The changing face of venture

The onset of 2010 took the venture capital industry out of the post-GFC depths, particularly in key Asian markets, and even more so in today’s sexier sectors. The region’s VC story of late has really been a focus on China and India, and off the back of the recent economic shakeup, coupled with the progress made by developers in key areas including IT and cleantech, these markets have solidified their places as real competitors for Western VC dollars which would have otherwise been spent domestically.

Global VC by the numbers

In terms of numbers, global VC firms invested $10.3 billion in 1,160 deals in the US, Europe, Canada, Israel, mainland China and India from mid-2009 to mid-2010, according to a report by Dow Jones VentureSource in July – a 29% capital increase and a 14% rise in deals from the same period last year. Mainland China specifically saw a 52% increase in VC investments from the second quarter of 2009 to 2010, accounting for $689 million in 58 deals, though capital invested was below 2Q08 levels, which hit $1.8 billion into 96 deals. Meanwhile, India saw $182 million invested in 23 VC deals in 2Q10, up from $95 million into 15 deals one year earlier, with investment into service-related industry a key trend.

Though some areas of Asia are seeing increased activity in the venture space, the GFC has slowed progress in others. Emerging markets are not experiencing an increase in transaction flow; Vietnam and Indonesia are still undercapitalized and sluggish to catch up to earlier performance levels.

Elsewhere, the Japan Venture Capital Association reported that VC investments made in 2009 fell by about 40% to JPY37.8 billion ($417 million) in 472 deals the year earlier, an even more when compared to 2007, when VCs invested about JPY193 billion ($2.1 billion). That momentum has not been regained (though the $46.8 million investment in August by the Innovation Network Corporation of Japan and JAFCO in Enax Inc. is one of the largest VC transactions of the year).

Australia has witnessed the same, where the Australian Private Equity & Venture Capital Association reported that Australian VCs raised $168 million in FY2010 up to 3Q10, approximately half the amount raised the year before. VC investment also declined by 7% year-on-year to $187 million, and much of the transactions for both PE and VC investments came in the form of follow-on investments rather than new deals.

But in the markets where the industry flourishes, funds aren’t merely investing, they’re exiting too, says Spencer Tall, Managing Director of Allegis Capital. “During the GFC, it all came down to the cash that you held. If you held cash, you kept your investments and paid even more to keep them, investing longer and using more capital to maintain. If you couldn’t hold on then you sold it at an oftentimes distressed rate. Now, we’re absolutely seeing exits because the market’s picked up.”

TMT, the flavor of the industry

Venture capital can largely be classified by a three-letter acronym: TMT, or technology, media and telecoms. That was the story leading up to 2000, at the high of VC’s glory; a\the year that the US-based National Venture Capital Association saw approximately 5,500 VC-backed companies in the US – a figure that halved by 2009. It was also the story in 2007, when online gaming was the decided trend. It remains to be a prevalent factor in 2010 with every VC firm scrambling to find a cleantech company to call their own.

Of course, the industry has seen a systemic shift upward. For example, data analytics was once a hot trend, and while there are still VC opportunities in the direct space, a lot of attention has instead shifted to data storage. The same applies to mobile applications: content was once the theme, but now investors are sweet on the security aspects for those features. Online gaming is still big, but virtual goods and payments are poised to get bigger.

“Internet and wireless are becoming extremely interesting sectors again. In addition, with mobile devices becoming more portable, powerful and user-friendly, many of the trends that have taken place over the computer are happening on the mobile device. Sectors like education, cleantech, consumer services, and internet infrastructure are also strong investment areas,” says Ron Cao, Managing Director of Lightspeed Venture Partners.

The proof is in the returns. In August, Nexus Venture Partners made its very first exit, offloading its stake in digital classifieds advertising platform OLX after holding the asset for two years. In China, online content aggregator ChinaCache International Holdings applied for a listing on the NASDAQ in December, promising a liquidity event for investors including Intel Capital, Qiming Venture Partners and JAFCO Investment. The same can be said for online video major Tudou.com, whose backers, including GGV Capital, IDG China and KTB Ventures, could cash in when the company also debuts on the NASDAQ, aiming for $150 million.

China: renewable interest

Analysts can nary discuss technology and venture capital without citing cleantech opportunities, and China has been the most enterprising nation worldwide on the subject. According to US-based Cleantech Group, Chinese companies raised $331 million in VC investments in 2009 – comparable to 2008’s figures – for 28 deals across industry sectors such as energy generation, transportation, recycling, efficiency and storage. Twenty-nine M&A transactions were also brokered, worth $5.5 billion.

Thomas Chou, Partner and Co-Chair at Morrison & Foerster’s Asia PE group, further notes that, in July, China announced that it would spend RMB5 trillion ($738 billion) on new energy technologies and carbon-dioxide reduction measures over the next decade. Given these government policy initiatives, plus higher energy demand, “China is rapidly becoming the leading global destination for clean energy investments.”

“The majority of such investments have been in the solar industry, with the rest of such investments in wind, other renewables, and energy efficiency/low-carbon solutions, such as smart grids,” Chou says. “Despite the massive overall investment in this sector in China, only a very small fraction is currently attributable to PE/VC investment – according to Ernst & Young, China received $33.8 billion of clean energy financing in 2009, but only $200 million was allocated to the PE/VC industry.”

Allegis’ Tall takes such observations a step further. “In terms of cleantech and biotech, the US faces a lot of regulations. A lot will be coming out in the next few months, and if these regulations aren’t conducive to investing, the US is going to have a lot less support,” he says, adding that the California government is currently awaiting a vote on such a crucial subject. “Markets require clarity; tell us the rules and we will go to work. That’s all people are asking for, and investors will absolutely back off US investments and turn to China to spend that money.”

But cleantech isn’t for everyone. Another prominent theme comes in the form of healthcare. China has seen $125 million worth of VC investments in seven healthcare deals in Q2 2010, according to Dow Jones, and tech-related investments still account for two of the top investments of the year: Tiger Global’s $150 million investment in 360buy.com; and the $65 million investment into iSoftStone Information Service Corp. by the consortium of AsiaVest Partners, CEL Venture Capital, Fidelity Asia Ventures, Infotech Pacific Ventures and MVC Corp.

Where to find the next big thing

Despite all the growth in key areas, one China-based VC insider paints a picture of the direction of the industry. “In 2002 and 2003, I was involved in a deal in China that exited with 13x return out of a $40 million base investment we made and then exited in 20 months. We paid 9x historic PE for a net profit of $25 million. The company, which was in online gaming, went public on NASDAQ in 2004. The deal overall demonstrated that we can make money in China.”

“If you fast forward to today there isn’t anything with a $25 million net profit that’s not been invested by someone already. If there is a company with $25 million net profit, it doesn’t matter what it is, you are probably looking at 13x forward-looking PE today instead of 6x in 2003, and you are probably competing with another 10 termsheets,” he continues, citing congestion as a key factor.

While the VC space in China and India is far from saturated, these markets are much more popular than years prior, making it more difficult to identify top opportunities, and certainly more difficult to get them at a bargain. Yet, these are still the most eyed markets in the region. North Asia – namely Japan and Korea – is just as congested as advanced Western markets as well, local VCs suggest. Tall further noted that, from a Western firm’s perspective, Asia-based groups are losing their historical edge on technology firms. This is happening because the focus has moved back to the US, with companies such as Apple now viewed as global innovators.

While there are certainly opportunities in Asia, “It will be very hard to achieve 13x return if you are focused on late-stage profitable firms,” says a prominent China VC. “You have to be the first one who looks at a completely new territory that hasn’t looked at before. And, you are going to have to spot it a lot earlier to have a chance at big returns. Get in before they become profitable.”

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• Topics
• Venture
• Early-stage
• Greater China
• JAFCO
• Qiming Venture Partners
• Intel Capital
• IDG Ventures
• FIL Capital Management / Fidelity Asia Ventures
• AsiaVest Partners, TCW/YFY