Scandals or not, VC firms still love China Net startups

By Melanie Lee

SHANGHAI (Reuters) - The rash of accounting scandals that has hit U.S.-listed Chinese stocks has not curbed the appetite of private equity and venture capital firms looking for the next set of Chinese Internet stars in the mainland's "So-Lo-Mo" and luxury e-commerce sectors.

PE and VC firms are still betting on firms in So-Lo-Mo, shorthand for the social, mobile and location-based services, including Digu.cn and UCWeb, because of the impending cheap tablet and smartphone boom in China.

"We invest into the early side, around pre-revenue. We already know there are risks but this just puts an extra layer of having to be extra careful with due-diligence," Cyril Ebersweiler, partner at Ireland-based SOSventures, said of the accounting scandals.

Many of the firms caught in the scandals have seen their stocks plunge and the uncertainty has caused investor anxiety about most Chinese plays listed in the United States.

But VC firms, who invest into earlier stage companies, peg their hopes on hot start-ups still years away from listing.

"More and more people are betting on mobile because of smartphone use picking up," said Harry Man, partner at Matrix Partners China. Matrix Partners China, an affiliate of Matrix Partners in the United States, has about $650 million of assets under management.

"You can see that there will clearly be big, big names evolving in that space," Man said.

At the end of 2010, mobile internet users in China totaled about 300 million. This meant more than 60 percent of all Internet users in the country accessed the Web through a mobile phone.

Song Li, the founder of Digu.cn, said the mobile location-based social networking site is looking to raise $15 million over the next few months. Digu, China's answer to American location-based social-networking service Foursquare, allows users to check into cafes and bar and redeem coupons.

"I have raised money on the strength of a business plan before and since Digu has been ranked the number one location-based social network in China, we are in the position to raise even more money," Li said.

"Obviously anything negative about Chinese companies will not be helpful but I'm confident of the future of China's Internet industry, especially the mobile Internet," Li added.

UCWeb, which counts Alibaba Group and GGV Capital among its investors, makes a popular mobile Web browser.

Another hot favorite listed by VC firms is the personalized luxury shopping space. Rising consumer spending and brand awareness, coupled with Internet usage, has ripened the sector for investments, they said.

Firms such as Xiu.com, a high-end luxury e-commerce website that received $20 million in funding in April from Kleiner Perkins Caufield & Byers, and VIPstore, backed by GSR Ventures, a luxury groupbuying website, are hot picks.

"Everything that surrounds personal consumption: How to buy, How to rent something, those are compelling ways of knowing where your money is. That's where we are looking at," said Ebersweiler of SOSVentures.

Insiders said some of these luxury e-commerce firms are in the process of fund-raising.

AVOID HOT NAMES, GO LOCAL

Some venture capital firms say expansion stage companies in sectors like e-commerce and groupbuying have become too expensive. This has led VC firms to shift their investment portfolios to invest in earlier stage companies.

"We are looking at deals a little bit earlier. A lot of the more mature companies' private valuations are now much higher than the public valuations so it makes no sense at all to be doing private company valuations at a higher multiple than what the public market is priced at today," said Gary Rieschel, managing director of Qiming Venture Partners, which manages over $1 billion in assets.

360buy.com, China's leading online electronic retailer said earlier this year it had raised $1.5 billion from DST, Wal-Mart and a consortium of other investors. The firm is planning an IPO in 2013 although it has said it will not be profitable for two to three years.

Local media reported in April that DST had paid $500 million for a 5 percent stake in the company, giving 360buy.com a valuation of $10 billion. 360buy.com declined to comment.

"They are considering raising some more money now at a valuation that the market simply won't support," Rieschel said.

"You have to be quite rational about what kind of valuations you expect companies to grow into in the next two or three years," he said.

Many venture capital firms said they would shy away from the groupbuying firms also because of intense competition in the sector.

Tencent and Groupon operate groupbuying site Gaopeng in China while hundreds of other smaller firms, like Renren's Nuomi, Meituan and Wowo Tuan, are also in the space.

Groupbuying firm Lashou, which was founded a year ago, raised $100 million in venture capital funding in April, valuing the firm at $1 billion.

"So far, people have been investing into low-hanging fruits, meaning companies that use business models copied from the West," said Ebersweiler of SOSventures.

He said the new trend is for VCs to look for firms that are creating something unique for the Chinese market, adding that firms like Douban.com, a Chinese books and movies reviews site, is something that would interest investors.

"Douban is totally underrated in China, they really created something for China. They are growing by revenue and it's really firm proof that Chinese entrepreneurs can create new things for the Web."

(Editing by Kazunori Takada and Muralikumar Anantharaman)