The Hefei Model: Attracting Industry Like an Investment Manager

This article describes Hefei, known as China’s strongest venture-investing city, and how discerning judgment and bold investment positioning helped it grow rapidly. Robin believes Taiwanese cities could learn from it. Hsinchu prospered through semiconductors. Other cities, such as Kaohsiung, Taichung, and Taoyuan, could draw extensively on Chinese cities’ ambition to develop industries, bringing in professional venture capital or private equity teams to help plan that development. Robin: Think through several questions—“Who am I?” “Where am I now?” “Where do I want to go?” and “How should I get there?”—then use investment positioning to accelerate core priority industries. ---- Hefei has been one of China’s fastest-growing cities over the past decade. Its technology-industry foundations already include the world’s largest flat-panel-display base, a memory-industry base, and China Speech Valley for AI. Even China’s first quantum-computing operating system, “本源司南” (Benyuan Sinan), has just been developed by a technology company in Hefei. Two distinctive strengths underlie Hefei’s rapid development: The University of Science and Technology of China is there, providing a technological backyard for local development. The municipal government is also extremely active in industrial investment. Online commentary calls Hefei’s municipal government China’s most formidable venture capital institution. In 2009, it committed one-third of the city’s fiscal revenue to panels, investing in BOE and ultimately making more than RMB10 billion. In 2011, it wagered more than RMB10 billion on semiconductors through ChangXin and GigaDevice, won, and was estimated to have unrealized gains exceeding RMB100 billion upon listing. In 2019, it bet another RMB10 billion on new energy by investing in NIO, with Volkswagen’s new-energy operations subsequently locating in Hefei… One word keeps recurring in the municipal government’s industrial-development strategy: investment. This distinguishes Hefei’s development model. Traditionally, cities attract investment by offering land, loans, and tax incentives. Even Shanghai used that model to attract Tesla in 2019. Since the 2000s, Hefei has experimented with attracting industry through capital. The government first establishes commercially operated industrial investment funds to invest in strategic industries it has identified. Capital draws companies to Hefei; once they develop, it sells shares at a profit, then searches the market for undervalued companies aligned with the city’s industrial strategy. The story of how Hefei brought BOE to the city in 2009 illustrates the venture-capital-like aspect of its decision-making. In 2006, Hefei chose “building the city through industry” as its development direction: industrialization, rather than the internet, tourism, or cultural and creative businesses. Hefei had substantial educational and research resources, including USTC, Anhui University, and dozens of other higher-education institutions, but lacked an industrial base. Even when universities had technological resources, those resources flowed elsewhere, leaving Hefei out. Moreover, coastal industries would, as a general pattern, move inland toward lower costs. The city that prepared first could receive them. Hefei therefore attracted companies such as Gree, Changhong, and Midea to establish production and developed upstream and downstream support for them. It gradually built a local home-appliance cluster, becoming one of China’s three major appliance bases alongside Shunde and Qingdao. Developing appliances revealed a gap. Refrigerators, washing machines, and air conditioners could achieve local sourcing rates of 60%–70%, meaning six or seven out of every ten components could be supplied locally. For LCD televisions, however, the rate was only 30%. Chinese companies did not then possess the core LCD-panel technology, and more than 90% of panels had to be imported. An opportunity arose in 2008. BOE, then China’s most promising LCD manufacturer, planned a sixth-generation production line. Such a line required an investment of at least RMB17.5 billion. BOE could not supply that much capital itself and sought a local-government partner. BOE had just demonstrated its technological capabilities, ending its losses in 2007 with net profit of RMB700 million. This gave it confidence to make a major investment for its next stage in 2008. But the global financial crisis then hit, and it lost RMB800 million in 2008. The market began to suspect that its 2007 profit reflected luck rather than capability. Hefei did not hesitate and immediately pursued the opportunity. BOE was mainly considering Shenzhen and did not initially take an invitation to inspect Hefei very seriously. Once there, however, it was impressed: the government said land for the factory had already been prepared, along with an alternative site. Whatever Shenzhen could offer, Hefei would match. Beyond policy support for land and energy, Hefei promised to backstop the entire RMB17.5 billion project. The government would initially invest RMB6 billion and strategic investors RMB3 billion. If BOE had trouble securing the remaining RMB8.5 billion, the municipal government would also take responsibility for arranging it. The sixth-generation line consumed enormous amounts of power. Hefei even built a dedicated 110-kilovolt substation at remarkable speed—in six months. Was Hefei exceptionally wealthy? No. Its annual fiscal revenue was only RMB30 billion. To take on BOE’s project, the municipal government even suspended its metro project. An official reportedly said that year: “To get the project launched, Hefei is prepared to invest 80% of one year’s fiscal revenue.” The government demonstrated an ability to define its own problems and a strong determination to lead local development. Hefei wanted to build an industrial city. It was not pursuing whatever looked attractive, but filling the gaps it actually had. Were creative industries attractive? Yes, but they were not the missing piece in Hefei’s industrial landscape. LCD panels were, so the city had to persuade BOE to come even at a high price. Hefei wanted not only jobs and tax revenue but control over the central direction of its industrial development. This genuinely resembled the thinking of a large industrial investor. In filling a core gap in a core industry, Hefei also showed a strong appetite for risk, much like an investment institution. Its industrial landscape needed BOE, and there were few alternatives. Even if it had to guarantee the funding, it would bring BOE in. Professor Lu Feng of Peking University’s book 光變：一個企業及其工業史 (Guangbian: A Company and Its Industrial History, descriptive title) records a dramatic episode. Just as Hefei and BOE were about to sit down and discuss details, BOE’s Japanese rival Sharp intervened. Sharp told Hefei that BOE’s technology was inadequate and that the city should work with Sharp instead. Did Sharp really want to cooperate? Not necessarily. It was seeking to prevent BOE from growing into a rival rather than genuinely build its core value chain in Hefei. In 2004, it had used the same pitch to derail BOE’s sixth-generation-line plans in Shenzhen and Shanghai. After BOE was pushed out, Sharp found reasons to break its commitments and left as well. Objectively, however, Sharp’s technology was stronger than BOE’s at the time. That was a tremendous temptation for Hefei, and officials could not know in advance whether Sharp was acting maliciously. It was hard to resist. The municipal government reached a bold decision: accept both BOE’s and Sharp’s projects and pursue both. Why was that bold? The city’s fiscal revenue that year was only RMB30 billion, while it had already backstopped RMB17.5 billion for BOE alone. If Sharp also demanded substantial government investment, imagine the fiscal pressure. Once that decision was made, Sharp immediately realized it could not prevent BOE from locating in Hefei and soon withdrew. The pressure on the municipal government eased. With that determination, BOE’s sixth-generation line began production in Hefei in 2010, ending China’s complete dependence on imported large LCD panels. With panel capacity available, Hefei’s appliance industry exceeded RMB100 billion in scale in 2011. Hefei overtook Qingdao and Shunde to become China’s largest appliance-production base. After 2011, Hefei’s state-owned capital began exiting the BOE project, earning cumulative returns exceeding RMB15 billion. Their relationship did not end there. After establishing itself in Hefei, BOE continued reinvesting in the city. By 2017, its investment there exceeded RMB100 billion, supporting not just production lines but also smart manufacturing and digital hospitals. Hefei originally brought in BOE to fill a gap in the color-television supply chain. But at the time, two possible technologies could define the future of TV screens: BOE’s LCD panels and plasma displays. After warmly inviting BOE, Hefei also opened its doors to Changhong’s plasma-TV production line in 2009. That was its backup plan. Although Hefei’s state capital exited the Changhong project in 2011 and plasma screens subsequently disappeared from the industrial landscape, the decision still reveals industrial leadership and risk hedging. Hefei wanted a complete color-TV supply chain, so it backed both technological directions. Whichever won, its industrial position would be complete. This approach and way of operating certainly deserve a place in the history of China’s local industrial development. Through BOE, Hefei established a strategy: find weak links in strategic industrial chains, identify companies with technological promise, and show genuine commitment when those companies are vulnerable. Hefei became the largest appliance-industry base as China’s appliance sector expanded into smart appliances and digital electronics. It gradually supported more than 100 integrated-circuit companies. Along the way, it made another major bet, incubating a company that produced DRAM memory chips for China and achieved a domestic-market breakthrough from zero to one. That breakthrough also put Hefei’s local semiconductor industry on track to reach approximately RMB100 billion in scale in 2021. Seeing the electric-vehicle trend, the government also invested in NIO in 2020. Investing in NIO In 2020, many people learned that Hefei had invested RMB7 billion in NIO when the emerging automaker faced its most acute funding crunch. Founder Li Bin later said that Hefei had brought NIO out of the ICU. Compared with the BOE deal, this investment showed even greater ability to structure and control a transaction. Some details were exceptionally professional and seasoned. First, NIO had already listed on the New York Stock Exchange in 2018. Hefei’s industrial fund was a domestic renminbi fund and could not invest in a US-listed company. For their 2020 partnership, Hefei required NIO to establish a new company, NIO China. Within one year of receiving the funds, listed NIO had to transfer its Chinese assets and operations into NIO China. NIO China was effectively a Chinese joint venture between NIO and the municipal government. Hefei required NIO’s China headquarters, R&D base, and second production base to locate in the city, as well as help develop a local smart-EV cluster. Second, the government required NIO China to generate total revenue of RMB420 billion from 2020 through 2025 and at least RMB7.8 billion in total taxes. Third, NIO China had to complete an IPO within 60 months of receiving its first investment installment, with the listing venue approved by all shareholders. This requirement concerned NIO China, not NIO, which was already listed in the United States. Requiring shareholder approval of the venue sent a clear message: a domestic listing would make it easier for Hefei’s state-owned capital to exit. The timetable for recovering the investment and the exit mechanism were thus explicitly arranged. There were many other detailed agreements: the founder could not cash out and leave, and NIO China could not deliver fewer than 20,000 vehicles for two consecutive years after receiving the investment. A glance at these terms reveals an experienced investment team. Hefei accumulated these seasoned investment capabilities through individual investments over more than a decade. Its 2018 Guide to Attracting Investment in Key Industries listed 18 priority industries, including new displays, integrated circuits, software, speech technology, and AI. It professionally detailed each industry’s trends and value chain, where to find investment prospects, and which companies to approach. Members of Hefei’s investment-promotion team spent 200 days a year traveling across China to pursue projects. After inspecting a company’s factory and equipment, one official could estimate its investment at RMB38 million, astonishing the company head: the actual investment was a little over RMB37 million. Many of Hefei’s investment-promotion staff get straight to the key problems and needs at the first meeting, leaving their counterparts with the impression that they understand the industry deeply. The government’s investment mindset is reflected in training its promotion team like investment managers. By the time the team approached NIO, it could already make clear assessments of emerging automakers, China’s new-energy-vehicle industrial plans, and even global market trends. Consider what happened over the year following the investment. In 2020, new-energy vehicles became the hottest sector, and NIO’s US-listed company became a capital-market winner. On paper, Hefei’s RMB7 billion investment earned RMB100 billion. During this period, the city assembled more than 50 major new-energy-vehicle projects and attracted over 120 upstream and downstream companies, including JAC, Volkswagen, and Gotion High-tech. Hefei now had vehicle assembly, key components, applications, and supporting businesses. In 2021, Hefei invested in another emerging automaker then out of favor, Leapmotor, bringing it to the city to build a factory. Reports said Leapmotor was also preparing an IPO on the STAR Market. The municipal government’s investment-banking mindset Hefei is strongly committed to revitalizing local industry. Its methods represent a different school of local-government practice: attracting industry through capital. The process repeatedly displays several characteristics: First, industrial positioning: investments complete a strategic industrial landscape. The aim is not only tax revenue and employment but also rooting industrial value chains locally so that they cannot easily move away. Second, buying at the bottom: Hefei likes finding value in companies with nowhere else to turn. It lacked the appeal of Beijing, Shanghai, Guangzhou, and Shenzhen, so instead of chasing celebrated top scholars, it sought promising scholars who had fallen on hard times. Third, risk appetite and performance commitments: Hefei is willing to make substantial bets while investing in several companies with complementary strengths and signing performance-based agreements to protect state assets. How can a local government develop an otherwise ordinary regional economy? These are the aspects of Hefei’s answer that outsiders find so interesting. --- #Dedao #CaiYuBusinessReference