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A talk with a professor in Beida


Paul Gillis has worked at PWC just after his graduation from college until the age of 50 when he got retired. For the last 6 years, Paul has taught at Peking University, also called Beida, to MBAs. Paul has worked in accounting for MNCs doing business in China especially on tax issues. He helped many companies raised money abroad. Paul is now working on a project basis for the SEC, CRCC, US government, the European Union and some hedge funds. For the European Union, Paul has worked on helping the EU to assess whether China is a market economy. For the SEC and CRCC, Paul has worked on regulatory and accounting issues. He has worked on issues such as access to capital for Chinese companies especially for IPOs.


China began to open after the cultural revolution. Which was seen at that time as the wrong direction. Deng Xiao Ping decided to open up the economy in the late 70s – early 80s. At this time, private ownership became legal even though it was not totally legitimate. With the events of 1989, Chinese leaders did not know which direction to take: either the right, either the left. Deng Xiao Ping went in the South and pushed for more reforms in 1992. It was called “the Southern tour”.


In 1990, stock exchange reopened. The last exchange place, Tianjin exchange close in 1956. Shanghai re-opened  and then Shenzhen opened as well. They also began to privatize some State Owned Enterprises (SOE). Twenty years later, few companies were on the private exchange.


The internet sector has changed the deal as well. They could get listed at the highest cap ever in China. Many Chinese coming from the US (after Wharton and other top B-schools) decided to come back to China and copy successful companies from the US.


In 2011, Zhang Zemin came with the theory of the 3 representatives which was one of the biggest changes. He said that entrepreneurs. Who are doing business can become communists. The communist party became more like a business club or a chamber of commerce. At the same time, China developed institutions to support entrepreneurship such as VCs, stocks markets, SME. The big change came in 2009 with a new stock exchange called ChinaNext which valued for 90 billion USD of assets. Previously, co;panies went to the US to raise money (few of them went to Toranto neither Hong-Kong). Mainland investment banks encouraged this switch to the US as the market cap was higher so the fees were higher. A total of 90 to 110 billions USD market cap were listed in the US. Smaller caps were listed in China. The problem is that the US shut down for 1.5 year with only 1 IPO which failed. (VIPShop). 100 companies would like to do IPO but there was no mwrket. PO is the only exit for Private Equity firms (either selling to other PE firms, either selling to corporate buyers, either do IPO). Moreover, a lot of businesses are restricted in the US. For instance, all internet and education companies are restricted in China. It is impossible to get authorization in China as a foreign company. So Chinese companies looked at an offshore company in the Caiman islands and they could make it without China’s approval. Baidu and Sina did so.

That leads to an other issue which is VIE (which is a form of contract within the shareholders are not linked through equity but through contracts as education and internet businesses cannot be owned by foreign entities). But the problem here is that some companies decide to do the thing on their own. That happened to Danone, to Alibaba and Yahoo with Alipay (valued at 5 billion USD). This type of contracts and the history around this type of contracts killed the market. So people did not believe in the structure anymore and the companies were traded at a very low level (such as 40% lower, with a 10-year-PER). Meanwhile, people witnessed a huge number of accounting frauds so that the companies got deregistered from the stock exchange. It made it difficult to believe in numbers.


About entry barriers for entrepreneurship, we can say that 15 years ago, China was not a place for entrepreneurship. They wanted the fortune 500 to come and make huge investments. It was really expensive. The capital requirements went down when China became member of the WTO. Then, people could open easily restaurants, small businesses including for foreigners. Foreigners could use VIE in order to get involved in regulated businesses. Ten years ago, some big changes appeared as well. Setting up a foreign company without Joint Venture was possible (WFOE) in businesses such as distribution, consulting, services.  As such, a lot of real estate companies from Hong-Kong, Taiwan, Singapore come and invested in China. Chinese government does nto really care in fact about small foreign businesses. Education is a big market in china but very hard for IPO abroad as it is heavily restricted. For foreigners, small business opportunities can lie in travel. You have some niches for small businesses. As for travel, foreigners bring something even though they are smaller than ctrip or elong. In this business, SOE underperformed for inbound travel. Also, you had some regulations such as forbidden individual tourism in Taiwan where only groups were authorized.


Let’s take HK as an example. Over the last 15 years, huge changes happened in Hong-Kong. Mainland Chinese bought more and more apartments so that HK restricted the sales of apartments by mainland Chinese as the prices were skyrocketing. When the HKD and the RMB reached parity, Hong-Kong people were scared. Shenzhen is now as expensive as Beijing or Shanghai.


China went through 3 different phases of development:

–        Cheap labor. Labor costs. China has some competitive advantages.

–        Cheap capital. In the early 2000s, China poured money into infrastructures. Government was selling lands.

–        Cheap Intellectual Property (IP) which is the current and next stage. Look at high speed trains. They can get the technology and develop it for cheap. Many foreign companies just sold their technologies looking at very short-term objectives.


At the same time, R&D was developed in China because of the number of engineers and cheir cheap costs. Chinese education system is successful in sciences and technology, especially in maths. Assembling is over in China. Foxcom is going to Vietnam and Indonesia. Manufacturing is nevertheless still possible as all the infrastructure is still in China.


In the retail industry, you have few national champions except Gome, Taobao, Sunning.


There is somewhat a big gap between the old manufacturing and the new PCC. PCC only wants to protect itself, not the Chinese industry. For instance, Caterpillar versus SEO is more a likely to be a war won by Sani, the Chinese equivalent. IT is better not to choose an industry where the state is involved and leading the field.


A study in 2006 showed that 99% of companies did not have bank loans. Companies had to go to the capital market to get money and investment. And the crisis happened which made things even harder. The government decided to develop capital markets in China. ChinExt was born but it is way too small compared to the needs of Chinese companies. Actually, China should open the capital markets to foreign companies to create RMB Pe / VC funds. This may happen in 5 to 10 years. That is nevertheless not sure we are heading to this direction as the government is acting in a schizophrenic way with a lot of different policies with different views. On one hand, CRRC is more progressive whereas the ministry of finance is more conservative. The advice of the International board of Shanghai is interesting but fights against other views. This board wanted to create an exchange to list your Chinese entity in China such as for HSBC or Nokia but companies did not want to do it because they could not use the money raised in China to invest abroad. THe money had to stay in China. There is this ideological assumption that RMB is people’s money and so Chinese money cannot be sued to fuel capital to other country’s companies. This went nowhere and was not done. The new government with Xi Jin Ping and Li Ke Qiang may change this and be more flexible. They may somehow give the chance to Chinese citizens to buy Mc Donald’s shares.


Is there some anti-foreign attitude? Certainly in some way. This happened to Americans. His happened to Japanese. It is becoming more and more difficult to manage protestors. An other issue of discontent will appear with the men / women ratio. 100 million men are going to be left. Look at the Taipei revolution. If this happens again, that could be scary.


About all the polemics on the Iphone made in America or in China. 90% of the price of the Iphone is IP-related and most of the components are not built in china but in Germany, Japan and the US. Assembling in China costs 7 USD for 1 Iphone.


Importing products to China can be a trend for entrepreneurs. The question is to know what products. Remember the Opium wars. Chinese can be very sensitive with that. The SU may support businesses which export to China. Some products cannot be sold even though there would be a market for it. Helicopters cannot be sold for military reasons. People are more willing to pay for quality. Pricing power is very important in china. The more expensive it is, the more attractive it is. It is a way to show off. It is all about status. For instance, as for cars, if the price is too low, that suppress the demand. Organic food is 4 times the market price. Safety and status are the 2 main things to sell.


About corruption, it is a very interesting part to analyze. The party is going to have a look at it. This is not bribes actually which really matter, this is the access to opportunities. Such as other countries such as the US, when you have some power you can do some PE (the Bush family) pre-IPO and make a lot of money.

About SOEs, the return on capital from these companies has been very bad. Zhu Rongyi reformed them to make them profitable. That was a real big change. They went really big. They became too big to fail. There is not much chance it is going to change for the next 10 years.


As for education, critical thinking is a big issue. Paul wants to change it but that is difficult. The hard part has been to teach decision making.


Which recommendation to the EU I would to? It would be critical to negotiate better access to the Chinese market. Get a market access without restriction. In fact, Chinese have nothing to lose. They should tackle the barriers to invest. For instance, the internet, they should work to make it easier to get access to this way of selling. The Chinese economy is pretty much an internet economy now. Delivery and payment are the biggest issues for foreigners. This could help promoting exports. They should let foreign entrepreneurs start e-commerce.


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