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  • The successful IPOs of Chinese ecommerce companies VIPSHOP (ticker VIPS), Jumei International (ticker JMEI), Jingdong (ticker JD) and the much-anticipated one of Alibaba in the near future, have one thing in common, ecommerce.

    Stock Performance of VIPS

    Stock Performance of JMEI

    Stock Performance of JD

    These companies have benefited from Chinese consumers’ embrace of online shopping, which has been a result of fast-growing disposable income per capita in China.

    Continue reading on the KGA blog

    Coco Kee is Managing Partner of Kee Global Advisors LLC (KGA), a corporate development advisory firm based in New York. KGA advises companies on cross-border expansion between China and the U.S., specializing in market entry and customer acquisition, growth capital raising and M&A.

  • Shortly after the conclusion of the 3rd Plenum of the 18th CPC meeting on November 12, 2013 an extensive and comprehensive communiqué titled “Resolution Concerning Some Major Issues in Comprehensively Deepening Reform” was announced to the public.  The communiqué outlined with clarity a 60-point blueprint of social and economic changes for the coming decade.  The document alleviated the disappointment that many domestically and abroad had with the previously issued brief and ambiguous announcement at the end of the plenum.

    Not everybody feels positive and optimistic about the blueprint, especially those who expected to see drastic changes with regard to political reform.  Throughout the document there is no evidence of plans for the relaxation of the Party’s control.  What is worse, as some observers pointed out, Xi Jinping has consolidated and strengthened his power by creating two new governing entities, the National Security Council and the Leading Small Group, both of which he sits atop.

    Politically nobody should expect China to enact extensive reforms anytime soon.  Out of fear of social instability or as a concession to the loyal disciples of Mao, the new government will maintain the status quo while pursuing aggressive changes in social policies and economics.  Will this work?  There appear to be as many optimists as pessimists.

    Let’s look at the encouraging side of the picture.  Here are some of blueprint’s highlights:

    1. Create an open, fair and transparent market which allows corporations to conduct business in a fair way as long as the business is not included on the Negative List issued by the government;

    2. Further open up China’s economy, including finance, education, culture and healthcare, by relaxing the restrictions on foreign investment;

    3. Deepen reform in science and technology through encouraging innovation and strengthening IP commercialization and protection;

    4. China’s economy will have public ownership as the mainstay while additionally allowing multiple other types of ownership.  Non-publicly owned entities are allowed to be shareholders of publicly owned entities.  Neither publicly nor privately owned property should be vandalized.  Abolish unreasonable policies or invisible barriers that negatively impact or limit growth of non-public companies and markets;

    5. Allow the use of qualified private capital in the establishment of small and medium sized banks and other financial institutions

    6. Redefine the role of government, reducing its interference with the market and focusing more on turning itself into a service provider that rules by law; government will no longer approve investment projects but let corporations make their own decisions while following government regulations. unless the projects are critical to the country’s security, environment, national planning of productivity, strategic resources development and important projects related to public interest; establish mechanisms to resolve and avoid over-capacity;

    7. Change the focus of using the GDP growth rate as the sole indicator of success of the government to the use of other indicators such as consumption of resources, deterioration of environment, over-capacity, innovation, employment, people’s health, etc.

    8. Improve budget management infrastructure through the implementation of standard and transparent systems; establish and standardize debt management and alert mechanisms for both the central and local governments; deepen tax reform through simplifying taxes, including increasing direct tax and reforming the VAT tax; gradually establish an individual income tax system which combines general and itemized categories; accelerate reform in real estate, natural resource and environment taxes;

    Although “the Resolution” states that public ownership will remain dominant, it also asserts that the market will play a decisive role in allocating resources.  Compared with the wording of the 14th CPC meeting, “under the macro adjustment and control of the government the market plays a fundamental role” or that of 11th CPC meeting, “central planning plays a dominant role and the market plays a supporting role,” the role of the market is growing.

    Economic and tax reform are clearly the top priorities of the new leadership.  Meanwhile, as a comprise, the new government under the leadership of Xi Jinping has promised SOEs a relative status quo, however, they may not expect to continue receiving generous subsidies from the government.  In additon, the SOEs will have to shoulder more responsibilities for social welfare, improve operational efficiency and return on investment.  SOEs are also expected to be increasingly receptive to sharing with private enterprises the industries that historically they have monopolized, such as banking.

    The new leadership has done an excellent job designing an ambitious blueprint for China and, in particular, notable are its concessions to various interest groups, such as limiting political reform and maintaining SOE’s dominant positions, at least in perception, as a bargain for broad social and economic reform.  While the optimists have good reason to be hopeful, it is too early to predict any outcomes given the details have yet to be designed, finalized and executed.

    Coco Kee is Managing Partner of Kee Global Advisors LLC (KGA), a corporate development advisory firm based in New York. KGA advises companies on cross-border expansion between China and the U.S., specializing in market entry and customer acquisition, growth capital raising and M&A.




  • The following is the interview with Bruno Raschle, Chairman of global fund of funds Adveq, who discusses Adveq’s investment activities and performance in China, how to pick fund managers to back, and his views on […]

  • It depends on which funds. Some of them do well in China, and some not. I do not need to ask them this question. I work with them. Therefore I know the answer.

  • While institutional investors were still recovering from the shocks of some accounting scandals involving Chinese companies listed on U.S. exchanges through reverse merger, Caterpillar’s $580 million write-down due to fraudulent accounting practices of its Chinese subsidiary cast yet another chill on future transactions U.S. companies and/or investors are considering.

    In the reverse merger examples or Caterpillar’s fumbled acquisition, the ultimate problem lies in the lack of quality due diligence. Standard due diligence, including validation of documents, materials and interviews of the management team, has proven far from sufficient in a market like China’s.

    The biggest challenges come from prevailing business and transaction practices in China, which are dramatically different from those in the United States. One of the most common practices by Chinese companies is the conducting of their business in cash without providing VAT Fa Piao (which means official receipt used by Chinese tax authorities to calculate and collect VAT taxes) to purchasers of goods or services.

    There are three primary taxes a Chinese company pays to tax authorities, Corporate Income Tax (CIT), Value Added Tax (VAT), a tax collected each time a business purchases products in the supply chain, and business tax. Standard CIT rate is 25% and 17% for VAT. Business tax, imposed on businesses other than manufacturing, varies from 3% to 5%, depending on the type of business.

    However, some Chinese companies tend not to play by the rules. For example, when a vendor which makes steel sells its products to its customer, such as a refrigerator manufacturer, instead of collecting VAT tax from the customer, the vendor may offer a cheaper price of steel to the manufacturer if VAT Fa Piao is not required, which means the vendor does not collect VAT from the refrigerator manufacturer, the buyer. In this way, the vendor can report lower sales, which will lead to less VAT, CIT and other related taxes, while the manufacturer pays less for its steel. This practice may well run throughout the whole supply chain.

    When a company prepares to go public or to be acquired by a third party it has to restore all the VAT and CIT owed to tax authorities. It is a challenging task and many issues may arise. The first issue is to what degree the restoration will extend, which dictates the revenue and income the company will reflect on the financials it may present to investors/buyers. If the revenue and income are restored to a level that is slightly below or up to the actual level, it is acceptable. But if the revenue and income are inflated throughout the process in order to attract investment, this obviously becomes very problematic.

    How does a company restore its VAT and CIT? First, the company has to work closely with their suppliers and vendors to locate the uncollected VAT. The company may have to absorb any costs and expenses incurred by the restoration. Second, they have to go to the local tax authority and relay the truth. Both parties have to negotiate terms and conditions and reach an agreement. A large number of local governments in China provide incentives, including tax benefits, to companies to encourage them to go public. The local authority for example, may allow the company to pay the tax it evaded in past years through installments after the company goes public while some may even agree to forego the tax the company owed in the past and agree not to penalize the company. In return, once the company goes public it will file their tax returns truthfully and therefore bring more tax revenue to the local government.

    It is widely known that some Chinese private companies keep multiple books. The discrepancy between the revenue and tax a Chinese company reports with China’s SAIC (State Administration of Industry and Commerce) and to the tax authority has been used by short-sellers to accuse a Chinese company of accounting fraud. In most cases, it is misleading. Most companies treat the annual filing with SAIC as routine and often outsource the work to a third-party service provider. Even with the tax authority the company does not report the full amount of income. Tax evasion is a prevailing practice in China. Some people blame it on the high tax imposed on corporations by the government.

    Thus the question, is there an efficient way to find out a realistic and accurate picture of a company’s revenue? The answer is yes. However, an investor should be prepared to pursue multiple avenues to piece the puzzle together. One reliable information source is the company’s bank(s). Most private companies obtain loans from local banks. While applying for a loan, companies are typically asked for a lot of information by a bank, especially if it is a private company. Secondly, visit and speak with the company’s major distributors to evaluate the business. Distributors have first-hand knowledge of how the company’s products are performing in the marketplace. Thirdly, conversations with major vendors should shed light on the company’s business. For example, a soft drink manufacturer’s container supplier will tell you how many containers they have sold to the manufacturer. Finally, do not forget the company owner should hold the best answers to your questions. Most business owners are willing to share more information if they believe you are sincerely interested in helping their business. We suggest having a conversation with the owner in a private and discrete manner ensuring him/her that you will keep what you learn from your conversations confidential.

    We observe that some service providers mislead Chinese business owners by setting an unrealistic IPO date or minimum amount of net income that the service providers believe will be attractive to investors. Because of that, these service providers offer to help business owners re-engineer their financials to meet the desired criteria. It is critical to qualify thoroughly the credentials of the service providers who work with the business owner.

    On the other hand, some investors want to strike rich fast without putting forward too much effort, and, therefore, setting unrealistic criteria for their investment targets. The reality is that there are not many companies that are ready to go IPO within a short period of time in China. Most of them need a lot of help, capital and time to meet IPO criteria. Until investors set their expectations correctly, Chinese companies will continue to try to “re-create” themselves to please investors.

    Unlike the U.S., China lacks sophisticated background check infrastructure. Thus, how does one conduct the essential background check? Online via a search engine is a reasonable starting point. Since Google is blocked by the Chinese government, Baidu is the best option in China. Secondly, ask for detailed resumes from the senior management and do due diligence on each of them and the companies they worked for previously to assess what kind of people they are and whether they potentially have any issues of concern, such as dishonesty or fraud, that may raise a red flag. Additionally, one should also try to learn about the business owners’ family members. In China, wives often control the finances of a family and, therefore, they may have considerable impact on their husband’s behavior, values and business decisions.

    Sometimes, you may have to rely on and trust your instincts. If someone does not look or behave like a decent person, you may well be right. A company that owned and operated a dredging business once approached my colleagues and me. After meeting with the two owners one of our team members from China expressed her concerns for the seemingly ridiculous reason that one of the owners had a “bad” guy’s face. We did not brush off her doubt; instead we started looking into the situation. The routine background check did not come back with helpful findings. We continued to talk to people who knew this owner. In the end, we discovered that this owner with ‘bad” guy face was deported from the U.S. more than 10 years prior for involvement in illegal business activities. Never be afraid to trust your instincts.

    China has a very different business environment and practices than the U.S. Being well aware of the differences will allow investors to understand that standard due diligence practices will likely not work very well in China. Some of the guerilla techniques, or irregular techniques, we have discussed are essential to the conducting of adequate due diligence there. Institutional investors have to spend the time and money in the trenches kicking the tires and cannot rely solely on the big four accounting firms or large law firms to do the work. It is not harmful and often it is prudent to be skeptical about what you see. Keep asking questions and dig deeper. Always be willing to walk away from a potential deal that seems too good to be true, especially in China. But with proper, thorough due diligence, investors have and will continue to identify and profit from the many excellent investment opportunities that exist in the dynamic and rapidly growing Chinese economy.

    Coco Kee is Managing Partner of Kee Global Advisors LLC (KGA), a corporate development advisory firm based in New York. KGA advises companies on cross-border expansion between China and the U.S., specializing in market entry and customer acquisition, growth capital raising and M&A.

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    How Institutional Investors May Avoid Due Diligence Pitfalls in China

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