Revival in China’s Northeast(2)

For the first time ever, the China Venture Capital Forum recently held an investment summit in Shenyang, China.

The theme of the conference was the Revitalization of Northeast China, which was announced as a major policy of the central government at the 16th National Congress of the Communist Party of China (CPC) in 2002. In fact, Northeast China, including Liaoning, Jilin and Heilongjiang provinces, has been designated as the “fourth growth pole” of the national economy after the Pearl River Delta, Yangtze River Delta and Bohai Bay.

The conference attracted renowned speakers from government, business and finance to address critical development issues such as:

? From a policy perspective, how should Northeast China capitalize on its prominent position with respect to national policy?
 
? What strategies should be adopted to efficiently expand its economic base and what are the most effective means to speed up the reform, restructuring and revitalization of the old industrial base?

? Are there natural regional alliances that could or should be formed with countries such as Taiwan, the Republic of Korea and Japan?

? How is the Northeast viewed by foreign financial institutions and what can be done to enhance its image to attract more foreign financial institutions and intermediaries?

? How should entrepreneurs present their businesses to venture capitalists?  What governance structures, profit models, and management teams are most likely to secure venture capital financing?

It is worth briefly reviewing the history and challenges facing Northeast China. From the 1950s through the 1970s, Northeast China was at the center of China’s planned economy and dominated key industries such as steel production, chemicals and the production of heavy machinery. In fact, as recently as the early 1980s, Liaoning province’s GDP output was twice that of Guandong’s. However, with the opening of China’s economy in Guangdong and Fujian provinces in 1979, the economic fate of the provinces has essentially reversed and some have labeled the Northeast, perhaps to some extent unfairly, the “rustbelt of China”.

Economists and market commentators have put forth a variety of theories for the decline of the Northeast. These theories range from the financial and industrial resources being diverted to other regions of the country, to the planned-economy stifling innovation, and the view that the development models adopted by the region have not been appropriate for the development of a market economy. Others have suggested that, in a rush to adopt economic policies that were in vogue in other areas of the country, the region overlooked its own competitive advantages.

Based on the comments of the conference participants, none of these theories is wrong, per se. Instead, elements of each of these theories were interwoven into the thoughts of the various panelists. What emerged were several common tenets.

To begin with, China’s government is committed to the revitalization of the Northeast.  As recently as June 2006, Premier Wen Jiabao called for central government mechanisms to strengthen the industrial base of the Northeast through sustainable development. He also stressed that state-owned enterprise reform should continue. At the same time, he emphasized that the private sector must be nurtured (including high-tech industries and the service sector) and that local officials should cooperate with other regions and countries. He also urged local officials to take action to insure the reemployment of laid-off workers and expand the social insurance system. These policy tenets closely mirrored the recommendations of two World Bank reports on Northeast China published earlier this year and were supported by provincial and local government officials as well as many of the panelists.

For example, Zhao Changyi, the Vice Mayor of Shenyang Municipal Government, stated that a strategy of “self-innovation” is the key to the economic development of the Northeast and, consequently, the local government has developed policies to support high tech startups and venture capital institutes. Further, he stated that the Shenyang government will allocate RMB500 million to help development of high tech industry and that Shenyang will provide a “good policy environment” for foreign investors. It was also stated that China’s financial institutions have provided significant financial resources to the sector and are willing to commit more loans. However, there is still a need for venture capital money and expertise.

Ronnie Chan, chairman of Hang Lung Properties, and a well-known regional venture capitalist who has invested over RMB10 billion in Shenyang, offered a number of insights to the regulators present. He suggested that Northeast China should develop those industries which have competitive advantages over other regions (e.g. software outsourcing, energy, medicine) while not competing directly with Shanghai or Beijing in “hot” industries such as new media. He also pointed out that a culture of encouraging entrepreneurship and improving English language skills are important to Northeast China’s development.

The principal of focusing the Northeast’s valuable resources on areas of competitive advantage was emphasized in numerous ways during the conference. Heavy industries such as energy, chemicals, metallurgical, heavy machinery, new material industries as well as ship and auto manufacturing were cited as growth industries where the Northeast has traditional competitive advantages. For example, Dr. Shi Xiu, the director of Taiwan Electrical and Electronic Manufacturer’s Association, noted that the world market for electronic auto parts is over $160 billion and the production value of China’s auto industry ranks third worldwide (behind only the US and Japan).

The rapid growth of China’s auto industry also highlights the significant possibilities for regional cooperation mentioned by Premier Wen Jiabao. Yu Muming, president of the Taiwan New Party, noted that Taiwanese are investing in the chip industry in the Northeast (e.g., the Changjiang and Zhujiang deltas are two major bases of chip making) and it is his hope that Taiwanese investors will be critical participants in the development of the auto industry’s electronic components supply chain.

In 2005, WI Harper Group was invited by the governments of Liaoning province and Shenyang city, to participate in the Shenyang auto microelectronics project. During the past year, WI Harper has leveraged its global resources to assist in implementing the project by bringing in numerous international strategic partners. The firm intends to continue to assist in the project’s development through both fundraising and the introduction of additional foreign partners.

With respect to the investment climate and the ability of local entrepreneurs to attract venture capital, the panel provided some interesting insights. Li Kaifu, the CEO of Google (China), noted that China was awash with capital and, more than ever, the investment process is a two-way street whereby it is important for the entrepreneur to select the most appropriate investors that bring more than capital to the table. He also emphasized the importance of innovation, especially in respect to the firm’s business model. As a case in point, he noted that Google would not become a $150 billion company without an innovative business model.

Hu Zuliu, managing director of Goldman Sachs (Asia), observed that while China has developed tremendous manufacturing capabilities, most of the products made in China are low-end with a low value-added component. In his view, the essential issue is that China has less intellectual property than more developed countries. Consequently, as the industrial base of China, the Northeast area should pay more attention to investing in intellectual property. He further stated that, eventually, he hopes the Northeast can accomplish the transition from “made in China” to “created in China”.

In the same vein, Doris Blasel, managing partner of funds of funds for Siemens Venture Capital, emphasized that innovation was Siemens’ lifeblood and venture capital investing an integral part of Siemens’s innovation and growth strategy. Since software, new technology applications and life science are among Siemens’ investment focus, there should be many investment opportunities for the firm in Northeast area.

Peter Liu, chairman of WI Harper Group, reminded investors that, based on his 14 years investment experience in China, start-ups and the industries they occupy require significant development support. Consequently, early-stage investments can take longer to develop in China. For example, WI Harper has taken more than nine years to support Beijing Xinwei, which has developed the necessary intellectual property to become a driving force in the modernization of the wireless communication industry in China.

Clearly, Northeast China has significant obstacles to overcome to become a leading region in China’s development story. It must develop programs to support the millions of workers that have been laid off in the restructuring of state-owned enterprises. The Noertheast needs to continue to develop appropriate incentives to attract domestic and foreign capital and it must nurture its fledgling private sector.

Nonetheless, a number of trends would suggest that the region has begun to turn the corner. Since the Revitalization of Northeast China was announced, the National Development and Reform Commission has approved more than 100 industrial development projects that will require in excess of RMB61 billion. Most of these projects have been given preferential treatment both in terms of bank support and governmental incentives. Further, annual foreign investment has tripled in Liaoning province since 2000, reaching $2 billion in 2005. Further, Liaoning’s GDP grew to RMB224 billion in 2005.

Heilongjiang province has successfully reformed its economic system over the last three years and created a good foundation for mergers and acquisitions. Foreign direct investment was approximately $1.45 billion in 2005, which represents an increase of seventeen percent over 2004 figures. Jilin province, meanwhile, showed the greatest percentage increase in foreign direct investment in 2005, over 42 percent.  However, it should be noted that foreign direct investment in aggregate was only $453 million.

Albert McLelland is a senior managing director of AmPac Strategic Capital LLC (AmPac). AmPac is a boutique investment bank that specializes in assisting foreign strategic and financial investors to build their businesses in China.