CNBC Interview with Ben Harburg, Managing Partner, MSA Capital

Below is the transcript of a CNBC interview with Ben Harburg, Managing Partner, MSA Capital and CNBC's Geoff Cutmore. The interview took place at CNBC's inaugural tech conference, East Tech West, in Nansha, Guangzhou.

GC: Terrific, thanks very much indeed, Mandy, for that, and you are a living, breathing example of survivor bias, because you're all here, and there are a lot of people that aren't, but you get the opportunity to speak directly to Ben, which I think is tremendous, and thank you so much, Ben, for giving us that chance. Before I open up to the floor, though, I'd like to just ask you a few questions if I might, and can I just start by getting some thoughts from you around this G-20 Argentina meeting coming up. Obviously, there's a lot of uncertainty and nervousness about where this China/US trade story is going. In your world, what difference is it making at all, to the way you think about investing into Chinese technology companies?

BH: Yes. Um, I think that, regardless of what happens in Argentina, the expectation is there's a hard reset going on in relations between China and the United states, and so I don't think that'll necessarily change if we're able to assuage some of the issues around trade deficits, or issues around technology transfer, IP theft. What's informed our investment process, as a result of these developments, is certainly a more heavy investment in core technologies. Certainly, events like the banning of selling components to ZTE, and some of the now discussions around displacing a lot of the, kind of, higher end manufacturing supply chain out of China, will certainly cause us to continue to work to develop native industries. And so, over the last few months, we've certainly done more investment into chips, into robotics, machines, things that would be developed organically, domestically, and will have a lot less dependence on US inputs, and in the long-term, I think that's going to benefit China's own chip - supply chain, and their targeting of markets ex-United States, so Southeast Asia, Middle East, Africa, Europe, otherwise.

GC: Which is a very sad outcome, if a lot of these innovative business models are not going to make it in to the US market, but can I just expand on that? Obviously you're based in China, and you're investing in Chinese companies, to take their business out of China - how and why?

BH: Yeah, so-,

GC: I mean, this is a big market. Why do you need to go and look at some of these other locations? And if you're doing it, how are you doing it?

BH: Right, so more and more Chinese entrepreneurs are thinking global from day one, and looking to build platforms that are not just useful to China, but also globally, and hoping that their business can start to diversify away from the Chinese market. It's certainly a result of the highly competitive nature of the market in China, you know, folks acknowledge that there are certain geographies where, you know, their technology is at a lower level of development, and where markets are still relatively greenfield, and where there's a lot of white space, and so we've identified a number of models that we think can be exported globally. We think that markets like Southeast Asia, India, and MENA, are particularly applicable for Chinese technologies, because, one, the kind of dynamic between government and private sector in those markets is actually more reflective of the Chinese dynamic than the US, two, a lot of those markets seem to be at a similar stage in their technology evolution, adoption of technologies, like China, so kind of a mobile-first basis, as opposed to having to unlearn old consumption habits, or wean themselves off of PC-based businesses, and third, you know, Chinese business models, particularly these platform approaches, where you start with a core product, like messaging, and then you build off of it, to include restaurant bookings, and tickets, and ride sharing, that model works, and it's proven to build multibillion dollar companies, in a very short period of time, and so that is a really attractive approach, that now folks in those geographies are attempting as well.

GC: How President Trump can say, this is not a competitive marketplace, I don't know. I look at the bike sharing story and we've gone from 40 companies to 4 companies in the space of about 12 months, I mean, this is Game of Thrones writ large, it seems to me, in the tech space. But let me ask you, because you invest in these businesses and some of them are bleeding, and some of them are bleeding for a long time--

BH: Mm-hm.

GC: --when do you decide and how do you decide, that you're going to cut loose, and take your loses, and move on? What triggers that, in this marketplace?

BH: Yes, so China has historically been a market where scale can often trump product, so in many of these industries, the key concern is first to get as much of market share as possible, and then to iterate on the product, as well as improving margins. And so, we've certainly invested in a few of these highly competitive marketplaces, bike sharing, we were with Mobike, when there were-,you know, we picked Mobike out of a basket, when there were about 40 other competitors. Our view was that they had a unique set of technology advantages, that gave them kind of a head start on the rest of the market, as well as a really strong team of entrepreneurs, that had rolled out large-scale businesses previously in China, and therefore were uniquely suited or that kind of a hypercompetitive market. Meituan is another one of our portfolio companies, that had to go through literally thousands of competitors, in kind of the-, particularly in the food delivery market, group buying, in order to get to where they are today, nearly a $55 billion dollar company, listed in Hong Kong. And so, our view is that, largely in China, a lot of that cash burn can be justified, along the way, to build that dominant market position, but once you're there, you've got to really start to hone margins. And we-, you know, we look at opportunities along the way to take some money off the table, depending on how the market dynamics are shifting, as well as to really help support and direct entrepreneurs, to cut off the businesses that aren't working. Meituan is a great example, they-, you know, they practice really kind of a try fast, fail fast model, which, they'll pilot a new service, and if it doesn't work, they're pretty brutal about cutting it off very quickly, and so that's how they evolve quickly.

GC: Again, you know, to contradict the President, Uber's come to this market, and has done the Didi tie-up-,

BH: Mm.

GC: So you can have western and Chinese companies in this space coming together. You have an investment in Tujia. Is that an Airbnb deal, at some point?

BH: It's a good question. We're not only invested in Tujia, we're also invested in a company called Xiaozhu, which in some ways is even a closer DNA match to what Airbnb are doing, and we suggested, actually, to Airbnb management, about a year and a half ago, that it might be an interesting opportunity for them to acquire. At that point, it was a couple of hundred million dollar valuation, maybe about 150. The company just raised a new round, about three weeks ago, four weeks ago, at a $1.3 billion dollar valuation, and so I think they're now a little outside the range of Airbnb. Airbnb have decided to take a different route, to try to build organically. I think that Airbnb are going to find it harder and harder to compete in this market, just given the regulatory dynamics, around house sharing, and the tax and security implications of that. So I don't think that, at this stage, Tujia or Xiaozhu, just given their scale, are going to be acquisition targets.

GC: That sounds like negotiating talk to me-,

BH: [Laughter].

GC: But we'll set that to one side. Would anybody like a question? We can open this up to the floor, if anybody would like to pop a hand up. And then we can get a microphone to you. Anybody feeling brave? Anybody got anything they want to get off their chest this morning? No? Nobody has a question? Okay, well you have a think about it, and if you want to have a question, raise your hand, and I'll bring you in to the conversation, because we've got some ladies here with microphones. The alternative route, I guess, is the private secondary offering, which we were talking a little bit about, before we came on stage. It's not a very well-developed process here in China. Is that going to be transitional, do you think, in the maturity, or the maturing, of private equity here?

BH: You know, I think, historically, a lot of investors in China recognized that there were great returns in the market, but weren't seeing a lot of DPIs, we call it, so capital returned back to them. And so the result was that, I think, that there were some question marks around the market, as a kind of overall basis. What we've seen in the last few years is a really maturing of the liquidity routes. So, Hong Kong, particularly, has taken huge steps to now be a tech-friendly IPO hub. The Chinese A-share market has taken, kind of, mirror, similar steps, and also through the, kind of, Hong Kong-Shanghai connect, Hong Kong-Shenzhen connect, there's a greater ability for foreign investors to access the A-share companies. And then we've certainly seen, now, a maturing in the M&A market, which was something, historically, we didn't have in China. We-, just in the last year, we've sold two companies on to other businesses, Baidu bought one of our companies, Meituan bought another, and so, more and more so, we're seeing companies that are being built to fit in to a larger mothership, which is a nice way to take money off the table. And then the private secondary market, as we discussed, so the ability for people to sell shares in companies that are still private, and take a little bit of money off the table, maybe their cost basis, but still enable them to ride the upside in the market, once there's a listing. And certainly in China, I think if we were to compare it with the US, it's clear that companies are much more rapidly going out the door for IPOs. I mean, we've had-, we've had six IPOs already in the last year and a half, it's-, you know, even companies that maybe feel like they're not so ready are pushing out the door, where we have the opposite situation in the US, you know, large companies like Airbnb, Palantir, Uber, have been private for seemingly decades. And so it's a different dynamic. So, I'm not sure how long-lived that secondary market will exist, because they're going for an IPO so quickly, I mean, we have companies like Pinduoduo, a company that, you know, 2.5 years after founding had a NASDAQ IPO at $25 billion dollars, so.

GC: Is there a risk that the government, at some point, steps in to this story, though? Because it doesn't create a great impression if you IPO, and then the price falls very quickly, and then investors feel that they've been sold a pup, and I guess, when you're putting so many companies in to the market, in such a short space of time, and you're being affected by global political stories, as well, that are driving Chinese equities lower, then there are all sorts of headwinds. Do you worry about the government taking a more robust position, and perhaps blocking the pipeline?

BH: Historically, it's been the opposite, right? So when we first started investing, we had a number of our portfolio companies that were stuck in that A-share queue for three years, and the big fear was that you could invest in businesses, and even though they were ready for IPO, they couldn't get out of the queue. And so we're now seeing the opposite, which is where they're facilitating that. I think that, you know, whether the share prices fall after IPO is more a dynamic of the public markets, and perception of those individual companies, and we could go company by company, but I think that, if that continues to happen, certainly more of the entrepreneurs will want to hold back, so I think it will be kind of a natural dynamic, rather than something that's forced. You know, you have to really look at each company, to understand why some of shares have fallen. Xiaomi, for instance, I think a really great business, but one that's largely misunderstood by, particularly, investors outside of China, Tencent hit by gaming regulations, so each has, kind of, I think, an individual story, not necessarily tied to an overall trend.

GC: Can you share with us how you see the broader journey for private equity and technology? Jim Breyer yesterday appeared to suggest that people need to reset their expectations about returns in this sector now. Is that a short-term phenomenon? Will the bigger money come back? Or have we just reached the end of the growing phase for this business, and then we're in a-, a longer maturity phase? We've done the adolescence, now it's becoming grownup. I mean, share with us your thoughts on that.

BH: Listen, returns are never going to be sustainable, as they have been over the last few years, for the indefinite future, right? I mean, you know, certainly, even at a GDP level, we're not going to be able to achieve 6% returns every year, that's not realistic. But I do think that it's pretty early to call time on the types of returns that we're getting in China today, and for a few reasons. One, the capital is there for these companies, so they're going to continue to grow, and have plenty of fuel to support them. If anything, today, most global asset managers, and typical institutional investors, are underexposed to China, a lot of them fearing, again, some of the traditional, kind of, narratives around China, around real estate bubbles, or whatever, and fearing that type of an environment. But what we've proven, certainly, particularly this year, with huge IPOs, like Xiaomi, Meituan, is huge amounts of capital now have been returned to those institutional investors, so they'll be re-upping, and they'll be bringing their friends. So, there's plenty of capital for the market. I think there are certain sectors in China which have become overheated, and certainly hypercompetitive, ecommerce, ride sharing, you know, some of the usual suspects, certainly fintech, but the result is obviously then that now we'll evolve down the value chain to other sectors, so life sciences, healthcare services, plenty of under penetration in manufacturing, industrial redesign. So, I think there'll be plenty of returns to be achieved in other sectors, outside of the, kind of, core mainstream.

GC: And what's the trigger word for generating your excitement in putting some money in to a new company today, in terms of-, whether it's in healthcare, or whether it's in another industry segment? What gets you really excited? What do you think the hottest sector to be in right now is?

BH: Sure. Well, we're certainly looking for places where we can have a very moded business, something that's irreplicable, so a dataset, something of that nature, that is-, that is so large, and aggregated, and has so many, kind of, knock-on monetization opportunities, that's really attractive to us. So, one of our portfolio companies is now arguably the world's largest healthcare big data company, and we've aggregated a dataset of about 290 million people. So, places where we can do that over and over, we're looking at other companies, along those exact same lines today, in big data, but for other sectors, in SaaS, fintech, things that can be used for fraud detection, for giving-, pricing loans, things like that, insurance pricing. You know, those types of areas are really interesting to us. We're also looking for platforms, and that could be, again, in any sector, but something that enables us to start with that core product, and tack on services around it. So, perhaps it's a trading platform, in its core, but then we can tack on logistics services, warehousing, finance. And so, you know, that's the kind of attractive play that we're all looking for.

GC: And just to wrap up with a final question, really, I mean there may be some people in the room here, who are beginning to look for funding for a business idea here. How has the pitch got to change, now that we seem to have come past that big initial wave of money? It does feel the marketplace is becoming much more discriminating, and harder nosed. What do they need to be able to say to you, in that pitch, very early on, to stop you walking out of the room?

BH: A lot of factors go in to that pitch, certainly. I think that, first and foremost, the market has shifted, I think entrepreneurs' expectations have now gotten a little bit more reasonable, there's a little bit more humility in the room, when we talk to entrepreneurs. Certainly, again, you've got to have something very unique about your model. Either it is the business itself, in a very unique space, that other people aren't looking at, there's something very unique about you, as an entrepreneur, you have deep domain expertise, in a very difficult sector, that other people are afraid of going in to, or have stumbled in, because it's so complicated. We'd like to see the ability to very quickly scale a business, so, you know, the types of platforms that can grow virally, but also where there's a view towards also making a profit, so where your unit economics still make a lot of sense. We're certainly out of the era where we pay for eyeballs, pay for users, and so you've got to show a very clear path to monetization, and a very clear path to becoming profitable.

GC: And I said last question, but I'm just going to nick one more, if the boss doesn't mind, and it's a question about the attractiveness of you, being based in Beijing, at a Chinese business, and say Jim, or somebody else, who's coming from the outside, to try and put money in. When you talk to some of these startup entrepreneurs, do they express a preference, and if they do, why?

BH: Yes, so if you, kind of ,trace the evolution of Chinese venture, let's say, since 2000 or so, which is really where things kind of started, and many of the biggest funds in China today have only existed since 2005, 2006, there was a period of time where there wasn't a lot of international-, or a lot of US dollar funds that were local to China, and so you had a lot of the larger global buy-out folks coming in to the market, and providing that initial capital for some of the core businesses, and that's why a lot of US companies can claim that they were, kind of, pre-IPO investors in folks like Alibaba, and others. I think those days are starting to wind down, we certainly have plenty of locally based venture capital, private equity, growth capital funds, that have raised multiple billion-dollar funds, even some as high as $10 to $12 billion dollars, and local entrepreneurs need local support. And so if someone is parachuting in from Hong Kong, has one person sitting in Hong Kong, or sits in Silicon Valley, or, god forbid, sits in New York, and has an IC decision, that has to, kind of, govern what's going on in China, they're not going to get their head around the model fast enough, and they're certainly not going to be there to support the company, as it goes along. And so, we've found, in some of our rounds, that the global buy-out shops were sniffing around our deals, but couldn't come to a decision fast enough, and certainly couldn't support businesses. You know, we specifically liked Mobike, for instance, because the core of its investor group were local warriors, funds and strategic, like Tencent, that could add a great degree of value to that business. Our competitor, at the time, had a lot of international money, and the result is now where we've had a really nice multibillion exit on Mobike, and the other company is just about gone. So, it's really critical that you have local support for these businesses.

GC: Well, let's-, let's finish on that high, thank you so much, Ben, for speaking with us.

ENDS

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