The outlook of investing in China is suddenly brightening up as the country gradually phases out its draconian zero-COVID policy, which has caused disruptions in businesses of all kinds and kept the country’s borders shut for the last three years.
For venture capitalists, the pandemic has been a tumultuous ride. Tony Wu, a partner at Northern Light Venture Capital, a China-focused VC firm with $4.5 billion assets under management, calls 2022 the “toughest” in his 15 years of investing in Chinese startups.
“Now spring is finally bringing new life to dried trees. There’s a lot of optimism for 2023,” says Wu, who focuses on the consumer internet realm at the firm, in an interview with . NLVC’s wide-ranging portfolio includes China’s on-demand services titan Meituan; BGI, the country’s gene giant; and Black Sesame Technologies, one of the few home-grown makers of automotive chips.
What went wrong in 2022? And what makes Wu more hopeful about the coming year?
Herald of spring
In the past few years, China’s regulatory crackdown on its internet industry, coupled with COVID restrictions that caused great uncertainties in the economy, has drastically dampened investor confidence. Venture capital deals plunged 44% year-over-year to $62.1 billion in the first 10 months of 2022, according to research firm Preqin. Equity investments were down 33.9% in the first three quarters of the year, shows another report from the Chinese market researcher Zero2IPO.
The bearish mood of 2022 “was on par with 2008-2009,” Wu reckons. But unlike the 2008 financial crisis, he argued, this round of downturn “fundamentally hurt the vitality” of the country’s venture investment. “Money fled, talent left, and a lot of internet bosses moved to Singapore.”
Regulations is nothing new in China’s tech space as the authorities are always rushing out new legislations to rein in the reckless growth of emerging sectors. But the recent wave of clampdown, which roughly started in 2020 when the government suspended Ant Group’s colossal IPO, is widely seen as the toughest in decades, forcing tech companies left and right to rethink their strategies.
Companies operating in heavily-regulated areas, like social media, video games, and web3, saw a narrowing window of opportunity domestically, so many of them packed up and headed for the culturally familiar and geographically nearby Singapore. Their investors, especially those who raise money from international limited partners, followed suit and set up outposts in the city-state. An era of growing U.S.-China tensions further prompted Chinese companies with overseas ambitions to cut ties with home.
The abrupt end to the zero-COVID policy and early signs of regulatory loosening is giving investors hope that some aspects of the tech industry could finally be back on track. At the least, investors can meet founders in another city casually without worrying about being quarantined on their way back.
Clouds seem to be slowly scattering in the regulatory space, too. In December, China granted a batch of licenses to 44 foreign games, ending an 18-month hiatus that hit gaming giants like Tencent. Wu believes regulators will also begin to lift some of the curbs on Ant Group, which overhauled its fintech business at the behest of regulators to act more like a traditional finance group.
Chasing web3
Even if the darkest days of regulations might be behind us, the revival has limitations. The reckless, high-growth era of social networks, ride-hailing and other consumer-focused businesses has come to an end. In web3, one of the few remaining areas in tech that were still delivering astonishing returns for VCs until the recent market crash, “there’s no perceivable future for China, for now,” Wu suggests.
That’s a conclusion shared by many founders and investors. Over the years, China has moved to ban much of the underlying infrastructure of web3, most crucially, cryptocurrency trading. Many serious web3 projects have relocated offshore as a result.
Despite the exodus of talent, Wu continues to back web3 entrepreneurs originating from China. In 2023, he plans to allocate at least 60% of his “energy” to web3, which he believes is just as disruptive to venture capital as it is to the internet.
“Web3 has fundamentally changed how investment is done,” the investor observes. “In the past, you are investing Chinese founders with operations in China. Now, a web3 startup could have its R&D in China, but its product is global, and the rest of its team could be in Singapore or the U.S. It’s taking equity as well as token investment. And instead of 10%, we are only taking 1% of its stake.”
Like others who remain bullish on web3 despite the crash, Wu believes the bear market is a good time to “build” when people finally aren’t viewing crypto as a speculative asset class. “We should be looking at how many users and new developers are piling into web3 instead,” he notes.
China also remains pivotal to the global development of web3 even though a domestic market doesn’t exist for the decentralized technology. Two decades of frantic growth at tech giants like Tencent, Alibaba, and ByteDance have given rise to a pool of skilled software engineers who are known for delivering results under pressure and strict deadlines, and who, on average, cost just one-fifth of their American counterparts.
China’s internet talent is also experienced in dealing with fast-expanding, large-scale internet services, Wu argues. “Solana is known for being fast and cheap, right? But it’s also had a few outages. The blockchain is just managing over a thousand nodes. But name any major Chinese internet firm — it easily operates hundreds of thousands of servers.”
He continues. “The question is how to unleash the supply of China’s developers for the global web3 industry.”
Electric car race
While Wu is following China’s web3 founders abroad, he’s also placing bets on domestic players in another heady area: electric vehicles. Even in the relatively new EV industry, he reckons the race has already entered “the second half” and competition is becoming “cutthroat”.
China shipped around 20 million vehicles in 2022, 6.5 million or 32.5% of which were run on “new energy” like electricity or hybrid, according to China Passenger Car Association. “Give or take the EV penetration rate reaches 60-70% — because there will still be some petrol cars — [a 30% penetration means] the industry is moving into the second half,” Wu says.
So far, none of China’s EV companies is remotely close to the level of brand recognition enjoyed by the German luxury carmakers. But they each offer their unique selling point. Upstart Nio puts much effort into customer service and its rival Xpeng prides itself on advanced technologies like autonomous driving.
Wu singles out BYD, the 28-year-old battery and EV giant, as the trailblazer in globalizing Chinese EV firms because of its incredible affordability. In December, BYD’s overseas sales surpassed 10,000 units — which doesn’t sound like a lot. But the carmaker is already well-established in China, often wrestling with Tesla for the top spot in the world’s biggest EV market.
“The globalization of Chinese EVs is inevitable. We have a complete supply chain, and our price advantage is already pretty obvious,” Wu argues, pointing out that BYD is the only Chinese EV maker in control of the entire supply chain like Tesla, which gives it wiggle room to lower prices. “You got to remember, these Chinese automakers are coming out of an extremely competitive environment.”
