Q&A: Legend Capital's Richard Li

Q: What are your expectations for relations between China and the US?

A: China has grown up to become the second-largest economy in the world. The relationship between China and the US is increasingly complex, especially after COVID-19. I expect the sorts of conflicts we have seen recently to continue for the coming five to 10 years, at least until China’s economy becomes larger than the US. Over the past three decades, China has benefited from globalization. Now, though, we see global value chains restructuring. China, the US, and Europe – and the likes of India and Korea as well – are all trying to build supply chains that are more independent. This leads to rising competition and conflicts. We call it sustainable co-existence. On the trade side, for example, China will continue to be an important partner because it is the largest manufacturing center in the world and one of the largest consumer markets.

Q: China claims to have entered a new era of development. What does that mean?

A: Economic growth has averaged 8% for the past 30 years, but the government knows this rate of expansion cannot be sustained. There is much more emphasis on the quality of growth, and on the risks created by a widening gap between rich and poor. The near-monopoly positions occupied by the country’s internet giants and the economic burden created by rising costs in education and healthcare – these are seen as detrimental to society, which is why the government has introduced so many regulations in the last 12 months. Whether it involves closing the wealth gap, bringing large companies under control, or banning the abuse of personal information, the goal is to make the economy more sustainable. In that sense, what we have seen in China is not so different from what happened in the US and in Europe. They also wanted to address these risks, but China has moved on it in a very short timeframe, which it can do given the structure of the economy. Some foreign investors need more time to understand the situation.

Q: It has been suggested the regulatory push is in part a response to action taken by the US in areas such as trade, finance, and technology. Do you think there is a connection?

A: I think US-China tensions, as well as the pandemic, have contributed to an acceleration in related legislation and supervision. But the anti-monopoly policies, the tighter supervision of education, and the data security regulations are not entirely new. For example, there is a widely held belief that China sought to ease its reliance on exports in the semiconductor industry because of US trade action. In fact, the Big Fund [formally known as the China National Integrated Circuit Industry Investment Fund] was launched in 2014. The driving factor was the size of China’s market and concerns that a lack of supply chain control in key areas could be detrimental to national security.

Q: Which areas stand to benefit from these regulations?

A: For 20 years, foreign investors have focused on consumer-internet because it's easier to understand and there are plenty of reference points in the US – companies are labeled China's Amazon or China's Google. Now, though, technological innovation has become more important as a source of future growth, and the government has launched programs in areas like decarbonization, new energy, electric vehicles (EV), semiconductors, software, and big data and cloud computing. There are a lot of opportunities.

Q: In the semiconductor space, how much of the investment thesis is based on import substitution?

A: We have invested in chip designers, foundries, and semiconductor packaging companies. We cover the entire supply chain, upstream and downstream. But we don't just want to focus on the replacement of low-level products. There must be evidence of true innovation, such as RISC-V, which is the new standard for semiconductor design and packaging.

Q: Are we also witnessing a realignment in terms of exits, and the relative importance of the US to Chinese start-ups?

A: A lot has changed in a short period of time. It’s clear the government wants new economy and technology companies to list domestically, including in Hong Kong, rather than relying on the US markets. The private equity and venture capital industry is heavily dependent on the US dollar and the US capital markets. GPs raise money from outside of China; invest in China through VIE [variable interest entity] structures; and exit via IPOs on NASDAQ and the New York Stock Exchange. It won’t be sustainable in the future. US dollar-denominated investors must understand that we need to invest in China through joint-venture structures, rather than VIEs, and do more IPOs on the A-share market or in Hong Kong. We’ve done about 100 IPOs in the 20 years. More than half were on the A-share or Hong Kong markets, and over 20 used joint-venture structures.

Q: With more onshore exits, will renminbi funds will become increasingly important？

A: Our US dollar and renminbi funds are both investing in technology and industry empowerment by technology, but are different in terms of niche segments, deal profile, and exit channels. US dollar funds are unable to access sensitive areas that relate to data aggregation or national security, but for deep-tech, hardware, software, and new drug discovery, there’s no problem. US dollar funds will continue to play an important role in China, since US dollar funds are usually longer in fund term, and have a much established and mature LP base.

Q: How do US dollar funds move investment proceeds offshore?

A: The channel is transparent, there’s no problem. You register with the government, disclose your entry and exit amounts, and then convert renminbi to US dollars, paying a 10% withholding tax. The money leaves the same way it came in.

Q: What areas or business models would you avoid under this new normal?

A: First, the cash-burn business model is no longer valid. Previously, investors could pump capital into consumer-internet companies, scale rapidly, and leverage low pricing to kill off the competition and establish monopoly positions. They would convert internet users into consumers and monetize that traffic by controlling data flows. We don’t like business models that achieve monetization by leveraging data. Second, investors must be careful around basic services – like education and healthcare – that are inextricably linked to people’s daily lives. The government wants to control costs, or even reduce them, which will be problematic for monetization.

Q: Does that mean telemedicine platforms that connect patients, hospitals, and pharmacies would likely be targeted by regulators?

A: Some companies build patient-facing networks and the business model is like consumer-internet in that they charge intermediary fees. Assuming these companies take $1 out of every $10, are they adding enough value to justify a 10% fee or are they just pushing up costs? They might argue that they make the relationship between hospital and patient smoother and more convenient, but this can also be achieved by being a technology provider. A start-up might deliver SaaS [software-as-a-service] to hospitals, enabling digitalization. It earns its service fee based on the technology provided, which is very different from taking a cut of each transaction based on control of data.

Q: Would you still consider consumer-internet investments?

A: We divide technology investments into three themes: software and hardware with ties to infrastructure; technology-enabled industries such as transportation and manufacturing; and platforms that directly face end-consumers and provide services. We are very cautious regarding the last theme. We examine the logic behind business models. It is destructive – for example, predicated on overwhelming competitors and controlling data – we wouldn’t touch it. We are fortunate in that we focus on technology and have an industrial background. In 2001, we made our first investment in the semiconductor space. In 2005, we went into lithium batteries, and in 2006 we added pharmaceuticals and drug discovery. With the current regulatory direction, we feel much better than before.

Q: How quickly did you expand across the EV supply chain after making that first battery investment?

A: That investment came about because of our close relationship with the China Academy of Sciences. We helped them convert their battery technology into products, even sending in people to serve as CEO and vice president of sales and marketing. Now, the company is China’s largest manufacturer of lithium batteries for use in electric bicycles. We were also one of the first investors in CATL [Contemporary Amperex Technology, a battery supplier to Tesla with a market capitalization of $234 billion] and we have a lot of exposure to autonomous driving technology. There have been 30 investments in that space in the past 15 years.

Q: What is the next big opportunity?

A: Intelligent power networks. We’ve made a lot of investments in software companies that support energy providers by helping them control battery life and optimize network efficiency. We are also interested in battery recycling – used batteries can create a lot of pollution – and intelligent EVs. Right now, a lot of the capital is focused on electrification. The next phase will be smart cockpits, which will lead to opportunities in semiconductors, sensors, and autonomous driving.

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• Topics
• Greater China
• GPs
• Regulation
• IPO
• Technology
• Early-stage
• China
• Legend Capital
• TMT