Perseverance and Breakthrough amid the Capital Boom


CAI Lei, founding partner of JD Capital, incumbent chairman of JD Capital. The article is an excerpt of the speech CAI delivered at the 2015 annual meeting of JD Capital in May, 2015.

About Capital and Bubble

The most significant period of monetary easing in human history

From my point of view, we are now at a historical stage with the largest capital volume ever. But how? It is known that from 2007 to 2009, the whole world witnessed the largest financial crisis in more than half a century, after which major economies fell into despair and introduced various bailout measures to stimulate the economy. To save the economy, these measures had to target the root problems, meaning that they should aim at adjusting the economic structure, eliminating low-efficiency assets, and enabling market clearing.

Unfortunately, neither the government nor the public is patient enough to wait that long. Therefore, countries took short-term measures such as printing money and issuing currency. The US, UK, the Euro zone and Japan all turned to quantitative easing. And they had to follow one another closely because against the background of financial globalization, if a country doesn’t issue money, the wealth of the state and its people would be diluted. So liquidity injection is destined to be a rush. In this process, the Chinese government was not sitting idle: for years, we have long been in the middle of excess currency issue.

China has issued a considerable volume of currency this year. The sole purpose of a series of measures, including interest cuts, reserve ratio cuts, medium-term lending facilities and replacement of local government debts, is to pump in liquidity and stimulate the real economy. Therefore, it is clear that we are in a period with plenty of funds. One phenomenon is that all enterprises, internet or finance, talk about their strategic goals in trillions. While talking big is costless, the bubble will not shrink easily once inflated.

A super bull market driven by funds

It may be easier to understand if we take the securities market as an example. Now, the A-share capital market is at the bull stage driven by large quantities of funds, where “stock deities” seems to be everywhere. The bull market can be divided into two types: the first one features the improvement of fundamentals, where the performance of enterprises is enhanced and stock prices increase accordingly; the second one is driven by capital, where capital is abundant and the bull market is compiled with large amount of funds.

Many investors present today have their own enterprises, so they are very close to the real economy. In fact, it is widely known that China’s economy is still going down. Therefore, this round of bull market is apparently the result of capital piling instead of the real economy. So how does this capital piling function?

The average daily turnover since 2015 exceeds 1 trillion yuan, and even approaches 2 trillion at peaks. What does this mean? Let’s compare it with some peak days in past A-share bull markets. In 1996, the average daily turnover of the bull market peaked at RMB 9.2 billion, which was even less than 10 billion. In 2000, the market size got larger, but the daily turnover was only a little over RMB 20 billion. The figure didn’t exceed RMB 100 billion until the major boom in 2007. In 2013, prior to the start of this bull market, the average daily turnover was also above RMB 100 billion. Nevertheless, it soon rocketed to RMB 1 trillion before we knew it, an increase of magnitudes. It can thus be observed that the bull market is piled up with capital. Such a substantial turnover is unprecedented in the history of securities market worldwide.

Now let’s look at the valuation of A shares. In terms of the ChiNext, by May 12, the overall PE valuation was 113 times. It is said that today there has been another significant increase in the index by nearly 5 percentage points, making it higher than 113 times. The ChiNext has thus been termed the “divine board”. Now the overall PE valuation in the whole Shenzhen market also reached over 60 times. What does this mean? Comparing it with the peak level during previous bull markets, we see that during the major bull market in 1996 driven by the return of Hong Kong, the PE valuation peaked on May 12, 1997 at only 61 times. On April 7, 2000, the peak of that bull market, the PE valuation reached 71 times. The year of 2007 deserves to be entitled a significant bull market as the Shenzhen index rose to over 10,000, and the PE valuation only topped at 68 times on October 9. Whereas regarding today’s market, the 61-time PE valuation has reached and even surmounted the historic high, meaning that we are experiencing a super bull market.

What is a bull market? In short, it is a lot of money plus foolish people. Mass purchases give birth to a bull market, so of course we need money. Also, people still surge in at over 100-time PE valuation, which is apparently unwise. Another feature of the bull market is “stock deities” – and they are everywhere.

There is apparently a bubble in the A-share market, but we are not suggesting that the public should sell their stocks at once, and my comments will not serve as reference for short-term stock investment. Actually, from my perspective, China’s stock market still has a long way to go. The index may rise to 6,000+ or even 10,000+. This is because it is driven by capital, and stocks have become nothing more than a commodity or a signal in capital demand and supply. If we compare China’s stock market to a pool with limited amount of stocks, then the several new stocks issued indicate that the sewer is still closed. Meanwhile, the government is still aggressively pouring water into the pool, causing the water level to rise constantly. Greenspan, former chairman of the US Federal Reserve, once said that we shall only recognize the bull when it bursts, but never before that.

When will the bull market come to an end? From the perspective of demand and supply, once the government turns off the tap, or opens up the sewer, e.g. by initiating the registration system limiting the number of listing opportunities to 3,000 enterprises a year, or by removing the gate between NEEQ and A-share, lowering the transaction threshold and facilitating board transition, etc., the bull market will be put in the danger of ending.

Capital significantly accelerates the development of industries and enterprises

In terms of the real economy, we see that emerging industries are fast thriving. For instance, Didi (a mobile APP for hailing cars) has changed means of public transport. As I recall, Didi was founded in 2012, and its valuation was only RMB 200 million in 2013. We have also received its financing plans. Now, Didi is doing another round of financing, and the value is estimated to reach approximately USD 10 billion. While JD Capital is growing fast, Didi is even faster. Uber from the US, founded in 2009, is doing even better. It is already a world-class enterprise, doing similar businesses with Didi in over 70 countries and regions worldwide, with an estimated value of USD 50 billion. Other examples such as Tencent and Ali, world-class enterprises originated from China, have a short history of just one or two decades, but their market value has exceeded RMB 1 trillion.

Rather than remaining silent, traditional industries are also witnessing rapid changes. One of the most traditional industries in China, cement, used to have plants in every city and county. However, through industrial integration, China National Building Material Company (CNBM), a state-owned enterprise, built a kingdom of building materials and changed the landscape of the cement industry in just a few years. The situation is the same for private enterprises. Utour is one of JD Capital’s successful cases. When we invested in Utour in 2011, it was still a medium-size travel agency in Beijing, with an estimated value of RMB 300 million. After it went public last year, the company attracted some money. Soon we promoted its M&A within the industry (acquisition of Beijing’s Bamboo Garden) and along the industry chain (acquisition of ClubMed with JD Capital and Fuxing and acquisition of Shanghai Uzai, an online tourist company). Utour has turned from a traditional offline travel agency into a corporate group, both online and offline, covering the whole industry chain and providing comprehensive outbound travel services. Its market value has exceeded RMB 15 billion.

The rapid development of these enterprises is attributed to their industrial background and outstanding entrepreneurs. But also, direct capital support should by no means be neglected: virtually all emerging enterprises are backed by investment from VC/PE institutions. The key reason for the fast development of some Chinese enterprises in traditional industries during the past decade is the availability of low-cost capital, be it bank loans or financing from the stock market. The rapid development of private enterprises such as Utour should also be credited to capital support from JD Capital and its own successful listing. This illustrates that massive low-cost capital has directly altered the pattern of corporate and industrial development. The underlying reason is easy to understand: in the past, it normally took decades or centuries for the industrial pattern to be fixed, because enterprises could only grow on its self-accumulated capital, and both expansion and competition took time. In contrast, plenty of low-cost and professional capital has significantly accelerated the development of industries and enterprises.

Economic development depends on demand in the short term, and supply in the long run. The supply side, in turn, depends on labor, capital and technology. The way we see it, technology is the result of labor and capital combined. In this sense, labor and capital are fundamental factors pushing forward human history and economic development. Capital, also a result of labor, is the collection of various kinds of wealth in human history. Acquiring capital means acquiring the most intelligent and diligent labor worldwide. Outstanding enterprises in the future, in my opinion, are the combination of two factors: entrepreneurs driven by creativity and action, plus intelligent and low-cost capital.

Three conclusions can be drawn based on observations of the present economic and market environment: first, there has been too much money. This is an era of excess capital, and the more money there is, the more capital owners and controllers would need to do, because inaction will lead to wealth loss -- this is a “move-forward-or-fall-behind situation”; second, the market valuation is indeed a record high. Blind investment is highly risky, and may easily be held up; third, there are still plenty of investment opportunities, and the participation of capital in the real economy as well as its significant effect on the accelerated development of industries and enterprises are hard to ignore.

As a professional investment institution, we need to provide solutions to said problems. Our strategy is to persevere and break through.

How to Persevere

First, stick to our ideas and principles

First, stay calm. This is in my opinion the most basic quality for professional investors. They need to be able to think independently and stay away from greed and fear. Tides shall finally ebb, and bubbles shall ultimately burst. From the long term, the market is a weighing machine rather than a voting machine. Though I haven’t been an investor for long, I have seen too many tragedies and comedies in the capital market, from the Internet bubble in the late 1990s to the global economic bubble in 2007. We must stay calm. Only when the tide ebbs will we know who is swimming naked, and some might even lose their arms or legs.

Second, stick to ideas. This has always been JD Capital’s tenet. Our fundamental idea is to adhere to relatively high profit with low risk, rather than high or extremely high profit with high risk; we adhere to value judgment, rather than price judgment; we adhere to investment supplemented by speculation, rather than the opposite; we pursue success in the long run, rather than short-term performance. Despite market turbulence, we always stick to these basic ideas which have been repeatedly proven right.

Third, stick to our main businesses and position. JD Capital specializes in equity investment, and will continue to do so before complete capitalization and securitization of China’s real economy. Even if most enterprises go public in the future, like the US, we are to insist on proactive investment, a position that will not fundamentally change.

Why do we insist on equity investment? First, from a defensive perspective, equity investment endows us with sufficient safety margins. The PE valuation of a single enterprise may be several or a dozen times during equity investment, but for stock investment, that could be hundreds of times. Yet it is still that same enterprise. We succeed by not losing in doing anything, hence the necessity of sufficient safety margins.

It is also the case from an offensive perspective. We deem that amid the present capital bubble, we should utilize such bubbles instead of creating them. If we continue with the purchase at PE valuation of 100 times, then we would be creating bubbles. The major earning pattern now is not to buy in stocks and go after raising limits, but to fully utilize the bubble to sell them, i.e. we aim to be a seller rather than a buyer.

There are two ways of being a seller in bubble times. For many enterprises which have already been listed on the main board or on the NEEQ, the best approach is to maximally finance or, in another term, money encircling, and substantialize the enterprise by selling their stocks at a high price. If a listed company doesn’t finance now, the chairperson is unqualified. Another way is that for unlisted enterprises to do securitization as soon as possible. The original PE valuation may be 10 times, but during the bubble period, it may reach 30 times, 50 times or even 100 times. This is precisely what JD Capital is engaged in — equity investment. Therefore, the larger the capital bubble, the more confident we are in our equity investment. On this account, it is important that we stick to our main business and long-established position.

Second, stick to ideals and beliefs.

If the insistence on ideas and principles decides whether we are a successful institution or not, then the adherence to ideals and beliefs decides whether such success will last long.

We should have reverence to the basic laws in the universe, in human history, and in social development. For instance, the success of JD Capital now is more of the endowment of the times. Timing is the No.1 factor for success, and this is a fundamental law. For another example, a person, no matter how powerful he or she is, will finally leave this world, which is also a fundamental law. We are so tiny in the whole universe and the history, whether as a person, an institution or an enterprise. Therefore, we should maintain our reverence to the insurmountable objective laws.

We should be grateful. JD Capital cannot grow without investors’ trust, so we should be grateful to our clients. The profit we gain comes from enterprises we invest in, so we should be grateful to our business partners. We should also be grateful to the market, to our staff and rivals. Without rivals to compete with, JD Capital could not have grown in a fast and innovative manner. While focusing on our own growth, it is more important for us to maintain a sound industrial or industrial environment.

We should have compassion. Objectively speaking, practitioners in the field of investment and finance are directly involved in the distribution of social resources, and more responsibility comes with greater capability. This is why we should show more concern to the disadvantaged groups that the market and public resources fail to cover and care for. In this regard, we still have much to learn from those excellent corporate citizens.

Also, we should keep forging ahead. JD Capital, consisting of a group of young people, will remain young for a long time to come, and hopes to always stay young. The “young” here has both a physical and a psychologically sense. JD Capital, with its vigor and vitality, will keep moving forward and always try to improve the status quo.

We should insist on innovation, because this is our label. Our listing on the NEEQ one year ago, a barely understood action then, is one of our innovations, and now we see many institutions following suit.. Recently, as an enterprise on NEEQ, we purchased a listed company on the A-share market, which is also an innovation that may be trend-setting again. JD Capital refuses mediocrity, and many of its past innovations have become the industry benchmark and practice, which is much to our pride.

We should also be pragmatic. JD Capital believes that hard work can rejuvenate the nation. As HUANG XiaoJie concluded on our last internal annual meeting, JD Capital’s core culture has two pillars: first, creativity, which means constant innovation; second, executive power, which means to be down to earth and get things done in full earnest.

Last and the most fundamental one is that there is a basic precondition and pursuit behind any of our decisions and businesses, and also the core tenet that JD Capital, as a financial investment institution, believes in: to strike a balance between performance and fairness for human progress and welfare. If we regard this tenet as the standard for making investment judgment, then we would never get lost amid the heavy fog or drift away with the tide.

How to Make Breakthroughs

JD Capital, if only insisting on perseverance, may be considered an arrogant institution refusing to make progress. Therefore, we also need to grow, evolve and make breakthroughs continuously.

Breakthrough I: on investment capability

The first breakthrough is a genetic one in the evolution process. The central rule of evolution is survival for the fittest, so we must continuously enhance our competitive advantages in the investment circle and along the industry chain, in order to excel in such competition. More importantly, we also have to win in the natural selection. For example, the dinosaurs living 100 million years ago, though once succeeded in the struggle for existence and dominated the earth, ended in vanishing. This could be attributed to its failure to keep up with the changes in natural environment. Competition at a deeper level comes from the response to the environment. The case is also the same for JD Capital, as we should not only excel in the industrial competition, but also develop some “mutant genes”. Our “mutant genes” include listing on the NEEQ, founding or purchasing financial institutions, deeply engaging in internet finance, and M&A with listed companies which are also JD Capital’s breakthroughs.

The second breakthrough is to grasp the trend in trends, rather than just superficial phenomenon. For instance, facing the social changes brought about by the Internet, we need to open up our minds. There is a concept for internet enterprises — iteration. Wechat may iterate by issuing new editions every day, and optimize the enterprise from every aspect through continuous and quick revisions in acceleration of its development. This is a major development mode for enterprises. Another concept worth mentioning is “sharing economy”, one that Didi and Uber take advantages of. While the traditional taxi industry provides people with physical displacement services, we can find a large amount similar service resources since everyone has a car. Therefore, we actually do not necessarily need taxis as long as we share the social car resources. These are all profound historic trends. For another example, significant changes are also taking place following the combination between financial system and the Internet. In the past, an enterprise had to contact with banks, VC, PE to get financed, but the situation has changed as “crowd financing” emerged on the internet. For those who have an idea to write a book, they may ask potential readers for funding, and even thoughts and suggestions. Besides this, there is also “crowd-sourcing” that assigns a task to different social entities and makes it accomplished. These are all changes in the basic social trends that are changing people’s life necessities, and we must grasp them.

The third breakthrough is being brave to make big bets. A saying is that, when making investments, you cannot put all the eggs in a single basket, i.e. you need to have plenty of baskets. However, this is different from JD Capital’s belief. JD believes that baskets are sufficient as long as each one of them is sufficiently firm and stable. Therefore, in the light of major tendency and systematic opportunities that we are capable to grasp, we shall make big bets and focus our capital and human resources on them. Previously, we had made big bets in enterprise securitization, and will continue to do so in the financial reform and state-owned enterprise reform ensuring the market reform, in the M&A business during industrial adjustment and reorganization, and in such specific sectors as education, medical care and war industry. For enterprises with promising prospects, we shall provide mass investment, repeated investment and long-term shareholding, and make every effort to contribute to their development, with an aim to reap huge profits. In fact, this is also Buffett’s investment mode.

Breakthrough II: on investment business

First, we need to make breakthrough development from an equity investment management institution to a world-class, comprehensive asset management institution. In this era, against the backdrop of China’s continued rise, it is certain that a batch of people or institutions, be it JD Capital or other institutions, will become world-class financial enterprises representing China. The times has given JD Capital such an opportunity and also a mission.

Our approaches to realizing this goal is to form a system with the M&A business as its core, and growth investment and fixed-income investment as key aspects. Originally, we depended on high-net value investors at the capital side. In the future, we should expand the size of institute investors and wealth investors, and increase our own funds. Correspondingly, our investment stage shall also extend forward, from growth enterprises to VC, and backward, to M&A, with business scope covering the whole world. With these targets achieved, we may be compared with, or even excel those top institutions, e.g. Blackstone, and become a world-class major asset management institution.

Second, we must provide long-term, relatively high and stable returns for investors. We are managing a fund of RMB 30 billion, making an annual compound return of over 30% for our investors. In the future, when we are managing RMB 300 billion, or even 3 trillion, we should continue to create satisfactory returns for them. Even if compared with Buffett’s IRR of 19%, the aim of 30% is too high, I’m still confident about reaching an annual compound return rate of no lower than 20%. Meanwhile, we also purport to help a batch of leading Chinese enterprises to become world-class market players. Buffet mentioned in last annual conference of Berkshire’s shareholders that he invested in 9.5 world’s fortune 500 enterprises. In my opinion, JD Capital should invest in at least 95 fortune 500 enterprises in the future, because we are 50 years younger than Buffett, and we still have 50 years to outperform him.

Last, we aim to become an institution that boosts the country’s prosperity, national development and human progress. There are many emprise factors (“Wuxia”) in Chinese culture, and its people have a strong sense of justice. The chivalrous spirit of making contributions to the motherland and its people is also what JD people believes in. We hope to become a responsible and much respected institution that lasts for generations. This will become the most important breakthrough we are to make.

This is what I would like to share today. Thank you!