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from A Round to Apple Inc.
General Commentary
December 10, 2017

Silk Road to Silicon Valley

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Market Snapshot

Indices Week YTD
GSV 300 0.00% 53.10%
S&P 500 -0.20% 15.30%
Dow -0.50% 18.50%
NASDAQ -0.20% 25.40%
Russell 2000 -1.30% 8.70%
MSCI -0.10% 32.20%
Valuations P/E Fwd P/E/G
GSV 300 27.5x 0.7x
S&P 500 19.4x 2.6x
I-Rates Now YTD
10-Year Note 2.40% -2.00%
3-Month Bill 1.23% 141.20%
Sentiment - Current
Bull-Bear - 45.1-23.1
Put-Call - 1.16
Vix - 11.29
Inflation Now YTD
Gold $1276 10.70%
Oil $56.90 5.70%
Mutual Funds - Week
Fund Flows (bil) - $4.70
Growth-Value 00-09 09-Now
Growth -34% 244%
Value 87% 147%

“The best time to plant a tree was 20 years ago… the second best time is today.”

— Chinese Proverb

“A journey of a thousand miles begins with a single step.”

— Lao Zi

Last week, GSV hosted the first inaugural Global Education Summit in Beijing, China, in partnership with TAL Education Group, the largest education company in the world by market capitalization, Tencent, China Development Research Foundation (CDRF), and Beijing Normal University. Featuring former President Barack Obama as a keynote speaker, the invitation-only conference gathered 500 global business executives, policymakers, educators, university leaders, entrepreneurs, and philanthropists with the mission of accelerating innovation in education and talent.

The Beijing location is both an acknowledgement of China’s central role in the future of education innovation, as well as Asia’s broader emergence as a critical strategic market in the sector. Academic partners for the event included Tsinghua University and Arizona State University. There isn’t a place on Earth that values Education as highly as the Chinese do, as evidenced by President Xi’s outsized emphasis of Education as THE key priority in the most recent 19th Party Congress.

2017 GLOBAL EDUCATION SUMMIT KEYNOTES

Source: Global Education Summit, GSV Asset Management

Interestingly, conventional wisdom is that the China growth story is yesterday’s news. Exports in China fell 7.7% in 2016, has given the “Chinese-Sky-is-Falling Crowd” extra ammunition in recent months.

But the Chinese story is just beginning.

China’s overall GDP is $11 trillion and GDP per capita is $15,000. In 1960, the GDP per capita was $1,500. Growing at a rate of 7%, China’s economy projected to double in 10 years on its way to surpassing the United States by 2028. (See GSV’s commentary on the VChIIPs, the group of countries defining the future).

If you look at the growth dynamics, it’s truly remarkable. A key catalyst is massive urbanization that is constant around the world but exploding in China. If you look at the United States, there are 10 cities with a population of one million or more. In China, there are 160.

TOP 10 CITIES: UNITED STATES VS. CHINA
Top Cities Ranked by Population

Source: OECD, U.S. Census Bureau
SHANGHAI SKYLINE, 1990 VS. TODAY

The official population for Shanghai is 34 million. But demographers will tell you that based on cellphone subscription data, it’s probably over 40 million. That is larger than the entire population of Canada. Most people have never heard of China’s tenth largest city, Xi’an. With a population of nearly 13 million, it is bigger than Sweden.

Importantly, these urban behemoths are clusters of young people who are embracing technology, brands, and digital commerce. They’re getting ready to change the World. Accordingly, we’re seeing accelerating innovation, with transformative businesses being created and accelerating venture investment activity across major Chinese cities.

FROM URBAN CLUSTERS TO GLOBAL INNOVATION HUBS
Top Chinese Cities: Venture Investment Activity + Notable Startups

You can understand a country by looking at how its people spend their money. Census data shows that families in Asia broadly and China specifically invest a disproportionate amount in the education of their children versus families in the United States.

For example, American families spend 33% of their income on housing. Chinese families spend 10%. On the flip side, American families spend 2% of their income on Education. Chinese families spend 15% of their income on education – nearly 8x more than American families.

On a trip I had this year to China, a headline in the South China Morning Post described “China’s Myopia Epidemic,” stating that students are studying so hard in China that by the tine they enter Universities 90% of them are short-sighted.

This year at the 19th Party Congress, President Xi gave a 3.5 hour long opening speech to the Chinese government officials. What’s more striking is how he spent approximately 25% of his speech talking about the importance and prioritization of education.

And with the One Child policy gone, there are currently 18 million babies born in China annually, a number we expect to rise as birth dynamics normalize. Coupled with China’s massive discretionary income spend on Education and the government’s unwavering commitment to Education excellence, we expect the Chinese Education market to be a nerve center for opportunity for decades to come.

Our view is that while the country has unmistakable cons, you want to be long on China. While you can’t predict the short term ebbs and flows, China is a Mega-theme for the future.

Today, the Middle Kingdom is positioning itself at the center of the Global Silicon Valley.

INTERCONNECTED FORCES

In Chinese philosophy, the concept of “yin” and “yang” describes how seemingly opposite or contrary forces may actually be complementary, interconnected, and interdependent.

According to the OECD, for example, the Global Middle Class has increased over 80% since 2000 — from1.4 billion to 2.5 billion today. While more people than ever now have the opportunity for a comfortable life, today, half of the world still lives on less than $2.50 a day or less. Over 22,000 children die per day from starvation, 2,000 die daily from lack of access to clean water, and 1.6 billion people — a quarter of the World’s population — lacks access to electricity.

Disruptive new technologies like the Internet and smartphones have democratized access to information and created broad new arenas for entrepreneurship. In fact, there are over 2.3 billion smartphones in the world today, effectively placing a computer in everyone’s pocket. But technology also means that nearly 50% of jobs are at risk of automation in the next 20 years.

So it’s exciting that one in three babies are now projected live to 100. But that means one in three babies will outlive their savings unless we rethink the way we learn and work.

We live in a hyperconnected world. Tencent’s WeChat has almost 1 billion users who send over 37 billion messages daily. But this hyper connectively has also allowed terrorist groups like ISIS to create broad global networks of radicalized followers through social media.

The power of interconnected forces drives the global growth economy.

The historic Silk Road which connected Central Asia, India and China was as much about an exchange an ideas than of physical goods. The trade route was catalyst for cultural development across China, India, Persia, Europe, and the the African continent. It catapulted China to economic and geo political dominance.

President Xi’s “One Belt, One Road Initiative” aims to create the modern Silk Road, focused on creating connectivity and cooperation between Eurasia and China.

THE OLD AND NEW SILK ROAD

Similarly, Silicon Valley wasn’t built on bits and bytes and chips. It was built on exponential ideas. For a long time, those ideas emerged from the 60-mile stretch between San Francisco and San Jose. Today, the spirit of innovation and entrepreneurship has gone global and viral. We are seeing entrepreneurs from around the world — especially China — transform critical sectors like Education and Talent.

That’s what was on display at the Global Education Summit.

THE FUTURE OF MOBILITY + THE INNOVATION ECONOMY
Deborah Quazzo (Managing Partner, GSV Acceleration) + Jean Liu (President, DiDi)

Source: Global Education Summit

Under the leadership of Jean Liu and Cheng Wei (Founder & CEO, DiDi), DiDi Chuxing has emerged as the world’s largest mobile transportation platform, completing over 25 million rides a day for 450 million users, while offering a second income to more than 21 million drivers. Today, DiDi is the world’s largest one-stop transportation platform by ride, and is on track to surpass Uber to become the most valuable private company in the World.

Jean is a powerful advocate for expanded opportunities for women in the innovation economy. Interviewed by GSV Acceleration Founder and Managing Partner Deborah Quazzo, Jean shared her unique “Eastern” and “Western” perspective from running a transformational, rapidly growing, global technology company.

OPPORTUNITIES IN EDUCATION GLOBALLY AND IN CHINA: THE PAST, PRESENT & FUTURE
Carlos Watson (CEO, OZY), Doug Becker (Chairman + CEO, Laureate Education) & Chris Hoehn-Saric (Senior Managing Director, Sterling Partners)

Source: Global Education Summit

In an interview conducted by Carlos Watson (Founder + CEO, OZY), Doug Becker and Chris Hoehn-Saric shared their perspectives on the past, present, and rapidly evolving future of the global education and talent sector and their outlook for emerging areas of opportunity and innovation around the world and particularly in China. Regarded as industry pioneers, Doug and Chris have both led and scaled multi-billion dollar businesses that are recognized for pushing the boundaries of innovation in education.

EDUCATION MEMOS FOR THE NEXT MILLENNIUM
JI Shaoting (Director, Future Affairs Administration), LIU Cixin (Hugo-Award Winning Author of THE THREE BODY PROBLEM), LIU Qingfeng (Founder and Board Chairman, iFLYTEK), JI Shisan (CEO, guokr.com)

Source: Global Education Summit

In this panel, Liu Cixin, Hugo Award-Winning author of the Three Body Problem, Liu Qingfeng, founder of iFLYTEK, and Ji Shisan, CEO of guokr.com discussed the ramifications of how science and technology will impact change in how education is offered in the future and made their predictions for how science and technology will intersect with the future of the future.

PROSPECTS FOR AR, VR & GAMIFIED LEARNING IN EDUCATION
Li Jiang (VP, GSV Asset Management), Anjua Dharkar (Head of Global Learning, Unity Technologies), Alvin Lee (Founder + CEO, Genius 51), Lauri Jarvilehto (CEO, Lightneer), Felipe Sommer (Founder + President, Nearpod)

Source: Global Education Summit

AR/VR isn’t just a computing platform, or even a vehicle for mind-blowing entertainment (although this is a key piece of the puzzle). It was fundamentally a new medium for acquiring information and knowledge. AR/VR represents a fundamental leap forward because it has the potential to shatter physical boundaries that separate the World of ideas and experience. It is going to be a powerful platform to learn anything… everything.

In this panel, GSV’s Li Jiang moderated a conversation with Anjua Dharkar (Head of Global Learning, Unity Technologies), Alvin Lee (Founder + CEO, Genius 51), Lauri Jarvilehto (CEO, Lightneer), and Felipe Sommer (Founder + President, Nearpod) on the implications of AR, VR and games in the future of an “invisible learning” World. 

A GLOBAL PERSPECTIVE FROM CHINA’S ONLINE EDUCATION UNICORN
Cindy Mi (Founder + CEO, VIPKID) + Michael Moe (Founder, GSV)

Source: Global Education Summit

Founded by CEO Cindy Mi, language learning platform VIPKID is the first female-led and founded Unicorn in Global Education Technology. Cindy shared her story of how she founded the company from her experiences starting at age 15 when she taught English to Chinese students.

Founded in 2013, today VIPKID has over 30,000 teachers delivering lessons to over 200,000 students in 32 countries. VIPKID is the fastest growing company in the World, going from zero dollars in revenue in 2014 to a forecasted $750 million in annual revenue run-rate this year, according to CEO Cindy Mi. This year, VIPKID launched Lingo Bus, an education platform that focused on providing high-quality Mandarin Chinese education using the company’s video-conferencing technology.  

Bubblin'

by Luben Pampoulov

Unlabeled

When there’s a problem, there an opportunity…the bigger the problem, the bigger the opportunity!

Looking at new investment opportunities, we are especially compelled by malfunctioning industries, and the startups that could disrupt them. Bigger problems are usually found in industries that have long-standing oligopoly structures, with only a handful of key players controlling (and exploiting) the market.

Take the consumer Music industry for example — after decades of expansion, physical music distribution got disrupted with the Internet. More innovative models such as iTunes emerged and brought the CD industry to its knees. No longer did we need to buy an entire album in order to listen to a few specific songs; iTunes allowed you to buy music on a per-song-basis.

But in less than a decade, iTunes itself got disrupted; Spotify’s on-demand, mobile-centric model allowed listeners to consume music, at any time, on any device, any where…and iTunes’ tedious syncing between your iPod and laptop was the one big issue that Spotify didn’t have.

Source: RIAA

Similarly, the music recording industry has been evolving into an Oligopoly over time. Today, three major labels (Warner, Sony and Universal) own the industry, and exploit artists by collecting a large majority of the revenue.

Labels are agencies that work with musicians and help them with distribution, analytics, and brand partnerships, all while letting them keep rights over their recordings. The issue is that throughout the years, the labels have became greedy and have been taking bigger pieces of the pie.

Consider this — for every dollar spent on Spotify, labels collect 70% and share only a small fraction with the artists. Essentially, labels put themselves way ahead of everyone, then give a cut to the artists, and also leave a cut to the distribution platform. Luckily (and rightfully so), the pressure on labels is raising, and they are feeling more pressure to increase the share to artists and to the streaming platforms. This past summer, Spotify and Apple Music “successfully” re-negotiated their streaming deals, lowering the payout to labels from about 55% to about 52%… A small step in the right direction. (Disclosure: GSV owns shares in Spotify)

But things are about to get disrupted. A new entrant is aiming to bring the record industry upside down. NY-based UnitedMasters is giving artists an attractive alternative to record labels, and is offering a broad set of services including data analytics on their songs, valuable insights on their listeners, and also merchandise support and marketing help. And importantly, all of that comes at much better economics to the artists.

So far there are over 1,000 musicians who’ve signed up with UnitedMasters, with the large majority of them being Indie musicians.

UnitedMasters Provides Data-driven Analytics for Artists

Source: UnitedMaster

Distribution is a major focus, and the ability to retarget fans, to give good guidance, and to license music, are all important components most existing platforms miss. UnitedMaster provides all of the above, and is further looking to rapidly expand its offering. To help fuel that, the company just raised a $70 million Series A round led by Alphabet, and with participation from Andreessen Horowitz and Floodgate.

The magnitude of the funding for a Series A investment is eyeopening, but even more impressive is the direct involvement of Larry Page, who led Alphabet’s investment, and the new Board seat taken by A16Z’s Ben Horowitz. Additionally, Larry Page is working on this investment with Google’s Corporate Development leader David Drummond, a former radio DJ himself.

We believe the record label industry is ripe to be disrupted soon, and will pay close attention to UnitedMasters and others. 

Pioneer Notes

by Li Jiang

The Only Way A US Tech Company Can Win in China

American tech startups and even more established companies competing to become a category leader in China is like European military powers trying to invade Russia during the winter.

It doesn’t work.

Google was slow to realize the rising competitive power of local grown Baidu. Facebook got censored and then largely displaced by Tencent’s WeChat. Uber ultimately bowing out by selling its China unit to Didi. Apple is besieged daily by new Chinese phone makers often with faster specs, and definitely at lower prices (more on Apple later).

Bless Mark Zuckerberg’s heart and his Mandarin skills but it’s going to be very difficult for Facebook to compete in China against Tencent.

The three factors that’s most difficult for U.S. (or really any non-Chinese) company to overcome is different consumer preferences, unfair government intervention, and the aggressiveness in which local competitors work.

Most company’s China strategy should and will end up in something other than growing organically. They can buy as Amazon did when it acquired Joyo for $75M in 2004. Joyo, now Amazon China, generated a reported $3B of revenue in 2016. Or invest as Apple did in Didi. Or create a joint-venture or franchise.

But the only way for a non-Chinese company to win organically in China is to build a BRAND. And not only any brand but one that is ASPIRATIONAL.

The Chinese consumer class is a new one, having made much of its purchasing power in the last two decades. In a mature market, people’s mentality is to buy the best product at the most affordable price. The Chinese psych is to buy products that reflect the aspirational lifestyle they want to have and will make the budget work.

Consumer models such as Louis Vuitton, Starbucks, KFC have seen success in China. In fact KFC is the largest restaurant chain in China with over 5,000 stores.

Tech models like Apple and Tesla also tap into the aspirations of Chinese consumers. Apple, while trying to fend off every form of competition, is still well positioned and beloved by Chinese consumers for its premium brand. It’s early lead may slowly get eroded by every other handset maker, but its brand and image remain an alluring moat for the company.

Apple store in Chongqing, my mom’s hometown.

Airbnb, which started life as a simple couch-surfing service, has created a lifestyle brand. Now it’s opening a separate China unit. Airbnb will need to continue to build the vision of bringing a curated experience and unique taste to consumers in China. Offering the prestige of international travel experience is also a differentiator that’s hard to copy.

Coursera is growing in China. In fact, it’s the number 2 market for the company behind the U.S. The reason Coursera is so appealing to Chinese consumers is because it offers people the opportunity to take courses created by Ivy League institutions, something both highly valuable and worth striving for. (Disclosure: GSV owns stock in Coursera)

Both companies still have a lot of work to before they can celebrate. Airbnb is facing multiple stiff local competitors and Coursera has only reach 1 million (of the nearly 700 million) Chinese Internet users.

But an ASPIRATIONAL BRAND like Airbnb or Coursera can succeed where a more utility service like Uber failed.

Easier said then done. Jia you!

Jia you literally translates into “add oil”, the most common refrain of encouragement in Chinese.

Six I's: Growth Economy Update

Week ending December 10, 2017

Interest Rates Now Week Trend Comment
10-Year Note 2.4% 2.6% N USD is down 11% against the Euro in 2017
3-Month Bill 1.2% 4.2%
Spread Corp vs. Govt. 0.7% -
Spread Junk vs. Govt. 3.0% -
Euro vs. $ $1.17 -
Pound vs. $ $1.32 -
$ vs. Yuan Y6.64 -
$ vs. Yen ¥113.51 -
Valuations Now Month Trend Comment
CPI 246.8 0.5% + GDP Growth in Q3 was +3.0%
PPI 113.5 0.4%
Oil Price $56.90 4.2%
Gold Price $1276 0.4%
Corn Price $3.44 -0.6%
GDP (latest Q) 3.00% -
Indices P/E ttm Month Trend Comment
S&P 500 24.3x 2.5% + MSCI at attractive value
Small Caps - -1.1%
Value - -2.0%
Growth - -0.2%
MSCI Earnings Mkts. - 0.0%
S&P 500 Earnings Yield 5.15% -
Sentiment Current - Trend Comment
Bulls-Bears 45.1-23.1 - + Bullish sentiment
Put-Call 1.2 -
Vix 11.3 -
IPOs 2017 - Trend Comment
# of IPOs 136 - + 10 IPOs last week up +4% on average
Pricing Above Range 19% -
Pricing In Range 64% -
1-Day Pop (Avg.) 14% -
YTD Performance (Avg.) 31% -
Median Market Cap (M) $530 -
Inflows Week - Trend Comment
Mutual Fund Flows (B) $4.70 - + $18.4B inflows in last 4 weeks

Market Update

Week ending December 10, 2017

World Indices

America Index 11/12/2017 YTD Week
U.S. GSV 300 115.7 53.1% 0.0%
NYSE 12322.6 11.4% (0.4%)
Dow 23422.2 18.5% (0.5%)
NASDAQ 6750.9 25.4% (0.2%)
NASDAQ-100 6309.1 29.7% 0.2%
Russell 2000 1475.3 8.7% (1.3%)
S&P 500 2582.3 15.3% (0.2%)
Brazil Bovespa 72165.6 19.8% (2.4%)
Mexico IPC 48028.3 5.2% (1.0%)
Canada S&P TSX 16039.3 4.9% 0.1%
Euro-Asia Index 11/12/2017 YTD Week
China SSE 3432.7 10.6% 1.8%
Heng Seng 29120.9 32.4% 1.8%
Singapore Straits Times 3420.1 18.7% 1.1%
Indonesia JKSE 6021.8 13.7% (0.3%)
Japan Nikkei 225 22681.4 18.7% 0.6%
India Sensex 33314.6 25.1% (1.1%)
Russia RTS 2169.3 (2.8%) 4.2%
France CAC 40 5380.7 10.7% (2.5%)
Germany DAX 13127.5 14.3% (2.6%)
U.K. FTSE 100 7433.0 4.1% (1.7%)



U.S. Indices Snapshot

Valuation P/E Est. P/E/G Price/Sales
LTM NTM Growth LTM NTM LTM NTM
S&P 500 24.3x 19.4x 7.60% 3.2x 2.6x 2.4x 2.1x
NASDAQ 25.5x 17.6x 7.80% 3.3x 2.3x 2.7x 2.2x
Russell 2000 25.1x 17.7x 6.30% 4.0x 2.8x 1.9x 1.7x
GSV 300 54.1x 27.5x 38.60% 1.4x 0.7x 5.7x 4.0x

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