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New industries drawing VC attention in mainland China

Venture capital investment in Mainland China in the first quarter of 2007 showed increased signs that it is diversifying beyond the traditional industries while overall activity was relati

Venture capital investment in Mainland China in the first quarter of 2007 showed increased signs that it is diversifying beyond the traditional industries while overall activity was relatively steady from a year ago, according to the latest China Quarterly Venture Capital Report. In total for the quarter, USD 343.5 million was invested in 36 deals, a decline of 5% in capital and four fewer deals than were completed in the first quarter of 2006.

Among the bright spots in the first quarter, according to the report which was released by Ernst & Young and Dow Jones VentureOne, the publisher of the VentureSource database were significant capital investments directed toward healthcare and energy start-ups, according to the report. In addition, while nearly half of all deals in Mainland China are early-stage deals, second- and later-round financings constituted a greater proportion of deals for the quarter.

"Venture capital investment in China has been dominated traditionally by innovative information technology and product and service type companies. However, this quarter we’re seeing a new appetite among investors to expand into the healthcare and energy markets, similar to what we’re seeing in the U.S.,’ said Jessica Canning, Global Research Director at VentureOne. ‘Certainly there is still tremendous interest in new global technology innovations that are being fostered in China, and IT remains the bedrock industry for the venture capital market. Still, the venture investment climate will ultimately be strengthened by supporting a wide range of entrepreneurial innovation.’

Industry breakdowns
The energy segment in Mainland China posted dramatic increases, reporting nearly as much capital investment as the entire information technology category, according to the report. In total, USD 124.8 million was deployed to four energy deals in the first quarter, up from USD 22 million invested in two energy deals a year earlier. Several of the investments in this segment were for companies producing silicon products aimed at alternative power solutions.

Investment in healthcare companies climbed in the first quarter: there were three deals and USD 15.0 million invested, compared to one deal and USD 3 million invested here in the first quarter a year ago, said the report. For Mainland China, this was the largest capital investment to healthcare in a single quarter since the first quarter of 2002. The three deals were in the medical devices and medical software and information services segments.

Information technology remained the largest investment category, with USD 164 million invested in 20 deals.  While this represented an overall 25% decrease in capital for IT from the first quarter of 2006, first quarter 2007 investment in the Web 2.0-dominated information services segment more than doubled to USD 108.7 million from $42 million a year ago, according to the report.  This included the largest deal of the quarter, a USD 45 million second round investment in software outsourcing company iSoftStone Information Service of Beijing. The software segment saw a doubling of the number of deals to eight, but had investment more than halved to USD 30.7 million.

The business, consumer and retail industry category, which is comprised of non-technology focused innovative companies, posted eight deals and USD 30.7 million in investment in the first quarter, which is three fewer deals and 73% less capital than in the first quarter of 2006.

‘The first quarter of the year is often among the slowest quarters of the year for investment activity because of the New Year holiday, which came later in 2007 than in the prior year. Despite the declines, there are positive signs that the venture capital market is maturing in China with a greater focus on providing start-up companies with second and later rounds,’ said Bob Partridge, Ernst & Young’s Transaction Advisory Services Leader – China. ‘The median round size, at $5 million, remains at an historically high level. And well over 90% of the companies funded this quarter were already identified as either shipping product or achieving profitability this quarter.’

Second rounds made up one-third of the deal flow activity in the first quarter, the largest proportional allocation to this round class in at least six years. In addition, the amount of capital invested in second rounds doubled from a year ago, to USD 121.9 million, according to the report. The number of later rounds also increased from a year ago, while the number of first rounds declined. In addition, there were no seed rounds financed in the quarter, the first time this has occurred in more than a year.

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