GP profile: China Renaissance

China Renaissance made its name as an early advisor to the country’s unicorns as they closed ever-larger funding rounds and began to engage in meaningful M&A activity. But within a year of the company’s founding in 2005, the partners were already investing their own money. Having committed so much time and energy to these start-ups, why not back it up with capital?

It was only a matter of time before they accumulated sufficient experience and confidence to consider building an institutional business around the investments and manage third-party capital.

“From day one, we were determined to launch an investment business that was separate from the banking business,” explains Fan Bao, chairman and CEO of China Renaissance. “The people, operations, and decision-making are all independent. Financial advisors can’t make investments because there are conflicts of interest – they might be less optimistic on companies their funds aren’t invested in or they might save good deals for themselves rather than share with clients.”

This led to the creation of Huaxing Growth Capital, which launched its debut fund in 2013 and closed with a modest pool of $62 million. Today, the Hong Kong-listed firm has RMB61.7 billion ($9.5 billion) in assets under management (AUM) across six funds – three US dollar-denominated and three renminbi-denominated – under Huaxing Growth Capital. The average IRR and gross multiple were 54% and 4.3x. It has raised three more funds under a separate healthcare-focused PE strategy.

The investment management business accounted for 50% of overall revenue in 2020, up from zero in 2015. About one-third of this constituted fees, with the rest coming from unrealized investment gains, primarily where China Renaissance has made balance sheet commitments to its own funds. Investment management was responsible for 84% of operating profit.

For Bao, it represents the crystallization of a long-term vision: a “twin-engine business model” that leverages synergies between investment banking and investment management in terms of deal sourcing, exits, research sharing, and value-added services, even as they sit behind ethical walls.

Maintaining focus

There are numerous milestones charting China Renaissance’s progress. Lisa Yuan, a partner responsible for consumer-internet sector coverage, identifies two: one that relates to scale and the other to internal organization.

In 2015, Huaxing Growth Capital began to scale rapidly, launching its second US dollar and renminbi funds, both of which achieved first closes later in the year. The escalation in AUM was significant for branding as well as economics: rather than participating in deals as a co-investor, the firm could take the lead. Then, in 2019, Bao assumed direct responsibility for business development on the investment side and fully dedicated himself to the funds. It marked a fundamental shift.

Investment management became China Renaissance’s main revenue driver soon after, but Bao prefers not to dwell on the contributions of different business lines because he sees them as distinct in function yet interdependent.

“To some extent, the profit model of an enterprise is nothing more than making money by people or making money by money. Yes, the AUM and revenue of our funds business are large, but that’s also because our entire group’s capital mainly invests in our funds, which becomes the vehicle for the group to make money through money,” he explains.

Net investment gains reached RMB933.1 million in 2020, up from RMB127.3 million a year earlier. As of December 2020, it held RMB2.37 billion in balance sheet interests in funds, two-thirds of which were in its own funds. It plans to increase these principal investments.

As an investment manager, China Renaissance wants to remain a boutique with highly concentrated portfolios. There is no interest in becoming either a platform that covers all stages and strategies or a sector specialist. Huaxing Healthcare is an affiliate business established in 2016 when two investment professionals spun out of Actis and were looking for a partner. China Renaissance holds a 51% interest in the investment manager.

The DST parallel

Huaxing Growth Capital’s latest renminbi and US dollar growth funds, both in their fourth iterations, have targets of RMB10 billion and $1 billion. This will be deployed across no more than 30 companies, with an equity check sweet spot of $50-100 million.

This could be interpreted as an efficient approach to identifying and then doubling down on unicorns. Of China’s 100 largest listed companies, 38 were still under private ownership 10 years ago. Huaxing Growth Capital invested in 10 of the 38, including online-to-offline services platform Meituan, ride-hailing giant Didi, short video app Kuaishou, streaming platform Bilibili, smart phone manufacturer Xiaomi, and drug development outsourcing business WuXi AppTec.

Comparisons can be drawn with DST Global, a well-known late-stage technology investor and unicorn hunter globally. Bao and Yuri Milner, DST’s founder, are close friends. Early in the acquaintance, Bao introduced Milner to JD.com, which led to DST leading a $1.5 billion round for the e-commerce player in 2011. JD.com listed three years later, with DST making a small partial exit through the IPO and retaining a position worth around $2 billion at the time.

Both Bao and Milner are well-known in their respective circles, which can be a useful source of deal flow. However, China Renaissance claims to leverage its on-the-ground resources and ecosystem to identify and solve pain points for entrepreneurs – such as structural problems related to cap tables and liquidity arrangements – rather than relying on its founder to open doors. A concentrated portfolio is helpful in this respect because it encourages close relationships with companies.

China Renaissance recently participated in a RMB10.3 billion Series B for Svolt Energy Technology, a battery manufacturing spinout local automaker Great Wall Motor. As a mixed ownership company, eight of Svolt’s shareholders are state-backed or state-owned.

“We don’t value the pure capital that highly as a resource,” Zhikun Wang, a deputy director at Svolt, tells AVCJ, while noting that the round was four to five times oversubscribed, "China Renaissance’s Chairman Bao is an industry legend and it is inspiring how the company has grown to its current scale. It also has resources in the industry supply chain and brings potential customers to us.”

Automotive agenda

Svolt is part of China Renaissance’s latest ambition: to build out exposure to electrical vehicles (EV), autonomous driving, and smart manufacturing. The firm has also invested in two of the three Chinese EV makers that are now listed, Nio and Li Auto, and backed EV components supplier HiRain Technologies, Calterah Semiconductor, which produces chips used in advanced driver assistance systems (ADAS) and autonomous vehicles, and an unnamed LiDAR technology developer.

Last year, Kate Zhu was recruited from Morgan Stanley, where she specialized in automobiles, general industries and infrastructure, to build a smart industry team at Huaxing Growth Capital that invests in and around the new energy vehicle and autonomous driving value chain.

Zhu recalls a domestic LP saying, “Isn’t it a bit late to be focusing on smart manufacturing?” Her answer was a resolute no. “People who invested in the sector earlier may have a different vision and angle to us. The things you see on China Renaissance’s platform can be quite different [from the mainstream],” she explains, citing HiRain as an example.

Despite posting revenue of RMB1.8 billion in 2019, the company was still loss-making. When it raised funding in early 2020 at a valuation of RMB7 billion, many investors dismissed the deal as too richly priced. China Renaissance, convinced by the work it had done on HiRain, didn’t drop out and ended up making a solo commitment of RMB210 million.

“What we value most is not the company’s current revenue, but what it can develop based on its strong customer network and its 2,000 top-ranked engineers. ADAS represents a particularly large growth opportunity,” says Zhu.

Her team’s due diligence included interviews across the industry spectrum that delivered insights into HiRain’s customers and competitors at home and overseas. A key hypothesis was that domestic original equipment manufacturers (OEMs) would be more aggressive in the smart car space than foreign peers addressing the China market through joint ventures with local players. It was a bold call because domestic independent brands have traditionally been followers rather than leaders.

“We think that in the era of electrification and intelligence, local players will do some overtaking,” Zhu maintains, adding that it is far easier to calculate market ceilings in areas – like new energy vehicles – where the government has issued specific development targets.

In the second half of 2020, as the industry recovered from COVID-19-related inaction and new smart car models began appearing at auto shows, HiRain’s orders took off. Suddenly, the company was a hot property in the investment community. China Renaissance re-upped in a pre-IPO round last November where the new investor allocation went solely to strategic players. HiRain’s application to list on Shanghai’s Star Market was accepted in June.

Regulatory minefields

Bao is also bullish on smart manufacturing, noting that the pandemic has created a rare opportunity for supply chain reconstruction. Domestic substitution, driven in part by US-China decoupling and the need to find local alternatives to imported technologies, has become a popular investment theme, but he believes it will end in a price war. More interesting opportunities go beyond pure substitution to areas where China is near-level with overseas players and may well overtake them.

EV fits into this category, while also benefiting from strong policy support. The shift in China’s economic environment from the pursuit of growth and efficiency at nearly any cost to a model under which sustainability and social equity are prioritized is profound. Investors must align themselves with these objectives to make the most of any government-driven tailwinds.

China Renaissance’s response was to apply an environment, social governance (ESG) framework to its deals, an effort that began internally last year. While assessing environmental impact is relatively straightforward, issues such as social welfare are subject to broader interpretation – and this has come to the fore in recent months as domestic regulators have cracked down on technology companies.

Online education has been hit especially hard, with government efforts to “promote educational equity” undermining the business models of various VC-backed start-ups. China Renaissance has limited exposure to the industry and Bao, a father of four, is wary of excessive screen time. “If they go out to play in the nature or play with friends, that’s more beneficial,” he observes.

As for the social and governance concerns around data privacy – a key issue for internet platforms and another area in which China is taking a tougher line – he takes a stronger line: “The notion that a company owns your data, just because it provides a certain service and has collected these data, is absurd. If a company uses a data monopoly as its most important competitive edge, I think it has a fundamental problem.”

Shifting focus

While China Renaissance has backed a string of consumer-facing internet companies, more recently its focus within the consumer sector has shifted toward brands. At the same time, too many start-ups have grown wise to methods of tracking brands through sales on e-commerce platforms. This has led to widespread gaming of the system whereby they spend massively – and unsustainably – on online traffic to create a best-selling product in the hope of attracting investor interest.

“We should not be too excited about current sales numbers. Instead, we should ask whether brands can stand the test of time,” Bao says. He notes that people’s dining habits change, which means food fashions can be as fleeting as those in clothing and apparel. He would rather back a business that meets basic needs in terms of sustenance – like McDonald’s or KFC – than more premium options.

Brands aside, China Renaissance’s approach to investment is increasingly B2B. Healthcare, enterprise services, semiconductors, big data, and cloud computing sit high on the priority list, alongside the automotive industry value chain and smart manufacturing.

Despite embracing the complexities or areas like deep-tech, there is an emphasis on simplicity and essential merits or use cases. “When we are discussing a potential investment internally, if you can’t take 10 minutes and two pages to explain it clearly, most likely you have no idea what you're talking about,” says Bao.

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• China Renaissance