In yet another sign of Southeast Asia increasingly catching the fancy of Chinese venture firms, Qiming Venture Partners has given itself a year to decide whether to continue investing in the region from its main fund or launch a dedicated Southeast Asia fund.
Is it not late to the party though? Qiming Ventures founding managing partner Gary Rieschel doesn’t think so.
“[T]here are half a billion people in the immediate Southeast Asia region, a good part of the technology infrastructure is several years behind what China has implemented particularly on internet related services, mobile related services. So, it will be different than China but I don’t think we have missed the investment cycle in the region, we have probably reached the investment cycle for the initial wave of sharing economy companies,” Rieschel said.
On the other hand, India is a market where Qiming has decided it will not adopt an aggressive stance due to the country’s weak early-stage record and its lack of infrastructure.
“[Y]ou’ll see us do some business. I don’t think we’re late, but I think we’re not going to be aggressive, because we’re not going to put a team in India anytime in the near future,” he added.
In a wide-ranging interview, Rieschel spoke about the US-China trade war – he prefers to call it a trade dispute -, the current fundraising environment and a long due rationalisation in valuations, among other things.
Are you seeing the so-called slowdown in China? What’s the big picture in terms of funding?
The big picture in China right now is a bit interesting. In our healthcare practice, we see no slowdown at all. You have to realize that it is such an important part of the stability story for the Chinese government that they’re not pulling back on financing for healthcare. They’re not being restrictive in terms of the kind of healthcare technologies that can be brought into the country and they’re increasing R&D spending, so all of that is a good story for healthcare.
For core technologies (what we call AI technology platforms, security platforms, enterprise software, and so on), that’s also an area where there is a great deal of domestic development but they’re not at all interested in taking technology into China from overseas.
Then you have the consumer space. For venture, it has always been ½ or more of the entire market, and that I think is interesting to figure out if we’re at the end of a couple of cycles. The sharing economy cycle has created a great deal of wealth, but it’s been now 15 years since Friendster, Facebook, and things were founded in 2003 and you have to ask: are we reaching the end of the cycle? If you look at Virtual Reality, it never really took off, so there hasn’t been a cycle yet.
What about AI then?
So, AI is interesting because AI has to be tied to a solution. When you say AI to me, it means absolutely nothing unless you tell me exactly what the solution space is that you’re trying to focus on. So what China has is a great deal of data, so there’s a huge amount of focus on the data analytics side. I think that is something that can continue for some time. But the real big markets in AI won’t be until you have solutions for very large industry segments. So, we’re investing in healthcare in that area, we’re investing in some of the enterprise solutions, productivity improvement; China’s productivity has not improved as dramatically in the last decade as you might have expected, so there’s a lot of ties to enterprise efficiency with AI.
So, AI definitely is a story that we will live with for the rest of our lives, but the real interesting part where it is tied to huge solutions of a particular problem, that I think is coming, it’s not where we are today yet.
Are you feeling any challenges because of the whole restrictions that some of the LPs from China face in investing in US VC funds?
For Qiming China, we invest in China for China, so typically our investments have not been focused on an investment in China where success was predicated upon doing business outside of China. There’s no issue in terms of export or overseas investing. For the Chinese nationals, they’re trying to take money out of China and deploy that money in the U.S, that’s getting harder. There are two sides that are hard. 1) The Chinese government doesn’t want them taking the money out of China. 2) The US government starts to be more restrictive in terms of the kind of money that can be deployed and the kinds of deals that can be deployed, so that part is becoming more difficult, but we don’t use any of that money. So we don’t have that type of LP or investor in our US fund, and in China, it’s not relevant to what Qiming does.
And then the other side was for Southeast Asia which right now we are taking our main fund and we’re investing out of the main fund following interesting entrepreneurs in this region and I think we’ve done four deals today, so that over time I think, will expand and I think we will have to decide do we continue to do that out of our main fund or do we raise a regional specific fund, and we haven’t made that decision yet.
When do you see that decision happening?
Within a year.
Have you sort of missed the bus compared to some of the other large Chinese VCs that have done significant investments in the region or you think it’s still early days in Southeast Asia?
I think it is for certain kind of deals; it would not make any sense to start a new Grab, right? I met the CEO yesterday and they seem to be doing just fine. So, funding a new Go-Jek or Grab doesn’t make sense. But there are half a billion people in the immediate Southeast Asia region, a good part of the technology infrastructure is several years behind what China has implemented particularly on internet related services, mobile related services, and so it will be different than China but I don’t think we have missed the investment cycle in the region, we have probably reached the investment cycle for the initial wave of sharing economy companies. That’s okay, you can’t catch every wave.
So, in Southeast Asia, you said that you are not basically looking at the whole sharing economy. What are the sectors that you will be looking at?
What about a market like India?
Personally, I find India very difficult and I think that when you look at the startup culture in India, most VCs have really struggled to do early-stage investments in India. I think as the market evolves, lots of VCs coming in late like Sequoia, which typically does later stage, a lot of the Chinese later come in and do later stage, SAIF in India was one of the founders of SAIF in China, so Ravi [Adusumalli] and that team I know really well. Even they would say it’s hard to do early stage in India.
The other thing that is difficult in India is the lack of infrastructure, so for e-commerce, the delivery logistics side is very challenging. The bureaucracy to launch a company, to get in the business, the lack of a complete physical infrastructure, and its middle class is not as big as China. China’s middle class now purchasing power basis is now $300-400 million depending upon on who you talk to; India is only about $60-70 million, so to me, it is one cycle behind where China is. It’s still big enough to be very attractive, but I think we’ll be conservative in terms of looking at where we will invest.
We obviously have a great relationship with Xiaomi, Shunwei – Shunwei has been more aggressive than us in India – and Xiaomi has a great ecosystem put in place in India. So I think you’ll see us do some business. I don’t think we’re late, but I think we’re not going to be aggressive, because we’re not going to put a team in India anytime in the near future.
Shunwei has done a series of deals in the last 2 years in India, especially on the content and social media side. They feel that is an area that can take off like in China.
Every time a VC does a deal, they feel it can take off. If you talk to any VC, the last deal they did is the best deal they’ve ever done. I think there’s a lot of enthusiasm among the Chinese VCs to look at other markets partly because China is so competitive and a very tough market to be successful in at this point. Part of it is the attraction of India, which you have to calibrate that against the difficulty of the Chinese market, and I think you have to weigh both of those when you’re talking about that.
Is it becoming tougher for many of the newer VCs to raise capital over the last couple of months?
The newer VCs, yes. We raise money in about a 3-month cycle, GGV raises money in about a 9-month cycle. They’ve raised $1.9 billion, we’ve raised $1.3 billion ($1.4 billion including the RMB fund). Sequoia raises a ton of money. So, the established players are not having any difficulty raising money. What the new funds are running into is how little liquidity there has been of the money back to the LPs. The vast majority of the Qiming LPs are overweighted in Venture Capital by 2x or more in terms of their target allocation, so their allocation on the books is 7 per cent, and they’re 17 per cent, 18 per cent or 20 per cent. So, to do a new fund, to enter into a brand new commitment without the liquidity forecast becomes very difficult. That’s why Qiming is focused on liquidity quite aggressively. For example, funds 1,2,3, and 4 are already in a carried position in terms of cash back to the LPs. Very few venture funds in 2006, 2008, 2011, and 2014 are already in that position and that’s just the way we manage our business.
Will it become tougher even for you going forward? Exits are sort of become more challenging in the sense that IPOs are becoming tougher?
In the Qiming family, we’ve had 13 IPOs in the last 18 months. We have 17 companies currently in the process of going public in the next year, so if we continue to have somewhere between 6-10 IPOs a year, I don’t think we’ll ever have a problem raising money. If we go two years without returning any capital, then I think everyone is running into a situation that fundraising will become more difficult.
You said you have 17 companies looking to do a public listing. With the current challenges in China, are you looking at listing outside of China? Maybe more in the US rather than Hong Kong?
So, it’s very difficult. It is quite complicated to change your legal structure to list in Hong Kong or the U.S, and it can delay a listing process by 6-12 months, so I think that’s a challenge. It’s even harder to take an offshore company and restructure it to list inside China. So the entrepreneurs always somehow think that this is easy, so they are always tempted to chase a P/E multiple in particular markets. I think the last 2-3 years showed them that is a very dangerous thing to do, that you are better off going public in the market you can access quickly, raise the money that you need to raise, and manage your business from that point forward. Chasing the multiple is definitely not a great idea for the vast majority of entrepreneurs.
The challenge in Hong Kong is that they have a new listing process for biotech, most of those have performed poorly once they went public, and that’s because people are having to be educated around what it is to invest in a relatively early stage biotech company, maybe phase 2 trial data, and it might still be 3-4 years before that company has a product in the market. So investors are excited about it because they look at the returns on the U.S side. Now you start to look at something that you may not have any news on for three years, and so that market needs time to mature. The analyst coverage needs time to mature, the exits on M&A in China need time to mature. All of that plays into a situation where it still takes quite a bit of time.
The other thing to look at when you look at exits, particularly in healthcare, is the most valuable Chinese healthcare company [Jiangsu] Hengrui has about a $30 billion market cap, Johnson & Johnson in the US is $300-350 billion, so you have a 10x multiple. On the intersumer side (consumer internet side), Tencent and Alibaba are roughly in the category of 1/2 or 1/3 of their US counterparts. That multiple difference is much smaller, so there’s a lot of room for the Chinese firms in healthcare when they go public to grow into much larger valuations compared to their overseas counterparts. All that also ties into how we think about it.
You mentioned that the US-China trade war hasn’t significantly affected you but, in the context of smaller VCs, do you think they will feel the heat? Are there even perhaps opportunities for VCs to take advantage of?
I think trying to take advantage of this situation is very dangerous, so I think you’re trying to survive it, not take advantage of it. The real risk is that the Chinese consumer stops spending, that’s the real risk to China. The tariff discussions /disputes between the US and China — I don’t call that a trade war — it doesn’t really affect the daily life of the Chinese consumer, but it makes them nervous. And if you’re a Chinese consumer you look back over the last few years, the stock market is down 30-40 per cent and you’re not happy with that. P2P lending, you’ve had tens of billions of dollars erased, you’re definitely not happy about that. You had this vaccine issue where bad drugs got into the market, so you’re not happy about that, you had melamine put into food products for kids, you’re not happy about that.
So if you think about Singapore, what do you take for granted? You never question the food, you never question the healthcare products, you don’t have the kind of runaway P2P lending here, so you question what the Chinese consumer can actually trust? They can’t trust the stock market, they can’t trust their food quality, this is a big deal. What they trust in China quite interestingly is e-commerce because of what Alibaba and Tencent have done on that infrastructure, and they trust the property market. Very little else in China has been deserving of the consumer’s trust.
If you add a US-China spat on top of it, the tendency would be for the consumers to just stop spending, and nothing on earth can get a Chinese individual to spend money when they decide they don’t want to, they just shut down. I think that’s one thing that the Chinese government is very, very nervous about because they know if that happens, maybe in 6, 12, or 18 months, and that behaviour goes back to being more consumptionary, they don’t control that, they don’t know when that will happen. So to me, that is really the big issue in terms of the domestic Chinese market.
The Chinese president talked about a science and tech board in Shanghai in terms of providing more liquidity to the startups a few days ago. Will that sort of encourage more companies to list? Do you think that’s just part of a speech?
I think that’s just part of a speech, I think it’s something that sounds good. When you look at all the reforms that they were supposedly going to undertake in the China capital markets, very few of them have been implemented. So I think that the idea of a new exchange for high-risk, early-stage companies – okay fine, so they can’t get the Chinese consumers to invest in the more established companies now, so why would people go and take more risk in public companies?
Do you see valuations stabilizing in the current environment of uncertainty? Until recently, China had multiple companies doing the same thing and all raising funding. Do you see, I won’t call it sensible, but more rationalization in the market?
Sensible is a good word. I think it does become more sensible, so I think you will see valuations stabilize. They were running away, so when we were comparing healthcare deals between the US and China, they were more expensive in China. Makes no sense that that was the case, so I think one of the big issues that no one has really been writing about is the fact that many of the early giant companies — the Xiaomis, the Meituans, the DiDis, ByteDance and so on — when they were growing the last 7-10 years, they were growing along with the wave of China going from a couple of hundred million people on mobile phones to 900 million people, 200 million people on the internet to nearly 900 million people on the internet, so the cost of customer acquisition was relatively low. Now, if I’m going to take you as a customer, I have to take you away from someone else, that’s expensive.
What’s happened is the prior spending behaviour of a Meituan-Dianping trying to consolidate a Groupon-like business with Yelp, etc. If you did that same thing today, it would cost you so much more and it takes so much more time because people already have a good alternative. So I think you have this wave of companies where the people getting funded today can’t go back and try the same game because I think the model of customer acquisition is becoming much more expensive.
I think if Ofo declares bankruptcy, that will be a great thing because that will show people that you can’t just randomly invest in any of the 10 companies doing the same thing, that you actually have to pick one of the best companies. You can’t just throw money trying to capture the market. At some point, some of these larger venture-backed companies will fail, and that will also change the incentive.
As a VC, are you also now competing with the so-called big unicorns? everybody from Tencent to Alibaba; they’re all sort of making investments downstream in terms of multiple related spaces.
Not that many really do it. Baidu, Tencent, and Alibaba are particularly aggressive. They have investments in over half of the 100 most valuable companies in China. Their counterparts in the U.S: Google, Facebook, Amazon, and Netflix, only have about 7-8 per cent. So, it’s 5-6x more intensive than what the US market has evolved to. Most of the other startups just don’t have the capital to try to do that.
At some point, are you competing for the good deals with the likes of Alibaba and Tencent?
The answer that every VC will tell you is “No, because we invest before them”. Actually, they’re moving earlier, so there are times where you invest at the same time. So what you end up doing is if Alibaba and Tencent are looking at a deal, then you have to decide to align yourself with one of them in the hopes of getting the deal.
It’s very rare for a VC by itself to outcompete one of those companies if it’s a slightly later stage deal. If it’s very early stage and it’s a ~$10 M investment, they don’t care. If it’s a $100-300 M investment, and they have millions of users, then that competition will be very fierce and you basically want one of your companies to have them as an investor because tapping into that ecosystem is so valuable.