GRUB GrubHub Inc

Li Yuan 

With a cooling and uncertain market for tech startups, Chinese venture investors who once searched for China's GrubHub or Uber are hunting for China's Starbucks.

Heekcaa Lab, a chain of 50 upscale teahouses based in southern Guangdong province, in August received 100 million yuan, or about $15 million, from a pair of backers including IDG Capital Partners, one of the most well-known venture firms in China thanks in part to early investment in search giant Baidu and video site Tudou. Nie Yunchen, Heekcaa's 25-year-old founder, has grand ambitions to make traditional tea hip with the young masses the way Starbucks did for coffee in China.

One of Heekcaa's competitors in that effort is Inwe Cha, which a month earlier received 500 million yuan in funding from Richard Liu, founder and chief executive of Chinese e-commerce company JD.com.

Nontech companies aren't a new concept for venture investors in China, but they have recently drawn much more interest for several reasons.

As with their Silicon Valley counterparts, China's venture firms have raised large amounts of capital they need to deploy. While some technology areas, such as artificial intelligence, remain hot, investors generally in the past year have grown cautious regarding tech startups after years of intense interest.

Restaurant chains and other traditional consumer companies also offer a play on China's young, free-spending consumers. In a slowing economy, many of these companies also boast something tech startups often lack: strong revenue and a clear path to profit.

Mr. Nie, for instance, says his Heekcaa chain, which operates under the company name Shenzhen Magcc Catering Management, brings in revenue averaging more than one million yuan a month per store and has never been unprofitable. Its tea drinks sell for 20 to 25 yuan apiece.

With Wheat, a high-end bakery chain in Beijing that received an undisclosed amount of funding from investor Sinovation Ventures in March, says it never opens a store unless it can garner revenue of at least one million yuan a month.

The business is profitable, says co-founder Ye Jiazhi.

Gao Hongqing at Fortune Venture Capital, which manages 20 billion yuan, says the "crazy hot" investments in the past few years in startups that use subsidies to acquire users for ride-hailing and other sharing-economy services aren't sustainable, because their customers are bargain hunters and have no loyalty. "Low prices and subsidies are passé," he says. "It's time to return to the fundamentals." Fortune has invested in a chain of handmade-candy stores and an indoor-playground chain, among others.

Such offline plays can be "safer projects for investors as we're looking for the next big trend," said Wu Shichun, founding partner of Plum Ventures. Mr. Wu's firm, an early-stage investor focused on technology and media, has invested in nontech startups including a custom ice-cream shop in Beijing.

Venture capitalists say domestic investors who put money into yuan-denominated funds increasingly prefer less-risky investments. Zhang Ying, a partner at Sinovation Ventures, says that for investors seeking to exit by having their portfolio companies list on China's A-share markets, strong financial performance is important because Chinese securities regulations have profitability requirements for public listing. In addition to With Wheat, Sinovation has backed a hair-salon chain and a hotpot-delivery service.

Investors in these nontech businesses are considering access to relatively wealthy -- but picky -- young consumers. A report by consultants BCG and Alibaba Group Holding's AliResearch Institute projected that by 2020, the number of upper-middle-class and affluent households in China -- those with annual disposable income of $24,000 or higher -- would double to 100 million and account for 30% of all urban households. That compares with 17% in 2015 and 7% in 2010.

Growth in Chinese consumption over the next five years would roughly equal a market 1.3 times the size of Germany or the U.K., said the December report. It also found that upper-middle-class Chinese consumers 35 and younger spend an average of 40% more than previous-generation consumers with similar incomes, while being more brand- and health-conscious.

Zhang Haiyan, a partner at Tiantu Capital, a private-equity firm known for its consumer-related investments, says he is surprised by how freely his younger colleagues spend. "Sometimes I worry if we pay them enough to support their lifestyle," he jokes. "Other times I wonder if we overpay them."

His firm led a 400 million yuan funding round in September 2015 in Baiguoyuan, which produces and sells fruit in over 1,200 stores around China. Its investment in the packaged-duck-meat company Zhouheiya Food, which went public in Hong Kong this year, is often cited as a successful example of investing in nontech companies in the internet era.

Zeng Xi, a 27-year-old product manager at a smartphone maker in the southern city Shenzhen, says he made several trips to Heekcaa outlets outside Shenzhen before the chain opened in Shenzhen, drawn by its hip décor and innovative drinks. "Heekcaa meets a uniquely Chinese demand," he says.

--Follow Li Yuan on Twitter @LiYuan6 or write to li.yuan@wsj.com.

Write to Li Yuan at li.yuan@wsj.com

(END) Dow Jones Newswires

November 03, 2016 02:48 ET (06:48 GMT)

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