Artificial intelligence (AI) companies in China have regained attractiveness as valuations become more “reasonable” against the backdrop of a slowing domestic economy and the ongoing trade war with the United States, says a venture capital (VC) executive.
“In general, the valuations of Chinese startups have come down, and the valuation of companies in sectors that we look into, such as AI and industry 4.0, is now quite reasonable. Between that and the government’s renewed emphasis on technology development, this is a great time to be investing in China,” said Chibo Tang, partner of China-based venture capital firm Gobi Partners, in a recent interview with DealStreetAsia.
Tang, who has over a decade of experience as a venture capitalist backing tech startups, believes that the overall AI industry is at an inflexion point. The valuation of a few AI companies might still be inflated but the industry at large is beginning to catch up to the hype.
With the support of favourable government policies, China’s AI sector has created some of the world’s highest-valued startups such as SenseTime, valued at over $45 billion, as well as raised concerns over frothy valuations.
The bullish investor sentiment, which was partially driven by Beijing going all-in in AI, indicated an overvalued AI market and a sharp focus by investors on a few lead players with strong commercial viability, such as ByteDance, SenseTime, and Megvii.
New use cases of AI in specific industry verticals “are still in the relatively early days,” Tang explained. “For such a wide range of application areas, the technology may still be unproven and many investors are still unfamiliar with the model, so valuations are quite reasonable.”
In 2018, AI investments in China experienced a year-on-year growth rate of 54 per cent, as the overall investments totalled $7.4 billion last year, according to a recent ABI Research report.
However, China’s AI industry and the overall tech sector, are undergoing – and are expected to continue suffering from – headwinds like China’s economic slowdown and a prolonged trade war with the United States.
The country has seen the Trump administration taking tough steps against its tech sector, including blacklisting Chinese companies and forbidding them from purchasing goods from American fellows. The country’s leading AI players, SenseTime, Megvii and Yitu Technology, were among the blacklisted firms.
At the same time, Beijing is also facing headaches due to the escalating civil unrest in Hong Kong – perhaps the largest one ever in the city – since June 2019.
Despite staying positive about the investment prospects in Greater China, Tang sees the clouded political and economic environment becoming an obstacle for general partners to raise funds, as more limited partners express concerns over investments in the country.
Tang is the head of Gobi’s Hong Kong office and manages the Alibaba Hong Kong Entrepreneurs Fund, an HK$1 billion ($140 million) sole limited partner fund backed by Chinese e-commerce giant Alibaba and managed by Gobi Partners. The fund specializes in early-stage investments in the fintech, logistics and AI industries, dedicated to finance local Hong Kong entrepreneurs and to nurture the startup ecosystem in the Greater Bay Area.
Gobi Partners, founded in 2002 and based in Shanghai, is one of the earliest homegrown venture capital companies in China. The company has launched USD, RMB and local currency-denominated funds in regions including Greater China, Southeast Asia and the Middle East, with investments in over 200 startups worldwide.
Besides AI investment opportunities in Greater China, Tang also talked about the overall startup ecosystem in the region, and his insights into a current trend of Chinese businesses and investors going overseas. Below are the edited excerpts:
What are the market opportunities that motivated Gobi to team up with Alibaba to launch the Hong Kong Entrepreneurs Fund?
I spend a lot of time in Shanghai and Hong Kong where the fund covers investments in the Greater Bay Area.
A lot of people were curious, and even doubtful, about why Gobi opened the Hong Kong office in the first place because, back in 2016, it was really early days of the innovation ecosystem in the region. Most Chinese investors questioned – probably they are still questioning today – whether it is worthy to look into venture capital investments in Hong Kong. But Hong Kong has proven to be a good investment destination in the past three years because of its innovation and high-quality entrepreneurs. About six to seven unicorns were born in the city.
Hong Kong Entrepreneurs Fund has invested in 25 startups in the Greater Bay Area with the investment size ranging from a few hundred thousand U.S. dollars to several millions of dollars. More than half of the 25 startups were in their seed or Series A rounds.
We are seeing the civil unrest in Hong Kong. How has that impacted you?
Hong Kong Entrepreneurs Fund is still as active in the market as we always are.
Not many people believed that Hong Kong could be a centre of innovation. Today Hong Kong boasts multiple tech unicorns and a vibrant startup ecosystem on par with most other global cities.
How is the investment performance of the Hong Kong Entrepreneurs Fund?
The fund has so far made 25 investments in the fields of fintech, AI and logistics. The investment performance is on par with Gobi’s other funds in mainland China, Southeast Asia and other international markets.
What are the differences in sourcing deals and nurturing startups in Hong Kong, compared to mainland China?
In mainland China, a lot of entrepreneurs focus on the domestic market because the market has a fast development pace and fierce competition. They think more about how to scale in the home city and province, and then expand into tier-one or other similar types of regions in the country. There is localization that needs to be done across China although it is one jurisdiction.
In comparison, Hong Kong entrepreneurs need to think from day one about how they will scale the business: Am I going into the mainland Chinese market or the global market such as Southeast Asia?
There are some business models that are probably more pervasive in the fintech sphere in Hong Kong, because there are enough institutional clients and market demand in the city for startups to make a solid and sizable business. However, most other businesses need to think about: How can I bring my products into other markets? Are my services and solutions “translatable”? What are the other similar services providers, and how can my business disrupt the industry at the end of the day?
What are the major measures for startups to decide whether to venture into mainland China or other markets?
It really depends on the management team, their “DNAs,” and competitive dynamics of their businesses in the respective market. If you’re doing a business model that is already played out or saturated in mainland China, you will not consider going there.
One of our portfolio companies, Sandbox VR, which was started in Hong Kong and received seed funding from Hong Kong Entrepreneurs Fund, has a very international team. The company founder and CEO, Steve Zhao, grew up in the United States so he is comfortable with the American market while not familiar with the market in mainland China. So even though he developed the technology and built the product in Hong Kong, Zhao still decided to make America the prior market. Sandbox VR also raised a Series A round from investors in the United States.
Which sector do you think will nurture more unicorns in Hong Kong in the future?
Existing unicorns in Hong Kong emerged from the fintech, logistics and AI industries, so I won’t be surprised if the next unicorn also comes from any of these three fields.
A lot of Chinese businesses and investment companies have been shifting focus from the domestic market to emerging markets in recent years. Gobi was also one of the earliest China-based venture capital firms to make investments in Southeast Asia.
The motivations are different. Gobi started to look at Southeast Asia ten years ago when we realized it would become a trend for Chinese businesses and entrepreneurs to go overseas.
In comparison, in the past one to two years when venture capital firms and businesses in China started to look for opportunities in the emerging markets, it became mainstream only because of the sharp decline in consumer-based investment opportunities in the domestic market.
Everyone was after the consumer-based business innovation, and they were burning a lot of money in the sector for around five to six years in China. The moment the bubble burst, people were looking for the next direction, but they couldn’t find one in China because the enterprise-focused business is not really within their expertise. That was how they noticed the business model innovation going on in Southeast Asia, where the number of venture capital firms was also limited.
The emerging markets are going down the same development path that China went through in the past ten years, which is building up its digital infrastructure including social, payment and logistics. People can follow the same footprint. That is the opportunity in emerging markets.
Are you seeing these Chinese companies more competitive than their local fellows in Southeast Asia?
It really depends on who are the local players we’re making the comparison with. In general, there are a limited number of local players in a lot of these developing markets in Southeast Asia. Most of them are relatively small and the capital they have is fairly limited.
Chinese companies do have some advantages: Firstly, they have seen the story so they know what are the key pain points that need to be solved. Secondly, they have access to capital, which is probably one of their biggest advantages.
Behind them are some of the largest funds like Sequoia Capital China and GGV Capital. These funds are able to lead Series C rounds and after, and write cheques of millions of U.S. dollars. They can connect better with Chinese entrepreneurs because they know them well, and they share the same language and culture.
If you are a local entrepreneur trying to raise a significant growth round from local investors in Southeast Asia, there are not many investment companies that you can choose from, probably a few sovereign wealth funds, and family-owned conglomerates which are just getting in on the trend to understand technologies.
Are there any sectors that you think local players will be more advantageous than Chinese competitors?
I think local players perhaps are more competitive in some consumer-focused sectors that really require the products to be specifically catered to local users, and industries that need more support from the government in terms of getting licenses, developing in a regulatory environment, and getting more local resources.
If it is just generic infrastructure kind of areas, all models can be copied from China.
We also see unicorns in Southeast Asia like Gojek and Grab…
I heard an interesting comparison between Gojek and Grab in terms of why companies are investing in one over another. The comparison has to do with how the geopolitical environment in Southeast Asia could potentially be in the future.
Grab, started in Singapore, has the business spreading across many jurisdictions, while Gojek, founded in Indonesia, also has a regional presence but more prominently in the home country. If the geopolitical environment changes going forward when countries become more protective of data and the way local users interact with the internet, Gojek could potentially be much safer than Grab.
In your opinion, how is the Chinese economic slowdown and the ongoing trade war with the United States affecting the venture capital investments in China?
I think the largest impact of the macroeconomic environment affects GPs who do not have funds to deploy because it is more difficult for them to raise funds as more LPs might be worried about investments in China.
In general, the valuation of Chinese startups have come down, and the valuation of companies in sectors that we look into, such as AI and industry 4.0, is now quite reasonable. Between that and the government’s renewed emphasis on technology development, this is a great time to be investing in China.
AI is a very general concept. There are a few unicorns developing AI infrastructure technologies like machine learning and computer vision. They may still be considered overvalued. But a lot of AI-enabled specific use cases and industry verticals are still in the early days. For such a wide range of application areas, the technology may still be unproven and many investors are still unfamiliar with the model, so valuations are quite reasonable.