In a frenzy, high-tech firms start pouring into China

The Chinese high-tech market is booming, prompting a gold rush on the part of Western venture capitalists and tech companies.

Planes flying into Chinese cities like Shanghai are packed with European and U.S. venture capitalists and tech company executives eager to tap into what is expected to shortly become the biggest market for everything from mobile phones to semiconductors.

“Frenzy is beginning to be the right word,” said Hermann Hauser, director of Amadeus Capital Partners, a Cambridge, England, venture capital firm that has its eye on China.

A number of factors are driving the market: Labor costs - including salaries for highly educated engineers - are one-fifth of what they are in Europe. The boom in technology and telecommunications infrastructure building there comes at a time when sales are lagging in the West.

And the sheer size of the market means it will have an influence on technology standards. For example, China, which has 250 million mobile phone subscribers, is already the world’s largest mobile market. Thus, the standards it chooses for the rollout of third-generation mobile services next year are expected to have global repercussions.

“It will happen in the world if it happens in China,” said Lothar Pauly, the Siemens board member responsible for business in China. The German electronics conglomerate is one of a string of companies that has invested $10 billion in the Chinese cellular phone sector over the past three years.

Of course, entrepreneurs and multinationals have had visions of selling products to a billion Chinese consumers ever since the former U.S. President Richard Nixon’s diplomatic breakthrough with China in 1972. Most have walked away bruised and disappointed because doing business in China remains difficult.

Major unresolved issues that particularly concern technology companies are that intellectual property is not protected and piracy is rampant. Other problems include the fact that the government continues to suppress free speech and censor the Internet and that Chinese start-ups are limited by currency exporting restrictions.

But venture capitalists like Joe Schoendorf, a partner at Silicon Valley venture capital firm Accel Partner, say they have the impression that “a lot of the risk is behind us.”

To secure access to portions of China’s fast-growing high tech market, dozens of foreign multinationals are setting up research partnerships. U.S. and European start-ups are selling into China by filling technology gaps that local companies have missed. And there is much talk about start-ups within China’s borders, new international joint ventures and initial public offerings.

For example, the British and Chinese governments in October wound up a contest they jointly sponsored for the best business plans from Chinese technology entrepreneurs. Of the 18 submitted, six were considered top-rate and may end up being funded by European venture capitalists, said Hauser, who is chairman of the committee.

“It reminds me of Silicon Valley in the late 1960’s. There is an electricity in the air, things are bubbling,” said Schoendorf, a partner at Silicon Valley venture capital firm Accel Partner, by telephone. Accel Partners is pressuring the companies it funds to have a strategy for selling into China.

Indeed, venture capital firms such as Intel Capital and Britain’s 3i invested in 66 mainland China companies in the first half of 2003 for a total of $332 million, up 30 percent from a year earlier and up 104 percent from the second half of 2002, according to Zero2ipo, a Chinese market research firm.

“Yeah, there are challenges,” Schoendorf said, “this is still a place where you don’t have democracy, and intellectual property does not have the same respect as it does in the West. But those things are moving in the right direction.”

In the meantime, Western investors are finding ways to bypass some of the problems posed by Chinese regulations, or lack of them.

Lawyers in the Cayman Islands and elsewhere are setting up offshore corporations that are joint ventures between Chinese and Western companies, with all of the intellectual property being held by the offshore entity, said Dixon Doll, a co-founder of DCM-Doll Capital Management, a Silicon Valley based venture capital firm that is active in China. The set-up also neatly sidesteps currency exporting restrictions and makes it easier for Chinese companies to list on foreign exchanges.

Setting up offshore corporations known as hybrids “has been the corporate vehicle of preference for virtually all the Chinese companies that have gone public on Nasdaq or in Hong Kong,” said Doll, who has invested in several large venture deals in China this year. “The main consequence of going offshore is that it is more cumbersome, more complicated and more costly, but it is the only way to satisfy institutional investors and do so in a legal way.”

Several ways of doing business is generating Western interest:

U.S. and European start-ups are starting to enter the Chinese market by filling technology gaps. For example, Cambridge Broadband, a three-year-old British company, in July won contracts to sell its fixed-wireless access equipment to China Mobile, China Unicom and China Netcom. The three Chinese operators recently were awarded licenses to operate in the 3.5 gigahertz band and the Cambridge, England, company is one of the few in the world to be able to supply this technology. “There are huge opportunities even for small European and American companies if they can come up with the right solutions for China,” Hauser said.

There is an increase in joint ventures because Western companies want access to the Chinese market and Chinese companies want market access in the West. Mtone, a Santa Clara, California-based company with significant operations in China that specializes in games and short-text messaging for mobile phones, is looking to partner with European companies.

Less-formal arrangements between Chinese and Western companies are also bearing fruit. For example, Beijing-based IVT, which supplies turnkey solutions for products based on the Bluetooth wireless standard to Chinese manufacturers, gets its Bluetooth chips from European companies such as STMicroelectronics, Infineon, Cambridge Silicon Radio and Philips, as well as American companies like National Semiconductor, said Quiang Gao, IVT’s CEO and founder.

There is a deepening of joint research and development: Like most semiconductor companies, STMicroelectronics first entered China to lower its production costs. But it is partnering with Chinese universities - on the joint development of integrated circuit designs for products such as digital audio broadcast receivers, as well as chipset development.

In fact, China is expected to become the largest market for chips in the world by 2007, said Jean-Claude Marquet, chief executive of STMicroelectronics’s Asia-Pacific division.

“Are valuations and expectations running too far ahead of reality?” said Duncan Clark, managing director of BDA China, an independent tech consultancy based in Beijing. “Maybe, but the fact is that multinationals and increasingly small and medium-sized enterprises in technology need to have a China strategy,” he said. “If you don’t come to China, at least to understand what’s going on, China may come to you - in the form of a lower-cost supplier based in China, for example.”

11/24 IHT