The big gamble that paid off(2)

A big screen near NASDAQ Stock Market shows welcome messages for JD.com Inc, which was listed at the bourse on May 22. JD.com is China's second-largest e-commerce player after Alibaba Group.[Photo/Xinhua]

In the case of JD.com, for example, despite being China's second-largest e-commerce company by market share and listed in the US in late May, it broke even for the first time only in 2013, 10 years after the company was founded in Beijing.

Western venture capital systems, US dollar-based funding and the rather flexible Western IPO regulations all create an ecosystem suitable for the growth of Chinese TMTs.

By injecting cash into Chinese TMTs and listing their shares in the US, the entire capital market in the West benefits from the Chinese Internet boom, sources say.

Apart from handling American Depositary Receipt business, Western banks also rake in lots of fees by underwriting Chinese companies' IPOs in the US. The six banks leading Alibaba's IPO reportedly will share $400 million in fees, assuming Alibaba raises $20 billion.

This year is expected to see a record number of Chinese companies make their debuts in US stock markets.

In 2010, 43 Chinese companies listed their shares in the US, raising nearly $4 billion. That was followed by two slower years for IPOs.

So far this year, five Chinese companies have gone public in the US, raising nearly $6 billion, and a string of Chinese TMT companies are expected to list their shares in the US in the near future.

While the booming IPO market brings foreign banks and investors lucrative fees and returns, where Western investors benefit most from investing in Chinese TMT companies is in access to the Chinese market.

"In just a few years, China's online retail market has become the second-largest in the world, after the US. Yet China has an online population that is twice the US population, and over 300 million active online shoppers. These Chinese companies offer Western investors the biggest and broadest entry into this booming industry," says Neil Flynn, chief equity analyst at Shanghai-based Chinese Investors, a leading financial analysis firm of US-listed Chinese companies.

"Obviously, this is a booming industry, and firms are posting impressive profits. For example, if you look at VIPshop, which has a niche role within the online retail industry, they are seeing incredible revenue and profit, and their stock price has risen 2,600 percent in two years," he says.

Plenty of opportunities remain for investors as the potential of the Internet market in China is huge, he says. "In terms of Internet penetration, we only have about 50 percent in China, whilst the developed nations such as the US and Japan have 80 percent Internet penetration, so there is certainly a lot of potential for the market to grow," Flynn says.

During the past 19 years, many people have asked whether TMT (technology, media and telecom) companies as a sector would continue to be a good bet.

Chuan Thor, managing director, Highland Capital Partners, a global venture capital firm with offices in Silicon Valley, Boston and Shanghai, says he believes it is always the best sector for early-stage investments.

Thor's company invested $17.5 million in the Chinese Internet security company Qihoo 360 at the end of 2006, and their 15.94 percent stake in the company had a total value of more than $630 million when it went public on the New York Stock Exchange in 2011.

"The deal with Qihoo 360 shows that doing early-stage investment in China can make a lot of money," says Thor, who also invested in 6.CN, Game-Wave, NetentSec, Viva and UUSee.

He says many Chinese equity investment firms used to seek pre-IPO deals when the companies were very mature and profitable, but such opportunities have been rarer and rarer.

Thor says that while TMT giants are quite strong, small companies can provide good opportunities and may become the new giants someday.

Thor cites Lycos, which used to be a popular search engine in the late 1990s. Yahoo overshadowed Lycos, and then Google rose up and became the giant, though Facebook, Twitter or something else might dethrone it someday.

"If a startup team works hard and is willing to innovate and reverse the traditional business pattern, it may create a great company," says Thor, adding that his company always invests in startups that are one or two years old, because that's when they need money the most.

Many experts, however, say the large number of cashthirsty startups in China's rosy Internet market do not add up to guaranteed profits for foreign investors.

Some cite concerns that the government might try to tighten regulations to limit foreign investment in the TMT sector, which has increasingly grown into the most dynamic part of China's economy, or launch policies to give local venture capital an edge in the sector.

Flynn says that such restrictions mean that Western investors will always be at a disadvantage compared with Chinese investors when investing in China. There is a growing number of local venture capital firms that could fund the next tech giants, he says.

A total of 189 new yuan-based funds emerged in China's venture capital market in 2013, raising a total of $6.38 billion that year. Only 10 new foreign currency funds emerged in China in 2013, raising $541 million, according to a recent report from Zero2IPO Research, a leading research institution in China's private equity industry.

China's increasing wealth has provided a new flow of venture capital funds for investment in Chinese businesses, analysts say.

"It's very easy for Western investors to see the likes of VIPshop and JD, and read the hype about Alibaba, and get a rosy view about China's e-commerce market. However, investors have to understand the nature of consumers in China, the contrast between the first- and fourth-tier cities, and understand that you can't just view Alibaba as the 'Chinese Amazon'." says Flynn.