Hello My China…
Hello My . . . China!
In our Investment Committee meetings, we have often considered our exposure to China. After all, how do you ignore the second largest economy in the world with the world’s second largest population, the country with the highest number of patents and the country with the largest number of STEM (Science, Technology, Engineering and Mathematics) graduates per annum. Do we go direct, with a discreet China exposure or do we go via the EM index? (Of interest the EM index is approximately 12% of the World index, and China is 25% of the EM index . . . making China approx. 2.5% of the global index.) SA portfolio managers often tout the phrase that “China is uninvestable”. Is this because of laziness and not wanting to do the hard yards, or not understanding the investable landscape (are the capital structures and ways of accessing the investable opportunities undesirable) or is there something else that we are missing or need to understand.
With these varying thoughts swirling in our minds, we were fortunate to be invited by Prescient Fund Managers, a business we use in our current investment solutions, to join a group of South African investors on a whistle stop tour of China . . . an “Intro to China 101”! (We must declare up front that we pay our own way and hence do not have to deal with any perverse incentives as a result of joining the trip.) The team from Prescient China put together an agenda of company visits and cultural experiences for us uninitiated, as well as carefully orchestrating a culinary extravaganza to test the palate. Our trip kicked off in Shanghai, followed by time in Beijing, Nanjing and Hefei before returning to the “Paris of the East” after 4 whistle stop days on the road.
So, let’s start by summarising what the standout experiences/learnings/observations were:
· There are a lot of people! The population of China is currently 1.419 billion people. The population of Shanghai is 25 million people, and the total population of the 4 cities we visited was 66 million, a little more than the population of South Africa. So clearly an economy with potential! Interestingly, however, the population growth is trending negative, largely flowing from the ‘one child’ policy.
· The cities we visited were spotlessly clean and very well cared for, with extensive urban gardens, grass verges, plentiful trees and flowers lining major boulevards. The “old” images of choking pollution and dirty streets have certainly given way to blue skies. The cleaning up of their environment has been a focus of the ruling party for several years.
· One is under constant surveillance. Not only is the presence of cameras ubiquitous, but the use of one’s identity document (in our case, our passports) is pervasive. The first thing to do when landing at Shanghai airport is to log your biometrics at a scanner BEFORE getting to passport control, where your biometrics are accessed again (obviously one’s biometrics are submitted as part of the visa application as well). We even accessed our train using our passport biometrics (no ticket is issued). And then when out in any public spaces; train stations, walking the streets, public transport or generally moving around the country cameras are capturing our every move. We often remarked that the Chinese government would be able to know where we were always to within the nearest 10m! This ‘invasion’ is offset by a surprising lack of police presence, with the recognition that they have moved from the streets to behind a computer screen to maintain order. One of the companies we visited – Sensetime - is an AI/machine learning company listed in China. One of its main “products” is using these cameras to manage amongst other things, garbage build up, unrest, fire risk, traffic etc. Not an investable stock in our opinion (more on that later), but a fascinating use of technology.
· The transport system is exceptional. Although, the sheer number of people commuting in Shanghai results in significant congestion, the freeway and public transport system is world class. The multiple elevated freeways, the tunnels and subways and everything in between, are often engineering masterpieces that work remarkably well. We enjoyed a high-speed rail trip from Beijing to Nanjing where we covered the 1,162 km’s in 3.5 hours. The top speed we saw on the digital display was 348 km/h, with an average speed of 332km/h.
The Chinese have built a high-speed network of 46,000kms of rail which is 2/3’s of the worlds high speed rail network. The image of “China” being a low-quality copy-cat are certainly challenged by these feats of engineering.
As mentioned, we had the opportunity of visiting several cultural/tourist sites to get another taste of China. The three that will linger in our memory were:
· The Great Wall of China – oh my goodness! This was just mind boggling! These fortifications, built over many dynasties starting as far back as 700BC, were built to protect the country from marauding nomadic groups to the north. The part we saw was built across the most inhospitable terrain one can imagine. Undulating would not fairly describe the walk we experienced! We had an hour to hike and managed to get 1.2kms out before we had to return, hence making a 2.4 km hike in 60 minutes . . . suffice to say we returned slightly out of breath and a little sweaty (nothing a local Tsingtao beer couldn’t rectify!). The total length of wall covered is 22,000km . . . the entire coastline of South Africa is 3,000km.
· Tiananmen Square and the Forbidden City: These two sites form part of the cultural heartbeat of China. Despite its open spaces which have held almost a million people in the past, the square is a totally authoritarian area with heavy surveillance in place to monitor and police visitors. Access is tightly controlled with multiple passport scanners and barriers managing the entry. Once inside, cameras are everywhere with the CCP ensuring that there is not a repeat of the 1989 student uprising which saw more than 300 people killed. Locals queue for hours to see the Chairman Mao Mausoleum, before entering the Forbidden City which housed the Emperors of former Chinese dynasties. It is said that this was the centre of world power during the Qin, Tang and Song dynasties. Today, it remains one of the most sought out tourist attractions, welcoming in excess of 16 million people per annum.
· Niushoushan is a newly developed cultural park on the outskirts of Nanjing. It is situated on an historic ancient Buddhist Mountain site and houses the skull bone of Shakyamuni, the founder of Buddhism. The place is incredible! With the palace and gardens covering approx. 130,000m². It was built between 2012 and 2014 for a cost of R 4.5 billion (how long did it take to build the Cape Town stadium?). In its first 3 years after opening, they received 5,000,000 visitors at an average price of R 250 per visitor (i.e. R1.25 bn of direct revenue, not including any ice cream sales!)
Company Visits
Despite the ‘whistle stop’ nature of the tour, we were extremely fortunate to experience China through a variety of lenses. The tourist experiences will remain in our memories for many years, but the primary reason for our visit was to get exposure to companies and get a sense of the economy. To achieve this outcome, Prescient set up 8 company visits during our time, including the Shanghai Stock Exchange, Sense Time, NAURA Technology Group (a business involved in the production of semiconductor chips), Xiaomi; Nio Inc. (an Electric vehicle manufacturer), Nio Capital; iFlyTek (tech in areas like speech synthesis, voice recognition, voice assessment, and translation) and finally, a presentation by Prescient. These businesses generally have a tech underpin and illustrate the rapidly developing Chinese tech sector. As mentioned above – no longer a ‘copycat’ economy. Of these businesses, we have chosen two to explore in more depth here – primarily to illustrate the challenge an ‘outside’ investor faces when allocating capital to Mainland China.
· The first business we visited was SenseTime – an Artificial Intelligence business with a wide range of applications, including medical, city management and education. We were taken through a range of demonstrations as to the practical applications of the technology. The most interesting of these was the connection of artificial intelligence to the huge number of cameras generating several petaflops (a unit of computing speed equal to one thousand trillion (one quadrillion) operations per second of data [we didn’t know either!]) daily. This assists local governments to manage cities, traffic, crowds, recognise the breakdown in services etc. There are medical applications where the SenseTime AI plugs into machines such as MRI’s and can analyse and provide reports for patients, allowing doctors to free up time and manage passenger backlogs. The application in an environment like the NHS would be extraordinary where >1.5m people are wating on diagnostic tests with a 2 ½ year waiting list.
At face value, SenseTime seems like a great investment opportunity. It has the state as one of its biggest clients, it has partnerships in place enabling the development of cutting-edge tech and it has access to capital. However, when one digs into the detail, you see that the government owns a ‘golden share’ in the company which gives it superior voting rights, as well as unpaid debts by the government for the past four years. This relationship with the state – while providing the company with a level of protection – completely changes the nature of the investment case, where you have a majority shareholder operating with a different motive to an ordinary shareholder. Profit is generally the driver of company management teams in alignment with shareholders. However, we heard of examples where ‘GDP growth’ is one of the performance metrics of a large company CEO. This aligns to the ‘Common Prosperity’ narrative that drives the decision making of the CCP but is a foreign concept to western investors.
· Another company we visited, Xiaomi, offers a somewhat different prospect. For context, we visited a Xiaomi shop at the start of our visit. It offered a wide range of electronic goods – phones, watches, vacuums, speakers etc. However, they have recently expanded their offering to electric vehicles! They were offered numerous incentives by the regional government of Beijing to establish their factory in the Beijing Economic and Technical Development Zone. The first factory covers approximately 500,000m² and was constructed in only 14 months. It started production in May and has already produced >100,000 cars. It has recently started construction on a second factory. It currently produces a single model of vehicle that is comparable to a Porsche Panamera and retails for $40,000.
The greatest difference between Xiaomi and SenseTime lies in the capital structures of the two businesses. As mentioned, SenseTime is partly owned by the government, while Xiaomi is a listed company with independent shareholders and was built up over time through the regular venture capital and private equity fund-raising process. It trades on a relatively high multiple but is the 2nd largest smartphone manufacturer in the world (behind Samsung) and it has declared its intent to become one of the 5 largest motor vehicle manufacturers in the world.
In conclusion, our trip to China was akin to ‘drinking from a fire hydrant’! We were exposed to a huge amount of information, people and insights in a very short space of time, and we would be naïve to believe that we could make a definitive investment decision based on this trip alone. However, it has opened our eyes to the possibilities and made us realise that there are opportunities if we are willing to do the research and work. As with all investment decisions, the allocation of capital is a carefully considered process where we weigh up the risks against the opportunities and consider the price you pay for an asset. The reality is that the risks in China are different to other markets due to the influence of government – both as a shareholder and policy maker. However, the current price you pay for assets is generally attractive and the underlying economy is robust – despite the well reported challenges. It is a space we will continue to work on, but until we make a call, we will reflect on an incredible week of growth, learning and fun.
China gallery
Shanghai’s diverse architecture with European influence and modern engineering
China is foodie heaven!
Ringing the bell at the Shanghai Stock Exchange. We can always dream!