ASPCONNECTWINTER 2015 NEWSLETTER

Chinese Venture Capital Outlook Bright Despite Stock Market Weakness

YAR-PING SOO, CFA PARTNER, PRIMARY INVESTMENT TEAM

On August 24, 2015, China’s stock market endured its biggest one-day decline since 2007, plummeting 8.5%, causing the Chinese state media to dub the event “Black Monday.” Since the devaluation of the Yuan earlier this year, approximately $5 trillion has been erased from the global equity markets1. In spite of all the reverberations felt worldwide, while we remain cautious of the slowing growth in China, we believe sectors such as technology, media and telecommunications, advanced manufacturing and healthcare continue to experience healthy growth and represent attractive investment opportunities.

The devaluation of the Yuan (RMB) represents an exchange rate reform on the part of the Chinese government—an effort to move to a managed floating exchange rate with respect to a basket of currencies. This is also in preparation to meet the IMF requirements for RMB to qualify as reserve currency. China’s equity market correction is unlikely to have a major impact on consumption as less than 13% of financial assets in China are invested in stocks, with the majority in saving deposits2. The correction is also in line with government’s intention to better manage runaway stock prices and ballooning margin financing. Nonetheless, the execution and timing of the currency devaluation was less than perfect, which resulted in market panic. We believe that the margin financing trend in the Chinese stock market has been largely reversed.

Given these facts and the state of the current market environment, we do not discount the importance of continued economic reforms by the Chinese government. It will be a long

1. The Great Fall of China, The Economist, 29 August 2015 2. HSBC Research, What Negative Wealth Effect?, 7 July 2015

and potentially painful process for China to evolve into a more sustainable and balanced economy. Undeniably, China’s economy is growing at a slower rate than before, although it still accounts for almost a third of global economy growth. The investment-led high capital expenditure growth seen in the past has also resulted in over-capacity and a burden on the environment. Following his elevation to President, China’s Xi Jinping publicly announced a desire to shift to a more consumer- and services-driven economy. Although this policy guidance was clearly a move in the right direction, the events that have transpired over the last few months reflect the significant execution challenges of such a shift.

Adams Street is cautious of the rippling effect of China’s further growth slowdown, and its impact on neighboring Asian markets. Export-oriented emerging markets such as Taiwan, Singapore and Korea are three of the largest exporters to China (as percentage of GDP), and these markets will find the near-term future challenging. In contrast, China accounts for a large share of imports for markets such as Philippines, Indonesia and India, and is very likely to be exporting deflation if the RMB remains weak3.

Internet Economy and Technology Disruption

China’s vibrant internet economy is highly market oriented and subjected to fewer regulations than in the US. In the enterprise services space, we observe that while there are no big players currently, that trend is gaining steam due to increasing labor costs and more recognition of internet providers. In these early days, we see Chinese replications of business models which have worked in the US. However, we are also seeing unique business models which cater more to the needs of local Chinese. We believe the current success of Chinese internet companies in the consumer internet space can be attributed to the following factors:

�With an internet population of 649 million, 86% of whom are smartphone users, China is the world’s largest smartphone market4.

3. HSBC Research, Implications of China, Commodities and Currencies on EM, 2 September 2015

4. Reuters, China's internet population hits 649 million, 86 percent on phones, 3 Feb 2015, 2014 figures

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2 ASPCONNECT / Winter 2015

� Internet talent is in abundance as more Chinese are equipped with Computer Science knowledge and related subjects relative to other developing countries.

�With the high adoption rate of technology by such a large population, competition further prompts frequent iterations of new improvements in technology and accelerates development in the internet space.

� The less entrenched organized traditional retail infrastructure relative to the developed world has also propelled China’s economy towards eCommerce.

As levels of innovation grow, Chinese internet entrepreneurs, who experienced early successes, are now re-investing their newly created wealth into venture capital funds, or are transforming into angel investors, hoping to back the next potential billion dollar valuation company, or “unicorn”. Young, post-90s entrepreneurs, inspired by their fellow friends and students, are eagerly embracing non-traditional employment, working at startups versus holding office jobs. Further up the chain of command, former senior executives from Baidu, Alibaba and Tencent (“BAT”) are working hard to prove to the world that they too are capable of building successful technology businesses from scratch.

Clearly, China’s ecosystem has undergone a significant maturation over the past few years, and now venture capital investors are increasingly pushing the future potential of tech startups forward to the early stage rounds of financing. This push, coupled with increasing competition between venture capital funds and increased deal flow, caused an unprecedented level of venture capital investments in China during 2014. However, it appears that the investment pace is now stabilizing. Disruptive business models are reshaping the traditional industries and we know that our job at Adams Street Partners is to position ourselves ahead of these future investment trends.

The Adams Street Partners Portfolio – Our Share of Winners

Adams Street’s Asian portfolio is on track to perform well, with our exposure in China largely aligned with small/medium enterprises in the dynamic and fast growing sectors of services, education, healthcare and technology, media and telecommunications. Adams Street also has limited exposure to the industrial and state-owned enterprise sectors which will continue to bear the brunt of the macroeconomic restructuring. With regards to Chinese stock market volatility, we have limited exposure to A-share listed companies, and benefit from the

potential privatization of sizeable US-listed Chinese companies such as Momo.

According to the Asia PE Review, there was over US $22.6B worth of shares held by private equity investors, both domestic and foreign, on the A-share market as of the 8th of July. Of this amount, for investors of USD denominated funds (in which Adams Street has invested), exposure to the immediate impact from government-imposed sales ban (>5% shareholding) only account for 5%, with the most significant of which still in their lockup period regardless of the ban.5

Our Thoughts on China Early and Late Stage Venture

When Adams Street first surveyed the Chinese venture capital landscape almost two decades ago, only a handful of funds existed – many of which were franchise extensions from the US. Today, the Chinese venture capital fund market has become much more competitive. From our research, we noticed that the established venture capital funds featuring the most successful managers in their portfolio are now losing market share, given the dynamic and ever-changing landscape of Chinese venture capital. Our coverage of the China venture capital market enables us to track and gain access to upcoming and rising venture capitalists. Many of these new leaders have outstanding track records, established in prior funds at top-tier firms, and are very motivated to creatively build their resources and teams. Over the last few years, Adams Street has reshaped its own portfolio, investing in funds managed by some of these newer high potential groups, and choosing not to invest with some of the older venture capital names from years back.

Today, China has the highest number of unicorns in the world after the US, and the Chinese venture funds in which Adams Street has invested feature a meaningful percentage of these unicorns. However, we are cognizant of the concerns regarding increasing froth and valuation of venture in China and rest of the world, especially in the late stage. While most of our China venture exposure is in the earlier stage, we are conscious of the impact of potentially lower valuations in certain venture-backed companies. Adams Street will continue to encourage our venture capital managers to seek liquidity via trade sale or secondary demand in the high valuation environment.

Important considerations: Adams Street Partners has prepared this newsletter (“Newsletter”) to provide information to its clients. This newsletter is not intended to provide investment advice to any particular client, and references to particular portfolio companies are not to be construed as recommendations of such companies. This Newsletter is not an offer of sale of any security or investment product or investment advice. Statements in this Newsletter are made as of December 2015, unless otherwise stated, and there is no implication that the information contained herein is correct as of any time subsequent to such date. All information with respect to portfolio investments and industry data has been obtained from sources believed to be reliable and current, but accuracy cannot be guaranteed. Past performance is not a guarantee of future results. Projections of forward looking statements contained in this newsletter are only estimates of future results or events that are based upon assumptions made at the time such projections or statements were developed or made. There can be no assurance that the results set forth in the projections or events predicted will be attained, and actual results may be significantly different from the projections. Also, general economic factors, which are not predictable, can have a material impact on the reliability of projections or forward looking statements. A complete list of Adams Street Partners direct venture/growth investments is available at www.adamsstreetpartners.com or upon request.

5. Asia Private Equity Review Greater China Edition, Bull Gone Missing, August 2015