Bridge the Gap

The Real Danger from the Bailout

I've been back in the US for several weeks now and watching the financial crisis and response unfold.  We'll see where the markets open up tomorrow, but what really concerns me is not so much the short term - frankly I think that the US economy is going to be in for a long recession.  And as much as I feel pain for people (and my own investments) this is a cycle, albeit a difficult one.  It will be a long trough and I guesstimate 3-4 years before we dig out. 

Europe will probably take longer to rebound given the lack of coordinated response capability and it is still unclear the impact in other parts of the world.  I think China will hurt for a while, as companies seem already to be having problems with credit terms and solvency.  The export focused groups are going to get killed, but this continues a trend that has occurred over the last year.  Since the RMB began to appreciate I have heard talk that 10+% of manufacturers (many with razor-thin margins) have been forced out of business.  Now that orders from overseas are being cancelled or postponed, it can only get worse.  For the domestic focused companies, the market is relatively better, but given the huge drop in the stock market this year and the reduction in home values, the consumer and corporate spending free seems to have been reined in.  Look for China's GDP growth to come in at 8% this year and lower next year.  Upshot: fewer jobs being created, which will cause major headaches for the mandarins in Beijing.

The biggest concern I have for the US though, is not the pain of middle America or the level of the Dow.  Mind you, I feel terrible for people that are getting kicked out of their homes and small business owners that are being squeezed because they can no longer get enough credit.  The biggest concern I have is the medium-term threat to the United States' position in the world.  For the time being, although the Treasury and Fed have been somewhat piecemeal in their actions, there has been no concern over the Fed's dwindling balance sheet or Treasury spending.  (Remember, Treasury spending is in the budget, but they are the ones printing money).   However, if the government fails to stabilize the markets and global investors start to doubt solvency, then we could be looking at a situation where the US dollar loses its luster. 

Far fetched?  Maybe and I hope so.  The Euro is certainly not a safe haven and thankfully there is no other currency that can act as a global unit (thank goodness an Asian currency unit has never really made it beyond the research pages).  But if oil is suddenly not priced exclusively in dollars or one or another government begins to buy fewer treasury bills, then a depreciation of the dollar by 20, 30 or 40% is within the realm of possibility.   For now, although the government has not been sufficiently clear with Main Street on the why of the bailout and bank buy-in and President Bush is clearly out of his depth yet again, other parts of the world have been more futile in their responses (perhaps save the UK).  What is critical is that the next president, whether Obama or McCain (full disclosure I am working for the Obama campaign right now and will be clinically depressed if McCain somehow wins), has to reassure the domestic and international community that the US is strong, solvent and ready to reclaim its leadership role.

Private Equity in China, or Where I Have Been for the Last Month

So you might have noticed that BTG has been lacking in new entries as of late.  The major reason is that I have come back to the dark side and returned to the financial industry.  I joined a private equity shop about 6 weeks ago as a Director, helping run the day to day business of the firm.  Since that time I have been in Shanghai, Fuzhou, Xiamen, Tianjin, Beijing, Harbin, and Hong Kong, doing marketing and beginning work on a new investment.  It's been an adjustment after my relative life of leisure earlier this year, but it is extremely interesting.

Private equity in China is still developing, so the established models one finds in Europe and the US simply are not here.  That makes the deals much tougher to do, but also more rewarding (potentially).  I have to say that I am learning a ton and really enjoying getting my hands dirty again after my high level, macro focused work at Intel.  More about the new company in a later post, but wanted to say hi to everyone again and let you know that I will not be quite so absent going forward.

Golden Pig Stock Market: 14 Days to 4,000

Amazing.  The Shanghai Composite Index closed above 4,000 for the first time ever today.  It took just 14 trading sessions since the index broke through the 3,500 barrier to reach the new peak.  This in spite of another hike in bank reserve ratio requirements during the same period.  The market is clearly not cooling at all, so expect more aggressive action from the government to try to better control what is even by China standards a major market bubble. 

China Venture Capital & Private Equity Forum Report

Back in Shanghai from my Shenzhen trip.  Was a good week, spending a few days checking out a potential job opportunity and then attending CVCF. 

CVCF was a bit of a letdown in the end.  The conference was very busy, with 1,000 reported attendees.  It was a great opportunity to learn about VC and PE if you were an aspiring entrepreneur, but if you had been around the block once or twice it was rather disappointing.  The attendees were mainly entrepreneurs, consultants and bankers, with a smattering of principal investors.  The highlight of the two day affair may well have been when Tim Draper of DFJ fame serenaded the awkwardly smiling audience with a 5 minute folk rock song entitled "The Riskmaster."

There were quite a few big names on the panels, but strangely the presentations and Q&A were mostly lacking in insight.  They typically went along these lines: 1) The China VC (or PE) market is growing; 2) These are the types of deals our firm does; 3) Here are some examples.  Basically, stuff you could read about on any firm's website. 

I was very much looking forward to a panel on exit paths. However, instead of debating the merits of domestic versus international IPOs versus M&A, the panelists used the time purely to promote their particular exchange; there was no analysis whatsoever.  The PE folks confirmed that (no surprise) they mainly are focused on minority investments in growth capital and pre-IPO deals.  Given government concerns about selling control of assets to foreigners, the traditional buyout market is just not yet realistic. 

On a positive note, there were some interesting new nuggets of information.  Andy Yan from SAIF pointed out that Israel's VC industry is still four times the size of China's, which is a pretty remarkable statistic when you compare the populations.  I was also surprised to hear one panelist say that the typical Chinese VC only gets about 5% of carry on a fund (normally this is around 20%).  I knew it was less than international funds, but 5%!; no wonder purely domestic VCs struggle to keep good talent on hand.

Overall, CVCF was worth attending, but not stellar.  I learned far more about the latest investment challenges and themes when I was in Hong Kong a few weeks back meeting with my VC and PE contacts there.  Still, hats off to the organizers for putting together such a large conference; hopefully next year they will have a more interactive format and push their panelists to use the time more for analysis rather than marketing.

A Little Later Than Expected, But We Are Above 3,500

The Shanghai Composite Index closed at an all time high today of 3,531.03.  It is the fist time the index has closed above 3,500.  I predicted at the Chinese New Year that we would see 3,500 by the end of March - so my timing was a bit off.  We had a short term pullback in late February, but since then the index has just been going up and up.  Seems like it is time for another pullback or at least a breather, but we will see.  For those keeping score, the index is now up almost 32% for 2007.

I'm in Shenzhen at the moment and will be attending the 9th China Venture Capital & Private Equity Forum tomorrow and Saturday.  I'll be posting reports on the latest thinking of the assembled who's who of the China VC/PE worlds, so stay tuned.

Golden Pig Stock Market Rollercoaster: Here We Go...

The Shanghai Composite was up 1.4% yesterday to 3040.60, then plummeted 8.8% today.  We are at 2771.79...

China Stocks: If You Thought the Market was Crazy, Just Wait 'til Tomorrow

The stock exchange in Shanghai will reopen tomorrow after the Chinese New Year Golden Week.  It seems that every Chinese person I know is talking about the market and those that have not taken the plunge clearly feel left out.  Scary memories of bubble era US markets in the late '90s aside, I fully expect the SSE Composite to open strong tomorrow and continue its upward climb over the next few months.  Having just teased everyone on the 16th by breaking through 3,000 for the first time, the index settled back to close at 2,998.47.  I would not be surprised if we see 3,500 or 3,800 soon.  I also think there is a real chance we may be below 2,500 at some point later in the year.  It is just that type of market.

There are lots of arguments on both sides of the market.  If you have not read any China financial news in the past few months here's a very brief recap: China's stock markets were in the doldrums in recent years due to low liquidity, memories of past scandals, rampant insider trading, poor shareholder rights records, and low corporate profitability, amongst other factors.   Last year they were up about 20% or so through the early autumn, then in November and December they went on a tear.  The SSE Composite was up over 130% for 2006 overall.  In spite of government comments that briefly spooked the market in January, the market has continued to soar this year.  It now trades at around a 35 P/E.

Recent opinions for the near future range from an Op Ed in the Journal holding that the market will sustain due to the large supply of pent up savings whose owners are looking for higher returns, to some sceptics saying a dot-bomb like collapse is inevitable due to low profitability at the majority of listed companies, while still others take the middle ground and see a mild correction while people catch their breath.  The only problem with that last scenario is that a large part of those investors who have been on the sidelines seem about ready to jump into the market.  Sitting around tables during the holidays talking with family members who HAVE been in the market set the gears turning in a lot of folks' heads.  In addition, with all the new regulations on real estate investments, the stock market is definitely the flavor du jour. 

I will make three predictions:
1) In March we will see the Shanghai Composite close above 3,500;
2) In 2007 there will be a close above 4,000; and
3) There will be a large (20+%) pullback later in the year due to government actions/regulations, some sort of scandal, or simply herd paranoia. 

In any case, hold on to your hats.  It's going to be an interesting Golden Pig Stock Market!

Grad School Days

I just uploaded a group of papers from my days at Johns Hopkins SAIS.  These were on my old personal website and people seemed to enjoy them.  If you have some time, you can check out some ramblings on politics, economics, and defense issues related to China, India, Japan, Korea, and Mexico by following the links in the Grad School Days section on the right side of the page.