Is China’s Interior Missing Parts? Or Are You?

Friday, April 4, 2008 23:39

Bill Dodson from This is China writes a piece in Euro Biz this month entitled Parts missing that looks at some of the difficulties a few friend are facing when entering China’s interior market of Chongqing.

It is one of those pieces that will surely get a lot of reads, because he is right. Chongqing is missing some hardware, a lot of software, and for many firms it has yet to develop the local market necessary to warrant real interest from a lot of firms.

why this article is interesting is that Bill’s writing reminds me of conversations I had 5 years ago with investors about Nanjing and Chengdu. they were in Shanghai, they were in Beijing, but when I mentioned Nanjing or Chengdu… the response was “where?”

In one case, I was working on a 10 million USD investment for 6 buildings. the development firms had gone bankrupt, creditors were knocking LOUDLY, and we had exclusive right to it. We spent two days going over the sites, mapping the locations, and building the models based on current market conditions and a general understanding that Nanjing was about to see a huge economic jump over the next 5-8 years that would make these properties really really sexy.

The result of our analysis was that without doing anything, investors would make 200% within 6 months (the lock out period) by simply flipping the properties.

200% sounds attractive right?

well… after meeting with 10 investment groups based in Shanghai, and more based internationally, we came to a single conclusion that 15% in Shanghai was better than 200% in Nanjing because investors really did not understand the fundamentals of China. It wasn’t that there weren’t opportunities. It was that these opportunities required some background, a little imagination, and patience.

Anyway, back to bill’s article. At one point he writes the following:

the interior is still a long way from becoming a viable, wholesale investment target for any but the largest Western companies.

Great hidden costs lie in store for potential investors, like government corruption, changeable policies, inflated costs of production inputs, a lack of skilled labor and experienced management, as well as reasonable salary levels for local hires.

and of course he is right. there are hidden costs. labor is harder to find. the logistics industry (trucking, warehousing, customs, etc) are not as fully developed, but where he sees barriers… I see opportunities.

Until the interior is able to update its operating systems to match 21st-century international standards, investors need to approach potential investment locations with deep, up-front investigation and analysis of hidden costs. Only then will China’s interior be a viable platform from which Western businesses can sell into regional domestic markets and export to markets throughout Asia.

Again. he is right, and again… where he sees barriers, I see opportunities… and where he sees this as a all or nothing, I would say that different industries/ models will see different opportunities

In all honestly, everything that Bill says is fundamentally correct, and for firms that are taking a conservative approach the barriers will be too high. However, just looking at the logistics industry, there is a reason why groups like Kerry Logistics and IDS are doing so well while others spin circles on the east coast. in a recent conversation I wsa discussing the difference between Mainland/ TW/ HK managers and US/ EU managers when it comes to investing in China, and there were three that we felt provided the Mainland/ TW/ HK managers, and why they were making so much money in comparison:

1) They know China, and they believe in the dream of China. To them, investing in Chongqing is not risky. It is getting in early before the dumb foreign money comes in and pumps the bubble

2) Their hurdle rates are much lower, and their time frames are much lower. Speak to a Chinese vs. foreign landlord and you will see that right off. the foreigner is trying to make money off the rent, and the Chinese landlords are thinking the RMB is going down 15% this year, the inner ring apartment stock is tight.. so 30% increase in capital market.. so all I need to do is cover the mortgage

3) Mainland/ TW/ HK managers are much more patient. HK developers will by land and wait 5 years before driving the first stake. Again, it gets back to the dream, but more than anything else, they see that others are buying into the dream around them, and they need to take the first steps (buy some land) even if they are not fully ready to act (build the building).

So, if I were an “investor” in China. I would suggest you see bill’s article not as a red flag, but as a green light. he is right. It will not be easy, and it will not go to plan, but if you speak to managers who opened Shanghai operations 10 years ago, they will probably have similar stories. this is a developing country, and different geographies have seen different levels of development… and were I a firm that required huge amounts of gas, I probably would have looked to see what the real capacity was of the area and spoken to others who were operating in the area rather than trust a single source (especially a gov’t source), and I wouldn’t trust a “contract” for service. China just had 17 province lose power..

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2 Responses to “Is China’s Interior Missing Parts? Or Are You?”

  1. Duncan says:

    April 6th, 2008 at 7:08 pm

    “HK developers will buy land and wait 5 years before driving the first stake” – just wondering, is this actually possible anymore with the 2-year develop-or-be-reposessed rule?

  2. Rich says:

    April 6th, 2008 at 8:37 pm

    Duncan,

    While I perhaps should have qualified that a bit, I do know of developers and cities who are “flexing” the 2 years well past the deadline without fear of the repossession rule.

    In conversations I had at the time of that announcement, many felt that was a rule for the 1st tier markets that didn’t take into account the fact that the 2nd/ 3rd tier cities are developing at a much different pace.

    R

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