Ensemble Capital Goes to China
“A little learning is a dangerous thing. Drink deep or taste not the Pierian spring; There shallow draughts intoxicate the brain and drinking largely sobers us again.” Alexander Pope, 1709
Arif and I have just returned from a week long research trip to China with Rui Ma and Ying-Ying Lu, the hosts of the excellent TechBuzz China podcast, who gave us an immersive, deep dive into the Chinese business ecosystem.
We were fortunate to have a dozen of our investor friends join us from the US, Canada, Dubai, London, Singapore, Spain and Mumbai. We visited with 28 company representatives, industry experts, and government representatives in Beijing, Shanghai and Hangzhou. From executives at well-known global companies such as Didi, Xiaomi, and Ctrip, to companies less known to western investors such as Qutoutiao, Nio, Bilibili, LexinFintech, MOGU Inc, Club Factory, and Ruhnn.
While we do not currently have any direct investments in Chinese companies, nor do we plan to make any in the foreseeable future, we believe that US and global investors can no longer simply say that China is outside their circle of competence. As investors in global businesses, we know that China’s economy and their thriving corporate sector will play an ever-increasing role in global business. So, we decided we needed to spend some time there ourselves. In this series of posts, we’ll share some of our takeaways from the trip.
From 2009 to 2018, Ensemble Capital held a large investment in Apple in our equity strategy. As the company became big in China, we came to understand that Chinese users spent so much of their online life in WeChat, an app made by Chinese tech giant Tencent, and that they were not nearly as loyal to the iPhone as users in the rest of the world. This was because a Chinese iPhone user could buy the new, cool Android based phone, download WeChat and have all of their content ready to go. While in the past, the iPhone was far ahead of other phone makers, today there is a proliferation of other high-end phones, such as this $3,000 phone that is wrapped entirely in screen that was on display at Xiaomi during our visit.
Given that WeChat is barely used in the US, it can be hard for US based investors to appreciate the importance of WeChat to the Chinese online experience. Let’s just say that in many ways, WeChat *is* the internet in China. With Google not available, Baidu’s search results reveal a spammy mix of irrelevant ads, and with much of the internet outside of China blocked, the “world wide web” just isn’t a terribly important part of the Chinese internet experience.
Looking at our portfolio, about half of our holdings have some sort of intersection with China. In some cases, it is companies like Tiffany or Starbucks who have material sales into China. Other times it is businesses like Netflix or Google, who do not do business in China, but which possibly could over the long term. And then there are businesses like Mastercard, which after being blocked out of China and watching it become the only country with a non-Mastercard/Visa-based, robust payment infrastructure, now finds itself facing possible competition with these Chinese tech/payment giants in emerging markets or even in the US where “we accept Alipay” stickers have started to pop up in some locations.
Many investors don’t appreciate the level of latent knowledge they already have about a company or industry before they start researching a company. For instance, most American investors would know before they even started researching a company like Starbucks that coffee can be bought at lots of different retailers, but the nuanced difference between buying coffee at Starbucks, McDonald’s, Dunkin Donuts, Peets or a Third Wave coffee shop is something American investors already understand intuitively.
There is even knowledge you don’t know that you know. For instance, American office workers don’t order coffee for delivery all that often. Why is that? Many American investor may not even be conscious of the fact that this is true in large part because the vast majority of American companies offer free coffee on site to their employees. But this is not true in China. And, so while it might seem strange to Americans that ordering coffee for delivery is big business in China, the reason has to do with subtle but important cultural differences that are entirely understandable if you take the time to learn about them.
Over the coming week or two, we’ll be publishing a series of posts on our key takeaways:
- The rise of local Chinese brands
- New Commerce
- Two Chinas
- The context that allowed for China’s rapid growth
As you read these posts, don’t get the impression that we’re experts on China. Our hosts for the trip are very much experts on China and if you’re an English-speaking investor who wants to expand your circle of competence related to China, we strongly recommend you listen to their excellent TechBuzz China podcast.
If you look back to the quote opening this post, you’ll note that we are acutely aware that a little knowledge can be a dangerous thing if you believe that knowledge makes you an expert. But the only way to become an expert is to wade through the early phase of having a little knowledge, recognize that you may have a tendency to get “drunk” on this knowledge and then keep learning more until you come out the other side and are “sober” again.
44% of the revenue of the S&P 500 comes from outside the US. Global markets have become far more correlated to each other as the world has globalized. The major global economic engines are now China, the US and the EU. But the thing about China is that it is changing so quickly. So knowledge that you have about China can get out of date quickly.
For instance, here is a photo we took of the Shanghai financial district. It simply dwarfs Manhattan and looks and feels far more developed than any of the mega cities in the US or EU.
And here is a photo of the exact same location in 1991.
We believe it is critically important for all active equity investors to decide that if China is not currently in their circle of competence, it is time to start building that competency now. And while a week long trip won’t do the trick, nor will sitting at your desk reading research reports.
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