Since the official opening on September 30, 2009, the Growth Enterprise Market (GEM) has ridden through the bumpy waters in a short period of time, leaving most people dizzy. Such fluctuations will possibly replay intermittently in the future, which, from a certain perspective, brings to the surface the unique intellectual property risks lurking behind the enormous returns in the expansion of the GEM.  

 

One distinguishing feature of GEM is its high proportion of intangible assets; up to 70% theoretically. On one had this is high proportions is a result of the influence of foreign GEMs, where no constraint is put on the proportion of intangible assets. On the other hand this is a result of the fact that most GEM enterprises are high-tech enterprises, where investing in technology is a common practice. However, since such a high portion of most GEM enterprises are composed of “intangible” assets, investing in a GEM exposes one to a high degree of risk.

 

 

GEM was born for technology and innovation-driven start-up companies.  

 

In accordance with the Interim Measures for the Administration of IPO and Listing on the GEM Board, what the GEM in China is most concerned with is an enterprise’s innovation and growth power. GEM is aimed at serving these enterprises and funding their independent innovations.   

 

Enterprises falling into the group of two “highs” and six “novelties” are most favored by the GEM. Two “highs” refer to high technology and high growth potential. Six “novelties” are novel economy, novel service, novel agriculture, novel energy, novel material and novel business model. These enterprises are mainly in the sectors of new energy, new material, biomedicine, electronic information, environmental protection & energy-saving and modern service. Enterprises in other sectors but with extra high growth potentials, as well as those having innovative technologies or business models, ranking in the top list of the industry, or occupying a high market share are also in this category. We can say that the Chinese government established the GEM out of respect for intellectual property. The hope was to use the governance role of the monetary and securities market to protect and promote the development of enterprises with independent intellectual properties, to reshuffle the small and medium-sized innovative enterprises, and to optimize the innovative enterprise market in China.   

 

Intellectual property and GEM are conjoined twins. Compared with other boards, the    GEM is more vulnerable to intellectual property risks.

 

The amendment to the prospectus of GEM enterprises is evidence of this vulnerability.  

 

The CSRS has put some special requirements on the articles of the prospectus related to intellectual property. For example, in the chapter of “risk factors”, it requires that issuers shall specify in accordance with their own specific situations the possibility of replacement of their technologies. Technological replacement is fatal to all high-tech enterprises. Moreover, in the chapter of “business and technology”, issuers shall specify the originality and innovation of their business operation, the sustaining innovation mechanism, and the nature of their core technology (whether it is an original innovation, or integrated innovation, or re-innovation based on digestion and absorption). This is to make the enterprise’s R&D power more transparent and to eliminate all infringement or expiration possibilities. For enterprises whose core competitiveness is intellectual property, IP infringement or expiration can be highly destructive.

         

Huayi Brothers Media has also referred to the intellectual property risk, mainly regarding the piracy problem, in its prospectus. Box office and benefits from TV broadcasting are the main source of income for video producers in China. But their derivative income is heavily impaired by piracy. As a contrast, American video producers can have a derivative income, which can double box office revenues. As long as piracy exists, the domestic video production industry will face extreme difficulties in expansion. Therefore, we can say that the GEM is exposed in IP risks. Investors shall first of all consider these problems before getting on board.   

 

 

As for how IP risks shall be weighed during investment in the GEM board, Fortune Venture Capital (Fortune VC) and Private Equity (PE) have solutions.

 

Fortune VC is one of the earliest investment companies and has a special relationship with the GEM board. It was set up ten years ago, which was exactly when the GEM began its listing preparations. When the 29 GEM enterprises were formally listed, Fortune VC became the only investment company winning three lots. Fu Zhonghong, General Manager of Fortune VC, told this journalist his understanding of the IP risks lurked behind the GEM.   

 

When talking about the IP risks mentioned in the prospectus, Fu Zhonghong said: “For enterprises listed in the GEM board, patent is their major intellectual property. However, it is not the only factor to consider before investing, because it can be easily replaced. When we invest in high-tech enterprises, we will check the number of intellectual properties they own, but this is only one factor. What we care more about is their innovation power. Intellectual property simply stands for a strong point of an enterprise. It does not mean that the enterprise can rely on it to achieve sustainable development. Enterprises must develop more new products, and watch out for copiers and followers, although this is almost impossible to do given the rampant piracy situation in China.”

 

Mr. Fu took the three GEM enterprises he invested in as the example to illustrate people’s perception of the intellectual property risks existing in the GEM. These three enterprises are EVE Energy Co., Ltd. (300014.SZ), AIER Eye Hospital (300015.SZ) and ChinaNetCenter (300017.SZ). He said: “AIER Eye Hospital is specialized in service and management. Hospitals are most susceptible to medical malpractices, instead of intellectual property risks. With the liberalization of private investment, medical treatment has become a promising industry. ChinaNetCenter is engaged in network acceleration services. It has many technologies and has to use many mathematical models. However, protection of such technologies and models is not an easy thing. Making an application for an Internet patent is very time consuming; it takes about two years for one patent. To ensure that they are not eliminated by the fast developing Internet industry, high-tech enterprises must make constant developments and innovations. Therefore, for such enterprises, our attention is put on their potential for sustainable development, not on intellectual property risks. EVE Energy Co., Ltd. is a producer of lithium batteries. The lithium battery it developed can be used for ten years on end. Involving patents and business secrets, the products will possibly be attacked by intellectual property problems. We must clearly discern these problems before we make the investment.”         

 

It’s not hard to see that professional investors are more reasonable in making investment decisions. They pay more attention to controllable elements and substantial results, such as core competitiveness, operation mechanisms and business teams, but they tend to be less concerned with the intellectual property, or its positive or negative impact on the GEM. Fu Zhonghong explained why: “In China, we don’t have many products that are completely independently developed. Even for a company with strong R&D capacity, such as EVE Energy Co., Ltd., some technologies are based on their foreign prototypes. The company just transplanted them and made some improvements.” It is true that the GEM board is from intellectual property, but it is not for intellectual property.        

 

There are also investors who are not enthusiastic about intellectual property. They take a wait-and-see attitude toward the two “highs” and six “news.” A fund manager from a large domestic financial institute said, when he was interviewed by Sanlian Life Weekly, that, “It is a fact that the companies initially listed were all high-tech companies and were specially chosen by the supervision and regulation department. However, will the high technology be smoothly converted into production forces? After having successfully financed the immense amount of capital, will the companies maintain the high growth rate every year? Technological power is an advantage of a company, but what underlies this advantage is the risk that is difficult to anticipate. Some companies have a PE ratio as high as 60. What does it mean? These companies have to achieve a 100% growth rate every year. This is irrational, and we will never place our bet on them. We don’t worship the “greater fool theory”, because we can’t afford time to wait and see the sustainability of their performance. Once the technologies are not profitable, the companies living on them will possibly collapse in no time. Such being the case, neither the supervision and regulation department nor the local government could be helpful. As long as the companies pay taxes according to law, no one, even the country, is allowed to intervene in it.”              

 

Some investors who have decided to invest in the GEM board seem to have a deeper understanding of GEM’s future. Zhu Min, Founder of the New Webex and President of Cybernaut, used a unique paraphrase of this board when he was interviewed by the 21^st Century Business Herald: “Owing to the GEM board, many local investors began to shift their eyes to small and medium-sized enterprises. Fortune VC is such a local investor – or possibly foreign-funded in future. In the past, their focus was on real estate or other highly profitable sectors. I think this shift is a big incentive for innovation. On the other hand, this is a reflection of their respect for the intellectual property.”  

    

When asked how this he reached this conclusion, Zhu Min stated that Chinese A-share listed companies only respect RONA (return on net assets), while American companies emphasize on PE ratio, which, in his eyes, is a reflection of the respect for intellectual property. Net assets are just like the appearance of a person. PE ratio is his ability. We shouldn’t only look at the appearance. PE ratio can also be compared to the intellectual property power of a company. However, this power has been neglected for years in China, and its interpretation is always limited in a narrow sense - “intellectual property is to sell patents.” “If you have an idea, and have transformed it into a valuable product, maybe you will earn 10 million Yuan. However, I value your company at 100 million Yuan, with the premise that you have to spend three years to prove to me that you really have this intellectual property. If you make it, you are in the money.” The significance of the GEM lies in its unprecedentedly unveiling of the intellectual property concept, and telling people that the source of the giant wealth of a small company is nothing but intellectual property.