In the Hutong
Winter into Spring
Eric Jackson at TheStreet did an intriguing interview with IDG’s Pat McGovern on investing in China. IDG Capital Partners was one of the earliest – and is today among the largest – of China’s venture investors. I would go so far as to say that they are to venture capital in Chinese technology what Kleiner Perkins is to Silicon Valley.
McGovern had several interesting tidbits to offer, but the two that I felt were most invited exegesis had to do with the M&A strategies of Chinese tech firms and with Google.
Why China’s Big Fish are Vegetarians
On the subject of M&A in China, Jackson asked McGovern:
A: The Chinese entrepreneurs are very proud of their companies and have great determination to have the company they have started succeed in the long run. They are not attracted to being acquired by a larger company which would prevent them from achieving their personal business goals.
With respect to Mr. McGovern, I think that answer might have been a bit sugar-coated. There are certainly Chinese tech startups that would prefer to retain their independence, but there are many who would not object to being purchased by the larger players, provided the terms were right.
I italicize the last because I think this, rather than some militant independence streak, is the real reason we don’t see more intramural M&A action in China: the terms of purchase would not make business sense for the buyer. There are several extant issues in the market that have brought this about, but the most important one is the great pool of cash sitting in China.
There is (and has been since about 2004) far too much cash and far too many players chasing too few viable technology startups in China. The combination of product idea, technical skills, and management ability is a rare one, but the country is thick with private equity funds, hedge funds, venture capitalists like Mr. McGovern, and strategic investment funds like those set up by Intel, Qualcomm, and the like. This pool has deepened with the addition of a growing number of local Chinese companies looking to capture the same opportunities.
So much money raised and uninvested places significant pressure on investors to put their money somewhere. This results in a degree of value inflation among viable investments, and more among the really good ones. I am certain Mr. McGovern does not want to hint that IDG might pay more for its investments than it needs to, and I would never make such an accusation.
But funds and investment houses are judged on a different set of criteria than Sina or Baidu, and this is where the disconnect occurs. As long as IDG buys in at a price lower than the price at which it cashes out, IDG wins. Major local internet companies, on the other hand, need to decide whether it is cheaper to buy a startup with an interesting looking business, or just grab the idea and do it themselves. Given their substantial internal coding resources, the power of their brands, the time cost and uncertainty around negotiating an acquisition, the possibility of a bidding war, and the headache of integration, and the unlikelihood of expensive IPR litigation over a business idea, one could see how it would make more sense to do it themselves.
It makes more fiscal sense for both the big players and the startups to continue along this vein as long as there is plenty of capital to support startups in the market, and as long as the big players believe it will be cheaper to duplicate than to buy.
There are other reasons, prime among these the aforementioned shortage of viable targets. Ask Kai-fu Lee at InnovationWorks: he chose to create an incubator because he sees so many interesting ideas and businesses die aborning because they lacked so many of the key skill sets to simply survive as a business. Investment houses have the time and the resources to form these into true companies, and by the time they finish that job, the wind is whispering “IPO.”
One could also suggest that China generally and the engineering-based industries in particular are more “make” cultures than “buy” cultures, and i seems that the M&A game has not yet become a national pastime in the PRC. One could also suggest that there is no shortage of founders’ hubris at the top of China’s largest internet enterprises. I think those are valid, and they contribute to the problem.
But simply suggesting that this is a mindset problem among Chinese entrepreneurs is an inadequate answer at best.
Google and Government
At the very end of the interview, Jackson drops to G-bomb:
Q: If you had been advising Google(GOOG) at the start of 2010, what would you have told them about doing business in China?
A: Doing business successfully in China is based on personal relationships. Google should do more to develop personal relationships with key levels of the Chinese government involved in the technology industry, the information industry, and regulating the information available on the Internet.
By establishing mutual trust among the Chinese government officials involved with regulating the Internet, each side would have more clearly understood the position of the other.
If Google is able to establish better personal relationships with Chinese government officials and work out business practices that accommodate the Chinese laws, Google will be better positioned to compete with other Internet search and service companies in China.
I like McGovern’s answer here, given the question, but Jackson asks the wrong question. By the start of 2010, there was nothing left to advise Google: the die was cast years before, as far back as 2003. Google’s actions had limited its tactical options by the end of 2009.
As to the issue of government relations, yes, Google probably could have done a better job at the most senior levels of the company to build relationships in China, but I question whether there was a consensus to do so among the top brass in the Googleplex. Doing business in China was going to be Just Like Doing Business Everywhere Else But With A Different Alphabet, so why bother?
In his answer McGovern was being polite and just a bit cagey. He was not offering any free lessons to foreign companies seeking to come into China. And why should he? IDG Capital does very well creating the impression that it does something very hard, if not magical: it makes money in China.
As a communicator, I have to applaud him for being “on message.”