What we’ve learned from decades of investing in China

“Let China sleep,” said Napoleon Bonaparte, “for when she wakes, she will shake the world.”

In the 1990s, after decades, perhaps centuries, of economic slumber, China opened her eyes, stretched her arms and knocked over the alarm clock.

Today, she dominates many of the world’s fastest-growing industries. China makes more solar cells and more EVs than anyone else. It’s a crucial part of the biotech development ecosystem, with around 30% of new global patents coming out of China.¹

In the defining industry of the 21st century, China is America’s most intense competitor. Former Google CEO Eric Schmidt and political scientist Graham Allison warned about this in 2020: “Most Americans assume that their country’s lead in advanced technologies is unassailable. In fact, China is already a full-spectrum peer competitor in terms of both commercial and national-security AI applications. China is not just trying to master AI; it is mastering AI.”²

Leadership in 21st-century industries is one reason to invest in China. Other attractions are scale and brainpower. China has 1.3 billion consumers and its scholars produce more of the most cited scientific papers than any other country.³ As Bill Gates once said, “In China, when you’re one in a million, there are 1,300 people just like you.”

Capitalism, competition and the CCP

But while China is the world’s second-largest economy, the rules you play by are different. The Communist Party’s constitution requires private companies over a certain size to have a Party ‘cell’.

That surprising governance measure is just one of many ways China differs from the Western economies it competes with.

• It’s a heavy industry economy. Industry generates 35% of GDP and services 57%. In the US, the service economy drives nearly 80% of GDP and industry just 17%. Pundits have long argued that deepening the consumer and service sectors of the Chinese economy would increase economic growth.
• Chinese companies are overwhelmingly bank-financed. The ‘Big Six’ state banks hold more than 50% of total banking assets and state ownership influences which companies in which regions and industries get access to funding.

We’ve recently returned from a visit to Beijing, Shanghai and Shenzhen, testing our thinking about the companies we already hold and layering new insights on top of the institutional memory Platinum has gathered from investing in China for decades. As expected, we saw a market where there are staggering opportunities as well as reasons to tread carefully.

It’s what you can’t hear that tells you what’s happening

Andrew Baud
Senior Investment Analyst, Platinum Asia Fund

Xiaomi the money

As we write, the Platinum Asia Fund has around 40% of its capital in Chinese stocks. One reason we want to be in that market is that the world’s largest communist country is full of ambitious capitalists and full of companies with leading positions in both Chinese and global markets.

Some Chinese entrepreneurs leap from success in one field to take on another. One example is Xiaomi, founded by a serial entrepreneur called Lei Jun and six partners. Sometimes dubbed ‘China’s Apple’, Xiaomi’s vision is to “make friends with users and be the coolest company in the users’ hearts.”

The company started life making mobile phones, then wearables, laptops and other consumer and household electronics. They now have their own EV brand and sales growth is impressive.

We met with Li Auto, another example of reinvention. Founder Li Xiang dropped out of high school to launch a consumer tech website. He made his first fortune listing Autohome, a data and transaction platform for the auto industry, on the NYSE.

His next move was Li Auto. Li took his vision of luxurious, long-range family EVs from idea to drivable reality in just eight years, building a factory that is 90% robot-automated. He also built a cash pile of 10 billion renminbi, approximately A$2 billion.

Burning a hole in their pockets

A big cash pile, in any currency, should be a positive. Instead, it’s a reason to be watchful. Chinese management teams have routinely proven to be poor managers of capital. Rather than distribute this cash to investors, Li could pivot into robotics and other emerging technologies.⁴

Chinese companies are crowding into robotics but are ahead of the demand curve. Companies that stray ‘outside their lane’ often burn capital and miss opportunities in their own core markets.

Beneath the surface

Josh Pettman
Investment Analyst, Platinum Asia Fund

Too much of a good thing?

One reason capital allocation is an issue for Chinese management is the muddled economic incentives in their home market.

Let’s look at one high-profile example. Provincial governments have targets around economic growth, industrial production and employment. Attracting a capital-intensive, labour-intensive business, like a car company, is a highly visible way to hit those targets. It explains why there are so many EV businesses in China. Every province seems to want one.

Some of the firms we met were still adapting to post-Covid realities. Prior to the pandemic, their biggest challenge was capacity, building the factories, plants, forges and workforces needed to meet domestic demand and fill ships with exports.

Covid, a property slump and trade tensions have combined to slow that growth and some management teams are struggling to adapt. There’s lingering overcapacity in many industries.

We met a manufacturer of photovoltaic glass, the primary component of solar panels. There’s already overcapacity in the solar panel market. Yet they told us they had refurbished their kilns and were planning new capacity in Egypt.

Too many Chinese management teams have one playbook for slowing or flat markets. In multiple sectors, like solar and EVs, marginally profitable Chinese firms faced with slowing growth turn to export markets as a release valve for domestic overcapacity.

Unfortunately, shifting geopolitics means this switch creates new trade tensions. Ten years ago, the release valve led to America. Restrictions introduced by Presidents Biden and Trump mean that market is closed, or much smaller.

Chinese firms switched their focus to Europe and manufacturers there are pushing back. Of 21 anti-dumping and anti-subsidy investigations launched last year, 18 target Chinese producers.

Reuters quotes one trade diplomat: “We live in a world of wolves now. We no longer live in a world of pink ponies and rainbows.”⁵ When we look at Chinese businesses today, we want to be sure their export strategy is designed for growth and based on competitive advantage rather than simply a way to manage overcapacity.

Trained to compete

An investor in China needs to understand how government policies affect the business you’re researching. It’s not as simple as varying levels of government ownership or having CCP members in key positions. It’s push and pull and changes in direction.

We met two surgical robotics companies, Microport MedBot and Shenzhen Edge Medical. Both can now rival the extraordinary technology used by the world leader in this space, Intuitive Surgical, and its Da Vinci systems.⁶

Chinese policymakers imposed sales quotas on surgical robots, effectively giving the Chinese companies time to catch up on Intuitive. But after giving them a leg-up, the government is changing how it funds robot surgery, adding it to the national health insurance scheme so there were more surgeries, but at a lower cost.

The economic prospects for surgical robotic manufacturers now look better outside of China.

Predictably, their response was to export, but these companies started exporting from a position of strength.

Some 73% of MedBot’s sales over the past year were in South America, Southeast Asia and Eastern Europe. Their technology is now nearly as good as Intuitive’s and, if you’ve been trained to operate a Da Vinci robot, it won’t take you long to master their Chinese competitors. In doing so, you can cut costs by 20% to 30%.

It’s easy to write these companies off as copycats. But they’re building a position in emerging markets where surgical volumes are growing, as is demand for the technologies needed for minimally invasive surgery.

They rode a dramatic shift in government policy and are poised for growth.

China: the long-term story

At Platinum, we’ve been investing in China for many years. While much has changed, there are core elements of its society that underpin its investment potential.

It has an education system that graduates a million engineers a year and a culture that combines patience with constant innovation.

Our focus always returns to individual companies. We’ve had successful long-term investments in companies like battery maker CATL, (up an average of 38% a year since first trading in June 2018) and engine and vehicle manufacturer Weichai Power, (up an average of 26% a year for the past 10 years.)⁷

We know there are companies with similar potential waiting to be found in the Middle Kingdom. That’s good news for investors with a long-term view.