China’s private equity champion on winning with the Chinese consumer
Most headlines today depict a China under siege, its long economic boom ominously waning as it duels with the U.S. in a volatile trade war. But Weijian Shan is talking about the other China, the thriving market of 1.4 billion customers that, he claims, stands shielded from tariff disputes—and is one of the world’s best places to invest.
On a wintry evening, we’re seated in a Maison Kayser coffee shop on Manhattan’s Upper West Side. I’m having a latte and scone, while Shan, a wiry 66-year-old who exudes Zen calm, orders hot water. Shan heads PAG, Asia’s largest private equity firm, and he’s about to phone in for the board meeting of a company PAG owns that runs an English-language tutoring school in Beijing. “The trade war is yesterday’s conflict,” he says, in soft, lightly accented English. “The prize is winning the Chinese consumer.”
Shan has been profiting from that prize for two decades. His prowess reflects three contrasting traits that have made him an unusually astute observer of China’s markets: He’s a successful on-the-ground dealmaker, managing $35 billion in assets; he’s a U.S.-trained Ph.D. economist and former business-school professor; and he’s a figure whose personal path mirrors his nation’s transition from repressive poverty to an economic miracle. Says Robert Aliber, a retired economics professor from the University of Chicago’s Booth School of Business who’s known Shan since he was a doctoral student: “I can’t think of anyone who offers a better streetscape view of the individual markets in China. That’s why he’s been so successful.”
“Successful” is an understatement. Shan’s firm operates a real estate investment fund and a corporate lending franchise, but his impact shows most in PAG’s $15 billion private equity portfolio, which he directly manages. He declines to disclose information about his investors or returns. But public records and other reporting show that Shan’s clients include major pension funds, insurance companies, and endowments. Among his private equity investors are Calpers, San Francisco’s public-employee retirement system, and the sovereign wealth funds of Singapore and Kuwait. PAG also took on U.S. private equity giant Blackstone as a minority partner last year. While returns of private funds are hard for outsiders to calculate, an analysis of the companies Shan has bought and sold and the profitability of his current portfolio indicate he’s been generating gains averaging about 30% a year on those companies—for a decade.
Those returns are rooted in China’s roaring domestic economy, and Shan expresses confidence that trade tensions won’t muffle that boom. In his view, President Trump’s tariff offensive “mainly hits an export sector that’s already in decline,” says Shan. “The consumer sector has kept thriving.” And that sector offers enticing possibilities because it is something of a world unto itself, since so much of what U.S. and Chinese companies sell to consumers in China is also made in China.
In conversations with Fortune over several months, Shan elaborated on that premise. It was a movable feast in which Shan did most of the moving, treating me to around 10 hours of phone interviews from PAG’s headquarters in central Hong Kong, where he also lives; from his car while driving to dinner at a hometown eatery; and while strolling in San Francisco, where he began his U.S. education. Along the way, Shan described how he spots megahit potential in the likes of day-care centers, dating websites, and a huge herd of dairy cows.
Shan grew up in Beijing, where his father worked as a customs official and his mother as a secretary. His schooling ended at age 12 in 1966, when Chairman Mao launched the Cultural Revolution. As Shan describes in his memoir, Out of the Gobi: My Story of China and America, that painful period, in which China’s planned economy created scarcity from plenty, made him recognize what a market-driven system could mean to his homeland.
In 1969, China’s government transplanted 16 million urban teenagers to the countryside. Shan’s destination was the Gobi Desert in Inner Mongolia, as part of a corps of farmers. His unit was tasked with growing wheat and corn in the barren soil. Shan also served as a “barefoot doctor,” supplying basic medical treatment to other soldiers. In the frigid winters, the only source of heat was burning frozen cow dung. “I was surprised that when people disagree in the U.S., one person calls the other’s argument ‘bullshit,’ ” Shan told me. “You can’t believe how precious that stuff was to me!”
Even amid hardship, Shan showed a knack for efficiencies. Assigned to a team of three to make bricks, Shan found that specialization hiked their output. He gave each teammate one task—mixing clay and sand, packing the compound into molds, or transporting bricks to the drying area—and the process nearly doubled their production.
In the wilds, Shan relentlessly sought knowledge about the wider world. He secretly listened to Voice of America broadcasts in English while studying a dictionary that matched English words with pictures. Later, when China began building ties to America under Deng Xiaoping, Shan seized his opportunity. In 1980, he won a scholarship to attend a U.S. university. Shan chose the University of San Francisco over Stanford and UC Berkeley, in part because the Chinese name for San Francisco had a prestigious ring. “It means ‘Old Gold Mountain,’ as it was called by the immigrants who joined the 19th-century gold rush,” he explains. After earning an MBA, Shan enrolled in 1982 as a doctoral student at Berkeley, where his advisers included Janet Yellen, the future chair of the Federal Reserve, who in Shan’s book recalls “a charming young man in need of a good meal and a new haircut.”
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Upon graduating, Shan worked briefly at the World Bank, then taught at the Wharton School. But the chance to capitalize on China’s shift to a market-driven economy proved irresistible. In 1993, he joined J.P. Morgan as an investment banker in Hong Kong, switching five years later to Newbridge Capital, then the Asian arm of private equity firm TPG. Shan worked with legendary dealmaker David Bonderman to revive two banks felled by the Asian debt crisis. TPG invested $500 million in Korea First Bank and $150 million in Shenzhen Development Bank. As the lenders rebounded, TPG sold its shares in Korea First for $1.65 billion and in Shenzhen for $2.2 billion. Shan, meanwhile, was typically dogged in unearthing other opportunities. “He told me that he’d traveled 36 hours on a unheated train in China’s interior to visit a factory,” recalls Aliber, the professor.
In 2010, Shan left TPG and quickly raised $2.5 billion to start his own fund at an existing firm called PAG. His contacts in top echelons of the Chinese and American financial worlds proved invaluable in raising money and spotting deals. But his observational skills were just as potent. “The way he’s gotten business isn’t by being an aggressive salesman but by being a professor-dealmaker,” says James McGregor, former CEO of Dow Jones China and a consultant who helps companies navigate China’s regulatory process. Shan is “great at analyzing and explaining the detailed mechanics of the sectors he invests in.”
The PAG fund launched just in time to capitalize on a historic transition. Since then, Shan says, “China has gone from the factory of the world to the market for the world.”
The recent slowdown in China’s growth is attributable almost entirely to a decline in exports and manufacturing—to the “factory,” in other words. Much of that, Shan notes, reflects government-driven deleveraging: Starting in 2017, Beijing took radical steps to shrink bloated, state-owned industrial enterprises and squeeze excess credit out of the banking system and housing market.
Even more central to the deceleration is China’s long-term shift from export-led manufacturing to consumption. As Chinese wages rise, families spend a higher proportion of their income on health care, entertainment, restaurants, and consumer goods. The shift to a consumer society, as a rule, dampens the overall growth rate. “In manufacturing, you have a multiplier effect,” explains Shan. “A new plant starts and hires people, then buys supplies and power from producers that hire more people, who generate more wages to buy things.” But consumer spending, “dollar for dollar, creates less growth.”
Shan emphasizes that exports and manufacturing started falling long before the trade war began. Since 2010, the value of goods China ships abroad dropped from 36% of GDP to 18%. That means U.S.-imposed tariffs sting less: Exports to the U.S. now represent only 4% of China’s national income, around one-third the level of a decade ago. This year, China’s shipments to America are expected to drop by around $60 billion. But as Shan points out, China has been exporting far more goods to the rest of the world, blunting that decline’s impact.
As manufacturing retreated, Chinese consumption rose. At 10% a year, Chinese consumer spending is growing 2.5 times as fast as the equivalent U.S. figure. Amazingly, China’s retail sector—defined as the market for consumer goods, but excluding services—grew to an annualized $6.22 trillion this August, surpassing the U.S. for the first time.
This consumer revolution isn’t completely immune to the trade war. “The psychological impact could be large,” Shan warns. He recalls that when the U.S. unleashed its first round of tariffs in mid-2018, panic reigned, and Chinese stocks dropped 25%, though they have since bounced back.
Still, Shan reckons that fast-rising Chinese incomes will triumph over trade fears. Among the businesses capitalizing on that growth are a host of U.S. companies—to the tune of $400 billion in sales inside China each year. While tariff tit-for-tats have hurt U.S. farmers and manufacturers, they’re so far sparing companies that make goods in China to sell in China—and those, as Shan notes, are plentiful.
Tesla is building Gigafactory 3, one of the world’s largest auto plants, in Shanghai, to serve a burgeoning Chinese customer base. Apple has more iPhone users in China than in the U.S., and GM sells more cars in China than stateside. Last year, Starbucks announced plans to more than triple its revenues in China—currently estimated at around 20% of total sales. McDonald’s promises 2,000 new restaurants by 2022. And Yum China—headquartered in Shanghai but incorporated in Texas—is China’s largest restaurant company. Its Kentucky Fried Chicken and Pizza Hut brands are the country’s leading quick-service and casual-dining eateries, respectively, and Yum is pursuing a long-term goal of expanding its store count from its current 8,900 to 20,000.
So where has Shan been reaping his gains? From the start, PAG has focused on businesses that cater to consumers and require relatively little capital to grow. Some of its earliest successes were outside China. PAG was a big investor in the Universal Studios theme park in Osaka, Japan, for example. Japan’s own growth was tepid, Shan explains, “but we thought [the park] would take off because of the explosive growth of visitors from China and other Asian countries. And that’s what happened.” PAG’s original investment was $120 million. In 2016, it sold its stake for $1.25 billion.
One of Shan’s biggest scores has been in digital music. Shan saw huge potential in an owner of music copyrights called China Music Corp. “It was a vehicle for purchasing the rights to songs, lyrics, and music labels,” Shan explains, “and it owned 70% of all the digital rights in China.” The problem: The streaming platforms at the time were paying no royalties. But Shan anticipated that legal trends in China would turn against music piracy. In 2014, PAG invested $100 million in CMC, enabling it to buy two popular streaming services—vertically integrating a musical rights holder with a means of transmission. And in 2016, he helped orchestrate a merger between CMC and QQ Music, the streaming platform of tech conglomerate Tencent, to create Tencent Music Entertainment. Today, that service’s dominant position has swelled its audience to 800 million active users—and strong copyright enforcement means it’s earning huge revenue. Late in 2018, Tencent Music went public on the New York Stock Exchange, and PAG’s $100 million investment is now worth around $2 billion. Tencent Music’s pop-oriented patrons don’t include Shan himself, who says, “I only listen to classical music, and I don’t mind jazz.”
Shan’s portfolio currently consists of over 20 companies, most of them private, in which PAG usually owns either 100% or a controlling interest. Health care in China is one of Shan’s themes. “As people become more affluent, they consume more and more of the sophisticated treatment I could never supply as a barefoot doctor,” he says. PAG’s health care investments include Jilin Yinglian, a leading maker of cardiac and central nervous system drugs.
PAG has also bet on the expanding culinary tastes of a more affluent nation. One holding is Food Union, a Northern European dairy-products purveyor that’s bringing its yogurt and ice cream to China, where such treats are considered high-end delicacies. PAG also owns a majority stake in China’s largest milk producer, China Youran Dairy. “We own more than 100,000 cows, one of the biggest herds in China!” says Shan, noting that thousands of them graze in the pastures of his old haunt, Inner Mongolia.
Consumer-facing technology also fuels Shan’s strategy. PAG is part of a Chinese consortium that owns Kentucky-based Lexmark; its sales have taken off in China, where the market for home and office printers is growing far faster than in the West. Shan’s fund also holds a majority stake in Zhenai, a dating website. The mushrooming matchmaker boasts 140 million members, and it posted roughly $400 million in 2018 sales. It tailors its model to a fervent goal for Chinese parents: finding an acceptable spouse for their daughters, a service for which some parents are willing to pay thousands of dollars a year for VIP memberships. “In China, dating is taken very seriously,” explains Shan. After a man and woman meet online through Zhenai, a female chaperone vets the man and oversees the couple’s first meeting. “She’s there to manage expectations,” Shan says.
PAG is also betting on another social-betterment business: China’s private schools. “Chinese parents spoil their kids,” says Shan. “More than 60% of the kindergartens in China are private.” He seized on the trend by purchasing Golden Apple, a chain in Chengdu that runs 60 kindergarten centers, with total enrollment of 15,700. Another PAG-owned academy, Lily English in Beijing, educates children from ages 4 to 12 in after-school courses conducted exclusively in English. For Shan, education is a model business that reinvests only small dollops of earnings to generate big gains. Through the first eight months of this year, Golden Apple’s Ebitda has soared 42%, to $31 million, with margins exceeding 30%.
When he visits Beijing, Shan says, he sometimes meets with friends from his years in the Gobi. Although they mostly recall the black comedy of their life in the wilderness, Shan is delighted when his old comrades talk about how their children are benefiting from the schools, entertainment, medical care, and other choices in the New China, the panoply he’s built a career around funding. “We were put in a cage, and we couldn’t fly anywhere,” he says of the old days. “The cage gradually opened, and the people started to fly. It’s a more open system that makes the difference.” And it’s the folks in the malls and restaurants and private schools who are now proving to be that system’s greatest strength.
Stocks That Ride China’s Spending Wave
To profit from China’s booming retail sector, investors’ best choices are domestic companies that do most or all of their business in the nation—many of which are listed on U.S. exchanges.
Jason Nogueira, portfolio manager for T. Rowe Price’s Global Consumer Fund, likes top names in consumer staples that are fast, consistent growers. He recommends Mengniu Dairy (trades in Hong Kong, U.S.). Another promising choice: Yum China (YUMC), the operator of Kentucky Fried Chicken and
For bargain-priced stocks, the best bets are cyclical companies suffering from angst over the trade war and the government’s squeeze on credit. A housing downturn has hit the appliance sector, but as consumers become more affluent, they’ll revive growth in residential construction. Gree Electric Appliances (Shenzhen) looks attractive at a P/E of just 14, as does rival Midea (Shenzhen) at 17. A slowdown in business travel and belt-tightening by families have hampered the travel sector. To play a rebound, Trip.com Group (TCOM), a provider of online reservations, package tours, and corporate travel management, is a good bet, as is hotel giant Huazhu (HTHT).
A version of this article appears in the November 2019 issue of Fortune as part of the 2020 Investor’s Guide with the headline “Ahead of China’s Herd.”
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