It is nearly 12 months since I last penned my thoughts on China. Why you might wonder has it been so long between drinks? Well, truth be known, there was not a lot else of great significance that I could add to my previous musing. There is so much information added to the many sources available today that I think it needs to be something that I believe you, dear China reader, can use should you want to, or indeed be undertaking business in China.
However, I have been struck recently by how much money a number of very experienced major investors and fund managers, mainly the latter, have lost, or are losing in China. Therefore, I decided I might be able to impart a few ideas that could be worth your consideration.
In the case of private investors, I don’t really worry myself too much because they are most likely to be using their own hard earned dollars. In the case of the latter, it is more likely they are applying the age old investment strategy known as “OPM.” (OPM = Other Peoples Money dear reader, yours’ and mine). They have done a bundle in the west and are now ‘experimenting’ with this simple strategy to invest in China.
I use the term ‘experimenting’ because once you understand why so much hard earned money (yes it belongs to the average punter via their Pension contributions) is being lost, the only conclusion one can reach is that it is an experiment! China is a big laboratory for financial experimentation. Only thing is the monkey keeps escaping because someone keeps leaving the lab door and windows open and unattended!
I marvel at how some of the worlds most renowned fund managers have lost such enormous, and I mean ENORMOUS amounts of OPM in recent times. Not only bad bets, but poorly implemented investment strategies in China. The amounts, in only a few cases, you can count on one hand, exceed US$1bn and that does not count all the poor souls that have lost money through fraudulent trade in China.
In three cases, the numbers go something like this, -$400m, -$230m, and -$460m. No small biscuits! Why, I don’t really know other than a rush to jump on the China growth band wagon led to poor analysis and investigation of investments. Yes, I realise that most readers are unlikely to be investing this much money. It is however, all relative. Can you afford to lose $40,000 through a badly implemented strategy? I know I can’t.
You will recall in my previous missive on China that the approach needs to be founded on a long term commitment and that that requires (indeed necessitates) a great deal of patience and persistence. A part of the exercise is to maintain, a disciplined approach throughout.
Have the patience to build deep rooted relationships. Keep as much of your powder dry until you are ready to move. Sure, there are many stories of people that have gone to China and started trading immediately. Note, I said ‘stories’. You can choose to listen to the stories and follow suit (I would rather go to the Crowne Casino in Macau. More fun and less to lose) or be your own person and stay the distance. Identify companies with a board of directors, and management that will be prepared to make $2 or $3 over the longer term rather than go for the quick buck today.
Okay, okay I hear you, so you want something now!
Presuming enough ground work through your professional searches, appointments, associations and other interactions, has been done that you now have good network of dependable domestic Chinese expertise, then you are ready to move as a team on consummating your financial investment in your target ( I do hope you do not turn out to be the unwitting target!). If all is well on this front then it is time to consider due diligence.
This is not a choice, it is critical. I am not going proffer as to why this aspect has been so problematic for so many investment forays into China. I can only surmise that has to do with the excitement of the project, poor risk management, or simply laziness. Problem is you are not going to know for a while after the investment is made whether you have been diligent enough or not.
So, how much and what is the due diligence likely to involve? There is, of course, the standard due diligence approach. Any half decent corporate or legal adviser is going to have an ‘off the shelf’ due diligence check list. Review the check list, if it looks similar to one you might encounter in the West then I suggest you might have to reconsider your advisers position. This is China, remember what I said last time around, ‘Think Global, act Chinese’.
Go DEEPER than you have ever gone before. You are venturing into your ‘Mariana Trench’. There could be nasty things there you can not even imagine right now in all the excitement and they will bite you right on the arse if your not wary. Here are a few things to think about;
Operating site visits – crucial in remote locations. I have visited sites where I have been around a factory that has buildings that are supposed to house operating equipment, raw materials, or finished goods. For whatever reason we can’t gain access. A big red flag!
Remember the investor that visited a very busy plant his company was investing in. There were hundreds of people milling about; trucks were moving in and out. The activity was frenetic. After the investment went pear shaped the Managing Director of the Company recalled visiting the factory.
He was corralled into the main office building were he was fêted in a plush board room and offices by the Company and local Government officials.
He left thinking; at sometime he would ‘…got back for better look.’ In the end, it was all a well managed charade. All the ‘employees’ were locals hired for the day to put on a show.
Operating assets assessment – make sure EVERY piece of equipment operates as you expect so inspect it yourself. If there are three shifts, visit a different shift on different days without notice. If this is difficult to agree with your target, why?
Access – is access available to the business to facilitate operations, supply, and dispatch, i.e. can the access roads handle the likely traffic said to visit the business?
Market research – if your product is going into China ensure that the research is genuine and soundly based (See Project RED below). The ‘China syndrome is still alive and well. Acknowledge the reality of your market and competition. Trying to outsmart the Chinese on their home turf is just plain dumb.
Are the Company’s customers and suppliers as described to you – visit materially important suppliers and customers YOURSELF and ensure that discussions take place with the owners. This is particularly important where no Government entity is involved. Faking clients, (including client offices), invoices, bank accounts etc, is not unknown.
Locations – COUNT every location/office your target says they own or from which they operate. If you are in retail and you miss this step, go directly to jail and do not collect $100!
Check orders – always check that any orders you place match what you expect to receive when it lands. You will have heard of the farmers that ordered fertilizer, paid for it when it left China and found the container filled with soil on arrival at its destination. Why? No due diligence to cover the risk.
These are, but a few cautionary suggestions. There are many more. Having the patience and discipline to understand and manage the risk of investing is the key. Business in China is only now beginning to grapple with western style governance. The West doesn’t have it right. Give your target the benefit of your governance experience through sharing the skill you have developed. On reflection if one is not taking these precautions anyway in acquisitions or investments generally, it is no wonder so much investor money lost.
In 2008 Calcorp was invited to participate in the financing and building of a small beverage plant to bottle and distribute Australian wine. The Chinese Partner was a Shanghai listed company that at the time had approximately 3,000 distributors throughout China. With such a captive distribution network, how could we miss? After all, we only need a fraction of the distributors to support us for our project to be a winner.
The total capital investment was A$10m, all of which needed to be contributed up front. This is a standard government requirement and that needs reporting against once the project is operational
The project fortunately did not proceed. Our Chinese Partner did a great deal of market testing among their distributors. While there was acknowledgement that our products might have some traction, the distributors unanimously agreed that their market demand did not warrant the investment. We all agreed to pass, remain friends, and keep monitoring the situation.
We invested hundreds of thousands of dollars (note ‘invested’) in the experience. This is chicken feed compared to what we and our investors and partners could have lost. The saving grace, a partner with whom we had built a trusting relationship, they were domestic Chinese, really understood their market and let us in on their distributor feedback. Their support of our due diligence was incalculable. In Master Card terms, ‘Simply Priceless.’
Every time I visit China, I dine with or spend the day drinking tea and eating in the many tea houses close to where my friends live and we continue to discuss whether we think the market has shifted. One day we might do something. In the meantime, we enjoy each other’s company, at least I do theirs, and discuss how we might solve the worlds problems, sound familiar?
Respect and humility at all times is essential. Assume the worst but don’t show it. When it isn’t so, be delighted and send me an ‘I told you so’ note, I will accept in good humour. Try not to become a statistic. I fear though, that to earn your stripes in China you probably need to have an unfortunate experience. Make it as painless as possible and then don’t give up. Most of all keep having fun.
Your always curious China (opportunity) miner,
Neville Calvert is involved with various investments into and out of China as well as advising business. He can be contact at email@example.com