China brushes off global IPO, M&A slowdown

OvumDespite a bounceback in tech stocks, many of the third quarter′s negatives worsened in Q4, especially for vendors. Venture capital funding fell again, M&A deals were hard to close, and demand for public stock offerings was weak outside China.
 
This matters because the competitive dynamics of the telecom market still depend on a steady influx of new start-ups. The best of this bunch can only prosper with a healthy IPO and M&A market, which provides backers with multiple exit options.
 
Last year was better than 2009 in this regard, but China’s 2010 pickup was far stronger than elsewhere. It is too early to tell if the 2H10 results are bad news for the industry, or just an inevitable result of a power shift towards China – or both.
 
Globally, M&A deals involving vendors were flat in 2010, with 251 worldwide, from 260 in 2009. The combined value of all the 2010 deals was $15 billion, 24% lower than in 2009.
 
There are signs, though, that the regulatory review of mergers is getting tighter, for various reasons. Most importantly, there are more jurisdictions involved, from the US, the EU, and more.
 
Now that China’s vendors are global powers, we can expect Chinese authorities to also get involved in reviewing deals. Ideally these reviews would be driven by considerations about economic efficiency, but “who is lobbying for what” is always a factor, unfortunately.
 
Right now, Huawei is asking a US court to put limits on Motorola’s sale of its wireless infrastructure assets to Nokia Siemens Networks. This comes just a few months after Sprint rejected Chinese vendors from a 4G shortlist under political pressure from an Obama administration official. There are almost always politics involved in M&A deals, especially cross-border deals.

 

Venture capital investments are also trending downwards: the annualized number of deals and aggregate deal value in vendor VC has been falling, almost without interruption, since late 2008. For 2010 overall, VCs invested $1.05 billion on vendor start-ups, down 21% YoY; the number of investment rounds fell 31%. The biggest recipients were ExteNet ($128 million in 1Q10), Acision ($100 million in 4Q10), and Ustream ($75 million in 1Q10); the average deal was a much smaller $10.2 million, slightly larger than in 2009.
 
Huawei and ZTE finished 2010 strong
 
In the last few days, before the Chinese New Year holiday, both Huawei and ZTE published unofficial 2010 results. Huawei claims it achieved $28 billion in 2010 revenues, which would comfortably exceed its 20% revenue growth target. We were skeptical of the 20% target, so this would be a surprise. For ZTE, its preliminary results claimed $10.4 billion in 2010 revenues, 18% growth from 2009. Even if actual results are lower than this, the Chinese vendors have been outperforming most of their western (and Japanese) rivals for several years, and did so again in 2010.
 
Huawei and ZTE have also focused much more on innovation and technical differentiation recently. Their innovation is done almost entirely in-house, but an increasing amount of it is done overseas, in places like Ottawa where venture-funded innovation has a long history. We don’t expect Huawei or ZTE to suddenly change their culture and start buying start-ups. In fact, some percent of the next generation of Huawei’s overseas employees may leave Huawei to develop start-ups that later compete with Huawei.
 
In the shorter term, there will inevitably be some envious entrepreneurs scattered around China, eager to become the “next Huawei.” Some of these may, unfortunately, be mainly concerned with exploiting whatever legacy position they have (social connections, physical assets, provincial government subsidies, etc.) in order to raise cash, and only secondarily concerned with innovation and satisfying customers.
 
Communications sector IPOs in China in 2010 were almost entirely of established companies, typically with some connection to state enterprises. For instance, the largest IPO in 2010 was of Guangzhou Haige Communications, which raised $475 million in August. Haige’s origins are inside the Guangzhou Radio Factory, founded in 1956 by the provincial government; Haige was only registered as a company in 2000.
 
To date, few Chinese start-ups – at least in telecom – are in the mold of the small Silicon Valley start-up, founded by a few smart engineers trying to solve a very specific technical problem, or to develop a new, cheaper, or faster process to replace an existing one. There have been many more garage-scale start-ups in China in the services and software sector, yielding such large new enterprises (now) as Alibaba, Baidu, QiQi, RenRen and Tencent.
 
Some of these have adapted existing business models for the Chinese market, benefiting from the high hurdles to any foreign tech firm penetrating the Chinese market. China has also had its share of such “copycats” in the telecom sector; preventing theft of its intellectual property by ex-employees is a perpetual problem faced by established Chinese vendors. These are the growing pains China has to deal with as it tries to cultivate a start-up culture; it’s not there yet, but is making progress.

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