2023 preview: Hard-tech

The definition of technology investment has changed over the years. If we take China as a reference point, consumer tech is increasingly defined as an internet platform play, a theme linked with giant e-commerce or social media platforms that face tighter regulatory scrutiny.

China GPs often use the terms deep-tech or hard-tech to capture a sub-sector generally supported by government policy. Business models tend to be based on unique, protected or hard-to-reproduce technological or scientific advances and they often solve key bottle-neck issues. Domestic substitution – developing China-made versions of technologies sourced from overseas – is also a prevalent theme.

“Hard technology is now the task of all the Chinese people. It is also the only sector that you can invest in boldly, and there is still no industry beta in other sectors. All stocks that solve the needs of China’s bottleneck technology problems are still performing well, and it should continue next year,” said Wayne Shiong, a partner at China Growth Capital.

However, for US dollar-denominated funds, getting exposure to these companies isn’t straightforward. Founders are mindful of geopolitical tensions and the possibility that regulations – enacted in the US or in China – could make life difficult for those with offshore investors. At the same time, most of these companies are expected to list domestically, so there is often a preference for renminbi capital.

While some investors have observed that the addressable universe for US dollar funds has narrowed, others take a more nuanced view. Some companies have technologies that are already globally competitive, so there is the prospect of helping them build a footprint in international markets. This is regarded as one of the biggest investment opportunities in China, and US dollar funds can participate.

"Software-defined robots also known as smart hardware is very exciting. We think it will be the next huge global opportunity after smart electric vehicles,” said Mingming Huang, founder of Future Capital.

“While Japan and Germany are leading in traditional industrial robots, they lack software talent and artificial intelligence expertise, so the real competition in the smart hardware sector may eventually be China versus the US. Only they can produce world-class companies, so it’s just like in electric vehicles.”

The intelligence era

Investors categorise this opportunity in different ways – typically high-end manufacturing or artificial intelligence (AI) applications. Wei Zhou, founder of China Creation Ventures, is most enthused by the shift from the mobile-internet era towards what he calls the intelligence era. It is characterised by the combination of three key capabilities: AI, autonomous driving, and robotics.

“China has accumulated a lot of knowledge in these areas over the past two decades and many strong companies are emerging across electric vehicles, intelligent warehousing and logistics, smart agricultural equipment, and service robots. Because these are at the product level rather than the infrastructure level, they are not sensitive. US dollar funds can participate in investments,” said Zhou.

Peter Chen, a managing director at 5Y Capital, has the same convictions. He views robots as a combination of algorithms and manufacturing – and China has a competitive advantage in both. “As overseas manufacturers lack the hardware ecology of places like Shenzhen, their product iteration is slow. This translates into a huge competitive edge for Chinese players,” Chen explained.

Tesla recently released a prototype of Tesla Bot, a “general purpose” humanoid robot. Future Capital’s Huang believes that the technology stack behind the Tesla Bot and an electric vehicle’s automatic driving unit is the same. This means robots are a natural extension of the smart vehicle space, which has been hot for the past few years in the US and China.

“What it does is first visual perception, then it uses the AI brain to make decisions and it plans through algorithms, and finally, it executes. The difference is just that the decision-making of the car- basically acceleration, deceleration and steering - is relatively simple, but the fault tolerance is extremely low and the decision-making for robots is much more complicated, but error tolerant,” said Huang.

 

Chuan Sun, a partner at Morrison Forester, believes that investor interest in next frontier adoptions of AI will persist through 2013. Application scenarios involving automotive, transportation, logistics, smart manufacturing, and enterprise software are all on the agenda.

“In 2021, AI was white-hot. Chinese AI start-ups received USD 17bn in PE and VC funding, which represents nearly 20% of the global total. In order to further encourage AI developments, the central government has broad guidance schemes in place while the local government of major cities, such as Shanghai and Shenzhen, have issued their own regulations this year to boost AI-related investment,” said Sun.

Valuation verdict

As for enduring concerns about valuations, Qizhi Guo, a senior partner at CDH Investments, is confident of a breakthrough. If 2021 was a year that created bubbles, 2022 was the process of removing bubbles, and in 2023 we will see a return to more reasonable valuations, he maintained.

“When the market heats up, valuations certainly follow. Will they rise again, just like in 2021? I think the probability is not high. More likely, valuations will increase rationally, in accordance with business growth,” said Guo. “This year has been unusual. Many companies have doubled their sales, but their valuations might be very close to where they were in 2021.”

There is a general expectation that policy support for hard-tech in China will continue in the long term, almost regardless of what happens to valuations. However, Zhanbin Dong, a managing partner of Qingsong Fund, expects the competitive dynamics to change in the short term.

“Some GPs started investing in deep tech a few years ago and came to realise that growth isn’t as fast as might be expected – it’s a long-term play,” he said. "Taking into account the high valuation risk, some investors have started making adjustments to their deployment, withdrawing from overheated sectors and re-entering relatively colder tracks like consumer.”

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• Topics
• Greater China
• Technology
• Early-stage
• Expansion
• China
• hard-tech
• Electric Vehicles
• China Growth Capital
• Future Capital
• China Creation Ventures
• CDH Investments Management
• 5Y capital