Q&A: Vertex China's Choon Chong Tay

Q: What exactly has changed in the structure and organization of Vertex Ventures China?

A: Previously, all the capital came from a single investor. We have now raised more than $200 million for a China-focused fund and Vertex Holdings contributed slightly less than half of that. The rest comes from endowments, family offices, and fund-of-funds. We retain an affiliation to Vertex - and we are keeping the name - but the structure incentivizes us to be more returns-driven because all the economic interest now comes to the China team. Investment decisions are now also taken locally, whereas previously we had some external participation in the process. This change in structure applies to most of the Vertex teams and Vertex Holdings will allocate $600 million to various independent funds.

Q: How much capital was previously allocated to China?

A: We started about six years ago and we divide it into two periods or funds. We had $80 million between 2009 and 2013, and then $150 million between 2013 and 2015. We have made close to 40 investments there have been seven exits so far.

Q: Which exits stand out?

A: There have been two realized returns of more than 10x, both from Fund I. We invested in 91 Wireless, a mobile app store business, in 2010 and it was acquired by Baidu three years later for $1.9 billion - at the time it was the largest acquisition by an internet company in China. The other one is a mobile gaming company called IGG, which we backed in 2008 and went public in Hong Kong in 2013. We also have a range of exits between 3-8x across both funds, and only two losses.

Q: To what extent are you seeing a wider variety of exit options?

A: It is no longer just about IPOs in the US. We listed IGG in Hong Kong and we have another portfolio company waiting for a listing in mainland China. Trade sales to local companies are another good exit point. In addition to 91 Wireless, we recently sold part of our stake in Meilele, an online-to-offline (O2O) furniture retailer, to Shanghai-listed Guangdong Yihua Timber Industry. We like the buyer because it can help in other aspects of Meilele's business and that was why we just did a partial exit - we see more upside in combining Yihua's expertise with that of Meilele.

Q: How much exposure do you have to the O2O space?

A: We have invested quite a bit in e-commerce side and in local services. These areas have a lot of potential because the services market is underpenetrated and the infrastructure is poor. Companies can take advantage of that through the internet. Meilele was one of the first to use online traffic to drive customers to offline stores where they can look at furniture and make purchases. The showrooms don't have to be in prime locations - because the customers come to them - and this saves so much on rental. We had a lot of interest from offline furniture companies that want to look at how they can address changing customer behavior. We have another portfolio company - Loho - that executes the same business model but for spectacles. They sell trendy spectacles at reasonable prices and people have to come to the store to get a prescription and try them on. Loho has grown to more than 100 stores in just 18 months.

Q: What about O2O local services specifically?

A: We have invested in a number of businesses that address different market segments. For example, Ayibang is a platform through which users can book part-time maid services. You can make bookings in real time, you know what the rate is going to be, you know where the maid is from, and you can find out how the maid has been rated by previous users. The maids become their own employers, they can manage their own time, and they can make more money. QingSong has a similar business model but for repairs - you can book professional repairmen, who provide standardized services and charge standardized prices, to come to your home and service air conditioners, washing machines, radiators and other appliances.

Q: How important frequency of use when trying to build scale in these businesses?

A: With Aiyibang and QingSong, it is not so much about getting high frequency as having customers trust your brand name. We spoke to consumers and there is definitely demand for these services. They don't really have anyone to provide them apart from mom and pop shops where the quality of service is unknown. With the emerging middle class, you can address a sizeable market serving appliances. Take wedding services, for example. This is a huge market, the frequency of use is low - maybe once in a lifetime - but when people do use the service it is a very intense experience. You provide a lot of wedding ideas, such as where to do the photo shoots and where to buy the rings, and customers place a high value on that.

Q: What are your views on companies that spend a lot on subsidies to achieve scale? And if scale is not achieved, what are the exit options?

A: Initially, companies might spend some money on marketing and promotions but in the long term they have to develop loyal customer bases so they aren't just competing on price. There has to be a depth of knowledge and technicians who are skilled professionals, so it is hard for companies running large platforms to do it themselves. You need this kind of barrier to entry; it's not just about getting a lot of users on board. As for exits, if we don't think the market size can reach at least $1 billion then we probably stay away.

Q: What are you seeing in terms of valuations in China?

A: Valuations for Series A and B rounds went up quite a bit in the first half of the year, but since then we have seen the market return to more rational levels. Given what has happened with the public markets, investors have become more bearish. Companies are now willing to engage you and let you carry out due diligence instead of just rushing around trying to get deals done. I don't think there will be a heavy valuation reset; it's more binary than that. Companies that are good can still raise capital at high valuations.

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• Topics
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• Vertex Management (II)
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