Rest Insured

China’s State Counsel is the final decision maker in whether it will approve state banks to get into the insurance business. If the decision goes through, it will mark a significant change in the way individuals residing in China turn for an insurance provider. Small, mom-and-pop insurance corporations will be squeezed out by heavyweight banks that provide everything from health insurance to earthquake insurance. Some feel that keeping insurance firms separate from powerhouse Chinese banks such as HSBC and Bank of China will keep such entities from becoming too powerful. The risk of banks being short of cash while also providing insurance would send a massive shock through any economy, let alone one as vast as China’s.

The decision for this increased bank autonomy rests mainly in the hands of Vice Premier Wang Qishan, the government’s point man on financial issues. His decision is part of a continuing debate – should China encourage its financial sector to consolidate into fewer powerful entities that offer a range of products from checking accounts to insurance to capital management? Citigroup tried to do this when it bought Traveler’s Group in 1998 and since then the merge has been very unattractive to investors. Citi is an immense organization with over 370,000 employees worldwide; they are currently trying to sell some of its business lines as they see how detrimental it is to dabble in many sectors.

Allowing insurance providers to invest in a range of products could also turn out very successful, thus the sector has caught the eye of many investors looking to put capital in the hands of capable firms. Look at the success of Warren Buffett’s Berkshire Hathaway; an insurance company that seizes huge stakes in other companies. Some Chinese insurers are finding loopholes even before the government makes a decision – they buy property which they occupy, using 10% of the building and leasing out the rest. Commercial properties may not be a bad bet for insurance companies because they generate steady streams of revenue that insurers crave. However, letting insurance companies and banks to merge will no doubt be extremely complex. China is still at a disadvantage for a serious integration – much of its financial services are still handled over the counter making it difficult to venture into the business of offering their customers an even further range of tools.

Player of the Month

Lily Jin is the Investment Director for the Growth Capital division of 3i Group, and has been named August’s Player of the Month. 3i is a leader in completing successful private-equity deals; the firm operates out of several offices throughout the globe. Ms. Jin has been a huge asset to 3i, thus much of the corporation’s success in Asia has been attributable to her savvy investing tactics and superb leadership. She has been the primary deal maker behind some of China’s most successful buyouts. On top of being the Investment Director and Chief Representative for 3i’s Beijing office, Ms. Jin is also the Co-head for North Asia; she has extensive experience with private-equity in both China and Europe and is fluent in English as well as written and spoken Mandarin. Needless to say, Ms. Jin brings a thick rolodex to a firm such as 3i who can benefit greatly from her list of contacts and skilled management.

Prior to joining 3i, Ms. Jin spent 10 years with Actis, a UK private equity firm, and returned to China and established Actis’s China operations in 2000. Lily’s investment track record includes: China Mengniu Dairy, the largest dairy brand in China and one of the most successful private equity deals in China; Suntech Power Holdings, now the largest solar cell and solar panel manufacturer in the world; Grentech, China’s leading mobile coverage system manufacturer; and CNOOC, the largest offshore oil exploration and production company in China. Lily sat on the board of China Mengniu Dairy for 3 years and was an observer on the board of Suntech Power Holdings.

Ms. Jin focuses her effort primarily on consumer and energy related sectors at 3i. The most recent completed deal she sourced at 3i was John Hardy, a leading high end designer jewelry brand. She received her MBA degree from Manchester Business School in 1995 and holds a bachelor degree in English Literature.

Ms. Jin was voted “The best Venture Capitalist in China“ by Forbes in two consecutive years of 2006 and 2007.

Fast Train for China

Today marks the 89th anniversary for the death of Andrew Carnegie, the tycoon of steel and the first revolutionary in the railroad business. Now, in the 21st Century, we have commercial airplanes, automobiles of every shape and speed, even Mache-speed jets, yet the popularity of railroad travel remains extremely popular. Look to China if you don’t believe me. The Giant in the East controls 24% of global railroad traffic, yet only has 6% of the world’s track. The sector has been somewhat of a barely-explored venture until a few years ago, as demand for rural Chinese to enter urban areas has surged along with gigantic growth in China’s manufacturing sector.

Nearly half of China’s population still remains spread out on rural farms and small villages, while there is noticeably larger demand for people travelling among the metropolitan cities. The amount of raw materials being shipped from the Western provinces of China to the manufacturing hubs on the Eastern coast have tripled in the last four years, as the preferred shipping method within China remains freight. Meanwhile, China’s railroad service can satisfy only about 35% of demand for manufactured products, and the 2.4 million seats of capacity is far short of the 3.4 million in daily demand for individual travel. China is clearly getting the ball rolling quicker recently, when the government approved 1.25 Trillion Yuan (~ $160b) in order to build railroad infrastructure through 2010. Connecting the vast country will sustain China’s growth pattern for decades, as nearly every part of the railway supply chain will benefit from the sector transformation.

The sector has drawn particular attention from investors, with many overseas locomotive companies looking to grab a piece of China. In 2007, Alstom Transport, one of the largest railroad companies by market share, signed two contracts worth more than $465 million with the Railways Ministry to build electric freight locomotives and high speed lines on the mainland. Or take Daqin Railway, which operates China’s biggest coal hauling line. It raised $2 billion in an IPO, its share price rising over 80% for the year, dominating China’s railroad sector along with only a few other players. All aboard the fast train.

Banks Looking for Cash Turn to Private-Equity

American banks that are strapped for cash are turning to private equity firms in an effort to shore up balance sheets and bring ailing earnings back to life. Massive equity firms with deep pockets aren’t hesitating to make sizeable investments in banks whose balance sheets have suffered billions from the credit crunch, while Wall Street analysts predict write-downs to continue for several quarters. Firms such as Texas Pacific Group are making risky bets such as their $7 Billion capital injection into Washington Mutual, in all taking a 50.2% stake in the bank. Washington Mutual has had their shares destroyed by investors in the last few months, and private equity cash dilutes shares and makes it even tougher for investors to profit.

I have analyzed some of America’s largest banks in order to better understand their capital position – there are twenty one banks with current assets exceeding $80 Billion. Washington Mutual alone has in excess of $317B, making it the sixth largest bank according to asset size. Despite its breadth, the asset size of the firm is irrelevant considering the current condition of the bank. Instead, look at the Return on Equity in order to evaluate the risk attached to TPG’s investment. ROE is annualized net income as a percentage of average equity on an annualized basis. In June, 2007, right before the credit crisis began to unfold; Washington Mutual had Return on Equity (ROE) of 12.89% and a stock price of almost $40, respectably. Investors generally consider ROE over 5% or 6% very healthy for a bank. The ROE is currently -17.02% due to heavy losses, and its stock price has dropped simultaneously, and currently hovers around $5. Their losses alone have eaten up a chunk of their equity base, and if losses continue for an extended period of time, there may be little, if any equity left on the balance sheet. Investors will continue punishing the stock as long as write-downs persist, knowing that WaMu is cutting deep into the little amount of capital they have remaining. TPG may be hesitant to double down for a second time if the bank continues to lose money. A bad investment? Not really. But clearly a risky one, as it may have been too early for TPG to jump in to supply the bank with cash. They could have been patient to see how the next few quarters turned out, with the possibility of buying the company cheaper, and with a lot less risk attached to it.

Get Savvy -- Gamble on Macao

For global investors and entrepreneurs looking for a sure thing, maybe they should look to Macao. In the midst of unprecedented growth, the gambling sector in China is attracting large dollars from casino titans around the world, yet certain individuals seem to be running away with the gold. The gaming hub in China takes place in Macao; the semi-autonomous region of mainland China located about seventy miles from Hong Kong. Las Vegas’ most famous casino tycoons have tried to claim huge stakes here, but none have been as successful as the American-Jewish billionaire Sheldon Adelson, the chairman and largest shareholder of Las Vegas Sands Corporation. For nearly forty years, Macao was ruled by Chinese entrepreneur, Stanley Ho, who enjoyed a government-granted monopoly on all of Macao’s gambling rights. However, the tables are turning in the new millennium; the gates to Macao have opened with a limited number of gaming licenses and Adelson has bolted far ahead of the pack in China’s gambling scene.

Adelson has earned the reputation of a savvy businessman since he began playing the casino business in 1989 when he bought Las Vegas’ old Sand’s Casino and built the largest private convention center in the country. In 1997, he broke ground on the Venetian in Las Vegas to cater to a growing number of businessmen and high-rollers travelling through America’s hottest gambling hub. The venture was so successful that in July 2001 the Vice-Premier of China, Qian Qichen, pushed Adelson to open a Venetian in Macao, as some skeptics thought Adelson was playing a tough hand considering each Chinese national citizen (excluding those in Hong Kong) needs a permit to enter the city in order for the government to control the number of visitors. In May, 2004, the first gamblers entered the Sands Macao. Its construction costs were two hundred and sixty-five million dollars, and Adelson made back his initial investment in a year. In December, 2004, Adelson took Las Vegas Sands public (according to Forbes, he owns sixty-nine per cent of the stock) and became a multibillionaire, overnight. The following year, Macao drew 10.5 million mainland Chinese visitors, a hundred and forty-seven per cent more than three years earlier—reflecting an easing of travel restrictions and an increase in the number of newly wealthy Chinese. By the end of 2006, Macao had become the top gambling center in the world, with gaming revenues exceeding $6.9 billion, a quarter of a billion dollars more than those on the Las Vegas Strip. The ambition and prudence of Adelson came early in his strong relationship with Qian, whose clout among leaders in China gave him the ability to win gaming licenses over Strip rivals such as MGM Mirage, who at the time was a much larger and financially powerful entity. The only other American casino magnate to win a license was Steve Wynn in 2002, but he moved much slower than Adelson and did not complete the Wynn Macao until two years after Sands opened. The success of Las Vegas Sands in China highlights how far the Chinese have come in their movements toward growth and capitalism, not to mention how much room there is to expand. In fact, Adelson plans on creating the “Las Vegas Strip of Asia,” on Cotai, an island linked by adjacent bridges to Macao. Adelson plans to spend roughly ten billion dollars to build a dozen new hotels, twenty thousand rooms, and high-end brands including the Four Seasons; all of the casinos will be owned by Las Vegas Sands. For a guy in the casino business, it doesn’t seem like Adelson is gambling on much – the numbers from China alone speak for themselves.

Culture for Capitalism

If New York is the city that never sleeps, then Shanghai doesn’t even sit down, and it’s not because there’s no room. The city is explosive in the way it moves; the people, the vehicles, the ideas. Go to Shanghai today and return two months later and the skyline will be more powerful and intimidating, there may be a new bridge linking Pudong and Huangpu, and chances are the city will be pulsating with even more vivacious people than the time before. A link between Eastern and Western, traditional and modern, Shanghai is known as the “Pearl of the Orient,” as anybody walking the eclectic streets can feel the transformation of both the tangible and the intangible taking place on the Eastern coast of China. After the death of Chairman Mao Zedong in 1976, the Communist phrase, “Look to the Future” (“Xiang Qian Kan”), became transformed into “Look to the Money,” because the words for “future” and “money” sound the same but are written differently in Mandarin. The craze for wealth and power are on the minds of each of the 20 million people living in Shanghai, specifically the young, zealous nationalist crowd that is molding Shanghai into a hotbed for both politics and commerce.

It is somewhat recent that students and 20-somethings have become so heavily involved in business and politics in China. Their greed for knowledge and flair for competition has turned this involvement into a race for wealth and power within the growing circle of metropolitan youth. In 2003-2004, there were over 61,000 Chinese students studying at institutions of higher education in America, and there are approximately twice that many studying in Britain alone. The flow of Chinese students into America highlights the ambition of these scholars; they often take their education from the States and return to China where the opportunities for educated, bilingual capitalists are infinite. The exponential growth of skilled laborers and professionals concentrating in cities such as Shanghai is the catalyst for its momentum. There are approximately 120 architecture/urban development joint ventures in China and more than 140 companies among the top 200 architecture firms in the world have set up offices here. Symbols of new-fangled Chinese power such as the Oriental Pearl Tower and Jin Mao Tower loom in the haze of the uber-modern Financial District of Pudong, on the east side of the Huangpu River. There are scores of modern buildings sprouting throughout Shanghai; many of the city’s most traditional places such as the 400 year-old Yuyuan Garden in Old Town are being washed away in a fervent urge to expand and develop the city. And it’s not just Shanghai that is on this trend of exchanging culture for capitalism -- there are over sixty cities throughout China that have over one million people living in them. Officials in Beijing predict that in the next two decades over 300 million Chinese will move to urban areas, thus challenging urban infrastructure and job creation. Watching a city like Shanghai take in hoardes of people and revolutionize the concept of a modern city, it makes me wonder how long the inevitable will take before other locales follow in Shanghai's steps. Of course, the most intriguing part is watching such cities mold some personality of its own as well.

China's Government and Media

In China, corporations are continuing to turn toward capitalism in an effort to be as least politically influenced as possible. Taxes on businesses in China (excluding Hong Kong and Macau) are often as high as 40%, with virtually no room for leeway such as tax cuts or shelters, making businesses eager to release themselves from the hawk-like eye in Beijing. From the largest Chinese corporations to the smallest start-ups, both executives and investors are encouraging free-market trends similar to those of the world’s richest and most developed nations. Large foreign private-equity groups such as Blackstone, Carlyle Group, and Warburg Pincus have become hesitant in recent months to pour more money into China, in the fears that its historically strict regulation on enterprises will not ease. And they have the right to be cautious, because the latest revelation comes courtesy of the media, one of China’s fastest growing and potentially-profitable sectors.

China is home to the world's largest population of Internet users, and there's reason to believe they will want to use the Internet in ways similar to their Western peers. So as the popularity of video-sharing sites like YouTube has exploded in the U.S., China has seen a slew of look-alikes pop up. Meanwhile, Google's $1.7 billion acquisition of YouTube in October 2006 lit a fire under the sector in China. That in turn spurred an influx of foreign venture capital -- close to $300 million committed to eight online video sites alone since 2006. However, the government regulation for what appears on the screens of the locals is very restrictive in the effort to disseminate state propaganda – sex, slander, violence, and perhaps most of all, political information – has restricted the Chinese from advancing to be as mature and informed as their Japanese neighbors, for example. Beijing has softened somewhat recently, providing a wide range of broadband infrastructure available throughout the country, transforming online video from a niche application to a mass market. The expansion for internet seems endless, with slightly more than 17% of China’s entire population [1.3 billion] even connected to the Web. However, the preventive effort in Beijing still frightens investors with dollar-denominated funds – many are looking to other sectors of China’s booming economy such as pharmaceuticals, mining, and urban development companies in the hopes of hitting the bull’s-eye. Of course there will continue to be billions invested into Chinese media for decades to come, but investors must be wary of government’s sensitive censorship role and how much longer it will last.

Player of the Month

July’s Player of the Month is Chris Freund, 36, the founder and Chief Executive Officer of Mekong Capital, the first private-equity firm to be headquartered in Vietnam. Mr. Freund is a pioneer in the business of capital management in Vietnam, a country whose past has been plagued by incessant inflation, poor working capital, and decades of strict communism. However, today Vietnam is one of the countries leading the way in Asia with cheap labor, a talented workforce, and very strong growth. Vietnam’s economy grew 24% in 2007 and is up over 20% for the year so far, which is booming since its stock market opened in 2000. The run in Vietnam’s economy has allowed players like Mr. Freund to benefit from Vietnam’s numerous enterprises with strong balance sheets and good management by injecting capital in the business in the hopes of taking it public within a period of time.

Known for his knack for risk-taking, Mr. Freund is a veteran in the sphere of Asia’s private-equity circle. He has been in Vietnam since 1995 when he arrived to build a new Vietnam fund for Franklin Templeton Investments. In 1997 the Asian Market Crisis sent Mr. Freund back to Singapore; however he didn’t sit out for long and has been running Mekong since 2001. Mekong is currently in control of three different funds, totaling over $160 million, and has taken majority stakes in some of Vietnam’s most profitable businesses. Since 2006, private-equity funds and venture capitalists have pumped roughly $386 million into Vietnam, which is small by global standards, but huge for the country and its relatively underprivileged inhabitants.

When I contacted Mr. Freund, I received worthy and inspiring advice; he told me to follow my heart, take risks, but most of all never give up. This meant a lot coming from someone who is revolutionizing business in Asia, fuelling the Vietnamese economy with his capital and management skills, and has certainly taken risks to get here. Mr. Freund was inspired by the potential in Vietnam when he visited on a trip from India, where he was studying abroad as a college student at UC Santa Cruz. Since then, Mr. Freund has been thrown a few curve balls in Vietnam such as corrupt accounting practices and steady inflation, however his composure allows him to come to grips with the fact that good things take time.

Find out more about Mr. Freund and Mekong Capital by visiting their website: http://www.mekongcapital.com/