China venture: After the boom

Qiming Venture Partners' 2010 investment in Chinese start-up restaurant chain YPX Cayman was a product of its time. This was a period of relative calm in the venture capital industry and several investors dipped their toe into the consumer space while pursuing pure technology deals.

"The investment thesis was that Chinese economic growth was 10% a year, so in an offline sector that was fast-growing you could do 20% a year, and if you are among the category leaders you might be able to grow 40% a year. You didn't have to be on internet back then, and you could also pick up assets relatively cheaply," Hans Tung, who led the deal for Qiming, told AVCJ last year. "What has become more obvious over the past five years is the impact of e-commerce on the offline economy."

Qiming has accumulated more than $650 million in commitments for its fifth China VC fund, capitalizing on a technology boom that has seen select start-ups soar in valuation as they progress through the funding rounds. GGV Capital, where Tung now serves as managing partner, is expected to close its latest fundraising effort with $1.1 billion for a Sino-US strategy encompassing a core venture fund, a top-up vehicle and an early-stage fund.

If these experiences are anything to go by, demand for exposure to China venture capital remains strong. But what kind of investment environment will these GPs face in 2016?

A regression into the restaurant space is unlikely because the fundamentals that underpin the internet economy are still moving in the right direction. The combination of rising smart phone penetration and increased consumer spending is a recipe for disrupting existing business models, and its influence now stretches from e-commerce into a host of other segments.

However, the consensus appears to be that valuations have gone too far. According to AVCJ Research, $11.6 billion was deployed across about 860 China venture capital deals in 2015, up from $8.8 billion for a similar number of transactions the previous year. In terms of capital invested, 2014 and 2015 together are just shy of the cumulative total for the preceding four years.

But this does not tell the whole story. The vast majority of venture capital deals fall into the technology, media and telecom (TMT) space - $9.9 billion out of $11.6 billion - but the surge in later-stage investments in these companies is not fully captured by the VC data. There were 75 TMT growth rounds worth a combined $19.4 billion in 2015, up from $5.5 billion across about 30 deals the previous year.

KPMG and CB Insights' 2015 global venture funding report notes that median late-stage deals in Asia have been greater than both the North America and Europe over the past year, rising to $150 million (versus less than $50 million in the other two markets) in the final quarter. Yet the same report records substantial drop-offs in funding for VC-backed companies in North America and Asia - led by China - during those three months. It would appear that China's headline number is being held up by mega-deals as the broader market fades.

This corresponds to anecdotal evidence and AVCJ Research's records. China VC investment in the final three months of the year was the weakest since the second quarter of 2014 in terms of capital deployed. It was the same for TMT venture deals specifically even as growth transactions in that space held steady from the previous quarter.

It remains to be seen whether Chinese companies can continue to raise these mega-rounds. While consolidation will allow market leaders to strengthen their positions and pursue growth strategies that are not based on customer acquisition at the expense of competitors, the valuations will probably even out. Mergers of one-time rivals will also reduce the number of large players to be funded.

Early-stage may see their paper gains on these unicorns eroded and the possibility of complete wipe-outs cannot be discounted. But the leading players will gain more than they lose from the tech bubble, come the final reckoning. As to how the likes of Qiming and GGV will deploy their capital, questions will be asked about the viability of top-up funds that allow firms to participate in growth rounds for existing portfolio companies. But an early-stage space with more realistic valuations is an appealing prospect.

After all, in addition to backing YPX, in 2010 Qiming re-upped in Xiaomi and e-Hi Car Services and got its first exposure to Dianping.

• Tweet  
• Facebook  
• LinkedIn  
• Google plus  
• Save this article  
• Send to  

• Topics
• Venture
• Greater China
• Early-stage
• Technology
• Venture
• China
• Growth capital
• Technology
• TMT