that includes the upstream artist development and IP operation, as well as the downstream product distribution and retail store management. It has created a very high barrier for newcomers and big companies from other fields trying to take a share in the segment.

Are you seeing any of your portfolio firms also mulling an IPO plan, or to be acquired by larger players in the second half of 2020?

I think most of our portfolio companies will go for an IPO instead of a trade sale.

Unlike in more mature markets like the U.S. and other western countries where consumer investments are mostly exited through acquisitions, I’m seeing that China’s consumer deals are mostly exited through IPOs. The reason is that China is at a time of drastic changes in the consumer landscape and infrastructure.

The result is that industry incumbents from the previous generation cannot cope with these drastic changes. They are giving up a huge market share to emerging brands that have a value proposition that is sharp enough and a team that is strong enough. We are seeing many more opportunities for companies [in the consumer space] to grow, to go public, and even to develop beyond that.

This is something you don’t see in other mature markets where consumer brands will run into the industry incumbents even when they just get to a rather small business scale. The channels are so tightly gripped by incumbents, whereas in China, companies started in 1990s don’t fully understand TikTok or Alibaba’s Taobao. This has opened up a lot of room for new companies to overtake and to grow to a sizable scale.

What do you think of the deal-making activity in China’s consumer market right now, as the country just crawled out of the impacts of the coronavirus pandemic? Is the sector still hot?

Yes, it is still very hot.

The bigger background [of the Chinese consumer industry], which is even bigger than the COVID-19, is that entrepreneurs have shifted away from seeking to build the next mega marketplace [like Alibaba’s Taobao, ByteDance’s TikTok and JD.com] because the competition landscape is pretty much settled, giving more limited chances for newcomers compared to five to 10 years ago.

We believe that the next 10 years will be a golden age for “content” on these marketplaces. By “content,” I mean consumer brands and goods. We realized it three or four years ago and have since built on the entrepreneurial gene of our founding team [to cash in opportunities in the area]. I think a lot of funds were just forced to realize [the trend] and to come into this space to compete with us. But these insights, strategic focus and resources will take years to build.

How much does BA Capital usually put into one transaction?

Anywhere from 20 million yuan ($3 million) to 200 million yuan ($29 million).

Do you think Luckin Coffee’s accounting scandals have changed the way investors think and evaluate their cash-burning portfolios?

Yes, it has. But it’s not a fundamental change.

If you look at BA Capital’s portfolio, over 80 per cent of our portfolio companies are profitable at the time of our investment or roughly one year after our investment. That represents a healthy consumer-brand operating model. As a consumer brand, you are not supposed to burn a huge chunk of money to accumulate users early on while hoping to monetize in later years. We don’t believe in that for consumer brands.

We believe, if you’re a brand that’s worth the premium that consumers are giving you, you’re supposed to make money quite early on. We’re very alerted to companies that are consistently burning money. It means that the brand does not build a reputation among consumers.

Our portfolios actually picked up better financial results during the pandemic period. They have become some sort of “risk harbour” for investment firms as they have high growth and positive cash flows. They are more appreciated by investors in the primary market and the secondary market – once they are listed.

What happened [to Luckin Coffee] will make investors more disciplined. It will push investors back to looking at the fundamentals of businesses, instead of just the sheer GMV growth or user number growth.

Has the pandemic influenced BA Capital’s investment focus and strategies?

No, it hasn’t. Of course, we will be monitoring consumer sentiments in case of any permanent changes in their mindset or preferences. In Q3, we will launch a large-scale consumer survey specifically focused on the COVID-19 issues – just as what we do for every deal that we invest in.

But so far, we haven’t seen a significant sign of permanent changes in consumer mindset because most of our portfolio companies have recovered very well, especially Long Time Ago [mutton shashlik brand] and Urban Revivo [fashion clothing retail chain shop]. The COVID-19 has further polarized the market. Top brands are getting more and more consumers and capital to expand, while average players are struggling.

What are the segments you will be mainly looking at in the second half of 2020?

We will look heavily into sectors that have seen the birth of super large listed companies with proven customer stickiness and high brand barriers, including food & beverage, personal beauty and other niche categories that could potentially become the next big thing.

How will the initial success of Shanghai’s Nasdaq-style STAR Market and the upcoming reforms of the ChiNext Market in Shenzhen influence investment exits in China?

I think all our portfolio companies are looking for a better certainty while accessing the capital market and any reforms that are moving towards that direction will help. Currently, they’re still leaning towards an offshore listing simply because there are more certainty and flexibility in the IPO process.

I would love to see the A-share market moving in that direction as well.

(Rosabella MacKenzie contributed to the story.)

Singapore Reporter/s

In Singapore, we are looking to double our reporting team by this year-end to comprehensively cover the fast-moving world of funded startups and VC, PE & M&A deals. We want reporters who can tell our readers what is really happening in these sectors and why it matters to markets, companies and consumers. The ability to write precisely and urgently is crucial for these roles. Ideal candidates must have to ability to work in a collaborative, dynamic, and fast-changing environment. We want our new hires to be digitally savvy and ready to experiment with new forms of storytelling. Most importantly, we are looking for hard-hitting reporters who work well in a team. Collaboration and collegiality are a must.

Following vacancies can be applied for (only in Singapore).

Following vacancies can be applied for (only in Singapore).   

  • A reporter to track companies/startups that have raised private capital, and have the potential to become unicorns. SEA currently has over 40 companies with a valuation of over $100 million and under $1 billion.
  • A reporter who can get behind the scenes and reveal how funding rounds are put together, or why they’ve failed to materialise. She/he in this role will largely focus on long-format stories. 
  • A journalist to track special situations funds, distressed debt and private credit (from the PE angle) across Asia.

Singapore Reporter/s

In Singapore, we are looking to double our reporting team by this year-end to comprehensively cover the fast-moving world of funded startups and VC, PE & M&A deals. We want reporters who can tell our readers what is really happening in these sectors and why it matters to markets, companies and consumers. The ability to write precisely and urgently is crucial for these roles. Ideal candidates must have to ability to work in a collaborative, dynamic, and fast-changing environment. We want our new hires to be digitally savvy and ready to experiment with new forms of storytelling. Most importantly, we are looking for hard-hitting reporters who work well in a team. Collaboration and collegiality are a must.

Following vacancies can be applied for (only in Singapore).

Following vacancies can be applied for (only in Singapore).   

  • A reporter to track companies/startups that have raised private capital, and have the potential to become unicorns. SEA currently has over 40 companies with a valuation of over $100 million and under $1 billion.
  • A reporter who can get behind the scenes and reveal how funding rounds are put together, or why they’ve failed to materialise. She/he in this role will largely focus on long-format stories. 
  • A journalist to track special situations funds, distressed debt and private credit (from the PE angle) across Asia.