China’s great VC experiment?

Right now, the 'One Belt One Road' initiative is mostly benefitting Chinese investors. Whether it will seed a bigger boom, capable of attracting a substantial amount of non-Chinese private capital is an open question. Nia Tam investigates.

It has been five years since Chinese President Xi Jinping proposed the ‘One Belt One Road’ initiative, a master plan that shapes Chinese outbound investments in a bid to promote trade and connectivity by building infrastructure across Eurasian countries.

Although there isn’t a leading agency nor any guidelines per se for the OBOR initiative, several billion-dollar institutions – such as Silk Road Fund and the Asian Infrastructure Investment Bank – were established to help finance and invest in some of the infrastructure projects being developed in the 60 or so countries covered by the scheme.

Today, OBOR’s ambition remains fluid. But with projects branded under the initiative under continuous development, we have been getting a front-row seat to how it’s shaping up, as covered in one of our yearly updates last December.

With that in mind, a couple of questions emerge: how has OBOR, driven by substantial investments from China, impacted the region? And is it catalysing non-Chinese infrastructure investment, particularly private capital?

“China is trying to create an ecosystem for trade and investments,” explains Alexious Lee, head of China research at investment bank CLSA. “Twenty-five years ago, China was the largest market for foreign investors. The Chinese have figured out what is needed to attract investors in terms of services and incentives. On that basis, the [OBOR] host countries will grow with China and become more attractive,” he argues.

But will they? A Hong Kong-based institutional investor was blunt when asked for his views on the OBOR initiative and any opportunities he sees it generating in the region: “I just don’t care. From a financial investor’s point of view, there is nothing for us. Some projects may make sense to Chinese investors, but not to people like us. As for whether Chinese investments have made these regions easier to be accessed by other foreign investors, I don’t see them helping.”

A more charitable view, taken by a group of S&P Global Ratings analysts, frames OBOR as “the world’s largest attempted venture capital project”.

“Success will ultimately rest on whether the Belt and Road projects can win local hearts and minds in the recipient countries, and whether China’s initial ‘seed money’ in the initiative will create creditworthy projects that attract true private sector outside money,” S&P’s China senior analyst group said in a report, released this April.

“The Chinese government is investing seed money to fund infrastructure and industry projects in the target countries. These target countries are the equivalent of early-stage or emerging firms in VC parlance,” they wrote, adding that the initiative is considered a VC fund with a twist. They also noted that in the OBOR model, there is a clear expectation of an ongoing relationship between Chinese government and the host countries, instead of simply cashing out and exiting.

“The trade-offs look pretty favourable – they include forging new markets and improving energy security,” the analysts noted. “The analogy to VC financing also highlights the risky nature of such undertakings, especially since they are external to China.”

ENERGY SECURITY
Over the past five years, it is clear that China kick-started its ambitions in Central Asia with a focus on energy security, followed by increasing activity in Southeast Asia over the past two-to-three years.

The geographical shift does not represent a strategic shift in China’s outbound activities, but rather points to catalysts in Southeast Asia that have opened the region to more Chinese investment, Lee notes. He adds that the changed political dynamics in Southeast Asia – especially with elections completed and new administrations in place – have provided the conditions for the Chinese government to negotiate better terms on new projects. That does not mean that Central Asia will fall off the radar, Lee stresses, not least because projects initiated five years ago will take time to complete.

“If you look from an infrastructure perspective, you can see that projects in Central Asia and even the Middle East are generally basic infrastructure, including transportation and oil and gas pipelines,” he points out. On the other hand, in Southeast Asia, where economies are more robust, investments are focused on more advanced infrastructure, such as high-speed rail and telecommunications.

However, they do not come with less political risk. A number of high-profile projects, such as the Kuala Lumpur-Singapore High Speed Rail and two dam projects in Nepal and Pakistan, have been scrapped over the past few months over what were seen as unfair agreement terms and unrealistic economic value projections. Malaysia’s new leader, President Mahathir Mohamed, ordered a review of all foreign contracts, including several mega-port and railway projects signed under the OBOR initiative, shortly after he took office in May.

Despite political turbulence and certain projects’ questionable financial sustainability, it seems that Chinese enterprises, both state-owned and private, are standing strong, continuing to actively do business in the region, even going beyond infrastructure.

‘CHINESE INVESTMENT 2.0’
Along the way, these firms are themselves evolving and that may turn out to be one of OBOR’s most immediate dividends. In the era of “Chinese investment 2.0,” as described by Jeffrey Sun, a China-based partner at law firm Orrick, the country’s investors are becoming “smarter and more selective”.

Sun echoes the views of Raymond Fung, chief executive of Shenzhen-based CGN Private Equity, expressed onstage during our April Tokyo Summit: “We are politically mandated to provide a push for the [OBOR] initiative, but we are extremely cautious [about making investments].”

Fung said the key is whether investors can find the right business model in the right market. “In the initiative, we need to take the leadership. We are the frontier sponsor, looking to create more opportunities,” he noted.

Historically, the track record of Chinese investors’ overseas deals has been “quite unsatisfactory”, Sun says. “Now as they expand internationally and adopt international standards, they are improving their investments’ returns, if only a bit. Maybe returns are lower than what others are making, [but] they are still good enough for [Chinese investors]”, he says.

With that in mind, Sun expects Chinese companies to be present in further mergers and acquisitions and more sophisticated PPP projects in these countries, as they are cash-rich and willing to take risks.

Like any successful venture capital play, the question is whether the risks being taken in these frontier, fast-growing economies are commensurate with the returns OBOR will generate. In the end, the latter will speak for themselves to define the initiative’s success.