Time For Chinese Money to Buy Silicon Valley Startups?

March 18th, 2008

The very dramatic unwinding of Bear Stearns and the purchase of its shares at a fire sale price by JP Morgan Chase has raised some very interesting questions.

Put simply, American assets are going to have to go at fire sale prices. We’re not talking about the Japanese buying Rockefeller Center, I mean real valuable and sometimes tangible assets. Remember that? And they will be denominated in US dollars, which most American banks still take. So this means a bargain on America for buyers smart enough to move quickly and take advantage of America’s double troubles on the banking and currency levels.

The Japanese in the eighties thought that real estate prices could only go up. Sound familiar? They learned that that wasn’t true in the nineties; it’s called “The Lost Decade” in Japan. Then US mortgage lenders sold the same crock of shit to Americans in 2002-2006 while the US Fed and Treasury passively looked on. Maybe someone can explain to me why there should not be at least a “Lost Couple of Years” in the US. Anybody who is thinking about buying US real estate now before the market has hit rock bottom needs their head examined.

Tom Foremski’s Silicon Valley Watcher has a very interesting article about how the investment banking crisis will freeze Silicon Valley M&A deals. According to the article, the Bear Stearns debacle means that many of the recent startups will run out of financing, which is now done by US investment banks, and may even go belly up because they are unable to obtain funding.

This represents an excellent buying opportunity for cash-rich Chinese corporations, venture capital firms and private equity firms to buy companies which have good intellectual property and/or business/sales relationships at very good prices. It would also be a good release of all that capital floating around in China, and is mostly going into real estate and other junk investments in China which don’t offer good ROI, especially with rising inflation.

There are three ways to do this: Chinese VC and PE firms could set up shop in SV and do the due diligence and offer term sheets and see what they come up with. So far, I have not seen any Chinese firm which has the people with the kind of capability to pull this off. There is a strong cultural component in dealmaking and most Chinese who have grown up and worked in China don’t have a feel for US dealmaking.

Or, they could partner with SV VCs, set up joint funds which the Chinese would fund, and which the American partners would do the due diligence on.

The third way would be if China Investment Corp. got really smart for a change and decided to buy several of the top-tier Sand Hill venture capital firms, funded them up, put in Chinese general or limited partners and/or board members, and started hearing pitches from entrepreneurs. The current crop of SV startups will start getting really desperate in 6-12 months, and that would be the best time to offer term sheets at favorable terms for the VC firms. (I’m willing to bet that even the leading US social networking sites will be going at low prices because they have not been successful in generating meaningful ad revenue even in fat times.)

To complete the M&A/IPO cycle, the Chinese would have to have partial ownership, preferably with a board seat/s, of one investment bank.

With all the mess on Wall Street, all they have to do is wait until the time is right.

Everything comes to he who waits (and has cash when nobody else does).

Unwinding Globalization

March 17th, 2008

JP Morgan Chase has just purchased Bear Stearns at $2 a share, an investment bank which was valued at $150 a year last year. Equity and capital markets are poised for a volatile week. The US Fed is set to make another rate cut, a desperation move, on Tuesday. This is likely to push the US dollar into free-fall, and set the stage for inflation in the US and later worldwide. More and more companies and individuals will choose to distance themselves from the US dollar.

Some time ago, I talked about why globalization, at least in its current form, would fail. Globalization has been oversold, especially in the US, where it was seen as leading to some growing kumbaya world where everyone just got along. That is not happening, and will not happen.

There is a strange resemblance between the way globalization was sold and the way real-estate was sold up until last year in the US. Up until 2007, Americans were told that real-estate prices would never go down, they only leveled off in bad times. When the bad times passed, then real-estate prices would climb again. Globalization was sold the same way.

It didn’t matter if American factories were relocated to China because Americans would find something else to do which would add greater value-added. Guess what? Americans haven’t found where that new value-added is, which in turn is leading to higher unemployment, and a generally angry population. We will see how their anger is channeled when the November elections come up.

In the meantime, Chinese government policy, through its VAT policy, encourages local governments to set up factories which waste energy to make products with very little value-added which Americans have bought on credit. Calling this real growth is just a fantasy, to use polite language.

This is why inflation is already flowing through the Chinese economy, first with food prices, and is now working its way through the system. It is likely that the situation will become much worse, and will soon hit the Shanghai and Shenzhen bourses.

The _real_ globalization where value is _really_ created is about enabling people to work productively in different regions with little or no damage to the environment, and enabling them to use their skills in a productive manner without having to travel great distances which previously took a lot of time. But that is not simple to explain, is it?

The business valuation models for these new productivity tools do not yet exist. Ironically, the valuation models for hocus-pocus subprime-mortgages did exist. It’s just that they got turned upside-down in a short time.

So what have all the risk consultants been measuring lately? I’d say that they’ve been out to lunch. That’s why, in these times, the Chinese approach to measuring risk makes more sense.

Not Changing Fast Enough (Part II)

March 16th, 2008

If there has been a major problem with the Chinese leadership, it has been its slowness to recognize that the old way of industrialization simply does not work with a population as vast as China’s. Western Europe, then later America and Japan were able to get away with industrialization because they had smaller populations and did not urbanize as quickly as China is now.

Not only does reliance on energy imports crimp China’s foreign policy in the near future, it is crimping the environment now. And the whole problem will only get worse.

This is the problem with the traditional view of industrialization and urbanization.

The tragedy for humanity and for China is that other development models are available. Using computers and virtual teams on service-related projects reduces the need for commutes and polluting transportation. Everyone will have to make some sacrifices in lifestyle, but the sacrifices are not that huge.

The trouble is that we are straddled with a bunch of old thinkers in leadership positions who can’t make the change to a new model fast enough. We are not in control of our own fate.

Not Changing Fast Enough (Part I)

March 15th, 2008

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This week’s Economist has a lead article and section on “The New Colonialists” which covers China’s expansion and search for natural resources on a global scale.

For many Chinese, being equated with colonialism is a bad thing, because Chinese have historically seen themselves as victims of colonialism, having had Hong Kong taken away by the British, and the Unequal Treaties with the leading European powers in the 19th century. When the Chinese see themselves portrayed as new colonialists, they go into hedgehog mode, curling up and sometimes fighting back against their western critics who are criticized for not understanding or being sympathetic to the Chinese point of view.

This kind of attitude is not helpful for the western critics, and is not helpful for the Chinese. The issues are real, and they are too serious to be trivialized, and for people to get into nationalistic shouting matches. The effects are huge, as they will affect the overall health of the planet.

Over the past thirty years, China has adopted an open economic development policy to raise the standard of living of the Chinese people. This policy has been enormously successful, unleashing the traditional Chinese ethics of curiosity about technology, thriftiness and hard work to elevate their standard of living dramatically. Today, China has the second largest economy in the world, trailing only the US, which is now currently undergoing a dramatic readjustment following the growing subprime mortgage debacle.

The party has been forcefully pushing a policy of development, and more significantly, urbanization of China, and plans to move more and more Chinese into cities. Throughout its long history, China has traditionally been a country mostly made up of farmers, engineers and small business people. The plan is for many of the farmers to become cityslickers, eating at restaurants, taking subways, and working in office towers.

The trouble with having so many big cities is that they are huge consumers of energy, which is why China now has to go overseas to satisfy this huge demand. Securing energy resources also means getting entangled in the affairs of many countries which are frankly, not very well-run. This in turn means that the country’s foreign policy has to feed its energy needs.

This is how America’s foreign policy and domestic energy policy got so screwed up. In Washington DC and across the nation, there is a strong and influential pro-Israel lobby, while the country depends on many middle-eastern countries which are hostile to Israel for its energy needs. These contradictions are unresolvable, and have resulted in the rise of middle-eastern terrorism and eventually in the 9/11 attacks.

Seeing these problems, it would seem to make sense that the Chinese leadership would find a new model for China’s economic development which did not depend so much on an outdated 19th century European mercantilist model for economic development in the 21st century.

The Shrinking US Economy:How Much Will It Shrink?

March 9th, 2008

The past week has shown that the subprime credit mortgage crisis in the US has metastasized into something bigger, and is spreading into other parts of the economy, and is now beginning to affect bond markets in the US. This is a worst-case scenario gradually unfolding before our eyes, and the Fed under Bernanke and the politicians seem unable to do anything to stop it, which is why they talk so little about it.

The issue made me think about something. Several years ago, a report was issued (I believe it was Goldman Sachs), which said that the Chinese economy would become the same size as the US economy by 2040 based on current trends. The key term here is “based on current trends”, something which almost never happens, as things almost never continue smoothly in politics and economics.

The present crisis in the US is causing what I call a double shrinkage. The size of the economy is shrinking as highly-leveraged credit derivatives are slowly worked out of the system. As these derivatives, which were as good as cash just two years ago, creating more money in the system than the Fed are worked out of the economy, the GDP of the US economy will shrink. It is not a question of whether it will shrink, it’s just a question of how much. That is something the market, the politicians and policy-makers are figuring out.

But it does not shrink just on the GDP level, it also shrinks on the US dollar level, which has been losing value steadily, and will likely continue to lose value as US interest levels fall. (The problem for the Fed is that although interest rates have fallen, US banks have tightened up their lending qualifications.) This means that US goods will become cheaper, and more foreigners will go to the US to buy real assets.

Roger Ehrenberg has written an excellent article about what US headlines will look like over the next 2-3 years on his Information Arbitrage blog. No wonder that even companies like Apple are looking overseas for sales growth in the face of slow growth in the US market.

This takes me back to the report which talked about China overtaking the US economy by 2040. The report did not take into account the shrinking of the US economy on both the GDP and currency levels. If the Chinese economy continues to grow and the US economy shrinks, isn’t it likely that the Chinese economy will overtake the US economy much sooner than 2040?

Of course, there are a lot of variables. Can China continue to grow at a brisk pace without a healthy US consumer economy buying Chinese exports? And what can the Chinese government do to curb inflation, which is growing faster than in the past 15 years?

We will find out…eventually.

Apple’s iPhone Computer SDK Just Changed the World Today

March 7th, 2008

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In Sept. 2007 I wrote an article about how Apple’s global marketing for the iPhone was attracting and creating a new user base in China. Now, we know that there are more than 400,000 unlocked iPhones in regular use in China.

Since Apple gets recurring revenue for the iPhone through its contracts with the operators, many analysts have said that these unlocked iPhones represent lost revenue for the company. In China, China Mobile gets all the revenue spent by users for moving data up and down from the cracked iPhones, and does not have to share any of the income with Apple. And the statistics show that iPhone users consume much larger amounts of data than competing mobile phone platforms.

Obviously this is a serious loss for Apple.

I say “Not so fast!”

Today, Apple just announced its new iPhone SDK. Now, the Apple iPhone will talk with Exchange servers, morphing the Apple iPhone from something corporate IT departments viewed as a consumer toy, to a full-fledged platform on a par with Blackberry, Windows Mobile, Symbian and Linux.

As in most Apple presentations, the most important stuff always get buried close to the end of the presentation. That was the announcement of the Apple App Store, which will allow developers from all over the world to build and sell their iPhone applications. Developers will be able to charge any price they want, and Apple will keep 30% to cover hosting, distribution and credit card fees. The App Store will be available as a new button on the iPhone beginning in June. Presumably, this download will work on all iPhones, including cracked and jailbreaked iPhones.

Make no mistake about it, this is truly revolutionary news. The iPhone platform has taken over the role which the carriers once took for themselves. Today is as important a day as when Apple announced the Macintosh platform in 1984, singlehandedly launching the desktop computing industry.

Today Apple launched the mobile applications industry. When the Macintosh platform was launched in 1984, it led to the growth of Microsoft with the Office applications suite, which was developed for the Macintosh before the PC platform.

Now, do you think that Microsoft will have enough sense to develop apps for the Apple App Store, or will they continue to stick to developing for the Windows Mobile platform only? My feeling is that if Microsoft developed for the Apple App Store, they would get traction very quickly, if only they would let their developers develop.

Make no mistake about it, today, Apple launched the mobile computing industry with the iPhone computer SDK which user statistics show, is the favorite platform among consumers, and is gaining headway in the corporate space.

Even in China, where it is not officially sold and supported yet.

With the iPhone computer SDK and App Store, along with Apple’s excellent development tools, any developer with any sense will start building apps for the iPhone computer.

Including in China.

So where does this leave China Mobile? Much press has been devoted to Apple’s unsuccessful negotiations with China Mobile to distribute the iPhone in China.

In reality, the interests of the companies are aligned.

  • Both China Mobile and Apple want the mobile computing industry to succeed.
  • Both stand to make MUCH more revenue when the platform takes off.

Right now, they are just jockeying for position in this new business ecosystem. Where they rub against each other is on the applications platform level, which China Mobile wants to control as much as possible, and on the revenue share level, which China Mobile wants to control, and does not want to share with anyone.

Today, Apple just won on the application platform level round on the rapidly growing iPhone computing platform.

But I predict that China Mobile is quietly pleased with all the extra revenue data consumers on the iPhone computer platform have been generating, and which it does have full control over. Have you noticed that China Mobile has not broken out those revenue numbers yet? When the Apple App Store launches in June, those numbers will shoot up even higher.

You see, there is nothing wrong with being a commodity data mover when you run into the ideal data platform for users.

Round two will be about who will define ad standards and specifications for the iPhone platform (Apple), and how advertising revenue will be shared in different markets on this platform.

Personal Lending + Web 2.0 + China = ?

March 2nd, 2008

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Two new startups in China have now entered the field of Internet-based personal lending and finance in China, and according to this article in China Web 2.0 Review, one of them, PPDai has already received first-round funding for an undisclosed amount from Essentia Equity.

The concept of personal lending is an outgrowth of microfinancing, which started with the Grameen Bank, founded by Muhammad Yunus in Bangladesh in 1971. The idea was to lend money to poor villagers, mostly women, in very small amounts. Banks did not lend money to these people because they did not have any collateral. Instead, these often illiterate women were asked to become co-signers for their fellow villagers’ loans, effectively guaranteeing the loan in case the borrower defaulted.

In the developing world, microfinancing has become an overwhelming success, and in recognition of his contribution, Muhammad Yunus was awarded the Nobel Peace Prize in 2006.

In China, the concept of microfinancing has been slow to gain traction in spite of official Chinese government support. The Chinese government still has four large state-owned banks, and it is much more profitable for them to pursue mortgage lending in China’s cities than to embark on lending to villagers in the Chinese countryside.

Now, add to this the Internet and Web 2.0. An important component of the promise of Web 2.0 is the idea of building new communities where people can feel a sense of community without feeling separated by time and distance. The most important online communities which have sprung up are MySpace, Facebook and LinkedIn. Among these three, LinkedIn, which is targeted at the business community, is now reputedly cash-positive, and will shortly announce IPO plans. Facebook had only US$150 million in revenue in 2007. While Facebook and MySpace have far greater membership numbers than LinkedIn, ad revenue has been disappointing, if only because it is hard to create effective creatives and clickthroughs for such a geographically diverse group with such wide interests.

In personal lending in China, the two web-based personal finance sites are PPDai and Qifang. Both companies propose to bring Web 2.0 tools to personal lending, making it easy for strangers to lend money to each other, and also including some kind of an informal feedback mechanism which would take the place of a finance credit system which has not yet been fully launched in China. Underneath it all lies the belief that the Chinese are now ready to experiment with and use a new web-based front-end system for personal lending. (On the backend, these systems tie into traditional bank payment gateways.)

Critics would say that the success of microlending depends on two factors:

  • Trust in developing societies depends on face-to-face contact between the lender and borrower, and ideally, they should live in the same community
  • China is now a low-trust society where people will run off with any money they can get their hands on

On the other hand, the Chinese government has put its very powerful media apparatus behind the idea of creating a “civil society”, which is a fancy way of saying that they would like Chinese to trust each other more, since the shysters are giving the society a bad name. Now, what could be more trusting than lending someone you have never met, or been referred to by a personal friend, money?

Qifang, in particular, has a strong social angle since it is targeted mainly at serving China’s students who are looking for funds to pay for their education. It has recently received coverage in TechCrunch in the US. In China, university education is an important indicator of future income, and poor families are willing to go into debt to send their single child (or children in the countryside) to good schools.

It will be very interesting to see how well these new and very innovative companies are received by Chinese users, and it would probably be fair to say that they will be very interesting barometric indicators of how much change and evolution Chinese attitudes to money and lending are now undergoing.