Editor’s note: China’s venture capital and private equity industry has undergone huge shifts over the past few years, thanks to a sea change in the global and domestic socioeconomic climate.
As Chinese businesses struggle to adapt to the new normal, marked by more stringent regulatory oversight against overseas listings, a Covid-battered economy and dwindling household consumption, and stronger headwinds as startups move up the value chain, so will their financial patrons.
How are VC/PE investors faring in these turbulent times? What are the challenges they deem the most intractable and what are their solutions? Conversely, which are the emerging areas of opportunities that can be turned into the next money-spinner with their Midas touch? More generally, how do they expect China’s entrepreneurial scene to evolve in the next couple of years? And most importantly, after having their finger on the pulse of the country’s innovations, are they still China bulls or have turned perhaps into China bears?
These are defining questions to which no one has the exact answer. But we at EqualOcean believe that one can at least get a glimpse into the future of Chinese economy by looking at how VC/PE investors are planning and making their moves.
With this in mind, we start a new series called “China VC Interview,” in which our analysts will sit down with frontline industry practitioners to hear their opinions about China’s VC/PE industry.
The following is the first in this series, conducted by our analyst Niko Yang after his talk with Liu Bin, founder of Real Fund (Chinese: 真为基金)
Niko Yang: China’s new energy industry is developing rapidly. Based on your experience, in what aspects have the government and the market done well?
Liu Bin: I believed the central government and the market participants had played a good role in the new energy revolution. In the early stage of the new energy industry, the Chinese government has given a lot of policies to bolster this sector, guiding productivity factors such as capital, talent, technology and resources to flow to the space.
Firstly, the government performed well, especially in laying the foundation. With the investment of resources in the early days, new technologies continued to emerge, and the gaps between firms were gradually reflected. The invisible hand began to play its role, and the government’s industrial policies were flexibly adjusted and steadily dropped. Innovative companies gained the first-move advantage, and these players slowly won the competition. A large amount of outdated capacity has been eliminated. The whole industry has also gone from quantitative into qualitative changes.
Take the new energy vehicle (NEV) industry as an example. In 2009, China began to introduce policies aimed at demonstrating and promoting 1,000 EVs in 10 cities. Then it started promulgating the policy regionally in 2013. Two years later, China began nationwide promotion.
During the process, many doubts were cast about NEVs, such as subsidy fraud and EVs catching fire. These incidents went viral on the Internet, and people worried about these “new gizmos.” Some people also have mixed opinions about the subsidy. After years of ups and downs, China has become the world’s largest NEVs market.
In addition to the incentives above, the Chinese government has released adaptive industrial policies.
The expansion of the NEV sector accelerated as the subsidies were gradually phased out since 2019. The government supports “the elite and the strong” in the post-subsidy era. Especially in the area of pushing technology boundaries, they have done an excellent job, including by increasing the lower limit of subsidy for EVs with battery energy density from around 90wh/kg in 2017 to about 105wh/kg now.
The Ukraine-Russia conflict made it hard for European countries to access enough energy, with Germany feeling the most pain. An energy structure reliant on a single source of energy is a significant threat to national energy security. With respect to this, Real Fund believes that the Chinese government is forward-looking, in the sense that it balances the use of new energy and fossil fuels. It is where China’s natural endowments came into the picture. For example, China has a rich reserve of coal and a smaller oil and gas deposit.
In recent years, the government has repeatedly said that new energy transformation needs to assume the format of (先立后破), meaning breaking the old energy structure to create a new one. I agreed with the idea. The energy transition must first ensure energy security and then seek the low-carbon transition.
The transformation has gone to the phase of market competition. To safeguard fair competition, China proposed to build a unified national market, cleaning up the many practices that impede the single market and fair competition across the country. It also released the anti-monopoly and anti-unfair competition regulations. These supportive measures will take effect. The country’s prime minister Li Keqiang proposed to establish a unified national market for NEVs two years ago. At that time, the NEV space was booming, and many local governments supported it and issued many preferential policies.
In short, the winners will stand out from the market competition.
Niko Yang: What is your investment logic behind the representative portfolio of your institution?
Liu Bin: We have invested in NETA Auto (Chinese: 哪吒汽车), which ranked second or third in monthly sales several times this year. When it comes to investing in the new energy segment, Sincere views from the perspective of the whole NEV supply chain. The NEV is a suitable terminal helping allocate energy. In addition to this, Real Fund invested in several companies dedicated to upstream and downstream auto services, such as NAAS(Chinese:能链智电), a third-party charging station operator.
In the case of investment in NAAS, Sincere is of the view that the company’s app is connected with most major charging infrastructure operators, including Teld(in Chinese:特来电) and Starcharge(星星充电). These will stand to benefit as China has massive demand for EV infrastructure. The EV to charging pile ratio was 3.5 in 2017 and declined to 3.1 in 2021. The pace of charging pile installation is slower than that of the fast-rising EV sales. As part of the government’s planning, the target ratio is 1:1 by 2030. What’s more, NAAS is a subdivision of Newlink, an energy solution provider backed by Bain Capital. This means the company can leverage Newlink’s other business, fostering synergies by spurring users to transit from fossil fuel to new energy.
Sincere also bets on the self-driving technology, which is part of the NEV ecosystem. In 2020, we injected capital into Hesai Tech(in Chinese:禾赛科技), a leading Lidar maker. Sincere believes that electricity generated by solar and wind power can be used to charge NEVs, making it possible for NEVs to realize autonomous driving with the help of sensors like lidars.
All in all, when exploring appropriate opportunities, Sincere would weigh the deal from the standpoint of prices and the next big thing in the value chain.
Niko Yang: What are your observations about this sector amid the risk of a slowing global economy?
Liu Bin: Factors like the Omicron viral outbreak in China, wars in Europe and a US interest rate hike may temporarily impact the NEV industry, but the long-term growth of the sector is constant.
China’s NEV industry has gone through a consolidation period or the survival-of-the-fittest phase, with a dozen incumbents remaining intact, as opposed to over 100 carmakers in the early years.
On the other hand, China has begun to issue “peak carbon emissions” plans. Its ministries and commissions have published a series of programs to guide the implementation of the “dual carbon” strategy. During the annual gathering of the National People’s Congress and the Chinese People’s Political Consultative Conference this year, Premier Li Keqiang delivered the government work report, laying out some arrangements for realizing this goal.
Judging from these aspects, our fund believes that solar power, offshore wind power and energy storage will see greater growth this year. In the next few years, we estimated that the compound annual growth rate of pumped storage power stations could reach between 13% and 15%. In contrast, the growth rate of the electrochemical energy storage market could be over 50%.
In terms of NEV sales, this year’s growth rate is a bit lower. But compared with internal combustion engine (ICE) vehicle sales, the increase is more significant. Although the chip shortage, the rising power battery prices and the disrupted automobile supply chain in Shanghai have affected car production, Real Fund thinks the ascendency of NEVs is irreversible, and it has an excellent prospect. We expect the best investment opportunities will come from this sector and related fields, followed by distributed photovoltaic power, offshore wind and energy storage.
Niko Yang: What type of companies will experience high growth next?
Liu Bin: Leaders in each niche market are likely to win the upcoming competition. The new energy practitioners have formed a certain barrier in areas like technology and financing ability. The competitive landscape of the sector has passed the phase of free contention, manifesting high industry concentration. For example, LONGi Group carried out research on monocrystalline silicon -- a relatively small direction long ago -- for a few decades, lifting its market value from less than CNY 10 billion to hundreds of billions of CNY.
The whole new energy market is far from saturated. Each of these market segments has a lot of room for growth — promising enormous opportunities for various startups to seize. Real Fund has been evaluating projects from two facets: technology innovations and business models.
Many nascent companies have significant capital and human resources deficiencies compared with large ones. But if these firms can focus on a specific scope and make goods, for instance, wind turbine bearings, or building-integrated photovoltaics, they have a lot of room for growth in these markets.
Take NETA Auto, which can be seen as an example of business model innovation. The company’s market position is in the lower-tier market, catering to the bulk of consumers in Chinese society. After all, this market is the largest for NEVs.
The Chinese government has vowed to grow the GDP by 5.5% this year despite a wave of Covid-19 outbreaks. I expect the central government to introduce industrial policies similar to those in the previous years, such as “sending cars to the countryside.” For affordable EV makers like NETA Auto, they should be able to enjoy more policy dividends.
Niko Yang: How do you view the global energy transformation given that many countries have set big goals on carbon emissions?
Liu Bin: China’s new energy market is growing rapidly, and this is inseparable from the government’s support. After years of development, the market experienced many fundamental changes. As subsidies decline, the NEV domain is still growing at high speed. Sincere thinks the growth is guaranteed over the next five to 10 years.
Other countries’ situations may be different from China’s. For example, some nations have a track record in making ICE vehicles, their price–performance ratio is higher, and the brand is trustworthy. Ownership of traditional cars is commonplace, which leads to resistance to embracing NEVs. Second, some countries like the US have abundant oil and gas reserves. This is different from the landscape in China.
On the one hand, China has a very tight schedule and a burdensome task to achieve the “dual carbon” target. On the other hand, the structure of the country’s new energy industry continues to be optimized. EV “new forces” are gaining bigger market share, while traditional car makers like SAIC and GAC are also on their way to shifting to E-mobility.
Some people think that capital inflates bubbles in the new energy space, but from a historical point of view, investment in a promising sector is always accompanied by bubbles. Investors had better get used to bubbles. In a nutshell, investment institutions must seek truth from facts.
People attribute China’s first-mover advantage in new energy to the lavish subsidies it showered on the industry. In the last two years, Europe and Japan began to stimulate these sectors by doling out fiscal largesse as well. The future competition among countries on new energy will center on innovation. In this sense, there is no stone to feel to cross the river for China; all it can do is to continue innovating technology and business models.