Hello BoF Professionals, welcome to our latest members-only briefing. China’s colossal size and dynamism makes it a top priority for any global business, but it remains opaque to many in the fashion industry. Leveraging our rare access and local knowledge, the BoF China team demystifies the Chinese market with weekly industry analysis and the wider socio-cultural context you need to sharpen your focus.
SHANGHAI, China — Last year was huge for investment in Chinese enterprises. The second biggest venture capital (VC) market in the world scooped up $107 billion according to research firm Preqin, including seven of the 10 most lucrative deals worldwide.
Now, however, some analysts say there’s too much money for too few good ideas, and by some estimates, 90 percent of Chinese start-ups are predicted to fail. In the absence of an exceptionally persuasive business case, they suggest investors keep their wallets shut .
Until recently, the trend looked much more positive. The country’s top 10 VC deals since 2006 have all taken place in the past four years. These investments went to companies such as dining app Meituan-Dianping, ride-sharing service Didi Chuxing, social media company Bytedance, group-buying platform Pinduoduo and Alibaba affiliate Ant Financial, which raised $14 billion in June - reportedly the most by any private company ever.
A spate of recent US IPOs—by Influencer platform Ruhnn, cosmetic surgery specialists So-Young International, streaming startup DouYu International and coffee delivery service Luckin Coffee—likewise paints a picture of huge opportunities for investment in China.
By January, however, with the Chinese economy slowing and the trade war with the US starting to bite, the outlook was less positive. According to Chinese investment firm Zero2IPO, investments plummeted 67.5 percent year-on-year to 29.4 billion RMB ($4.37 billion), with the total number of deals falling by 63.5 percent to 286.
One concern is that too much money has been pumped into too few companies. While there’s no shortage of attractive Chinese enterprises - 13 million new businesses were registered in China between 2014 and 2017 - there’s a perception that some recipients of capital are not that strong.
If you went to Beijing, Shanghai or Shenzhen two years ago, everybody sitting in a Starbucks was talking about investment.
“The reason [deals] slowed down late last year and early this year is that there haven’t been very good assets in the market for investors to buy,” says Shanghai-born Cyrus Yu, a former investment banking analyst at Morgan Stanley who is now managing director of London-based shoe brand Roker.
“Small companies are a bit risky now,” agrees Chen Xin (also known as Nikko Chen), managing director of Fosun Fashion. “No big investors like to look at these companies. They’d rather wait a little bit. Venture capital is having a difficult time now, so they’d like to see some concrete results from the company.”
According to Pitchbook analyst Alex Frederick, while “the vast majority” of VC investment in China went to early-stage startups in the past decade, seed funding has declined from 18.5 percent of deals in 2016 to just 6.5 percent in 2019.
That’s going to make it harder for early stage companies to raise funds than just a few years ago when money came easily.
“If you went to Beijing, Shanghai or Shenzhen—those typical tier one cities—two years ago, everybody sitting in a Starbucks was talking about investment,” Chen says. “But I don’t see that phenomenon now. Investors are more realistic.”
In the fashion industry, Chinese funds and investors have often preferred to pour money into fading European brands believing they can use their knowledge of the Chinese market to cash in on associations with old world quality.
That strategy hasn’t always paid off, however. As reported by BoF last week, Gansu Gantai Holding is reportedly looking for a buyer for Italian jeweller Buccellati after defaulting on a loan, and Shandong Ruyi has yet to complete its acquisition of Swiss luxury shoe brand Bally from JAB Holding despite having signed a deal back in February 2018.
Chen cites sports brand Anta as an example of how Chinese companies can continue to grow and prosper. “They started as footwear manufacturers, launched their own brand and they understood how to operate in the Chinese market. Then, they dared to acquire brands globally – especially Fila,” he said.
He says both luxury and fast fashion brands continue to have significant potential in China, but the latter consumers in tier one cities are now looking to fast fashion players for “standard products” rather than trend-driven items.
“That’s why Muji and Uniqlo have grown a lot, instead of Zara,” he said. “Zara and H&M are trying to put their brand positioning in the middle—very fashionable designs at a low price—[but that] does not work in tier one cities in China anymore.”
That leaves open the possibility for a Chinese Muji or Uniqlo to emerge from local fashion companies looking to reinvent themselves or from the wilds of Taobao. “Local fast fashion brands on Taobao are growing a lot,” he said.
Ningbo men’s fashion brand GXG is an early leader in this area, having sold a 70 percent stake to L Catterton Asia, the consumer-focused private equity firm backed by luxury giant LVMH in 2016.
Among Chinese designer brands that interested investors last year, Masha Ma raised $41 million from Vertex Ventures and Su & Partners, Mukzin raised 10 million RMB ($1.49 million) from Capital Nuts Investment Management Limited and Oriza Ventures, and BIFU raised over 10 million RMB ($1.49 million) from QF Capital.
When it comes to sources of funding, Frederick says, “among Chinese investors, the vast majority of venture investments in China comes from institutional VC funds. However, in 2018 Chinese tech firms such as Baidu, Alibaba, Tencent (BAT) and others played an outsized role in the venture space.”
While C Ventures and Yu Capital have focused on international investments in fashion-related companies like Dazed Media and Mary Katrantzou respectively, other Chinese investors are keeping a close eye on domestic players in the fashion-tech space.
Nowadays, investors are more cautious compared to the period when Xiaohongshu and Mogujie were actively in the market for funding
Looking ahead, entrepreneurs may not be able to tap the tech giants that have recently poured money into Chinese businesses. Eager to own Chinese people’s lives online and beyond, Tencent and Alibaba have together made over 1,000 investments, according to the FT. Nineteen of the 71 Chinese unicorns are either backed or owned by the BAT triumvirate, who together have a market cap fast approaching a trillion dollars.
In the fashion world, Alibaba invested an undisclosed sum in Rent the Runway rival YCloset last year, while Xiaohongshu completed a $300 million funding round, led by Alibaba and Tencent, to bring its valuation to $3 billion. Tencent is also the largest shareholder of affordable fashion e-commerce platform Mogujie, which went public on December 6, raising a total of $66.5 million.
“Nowadays, investors are more cautious compared to the period when Xiaohongshu and Mogujie were actively in the market for funding,” says Yu.
Making things worse, China’s tech giants are themselves struggling: property app unicorns Aiwujiwu and Pinganfang.com both folded in January; JD.com founder Richard Liu has urged overworked employees to work even harder, saying in a leaked internal email released by TechCrunch, “we have been in the loss for more than ten years”; and Uber-inspired ride-sharing app Didi, valued at a whopping $56 billion, reported losses in the hundreds of millions last year, leading them to shelve a planned IPO.
With even Tencent saying last month it would lay off or demote 10 percent of senior and middle management, China’s tech giants may be less willing and able to invest in other companies as they tighten their belts. And that’s if Chinese officials, increasingly wary of the two companies’ huge influence in China, even allow them to grow any bigger. Already, Alibaba has waited 14 months for approval to take a 33 percent stake in Ant Financial instead of persisting with its current profit sharing model.
We’re not necessarily heading into a capital winter
Of course, dedicated institutional VC funds in China and abroad will persist in searching for quality companies in the Middle Kingdom. Fashion startups “should look at individual investors and angel investors,” Yu says, but he insists that in the current climate “entrepreneurs have to work hard and provide hard evidence why investors should give them money.”
Sportswear brand Particle Fever was one Chinese fashion company that met investors tough expectations, raising an undisclosed amount of series B funding from China Creation Ventures in January 2019.
VC investment in China made up 29.4 percent of the global total in 2018, and it came from both at home and abroad, with foreign funds participating in 30.6 percent of the deals. Alex Frederick of Pitchbook sees the portion of foreign investors rising as they look to China’s huge market and its growing reputation for technological innovation.
He also expects total VC investment to rise thanks to China’s “incredibly strong entrepreneurial ecosystem” including technology parks and government seed funding, “3,500 VC firms managing nearly 2 trillion yuan”, changes to regulations and new public markets.
Also optimistic is Fosun’s Chen, who argues that the decline in VC deals in January “reflects the situation at least one year ago” when the trade war and the economic slow down began. Now, he says, “the market has accepted the trade war. They can always find another way, but it takes time,” he says. The Chinese government reducing VAT is another encouraging sign, he says.
“We’re not necessarily heading into a capital winter. The government is increasing m2 [monetary supply], and investing a lot of money in the market,” Chen says. “With market flows increasing, I think spring is coming.”
Additional reporting by Denni Hu
FASHION & BEAUTY
Wall Street predicted Kering would reach revenues of €3.74 billion ($4.19 billion) this quarter, but the French luxury group did even better, rising 17.5 percent year on year to reach €3.785 ($4.24) billion. Gucci helped Kering get across the line, beating the average with revenues growing 20 percent. Chief financial operator Jean-Marc Duplaix attributed the brand’s rapid growth to China, which has become Gucci’s third biggest online market after the UK and the US, and shows no signs of slowing down. Continuing to bet on China’s penchant for purchasing high-end items online, the French luxury group behind the likes of Balenciaga and Bottega Veneta added Alexander McQueen to Tmall’s Luxury Pavilion premium e-tail platform early in the second quarter. (Jing Daily)
Beauty App Meitu Launches Facial Cleansing Device IRL
Meitu’s 115 million monthly active users spend as much as 40 minutes editing a single selfie before uploading it to social media. Real life offers less than pixel-perfect control, but Meitu is nevertheless offering a solution, a facial cleansing device that resembles Swedish brand Foreo’s LUNA. The MeituSpa uses sonic pulses to clean pores and purports to help the skin absorb beauty products more easily. Meitu plans to begin selling its own skincare products too. This is not the company’s first foray into the physical realm. But their smartphones designed to take exceptional (if unreal) selfies sold fewer than 730,000 handsets last year, and Meitu has since sold the business to Xiaomi. (Abacus)
L'Oréal's Asian Sales Pass Europe for the First Time
L’Oréal SA now earns more in Asia than it does in Western Europe, a remarkable reversal from just ten years ago when European sales more than tripled those in Asia. The result is thanks in large part to China’s enduring appetite for luxury goods. The Paris-based company behind brands including Armani, Kiehl’s and YSL saw strong quarterly growth of 14 percent despite the Chinese economy as a whole slowing to 6.4 percent last year. Despite losing steam, China continues to outperform more developed economies. While L’Oréal CEO Jean-Paul Agon said sales in Western Europe showed signs of strengthening, he said they were nothing that would compete with sales in Asia. L’Oréal’s stock has risen 21 percent this year, with revenue up 7.7 percent to €7.55 billion ($8.46 billion). Last week, the world’s biggest cosmetics maker overtook oil giant Total SA to become France’s second most valuable company. (Bloomberg)
TECH & INNOVATION
There’s Something Same-y About US and China Tech Giants
China’s tech giants started as copycats of US businesses, but now the influence is increasingly heading in the other direction. Apple is introducing films and payments just as Chinese smartphone maker Xiaomi earlier introduced content and finance. Google is getting into gaming and Facebook is looking to integrate messaging and social media, two things Tencent—best known for WeChat despite its revenues coming largely from gaming—built its business on. Whether such copycat expansion is a smart move depends very much on how governments deal with the tech giants’ growing monopoly on our attention and data. There’s talk that Chinese officials wants to break up Alibaba and Tencent, just as US politicians rail against Facebook and Apple. (FT)
AI Designer Is Runner Up for Chinese Fashion Prize
Outfits designed using artificial intelligence (AI) won second place in the China International Fashion Design Innovation Competition. DeepVogue, an algorithm developed by Shanghai-based company DeepBlue Technology, was the sole non-human participant in a field of 16 designers from around China. It also won the “People’s Choice Award”. DeepBlue was quick to point out that a great deal of human assistance was instrumental to DeepVogue’s success, including the input of material that the algorithm was trained on. The competition’s panel of 50 judges said AI won’t replace human designers, or at least not all of them. (Radii)
Long After Livestreaming, Vlogs Catch on in China
The term vlog, or video-log entered the Miriam Webster Dictionary in 2009 but it’s only since late last year that the term shot up in usage in China. Video site Bilibili and Sina, which runs social media site Weibo, are among the companies that have pushed the medium. Bilibili, which pays 2,000 RMB ($300) for every million views, saw vlogs increase by 16 times and their views increase by 18 times in 2018. Bilibili went on to launch a 30-day vlog challenge in January to celebrate Chinese New Year. Web celebs and beauty blogs have now joined the trend. (Sixthtone)
CONSUMER & RETAIL
JD Opening Retail Complex in Chongqing
E-commerce and logistics giant JD will open a large retail complex in Chongqing, central China, later this year according to Yan Xiaobing, senior vice president of Jingdong Group. The complex will include the consumer electronics on which JD, previously known as JD.com, first built its brand, as well as home appliances. The Jingdong Home Appliance Super Experience Store will cover an area of nearly 50,000 square meters, including three floors of the main building and a smaller building in Chongqing Putai Plaza. The Experience Store will sell smart appliances, mobile communications and other IT products, while an additional comprehensive store will stock major categories such as digital, home life and daily necessities. (Every network )
Tencent Wins Approval to Sell Nintendo's Switch in China
It’s better late than never for Nintendo, which finally has permission to sell its hit gaming console, the Switch, in China two years after the device was first launched. Approval was granted by officials in Guangdong, where Nintendo’s China partner Tencent Holding is registered. Approvals for hardware and software are separate, however, with the Ministry of Culture and Tourism approving devices and the State Administration of Press and Publication approving the games, meaning there are no guarantees Nintendo will be able to sell all its IP. (Initially, the console will be sold with a game called New Super Mario Bros. U Deluxe.) Nintendo and Tencent previously collaborated with Tencent’s hit mobile game Arena of Valor available on the Switch. (Reuters)
Estée Lauder and NetEase Drop Lawsuits
Koala, NetEase’s e-commerce platform, has dropped a lawsuit it filed against Esteé Lauder for damaging its reputation, while the US beauty giant has in turn dropped the lawsuit it filed against Koala for infringing its trademarks by allegedly selling MAC cosmetics without a license. Estée Lauder (Shanghai) Co., Ltd. is the exclusive distributor of Estée Lauder products, including MAC, in China. The Manhattan-based company sought 1 million RMB ($149,000) in damages, while Koala was asking for 21 million RMB ($3.12 million) and an apology. Estée Lauder had also accused the Hangzhou-based company of selling fake Estée Lauder products on its site. (Jiemian)
POLITICS, ECONOMY, SOCIETY
Beijing Buys Stability for China’s Economy
Officials say the Chinese economy grew at 6.4 percent in the first quarter of 2019 compared with the same period last year. Despite scepticism over Beijing’s numbers, economists believe the slowdown has reached its bottom thanks to the hundreds of billions of dollars Beijing pumped into the economy, as well as encouraging more business loans from state-run banks. These gambles paid off when the Chinese economy was growing at double digits, but now analysts fear China won’t be able to shoulder its debts. One positive sign stood out, however, with retail sales up 8.3 percent in the first three months of the year. (NYT)
Banished for Tax Evasion, Fan Bingbing Returns to the Red Carpet
Once China’s most bankable star, actress and brand ambassador Fan Binging disappeared from social media and public appearances in July 2018. After reappearing on social media in October to apologize for tax fraud, and pay fines of more than 883 million RMB (US$127.4 million), Fan finally made a public appearance this week, attending an event hosted by video streaming site iQiyi. Fan had previously represented brands including Mont Blanc, De Beers and Thai travel retail group King Power. (Apple Daily via Asia One)
China’s Exporters Lament Losses at Canton Fair
A ceasefire in the China-US trade war can’t come soon enough for manufacturers exhibiting at the spring edition of the Canton Fair, which last autumn drew 190,000 buyers from around the world. Officials suggest the antagonism may soon be coming to a close, but already Chinese exporters have suffered its impacts. According to trade data firm Panjiva, US imports of container freight from China fell 6.4 percent in the first quarter of 2019, while US imports of Chinese-made furniture by Ikea, Home Depot, Target and others fell 13.5 percent. (SCMP)
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