Gaorong Ventures' Chang Chen: Consumer Markets in Third-, Fourth-, and Fifth-Tier Cities Are Full of Opportunity

On March 28, 2019, the Zero Boundary · New Economy 100 CEO Summit opened in Beijing. Chang Chen, founding partner of Gaorong Ventures, was invited to the "New Investment Forum," hosted by Zhou Wei, founding managing partner of CCV. Chang Chen joined Allen Zhu, managing partner of GSR Ventures; Zhang Yan, president of Wu Capital; and Yi Cao, founding partner of Source Code Capital, to discuss the capital environment, industrial internet, consumer investment opportunities, and changes in the venture capital industry.

Zero Boundary Summit "New Investment Forum"

Chang Chen's key points:

• The capital environment in 2018 was mainly characterized by tightening liquidity and relatively difficult domestic IPO exits. But for excellent companies, the macro environment doesn't matter much — what counts most is the company's own development.
• Third- and fourth-tier cities account for over 63% of total social retail consumption, far exceeding the combined total of first- and second-tier cities. Meanwhile, as internet and e-commerce penetrate into third-, fourth-, and fifth-tier cities, this market is full of opportunity.
• More and more outstanding entrepreneurs will enter the investment industry in the future, intensifying challenges and competition in the sector, which will ultimately drive industry evolution.

Chang Chen, Founding Partner of Gaorong Ventures

The following is an edited transcript of Chang Chen's remarks at the "New Investment Forum":

On the Capital Winter

From our own experience, we didn't feel last year was particularly cold. We had seven portfolio companies go public and another four or five exit through M&A. Looking at overall investment returns, it didn't seem that cold. If 2018 felt somewhat chilly, I think it was mainly due to tightening liquidity in domestic capital markets and the relative difficulty of exiting through domestic IPOs.

All seven of our IPOs last year were overseas listings; none were domestic. This year, with the launch of the STAR Market and discussions about a registration-based system for the ChiNext board, I think quite a few companies may give it a try.

But I believe that for an excellent company, as Jack Ma said, the macro economy has little to do with you — you just need to do your own thing well.

On Industrial Internet

Industrial internet isn't a new concept. Back in 2014, the Premier proposed "Internet Plus" — the deep integration of internet with many industries. Of course, when people talk about consumer internet versus industrial internet now, they're mainly looking at it from the 2C versus 2B dimensions. If there's a difference between these two areas, I'd say 2C consumer internet tends to achieve rapid growth, while 2B industrial internet requires winning deals one by one, so it's relatively more steady.

From a valuation perspective, industrial internet valuations aren't low either — some projects are trading at 10x price-to-sales.

On Lower-Tier Markets and Consumer Investment Opportunities

I think the opportunity in third-, fourth-, and fifth-tier markets is enormous. We looked at some National Bureau of Statistics data, and after analyzing it, found some very interesting patterns. Looking at disposable income across city tiers, if you remove mortgage payments, third-tier city residents actually have the highest disposable income. Second place goes to second-tier cities, then new first-tier cities, while original first-tier cities are negative — that's the first phenomenon we observed.

If residents don't buy homes but rent instead, after removing rent, disposable income across first-, second-, and third-tier cities is very close, between 2,500–2,900 yuan, with little difference.

We also found another interesting phenomenon: over the past few years, third- and fourth-tier cities have seen very rapid growth in social retail, reaching 12%–13%, while first- and second-tier city growth has been declining. Moreover, third- and fourth-tier cities account for over 63% of total social retail consumption, far exceeding the combined total of first- and second-tier cities. At the same time, as internet and e-commerce penetrate into third-, fourth-, and fifth-tier cities, I believe this represents consumption upgrading for this demographic — because they previously had no access to many services — so I think this market is full of opportunity.

For consumer sector investment overall, even with today's slowing GDP growth, we still believe there's tremendous potential. For example, in some counter-cyclical or even anti-cyclical sectors, I think we can find excellent investment targets.

On the Exit Environment

The large number of companies listing overseas last year had a special historical context. The VIE dismantling and return-to-China listings of 2015–2016 caused some harm to overseas investors. After more than a year, that wound has gradually healed. The wave of overseas listings in 2018 had these phased historical reasons. Last year's secondary market performance was mediocre, so many companies went public at a loss — this is something investors here should be wary of. If the final round valuation is negotiated too high, there may be a valuation inversion after listing.

We believe the 2019 exit environment won't be bad, because compared to 2018, uncertainty has decreased significantly. For example, the deleveraging trend may slow, and the government has introduced proactive fiscal policies including substantial tax cuts. At the same time, the US-China trade war will basically be settled. Overall, when these uncertainties decline, secondary market risks decline correspondingly.

On the Future of Venture Capital

The challenges facing the VC industry will only grow in the future — not necessarily competition within the industry, but challenges to ourselves. In the next 5–10 years, if you can't consistently invest in companies that can grow to $10 billion, you may not even get a seat at the table. That's a very real problem.

Second, I think more and more outstanding entrepreneurs will enter the investment industry. Looking at the US, many investors at firms like a16z were previously excellent entrepreneurs. I believe in China, as younger entrepreneurs succeed, many people interested in this field will enter, making challenges and competition in the industry more intense — which I think is ultimately a good thing for the industry as a whole.

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• Gaorong Ventures manages US dollar and RMB funds totaling approximately RMB 15 billion, focusing on TMT early-stage and growth-stage investments.
• Its limited partners include top global institutional investors as well as corporate giants from China's financial, retail, and advertising sectors.
• Additionally, dozens of successful entrepreneurs — founders of companies including Tencent, Baidu, Taobao, Xiaomi, Meituan, Dianping, 360, 002027, Weibo, Sohu, JD.com, Vipshop, Tudou, Autohome, and Ganji.com — are also LPs in Gaorong Ventures.
• The founding partners previously led investments in numerous excellent companies, including Xiaomi, Razer, Baofeng Technology, G-bits, Tudou, Wondershare, ArcherMind, 91 Assistant, 3G.cn, Mogujie, Dota Legend, Yuanfudao, and others.
• Since its founding, many of Gaorong's portfolio companies have grown into national or global leaders in their respective industries, including: Pinduoduo (NASDAQ: PDD), HUYA Inc. (NYSE: HUYA), Huami (NYSE: HMI), Mogujou (NYSE: MOGU), Lifesense (300562.SZ), Meituan (03690.HK), Ping An Good Doctor (01833.HK), Zhongrongjin (acquired by Homa Appliances), DeePhi Tech (acquired by Xilinx), Qianbaibao (acquired by Meituan), BIGO LIVE (acquired by YY), Fanpu Jinke, Beibei, Dewu App, Leqi E-commerce, DotC, Shiheng, Nuro, YITU, Roborock, Tiangong Intelligence, Zhuiyi Technology, Hupo Technology, Geek+, Oasis Labs, Beitai Haoche, Lianghuapai, Meili Jinrong, Shuidi HuZhu, Testin, Boss Zhipin, Doumi, Danke Apartment, Hellobike, Qian Damai, Perfect Diary, Ucommune, and others.
• Gaorong Ventures maintains investment teams in Beijing, Shanghai, Guangzhou, Shenzhen, and Hangzhou.

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