He Huang
It’s been a tumultuous few years, but China’s manufacturing industry is now on the rebound. Once an industry characterized by low-end manufacturing and intensive labor, it has transformed into a high-end manufacturing hub aided by technology.
Automation and robotics has the potential to modernize China’s manufacturing while improving labor efficiency and alleviating labor shortages. Predictably, companies and investors want to capitalize on this trend.
Robotics has been a hot sector for a while, but its popularity has shot up over the past couple of years. The sector recorded investments and financing of $6 billion in 2021, according to statistics from market research firms, and is expected to double in size in five years.
However, it’s unknown when these investments will provide a suitable return. Robotics is experiencing the biggest bubble in China’s venture capital industry, and is riddled with speculation and overvalued companies. Compared with similar investment bubbles over the last 10 years, this one is larger in scale, longer in duration, and could be more devastating than any before.
However, the “bust” is entirely avoidable. Investors and companies need to go back to business basics and resist the industry’s typical impatience for exits on both sides of the negotiation table.
Understanding the market
With the influx of capital investment, we’re seeing a partial and cyclical overheating of the market in China. Many investors caught in this investment tide are replicating the software investment model, because many institutions that invested in Internet startups are also aggressively entering this field.
So what’s behind this surge? Everything from China’s government policy to the launch of the Science and Technology Innovation board, which has opened a convenient exit channel. Compounding the surge is the drive to upgrade China’s industrial structure.
It’s crucial, however, that investors do not apply software investment rules to industrial technology investments. For one, the investment to exit period is different. Investment in robotics and other industrial technologies is relatively long-term compared to internet companies. Internet companies can go public in three to five years after investment, but industrial technology firms are likely to take twice as long or more to go public.
Prior to the launch of China’s Science and Technology Innovation Board, such companies listed on the A-share market, and averaged 12 years from establishment to IPO. As China’s stock market and direct financing landscape mature, listings are happening much faster, but industrial tech companies still take eight to ten years to go public.
Additionally, the more advanced the tech, the longer it’ll take to turn into a business. Every step of the process involves technology and market risks, and most laboratory technologies don’t complete the industrialization process, which involves testing the technology for its commercial viability. And even when they make it, the product or solution must be able to be manufactured en masse and meet customer needs.
For companies that pass this stage, the final step is growing revenue while innovating continuously to remain competitive, which can take a long time in this sector. Investors must understand the risks of early technology. Although high-end manufacturing investments are good targets, it’s essential to have patience and keep the risks in mind.
Traditional metrics are no longer applicable
Investments should always focus on a company’s balance sheet and profitability. Capital can ensure sufficient cash flow for a company in the short term, but at some point, the marginal effect of capital efficiency drops sharply. This is characteristic of robotics or industrial technology. As the business matures and develops to a certain extent, demand for funds will rise again, but not in the form of early investment.
The capital influx we’re seeing today is the direct driving force behind companies’ high valuations. The price-to-earnings ratio is no longer applicable for many listed companies, and the market-to-sales ratio has also gone out the window. The problem is, high valuations must correspond to high growth. If these robotics companies cannot continue to grow rapidly, they will not be able to support their high valuations, and many robotics firms don’t have the growth needed.
In robotics, the vision and AMR (automated mobile robot) areas are seeing the most capital investment right now. However, both are undeveloped, highly fragmented, and require a high degree of customization. What’s more, the competition is fierce.
Remember that robotics is an investment for the long haul, and carefully choose a team that shows solid commercialization ability, not just technical capability.
Look to the fundamentals, nuances, and experience
Though China’s manufacturing industry is dynamic, most companies are small-scale, multi-industry, and multi-category industrial enterprises. These companies generally have diverse requirements, are slow to accept new technologies, and lack technical capability. Such companies are difficult customers for startups.
Entrepreneurs need a lot of industry experience. It is difficult for a young team to gain a foothold in the market, and qualified entrepreneurs must have at least 10 years of industry experience. Critical skills include knowing how to enter the market to help customers solve specific problems, cooperating with integrators in the supply chain, and dealing with downstream and channel vendors.
Investors also need experience. A qualified investor usually has at least eight to ten years of first-line investment experience and has led more than 10 project investments. China’s VC industry is still very young at less than 20 years old, but it’s also thriving. The number of VCs and investors in China far exceeds the U.S. market, with tens of thousands of registered VC firms and millions of employees.
Unfortunately, many smaller institutions have amplified the bubble created by ample available capital and large institutions. The typical view is that a moderate bubble can promote the development of the entire industry, but with the current bubble, it is almost impossible for investors to benefit. In this high-risk, high-valuation climate, it’s likelier that investors will lose money rather than make any.
But high-end manufacturing technology has investment value in the long run. It’s just that the influx of large amounts of capital is causing disorder. Companies backed by significant capital may have market advantages in the short term, but startups with potential and strength may be crowded out. This bubble will extend the time it takes for China’s industrial technology enterprises to truly thrive — instead of taking 10 years in natural growth conditions, it may take 20 years under the influence of such a bubble.
The big question is when the market will return to rationality. It’s a hard one to answer, but now is the time to eliminate impulsiveness, exercise caution, and help startups develop in a healthy manner. It’s a clarion call for investors to respect the slower, deliberate development cycle of industrial technology, and avoid bringing along internet industry investment practices.
With these adjustments, we believe this investment bubble can be alleviated. All it needs is for us to pivot back to investing and business fundamentals.
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