Manage-Wise

Silicon Valley’s tech route to China

I am driving a convertible with the rooftop open, enjoying the sun and the scenery while heading south on Route 280 from San Francisco. The Pacific Ocean is just over the grassy ridges of the Santa Cruz Mountains to the west. At Sand Hill Road, I end up at Sequoia Capital amid manicured lawns, towering redwood trees, and blossoming roses.

Don’t be fooled by the perennial sunshine; this is the western Wall Street. Fueled by the Internet revolution and nearby Stanford University, this venture epicenter has created more wealth in a shorter time span than any other place in history. This potent mix of finance and technology in Silicon Valley produced Google, Cisco, Oracle, Palm, Yahoo!, Apple Computer, and Amazon.

An encounter

I am here to meet Don Valentine, a godfather in this valley, who founded Sequoia Capital in 1972. Valentine drives a red Mercedes Convertible and at 75 years of age is aging-movie-star-handsome with a silvery head of hair, a square jaw, and confident body language.

When Valentine talks, people listen. Now, in a conference room, Valentine is offering me his bleak view of China. China is too far and too foreign. It’s crippled by ills such as intellectual property theft, immature stock exchanges, and regulatory problems. Sequoia has made its stellar reputation by nurturing young companies within a 50-mile radius—driving distance from its office. It incubates promising start-ups upstairs, where the partners coach and mature fast-growing tech seeds, working hands-on with immigrants, first-generation Americans, and underdogs—Sequoia’s favorite kinds of people. As if on cue, the young founders of a start-up team pass by the meeting room. They are giggling. “I hear laughter,” says Valentine, “so it must be good.”

My meeting with Valentine was in spring 2003, and a lot has changed since then.

Today Sequoia is deeply invested in China. It is searching there for the next tech innovation that will thrill consumers, rock the public markets, and enrich the firm with sales of skyrocketing shares—a hit on the order of the Palm handheld digital organizer and its staggering opening-day valuation of $53 billion in the hyped-up public markets of early 2000. Only about 8 per cent of China’s gross domestic product comes from high tech now, but the government’s latest five-year economic plan is ushering in change with its emphasis on technology as a cornerstone of growth. Soon China—long known as a low-cost manufacturer—could be respected for innovations too.

The market emerges

Digging for gems in China, Sequoia raised a $210 million China fund in 2005 and planted Sequoia Capital China in Beijing and Hong Kong. Two more funds budded in spring 2007: $250 million for start-ups and $500 million for fast-growing companies. Suddenly, Sequoia had nearly as much gold-digging money in China as in the United States.

In less than two years, Sequoia’s 13-member team led by two Chinese prospectors, Fan Zhang and Neil Shen, has invested in 27 would be digital stars: streaming media broadcasters, online ad services, social networking sites and wireless search and video-sharing start-ups, among other software, semiconductor, gaming, and Internet deals. Young, savvy, and arrogant, Shen, a master’s graduate from Yale, took online travel portal Ctrip.com and Home Inns economy hotel chain public onto Nasdaq, and Stanford MBA Zhang, a former investor at DFJ ePlanet Ventures, financed the Nasdaq-listed search engine Baidu and online game player KongZhong Corp. With nearly $1 billion to invest, Sequoia has one of the largest wads of cash of any U.S. venture firm in the People’s Republic of China (PRC).

The money trail leads directly from once-parochial Silicon Valley to China, with emerging market India another favorite destination in the $32 billion increasingly global venture capital market. Chinese venture funds soared from $3.4 billion in 2006 to $3.7 billion in the first half of 2007, nearly half for all of Asia in 2006. China nudged up to the US funds of $6.4 billion in mid-year 2007. Another indicator of the momentum: In 2006, 112 Chinese start ups got venture financing, more than double the 54 in 2005. Fueling the momentum were China’s giant initial public offerings, the world’s largest in 2006.

Roller-coaster ride

Not as much investing frenzy has been seen since the tulip bulb craze in seventeenth-century Holland or, in more modern times, the Internet bubble of the late 1990s. Both surges came to a crashing halt. Billions were lost in the dot-com bust as companies with high-priced stock such as portal and broadband provider Excite@Home went bankrupt. Initial public offerings of venture-backed tech companies fell from 229 to 37 between 2000 and 2001. The fact that investors see China as the next big trend is in itself a warning sign: Japan was the hot market 25 years ago, and Eastern Europe followed it.

It is a little early to tell if the current heated climate for deal making is a repeat of the irrational exuberance of the Internet bubble in the United States. Preliminary indications are that China funds will do okay but probably will not come near the triple-digit financial returns of the top-tier U.S. technology funds during the boom times in the Valley, when practically every new tech deal turned to gold. So far, a few funds that began to invest early in China, beginning in about 2002, have managed to turn in respectable performances of 20 per cent. Successful investments in well-timed standouts such as Baidu and Alibaba helped.

Going forward, the challenge is to strike it rich with newer, unproven investments from a fresh crop of mostly local entrepreneurs. Most Chinese venture firms are predicting strong net returns north of 25 to 30 per cent for their China technology funds, but there is little proof of that yet aside from good progress in their portfolio companies. And there are a lot of ifs:

The possibility that the surging Chinese economy will collapse is just one of the many hazards in the already risky, highly cyclical venture business.

Excerpt from ‘Silicon Dragon’ by Rebecca A Fannin. Reproduced with permission © 2008, Tata McGraw-Hill Publishing Company Limited. Price: Rs 495. Vishwanath_Ghanekar@mcgraw-hill.com