China’s Nasdaq: a game changer for innovation?
China has launched its Nasdaq-style board (ChiNext) on Oct. 30 with first batch of 28 companies at Shenzhen Stock Exchange. There has been considerable enthusiasm for this new board in China, but there is also a concern that these shares may be overpriced. The first day proved to be highly successful with most share price doubling.
While the launch is widely noted by the media, few commentators have paid much attention to the potential of this board to be a game changer in China. If successful, it also has the long term prospect to transform the global map of capital, technology and innovation.
The idea of a Chinese Nasdaq was conceived over ten years ago at the height of dot.com rush. China realized then that it needs a similar capital mechanism to support innovative companies. The original plan was to launch it in 2004. It would be known as the Chuang’ye’ban (Start-up Board), stressing its role in innovative startups. When I researched in Beijing’s Zhongguancun—“Silicon Valley” of China during the early 2000s, there were many enthusiastic tech-entrepreneurs dreaming of IPO in this market. The bust of the tech bubble in Wall Street, and the poor performance and erratic speculation in China’s main stock market poured icy water over this idea. The plan was suspended. In the mean time, China’s high-tech startups struggled and those could not raise money overseas vanished.
Since 2003, venture capital (VC) investment in China picked up speed, fueled by the international VCs looking for next growing market. China had its own venture capital funds since the late 1990s. Yet their share of the market shrank just as the global interests on Chinese startups rose. In the middle of 2000s, I found that international VCs were active looking for new projects in Beijing, but domestic VCs were practically absent. “We contacted them, but nothing much came from them.” commented a manager in a business incubator in Zhongguancun. Entrepreneurs and experts attributed the ineptness of domestic VCs to their incompetence and lack of expertise in technology industry. They were all true. But there was another bigger problem: there was no domestic exit option for VC funds. China’s main stock market is oriented to state-owned companies. The threshold is too high for most small and non-state-owned companies. Without a fully functioning domestic capital exit, the circulation of investment could not be completed. Foreign-originated VC funds ended up dominated over 80% of China’s VC market.
This is certainly not because China lacks capital.
The odd thing is that China has one of the world deepest pools of capital looking for profitable outlets. It also has a large pool of able entrepreneurs with good ideas and a proven record, but have no access to this capital. Chinese banking system discriminates against small and non-state firms, and China’s stock market shuns them. The international VCs have been the only ones courting them. They brought China’s most visible startups, Baidu, Shenda and Sun-tech, to IPO in Nasdaq. But to get international venture finance, Chinese firms must meet the standards of Nasdaq. To fully appreciate how strange it is, imagine the start-up of eBay or Google could only receive venture investment from outside the US, and issue IPOs in a foreign stock market, even though their services might not work outside the US. To the credits of the international VCs, they have helped to create a start-up culture in China. But it is obvious how limited this channel has been for the vast majority of small Chinese startups.
The launch of this new board (ChiNExt) could change that. For the first time, China will have an institutionalized framework to channel its domestic capital to its entrepreneurial ventures. The exit will also serve as a standard for VCs to guide new startups. Already, in anticipation of ChiNext, the number of domestic VCs surged. The Asia Times reported that in Shenzhen alone, 35 new VC firms were set up in 2007. In the second quarter of 2009, the investment of domestic VC increased over 70% compared to the previous year. For the first time since the VC industry emerged in China, projects invested by domestic VCs exceeded those by foreign VCs.
Is this excitement over-rated? Possibly! Unlike in the early 2000s, most potential participants of ChiNext today keep low key and avoid high expectations. Plenty things can go wrong in the new board. Similar exchange in Hong Kong has not done well. The ChiNext might also repeat the same or worse speculative cycles in China’s main board. Yet, the fusion between one of the world deepest capital sources and its largest reservoir of future entrepreneurs could not be overstated. Chinese small high-tech firms have been battling endlessly with China’s financial system. The ChiNext provides an exciting alternative and a possible future direction.
What does this mean? International VCs should expect more competition from domestic VCs, but they may also see an increase of potential projects as more people become entrepreneurs. Chinese firms may choose domestic listing over foreign listing if their main businesses are within China, increasing competition for Nasdaq. If ChiNext works as it is supposed to, it could unleash a world of new ideas and innovation from China’s long under-served companies.
By Yu Zhou (周宇), professor of geography, at Vassar College, Poughkeepsie, NY. Yu Zhou is the author of Inside Story of China’s high-tech industry: Making Silicon Valley in Beijing (2008).