China-US EV: Electric avenue

The implacable socio-economic forces behind the global expansion of the electric vehicle (EV) industry are a natural fit for patient, long-dated capital. But investors are still under pressure to deploy. 

This may be especially true for those targeting one of the industry’s biggest global trends: the supply of US cleantech into the booming Chinese market. At first glance, it’s a simple equation of plugging the world’s most advanced auto tech ecosystem into an environment where urbanization and pollution stresses have caused an insatiable demand for innovation.

However, the heavy hand of government that typically flavors automotive concerns is complicating the scenario. Although looser US policies around fuel economy standards and generous Chinese concessions for EV players are incentivizing cross-border activity, these supports are inherently fickle.   

“I’m very positive on the China market, but the subsidies will definitely be gradually reduced in the next few years, and the whole industry is gearing up for dramatic cost reductions,” says Alex Pan, a managing director at GSR Ventures. “EV companies have to focus on reducing their costs and be viable businesses without government incentives.”

GSR has been one of the more aggressive venture firms looking to exploit the window of opportunity provided by the current policy landscape. It has backed a number of US cleantech players breaking into the Chinese market, including battery technology companies SPI Energy and Boston-Power as well as Protean Electric, a components supplier that designs novel in-wheel electric drive systems.

While this flurry of activity exemplifies the urgency among VCs to claim market share during the regulatory honeymoon, it also highlights an uncommon depth of investment potential. As the inroads of the US-China nexus come into focus, EV may reveal itself to be a fusion of hardware and software that transcends even the smart phone in terms of business development options. 

For China, EV represents a fresh start in the automobile game. Original equipment manufacturers (OEM) in the West may claim an insurmountable lead in traditional automotive technology, but the global playing field in EV remains relatively even. Furthermore, it is often observed that China is one of the few major nations that approaches pollution as an obstacle to economic growth.

For venture capital, the rationale behind bringing US technology to China can be somewhat quantified in a number of soft targets set by Beijing, including a plan for EVs to represent about one-fifth of nationwide car sales by 2025. Reliable numbers are elusive, however, leaving most cross-border players to point to convincing but more nebulous influences such as a general expansion in Chinese affluence.

Entry points

Tsing Capital has been active in this space since as early as 2009 when it backed a Series A round for US-based Lucid Motors. The firm says Lucid’s Air series of luxury cars is one of the few premium models that can compete with leading US player Tesla Motors, which began talks last month to establish its first China-based factory in Shanghai. 

“I don’t believe that there are any US cleantech companies that haven’t considered entering the Chinese market,” says Don Ye, founder and managing partner at Tsing. “China has become the number-one market for EV.”

At the opposite end of the consumer spectrum, public transport has perhaps attracted the most conspicuous VC attention. This includes a $400 million round for Microvast Power Systems, a US and China-based company focused on battery technology for hybrid-electric municipal bus fleets. Participating investors included CITIC Securities and CDH Investments.

The deal coincided with a spate of regulatory developments aimed at encouraging more companies to follow the Microvast formula in bridging the US-China divide. Although joint ventures (JV) are still necessary for US participation in the Chinese automotive space, new negative list rules are now in place that allow foreign ownership of JVs to exceed 50%.

Meanwhile, planned changes to government subsidies – a key incentive in the low-volume world of EV manufacturing – are pressuring investors to react. Depending on the specifications of the car, subsidies in China can deliver an offset of $5,000-7,000 per unit for car makers. But this program is set to be eliminated by 2020.  

US companies will consequently need to make greater efforts to tighten their cost profiles before committing to a China strategy – a prerequisite that may hamper an already difficult set of openings. Building up a team independently and engaging directly with Chinese OEMs can be an expensive process involving persistent international travel and third-party contracting. As a result, venture capital is coming to the fore as the primary means of brokering US-China deals.

“US companies need a VC’s understanding of Chinese culture, how to execute a deal and to push it forward,” says Benson He, a managing director at H&Q Asia Pacific. “If you’re a US company trying to talk with an SOE [state-owned enterprise] OEM, it’s very difficult, and you might never get a deal done.”

Earlier this year, H&Q invested about $5 million in Efficient Drivetrains (EDI), a US and China-based EV systems developer that the GP has subsequently been introduced to local strategic Yuchai Machinery Group. EDI has a number of sales offices in the country, but it has yet to establish a concrete manufacturing presence.

Physical in-country operations are generally considered essential for components companies. Although EDI sees its controlling software as one of its main differentiators, its fundamental focus on drivetrain equipment will likely mean that real factory developments are required in order to keep supply chain costs in check as subsidies begin to evaporate.

“The main barrier to entry and innovation in the auto industry is the capital intensity of tooling and factory,” says Kevin Czinger, CEO at Divergent 3D, a US-based company that develops 3D printing technology for designing cars with reduced environmental impact. “It requires enormous investment before knowing if there is market demand and then a long product cycle – 7-10 years – to be able to amortize the large capital investment over vehicle sales.”

Divergent received a $23 million round in January for expansion in China led by Horizons Ventures, a firm controlled by Hong Kong tycoon Li Ka-Shing. The company has spent the last three years perfecting an end-to-end production system that it envisions as a fulcrum technology for EV’s various constituent business models.

“We believe this will have a far more disruptive impact than batteries or drivetrains,” Czinger explains. “Cars will go from being mainframe computers with similar costs and long product cycles to a consumer product like a smart phone with fast product cycles, many new brands, and accelerated innovation.  Cars will also be much cleaner and more in harmony with human society and nature.”

IP issues

The streamlining of production cycles in this outlook would result in a more competitive and R&D-driven industry. To this end, the intellectual property (IP) issues that typically complicate US-China cross-border ventures could play a larger relative role in future EV development. 

Patents as territorial rights filed in another country have no effect in China, where a “first to file” system grants trademarks to whoever submits the application first. Investors in US start-ups with proprietary technology are therefore advised to be particularly careful that all paperwork is properly translated into Chinese.

“Technology drain is a major concern for investors looking to enter the Chinese EV industry,” says Zoey Erdenebileg, an associate in the business intelligence unit at Dezan Shira & Associates. “For due diligence, companies generally focus on legal, financial and operational aspects, but market, reputation and cultural factors should also be considered.”

For the moment, VCs active in the US-China EV space have downplayed concerns about IP protection. The prevailing perception is that hurdles related to post-acquisition management, localization and relationship building will dominate expansion and value-add agendas. “The most common challenges we have seen are differences in culture and speed in developing partnerships,” says Tsing’s Ye. “The Chinese market is more connection driven and requires more involvement and patience.”

GGV Capital likewise sees networking and portfolio synergies as key aspects of EV company development, but its reflections on overlapping the technical specializations of investee companies extend well beyond mere transportation.  The firm recently invested in US driverless car technology developer, Drive, as part of a bid to grow the company across Asia in the next 3-5 years. The plan embraces the standard technology supply-demand dynamic of the US-China EV space, but also incorporates themes around the “shared economy” and cloud-style dissemination of computing power.

Founded by a team from Stanford University’, Drive uses deep learning algorithms to develop autonomous driving systems that can better adapt to changing routes and traffic conditions. The plan is to supply corporate fleets with retrofit kits that transform traditional cars into autonomous models.

“When Tesla did its IPO roadshow, Elon Musk said it was not an automotive company – it was an internet platform company. It’s all about connectivity and coming up with new products,” says Jenny Lee, a managing partner at GGV. “If you think about the next platform beyond the smart phone, the car is obviously a natural platform because people spend a lot of time going from point to point. And if you don’t have to be behind the wheel, the question is, what else can happen in that environment?”

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• Topics
• Greater China
• North America
• Early-stage
• Technology
• Expansion
• China
• USA
• Transportation
• automobiles
• Venture
• GGV Capital
• Tsing Capital
• GSR Ventures