Q&A: Starquest Capital's Frankie Fang

Q: How has your portfolio been impacted by COVID-19?

A: We are focused on domestic consumption, healthcare, services, and technology that transforms traditional business. All these sectors have come on strong following COVID-19. We will have one or two IPOs next month. There is a huge desire to consume and be active in China. You go to the Luis Vuitton store in Shanghai and it’s full of people queuing up to buy things because they can’t go to Europe. At the same time, a lot of smaller businesses – mom and pop shops, not market leaders – have gone bankrupt.

Q: What are you seeing in terms of deal activity and valuations?

A: We make investments of RMB100-150 million ($15-22 million) in funds and we usually write checks of around RMB50 million for direct deals. Most of the funds are early stage, RMB1-2 billion. They do some Series A rounds, but mostly Series B and C. Companies at these stages can be sizable nowadays. We did a co-investment with a portfolio GP in Pop Mart [a toy figurine retailer] that generated RMB400 million in revenue last year. It is going public at the end of September. Valuations are still there – just look at how the public markets have rebounded. We invested in a Chinese Beyond Meat-type company that raised an angel round at the start of the year, a pre-Series A in March, a Series A in July, and now it’s doing a Series A-plus. The valuation has gone from $10 million to $80 million in six months. VCs are looking for the next big trends and wasting no time getting into deals. Entrepreneurs are also aggressively building their businesses, taking advantage of the big hole, big opportunity created by COVID-19.

Q: If rounds are getting larger and the length of time in between them is getting shorter, doesn’t the risk increase?

A: There is a fine balance. You want the company to be fully capitalized but you don’t the valuations to be too bubbly. It’s a concern in healthcare. Partly because of the Star Market – even companies still in clinical trials, with very little revenue – can go public. As well as drug discovery, it’s IVD, cancer screening, services, equipment. Valuations are hitting the roof, there’s no justification for them. You need to be careful. It boils down to GPs having the expertise to pick the right companies.

Q: What does this mean for sector specialization in China private equity?

A: When we first looked at these specialist funds in 2009, we asked whether they could outperform generalist funds. In the US and Europe, the returns for specialists aren’t necessarily better than for generalists. Now it’s not a question – you must be a specialist, particularly in China. This means generalists having dedicated teams for the sectors they cover. We have 15 funds in our portfolio and I would say half are specialists. We invested in Pop Mart alongside Black Ant, a consumer specialist. The firm didn’t exist five years ago. We backed their renminbi fund, they grew nicely, and now they are trying to raise a US dollar fund.

Q: Are US dollar-denominated funds favored over renminbi vehicles?

A: GPs realize that having only renminbi or only dollars is not enough. With the trade war and a history of policy-driven uncertainty in China’s capital markets, having different pockets of capital is important. Some managers who used to have dollar funds only are now trying to raise their first-ever renminbi funds, purely for strategic reasons. They are prepared for the worst.

Q: What challenges do local managers with experience in the renminbi space face when raising US dollar funds?

A: Most of them are first timers. They need to think about how to explain their strategy and focus to investors outside of China who cannot meet them in person. A lot of them use placement agents to help them construct the story. LPs in dollar funds put a lot more emphasis on how institutional you are and how sustainable your team is than LPs in the renminbi space.

Q: Has renminbi fundraising recovered from the drop-off in 2018 when regulations were tightened for financial institutions participating in the asset class?

A: There is a lot of capital but most of it is within government guidance entities; the private sector – financial institutions and high net worth individuals – aren’t as active. Local governments want to transform traditional businesses to the new economy, so I’m not surprised they are still launching these funds, though they are smaller than last time around. The performance matrix for these guidance funds is not really about a 3x return, it’s about bringing new business opportunities, employment tax, and industry guidance. A 6-8% IRR is fine if other requirements are met.

Q: What work are you doing with portfolio GPs on environment, social and governance (ESG) programs?

A: It’s very early stage – we don’t want to overwhelm managers on day one. We provide guidelines; we tell them what we are doing as a UN PRI signatory; and we have them start up ESG mechanisms within the GP structure and that trickles down to investment decisions and portfolio management. We realize the difficulty implementing that in emerging markets, so we are very patient. 

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• Topics
• Greater China
• Fundraising
• Renminbi fund
• Technology
• Early-stage
• LPs
• China
• Starquest Capital