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A Private Equity investor managing more than RMB 35 billion invested into 90 projects and only lost money on 1! What is his investment secret?



A Private Equity investor managing more than RMB 35 billion invested into 90 projects and only lost

Zhang Wei, Chairman of Co-Stone Capital


Author: Su Longfei

Source: New Fortune (WeChat ID: newfortune)

Original title: Confucian PE - The People-Oriented Principles of Co-Stone Capital


Assets under management of RMB 35 billion; of the 90 invested projects, only 1 resulted in a capital loss; 52 projects achieved exit or liquidity, among which 25 ones were IPO exits, representing a high exit percentage of 48.1%; a total principal of RMB 1.905 billion brought in a total return of RMB 16.05 billion, representing a return of 8.43 times. It's hard to imagine that Co-Stone Capital, which does not follow hot trends and compete for hot projects, could have achieved such amazing investment results, even surpassing globally recognized PE funds.


What lies behind this is the service centric, focused investment methodology developed by Co-Stone Capital over its 15 year history which is tailored for the Chinese market. Co-Stone Capital averages 5-6 investments per year, and the average amount invested in individual projects is approximately RMB 100 million, with 70% of projects in excess of RMB 50 million. Compared with other PEs of an equivalent scale, Co-Stone Capital has relatively fewer investments despite their courageous investment. The focused investment strategy is characterized by a small number of projects and high individual investment amounts, which means that project selection must be subject to strict criteria. For this reason, Co-Stone Capital emphasizes and evaluates both the growth potential of enterprises and the entrepreneurship of their founders.


Even for carefully selected projects, a prudent decision must be made to determine whether to make investment. In order to prevent the decision-making process from becoming a mere formality, in addition to the conventional risk control system, Co-Stone Capital designed two additional mechanisms. First, the partners make high-ratio co-investment in the fund as LPs, and second, an investment review committee mechanism where each partner has only one vote, even the Chairman. This aligns the interests between the GP and LPs, and prevents the project leader from railroading pet projects through.


Under this focused investment strategy, effective post-investment management is necessary to realize the expected growth for portfolios. For Co-Stone Capital, this means focusing on value-adding services. As with traditional portfolio management, Co-Stone evaluates the project progress and controls risks via periodic visits and reviews. In addition to this, however, Co-Stone Capital also provides their portfolio companies with value-added services such as strategy development, corporate governance optimization, M&A and other advisory services through their in-house professional competence and resource integration capabilities. Meanwhile, based on its network of industrial resources built over the years, Co-Stone Capital is also able to assist portfolio companies as they expand up and down the industry value chain.


This systematic approach enables Co-Stone Capital to achieve a high rate of success for invested projects, building a unique image within the domestic PE market which other funds are seeking to replicate. When Co-Stone Capital invests, whether in DD and transaction structuring or in considering management earn-outs and incentives, attention to the human factor is always a high priority. Given that private equity investment is becoming increasingly intensive, the investment style of Co-Stone Capital, planted firmly in the economic and capital market environment of China, has immeasurable value for this industry.


What do the following companies have in common: OPPLE Lighting (603515), Dezhan Healthcare (000813), Omnijoi (300528), Asymchem (002821), Kexin Technologies (300565), Silkroad Vision (300556), and Kersen Science & Technology (603626)?


The answer is Co-Stone Capital. All seven of these companies which listed or passed CSRC review in 2016 were portfolio companies of the same fund managed by Shenzhen Co-Stone Assets Management Co., Ltd. ("Co-Stone Capital") - Everest Co-Stone. As a result, Lin Ling and Chen Yanli, Managing Partners of Co-Stone Capital, may very well be the GPs who most frequently attended the bell ringing ceremony in the Listing Hall on the 8th floor of Shenzhen Stock Exchange in 2016.


Despite their outstanding investment performance, Co-Stone Capital is not well known to people in or outside the PE industry. This low-profile PE institution has been operating under the radar for 15 years, and with assets under management exceed RMB 35 billion, it is one of the largest players in the Chinese PE industry.


In the current PE fervor in China, other PE players are touting their star projects; however, in bidding for those projects Co-Stone Capital is nowhere to be seen. They have never appeared on the sites of many hot projects, including JD.com, LeTV, Didi, BGI, etc. The partners of Co-Stone Capital all hold the same opinion about this: "not interested"


Zhang Wei, Chairman of Co-Stone Capital explained that: "From the perspective of making returns, I don't need to invest in such high-profile enterprises. Those are ladies from noble families, requiring high prices matching their status. I prefer girls of a more humble birth and help them to improve their value and status thus creating real value. In reality, we often end up with the higher returns."


Co-Stone Capital’s numbers back up Zhang Wei’s statement.


A Failure Rate of Only 1% after 15 Years


PE funds are measured with three key indicators: the assets under management, the number of IPO exits, and the return multiple. How does Co-Stone Capital compare in these respects?


According to public information, from the first fund managed by Zhang Wei's team in 2000 to the present, Co-Stone Capital has managed a total of over 40 funds ranging across VC/PE investments, M&A funds, private placement funds, etc. The aggregate assets under management comes to approximately RMB 35 billion, of which about 20 equity investment funds account for approximately RMB 25 billion (Table 1).


Table 1: Details of equity investment funds under the management of Co-Stone Capital






Contribution (RMB ,000 m)

Paid-in capital (RMB ,000 m)



Huizhong Co=Stone Fund





Apr. 2004


Huashang Co-Stone Fund







Shenzhen Co-Stone Fund







Wuhu Co-Stone Fund


Liquidation Stage



Dec. 2009


Everest Co-Stone Fund


Liquidation Stage



Jul. 2011


CEIBS Co-Stone Fund


Liquidation Stage



Aug. 2011


Ocean Co-Stone Fund


Liquidation Stage



Sep. 2011


Lake Lithium Investment Special Fund


Liquidation Stage



Jan. 2012


Linghang Co-Stone Fund


Liquidation Stage



Sep. 2012


Qixinshi Film Fund


Liquidation Stage



Sep. 2013


Pioneer Co-Stone Equity Fund


Investment Stage



Jul. 2014


Lingkang Biology & Medicine Fund


Investment Stage



Jan. 2015


Co-Stone New Third Board Fund

Asset Management Plan

Investment Stage



Jun. 2015




Investment Stage



Oct. 2015


Xiansheng Investment Special Fund


Liquidation Stage



Dec. 2015


Xcar Investment Special Fund


Liquidation Stage



Dec. 2015


Jinhuayanghang Equity Investment Fund


Investment Stage



Jan. 2016


Anhui Industry Upgrade Fund


Investment Stage



Feb. 2016


Lingyu Co-Stone Fund


Investment Stage



Dec. 2016





Note: Data from Co-Stone Capital, bold font represents primary funds.


From the perspective of assets under management, Co-Stone Capital is second only to Shenzhen Capital Group within Shenzhen, key private equity hub. Compared to nearly 20 PE institutions listed on the New Third Board, the assets under management of Co-Stone Capital is only surpassed by Jiuding Investment and China Science & Merchants Investment Management Group (CSC).


As of today, Co-Stone Capital has invested in a total of 90 projects, and achieved exit/liquidity events in 52, including 17 companies listed via IPO, 5 companies listed via back-door listing or restructuring, 12 companies listed on the New Third Board, 3 share swap transactions, and the remaining 15 companies through trade sales (Figure 1).


Figure 1: Co-Stone Capital exit/liquidity events


A Private Equity investor managing more than RMB 35 billion invested into 90 projects and only lost

Looking only at IPO, back-door listing/restructuring, and private placement transactions, 25 companies were listed (or merged into a listed company), representing an aggregate listing ratio of 27.8%. In other words, one of every four invested projects was able to get listed. Excluding those listed on the New Third Board, 40 companies achieved exit, representing an exit ratio of 44.4%.


Compared with PE institutions listed on the New Third Board, Co-Stone Capital is ranked at the top in both the listing rate and the project exit rate (Figure 2).


Figure 2: Exit rate and listing rate of PE institutions

A Private Equity investor managing more than RMB 35 billion invested into 90 projects and only lost


New Fortune collected the data disclosed in the equity exchange prospectuses of five of the top PE firms including Jiuding Investment, CSC, Heaven-Sent Capital, Cowin Capital, and Legend Capital to investigate the number of projects that they exited via different channels.


As of the date of the prospectuses, these five PE firms exited from a total of 130 projects, of which 43 were IPO exits, representing an average listing rate of 33%. As for Co-Stone Capital, among the 52 exited projects, 25 were IPO exits, representing a high percentage of 48.1% significantly higher than the average level of the other five top PE firms.


Furthermore, among the 130 exited projects of the other five PE firms, at least 48 projects were buyback exits, accounting for 37%, and 26 projects were trade sale exits, accounting for 20%, resulting in a total of 57% in buyback and trade sale exits. Among the 52 exit projects of Co-Stone Capital, a total of 15 projects were buyback and trade sale exits, representing only 28.85%, which is even lower than the single ratio of buyback exits for the other five PE firms.


Generally speaking, the best investment returns come from IPO exits, followed by M&A/trade sale exits, while buyback exits generate the lowest returns. Co-Stone Capital exited projects via IPO at a ratio much higher and via buyback at a ratio much lower than other PE firms, indicating that the investment returns from exited projects would be much higher than other PE firms.


Based on the six funds currently in the liquidation stage at Co-Stone Capital, the internal rate of return is between 17% and 70% (Table 2). As of today, the total returned capital of RMB 16.05 billion corresponds to returned principal of RMB 1.905 billion, resulting in an overall return of 8.43 times, which is much higher than other PE firmss listed on the New Third Board (Figure 3).


Table 2: Overall rate of return from funds in the exit period of Co-Stone Capital


Launch time

Amount (RMB ,000 m)


Huizhong Co-Stone Fund

Apr. 2004



Huashang Co-Stone




Shenzhen Co-Stone Fund




Wuhu Co-Stone

Dec. 2009



Everest Co-Stone

Jul. 2011


In liquidation period (45% expected return)

Source: Co-Stone Capital


Figure 3: Assets under management and exit amounts of top PE firms

A Private Equity investor managing more than RMB 35 billion invested into 90 projects and only lost


It is worth mentioning that, among the 90 projects invested by Co-Stone Capital, Sunward Intelligent (002097) and Everyday Network (300295) achieved returns of over 100 times, and many other projects achieed returns of over 10 times, including Huitian New Material (300041), New Hope Liuhe (000876), Huazhong Numerical Control (300161), Leking Wellness (300247), Silkroad Vision, Kexin Technologies, Asymchem, and others.


In 2002, Co-Stone Capital invested RMB 15 million in Zhuzhou Cemented Carbide Cutting Tool Co. Ltd.; by 2010 when they exited via buyback, they got back RMB 123 million in cash, producing a high return of 8.2 times. Wang Qiwen, the person in charge of this project and Managing Partner of Co-Stone Capital, said: "this may be the project with the highest non-IPO returns among our projects so far."


Of all the projects invested by Co-Stone Capital so far, although there are several projects from which it recovered only the principal upon exit, it is incredible that Co-Stone Capital has suffered a loss of principal in only one project - Xuchang Hengyuan. This is a wig manufacturer located in Xuchang, the largest domestic hair product base, and for a while kept pace with Rebecca (600439) which is the industry leader. However, after failed IPO attempts in 2011 and 2014, it is in currently undergoing reorganization and bankruptcy proceedings. 27 investment funds had positions in the company.


Only one of the 90 invested projects suffered a true failure, resulting in a failure rate of only 1.1%; and a total return of RMB 1.905 billion in principal generated a high income of RMB 16.05 billion, producing an overall return over 8 times. What is the investment methodology behind such a high success rate? How does Co-Stone Capital implement this methodology?



Focused Investment


With a total of 90 projects invested from 2000 to the present, Co-Stone Capital has invested in only an average of 5-6 projects every year. This is considered to be quite low relative to other PE firms in the industry. PE firms established later and of a similar scale, such as Fortune Capital, CSC, and Jiuding Investment, have invested in projects at a rate 2-3 times that of Co-Stone Capital (Table 3).


Table 3: Comparison between assets under management and total number of investments by selected PE firms

Name of PE

Assets under management (RMB ,000 m)

Number of investments

Co-Stone Capital




274 (607 subscribed )


Jiuding Investment

214 (310 subscribed )


Fortune Capital



Cowin Capital



Heaven-Sent Capital


Note: The data is collected from public information; the data of CSC, Jiuding Investment, Cowin Capital, and Heaven-Sent Capital is as of the date of their respective prospectuses


A small number of investments combined with high assets under management allows for a large investment amount for individual projects. Tao Tao, Managing Partner of Co-Stone Capital, once made a calculation in 2012: "We compared the average investment amount for individual projects made by several large-scale PE firms with that of Co-Stone Capital. At that time, Co-Stone Capital would invest an average of RMB 40 million in individual projects, while other PE firms launched at the same time as us invested about RMB 10 million on average." Four years later, in 2016, the average investment amount on individual projects made by Co-Stone Capital increased to RMB 100 million, and the investment amounts in 70% of projects exceed RMB 50 million.


From this perspective, the invest strategy of Co-Stone Capital may be summarized as focused investment.


In the secondary market, focused investment and diversified investment are two lasting strategies with their own characteristics and proponents, with Warren Buffett advocating the former and Peter Lynch backing the latter. However, in the primary market, especially considering all of the opportunities of the China market, only a few PE firms truly embrace the idea of and practice focused investment.


Many PE firms tout the number of star projects in which they participate. Even over the last two years, despite many leading PE firms shifting toward a more narrow industrial focus, they normally diversify within their selected industries. Many of these funds invest in early stage projects, thus demonstrating VC-like attributes, and are even more unlikely to put all their eggs in a few baskets. One of the primary reasons is the limited amount of financing needed for early-stage projects, and because too much capital investment would dilute the shares held by the founding team, and therefore would not generally be accepted by most founders.


So why does Co-Stone Capital choose concentrated focused investment strategy instead of following the crowd? This can be traced back to when the team members of Co-Stone Capital first started their careers in the PE industry.


Investment rationale stemming from the domestic environment


In 1999, after observing the high valuations of dot-com shares listed on the NASDAQ, China floated the idea of launching a growth enterprise market (GEM) board. To do this, local governments selected from among a large number of candidate enterprises seeking to list on the GEM board, and to support those efforts, many venture capital institutions were established. For example, Shenzhen Capital Group, which is currently a well-known PE firm, was established by Shenzhen government during that period with a capital contribution of only RMB 700 million.


with this background, successful investment banker Zhang Wei, together with his fellows Chen Yanli, Wang Qiwen, and Lin Ling, successively entered the PE industry around 2001. The partner team of Co-Stone Capital later expanded to include, Tao Tao, Han Zaiwu, and Xu Wei, who also come from investment banks, together making up the current 7 Managing Partners of Co-Stone Capital.


PE firms and investment banks have significant business overlap by their very nature and PE investors commonly come from investment banks. Furthermore, direct investment by securities brokerages, which is currently a booming business in China, also started at a relatively early time. In 1995, China International Capital Corporation Limited (CICC), with Morgan Stanley backing, set up a direct investment department, thus becoming the first brokerage in China to take a page from overseas investment banks institutionalize the "direct investment + sponsorship” model. Wu Shangzhi was the general manager of CICC direct investment department when, in July 2001, the CICC Board of Directors decided to split the direct investment department. Following the split, Wu Shangzhi and his team left CICC and started their own business by establishing CDH Investments.


The academic studies and professional experiences of investors normally have a profound impact on their investment methodologies. Zhang Wei's team is no exception: their background in investment banking also result in a unique investment bank perspective for their investments.


Prior to the approval system of the Securities Law promulgated in 1998, the A-share market operated on a quota system, in which a local government official or industry regulator would recommend select companies for IPO based on the respective quota. This system is heavily characteristic of planned economies has long been criticized for its many disadvantages.


Zhang Wei, who entered the investment banking industry in the era of the approval system, made two key observations during this period. The first is how precious a high-quality company may be. "More than 10 years ago, there were actually only a few high-quality enterprises because the overall size of the economy in China was still quite small and the IPO quota system resulted in a large number of bad enterprises getting listed. As such, we realized that there were not many high-quality enterprises, hence we must be prudent in making investments."


The second is that, equity investment is a long-distance race: "China's capital market has been a policy-driven market for a long period of time, but the policies change frequently. Furthermore, from the second half of 2001, the market went through a 5-year bear market, and the IPO market was suspended nine times during this period. Therefore, a sprint mentality is incompatible with equity investments. Instead, we must help enterprises solve their problems which arise over the course of development with a focus on growing with the enterprises for an extended period of time."


Based on these two observations, Zhang Wei's team gradually formed the idea of focused investment. In the “Socialism with Chinese Characteristics” economy, only a few select outstanding enterprises can outrun the variable policy market to achieve stable profitability despite the economic shifts and market cycles. "From a long-term perspective, the most important thing is to find an outstanding enterprise. An outstanding enterprise with sufficient growth potential can withstand uncertainties in the capital market. As such, we bore this idea in mind as we looked for the most outstanding enterprises, and we attached high priority to their growth potential."


With this idea, Zhang Wei's team started to search for high-quality, high-growth enterprises throughout China, and found many subject enterprises such as Shandong Liuhe, Huitian New Material, Sunward Intelligent, Huazhong Numerical Control, Zhuzhou Cemented Carbide Cutting Tool, and others. With the assets under management of nearly RMB 200 million at that time, they invested RMB 67 million in Shandong Liuhe and RMB 24.1 million in Huitian New Material. Almost a half of their available capital was invested in only two projects. In the end, this strategy was validated as most of these projects achieved high returns: Sunward Intelligent achieved returns over 100 times, while Huazhong Numerical Control, Huitian New Material, and Shandong Liuhe achieved returns of 10 to 30 times.


The high returns further cemented concept of focused investment in the minds of Zhang Wei's team. The project that left the deepest impact on them is the first project they exited from - Sunward Intelligent.


In 2004, after completing the due diligence investigation and valuation negotiation, Zhang Wei's team invited Li Zhida to participate in the investment. Li was the founder of the skincare brand Mininurse, and with a large amount of cash on hand from the sale of his brand to the international daily chemicals manufacturer L'Oréal, he was also in need of investment opportunities. However, Li required Zhang Wei to also put some skin in the game. "Will you put money in? If you put your money in, I will do the same."


Under this challenge, Zhang Wei gathered the bulk of his wealth at that time, and together with Li Zhida's funds, invested a total of RMB 36.4 million in Sunward Intelligent. Fortunately, Sunward Intelligent listed on the SME board in 2006, and the expiry of the share lock-up period in 2007 coincided with an unprecedented bull market of the A-share market in which the share index reached 6124. Their shareholding produced returns over 100 times, and Zhang Wei himself also achieved financial independence through this investment. However, he admitted: "The return derived from our investment abilities was 10 times at the most. The remaining returns were an extra bonus given by the great bull market in A-shares at the time."


This 100-time return from the first exit project was a milestone for Zhang Wei's team. "This enhanced our faith in this industry, enabling us to make bold investments." Chen Yanli, who participated in the due diligence on Sunward Intelligent, recalled that: "People can understand 100-times returns in the Internet industry. This 100-times return in the engineering machinery industry changed our investment concept. Therefore, we insist on not searching for the hottest or trendiest projects all the time. China has space for many industries as it has a different development path and is in a different development stage from international markets.”  From that moment, Zhang Wei's team fomented their strategy of not pursuing hot markets and not following popular trends, and insisting on leading investments rather than co-investing.


Early in their investment careers, Zhang Wei's operated through a contract fund model of searching for projects prior to calling capital, as they could earn a certain percentage of the returns by recommending projects to investors. Huashang Media, Everyday Network, Motie Books, Metropolis Media, Eagle Ceramics, Geeya Technology, Zhongli Science and Technology, and Yuandong Drive Shaft are among the projects invested under that model.


Huashang Media was successfully merged into Huawen Media (000793) in 2007, and became an important partner with Zhang Wei's team. Together with Huashang Media, Zhang Wei's team invested in many projects including Everyday Network, Metropolis Media, and Motie Books. It also demonstrates a key characteristic of the LPs of Co-Stone Capital, where the invested projects or their founders invest back into the fund as LPs. Investees such as Huashang Media and founders such as Hu Guanghui from Everyday Network all become LPs of Co-Stone Capital funds.


In accordance with the Partnership Enterprise Law that went into effect from June 1, 2007, domestic PEs could establish limited partnerships according to international practices. This resulted in the establishment of a large number of privately owned PE firms. On June 26, Cowin Capital sponsored the first domestic limited partnership PE firm - Shenzhen Nanhai Growth Capital Limited Partnership. After that, many successful PE firms were established. The state-owned PE fund - China Investment Corporation - was also established in September of that year.


In August of that year, Co-Stone Capital was formally established, with shares held by five (later increased to seven) shareholding managing partners including Zhang Wei. The PE business of Co-Stone Capital entered a new stage, in which its idea of focused investment has been continued and improved.


Project selection: judging the growth potential and valuation of enterprises


Highly focused investment can achieve far above average returns; however, such an arrangement also means there is little margin for error when making investments. Co-Stone Capital must select truly outstanding, high-growth enterprises and devote every effort to closely follow the project. Effective post-investment management and value-added services significantly increase the likelihood of a high success rate, a low failure rate, and high rates of return.


The top priority is how to ensure selected companies are outstanding, high-growth enterprises?


Many people tend to consider PE investment as an abstract art, where subject selection is a based primarily on the intuition stemming from the GP’s rich professional experiences. Co-Stone Capital considers investment decision-making as a complex judgment process, the core of which is to accurately determine the growth potential and proper valuation of potential projects. High growth potential is an essential condition for a successful investment, while proper valuation is a key driver for realizing excess returns. All investment decisions are ultimately a factor of these two considerations. The core ability of institutional investors is to decide the growth potential and the proper valuation of potential projects.


Zhang Wei explained that: "50% of investment decision-making is to determine the growth potential of a given enterprise, that is, to comprehensively assess all the various factors impacting that enterprise - from the industry trends, the industrial competition, and the competitive advantages of the enterprise, to its organizational system and entrepreneurship. The other 50% is to make a judgment on the valuation. At which price are you going to make investment, and in what kind of market can you cash out the investment? Do you expect to exit via independent IPO, share swap into a listed company reverse list through a back-door listing or through a trade sale? All these factors influence the valuation which then influences the investment decision."


In the opinion of Co-Stone Capital, the growth potential must be robust enough to withstand economic cycles and have a demonstrated ability to generate strong cash flow. Short term growth driven by economic cycles, investment driven growth dependent on continuous investment or growth predominantly derived inorganically do not meet this threshold. Among the factors determining the growth potential of enterprises, the most important factor is the stage of the industrial cycle, followed closely by the entrepreneurship of the management team.


A significant decision-making factor is to identify the beginning and the end of industrial cycles. It's hard to achieve high returns on investment made at the end of an industrial cycle. Therefore, it is important to identify the pattern of industrial changes and the course of economic development, targeting investments in outstanding enterprises in emerging industries.


In addition, unlike many investment institutions, Co-Stone Capital attaches high priority to the organizational system and entrepreneurship of an enterprise. "When making investments, many people primarily consider the financial statements and the industry’s competitive environment. Co-Stone Capital does not consider the financial figures only, which are merely a presentation of the results produced by the organizational system and entrepreneurship of an enterprise."


As with growth potential, determining the valuation of an enterprise is also subject to a series of factors. Valuation means more than simply applying a valuation theory and plugging it into a model. It requires dynamic and comprehensive considerations. Co-Stone Capital considers that the valuation of an enterprise is jointly decided by three primary factors, namely the stage of the industrial cycle, the quality of the enterprise, and the state of the capital markets. For example, when looking at the industrial cycle, artificial intelligence and TMT have totally different valuation characteristics from the steel or coal industry. In comparing the quality of an enterprise, although Huawei and ZTE have roughly the same scale, their valuation would be obviously different. With regard to the capital market, the difference in the venue and the method of getting listed may result in a huge difference in valuation. Taking venue as an example, the valuation of a similar company listed the A-share market, the NASDAQ, and the Hong Kong Stock Exchange would vary significantly. From a global perspective, most shares on the A-share market have a relatively high valuation, which is a factor of the composition of investors, the regulatory environment, and the liquidity. On the GEM board featuring the highest liquidity in the A-share market, the annual turnover rate may reach 12 times, and the turnover rate on the main board reaches 8-9 times for most years. The turnover rate on the Hong Kong stock market is less than 1 times, and the US stock exchanges are between 1.5 to 2 times. As for the method of getting listed, the return of an independent IPO on the A-share market may be as much as 10 times, while the return of getting listed through a share swap is only about 3 times, and the return from a buyout by the majority shareholder is usually less than 1 times.


Co-Stone Capital has settled on an investment methodology that is relatively mature by now. However, like any successful equity investment institution, this is a result of experience and lessons learned.


Two major events occurred in 2001 when Zhang Wei's team first entered the PE industry. One is the dot-com collapse on the NASDAQ when many dot-com startups fell from the top and more were thrown into bankruptcy. The other is the accession of China into the WTO, which launched the economic miracle of industrialization and urbanization. Because of this, among the projects looked at by Zhang Wei's team in the beginning, with the exception of a few Internet-related companies such as Everyday Network, most of the projects were enterprises which had acquired unique competitive advantages through technology innovation and market segmentation in the conventional industries. According to Zhang Wei, "because the scale of the overall market is large enough, given the various operating environments of the emerging market, even conventional industries are full of opportunities in China." Examples of this include Shandong Liuhe and Sunward Intelligent.


The three founders of Shandong Liuhe, Zhang Tangzhi, Zhang Xiaocheng, and Huang Bingliang are classmates in the class of 1978 at Qingdao Agricultural University (formerly Laiyang Agricultural College) majoring in animal husbandry.  Upon graduation, Zhang Tangzhi was assigned to a government department, while the others were retained to teach at their alma mater. In 1992, Zhang Tangzhi ventured into business and launched Liuhe Group. One year later, Zhang Xiaocheng and Huang Bingliang resigned from the university and joined the startup.



Peng Jianfeng, an old friend of Zhang Wei, completed a consulting project for the Liuhe shareholders and made an introduction. In May 2003, Zhang Wei and Chen Yanli went to the headquarters of Liuhe located in Qingdao, Shandong Province to take a look. "It was during the SARS pandemic. After arriving in Qingdao, we were not allowed to stay in any of the hotels because we hold Guangdong identity certificates, and Guangdong at that time was a severely afflicted area." Chen Yanli still remembered the experience vividly.


In the feed industry at the time, the leading manufacturers were Chia Tai Group owned by the Xie Guomin family and the Hope Group owned by the Liu Yonghao family. Their business model was to distribute feeds through a complex series of wholesale dealers. The sales prices were high and the gross margins were around 30%.


Shandong Liuhe took advantage of Shandong as an agricultural province with a relatively high population density, and established concentrated distribution points in each county within Shandong by renting feed factories owned by local grain administrations, enabling them to sell directly to end farmers. This eliminated intermediate distributers, reduced logistics costs, and reduced prices. Meanwhile, Shandong Liuhe launched a "service marketing" strategy to provide free training seminars on large scale husbandry techniques. It recruited a large number of university students majoring in agriculture and animal husbandry to visit farmers at their home and help them to raise animals in a more scientific way. "Farmers only needed their own labor, livestock and some land. Liuhe taught seed selection for plant breeding, epidemic prevention, and composting methods. " said Chen Yanli.


The combination of concentrated distribution points and the service marketing resulted in rapid growth. Farmers were followed up by specially designated people, who maintained detailed archives of each farmers needs and feed factories kept in direct contact with farmers, which allowed Liuhe to produce product accurately based on the purchase frequency of customers, thereby managing the inventory of raw materials and finished products. This customer follow-up and production scheduling enabled Shandong Liuhe's inventory turnover rate - the most important indicator measuring the turnover speed - to reach an amazing 100 times. In other words, its inventory was circulating once every 3-4 days.


In addition, with regard to cash management, Shandong Liuhe settled accounts with downstream farmers in cash, and a certain settlement period was available forthe upstream grain trade administrations. As a result, Shandong Liuhe had strong cash flows and did not need to borrow from banks because of its interest-free financing from suppliers.


Therefore, although its gross margin was only 4%-5% because of the interest concessions it made to farmers, the superior turnover rate and the large amount of interest-free borrowings allowed Shandong Liuhe to reach a steady return on equity of 30%-40%, which was much higher than the industry norms. The rapid inventory turnover allowed it to reduce prices and make concessions to farmers, and rapidly secured market share from competitors. At its peak, Shandong Liuhe's market share in Shandong was five times that of New Hope, hence it became a model for China's new generation of agricultural and livestock companies which was ultimately followed by the rest of the industry.


"We did not know the agriculture industry at that time, but according to the financial data, I found that they had very strong operation capability and very high efficiency!" said Chen Yanli. When undertaking due diligence, financial indicators are very important items to be considered. As an investor with an investment banking background, Chen Yanli was more sensitive to the information contained therein. "What we considered was the competitive advantages of this company when we made the investment." In the end, Zhang Wei's team decided to invest RMB 67 million to purchase shares from all three founders, thus becoming one of four shareholders holding a 26.5% stake.


Sunward Intelligent located in Changsha was a similar story. Although Sunward Intelligent struggled for survival under the fierce competition from SANY Heavy Industry and Zoomlion Heavy Industry, Zhang Wei's team looked at its unique technical innovation in static pile drivers on one hand, and from the perspective of industrial cycle, looked at the development prospects for the engineering machinery industry and its role in the urbanization of China on the other hand.


During selection process, Zhang Wei especially emphasizes entrepreneurship. According to Zhang Wei, investors need to assess enterprises based on the value chain of their customers, but also need to understand the enterprises from the two perspectives of entrepreneurship and organizational structure. "Without the continuous drive derived from the entrepreneurship, an enterprise cannot succeed; and without a mature organizational system, the enterprise cannot expand."


This factor is not missing in the investment in Shandong Liuhe. "(Shandong Liuhe) was not a technology play. It developed because of its operational and management philosophy. For example, they were willing to provide long-term free trainings to farming households at high costs to themselves. Moreover, they would reduce prices as long as it was profitable. Although increasing market share was a driver, they also considered other concessions to farming households." Zhang Wei believed that the three founders of Shandong Liuhe, Zhang Tangzhi, Zhang Xiaocheng, and Huang Bingliang were dedicated to making contributions to the development of this industry.


For building the the organizational system, Zhang Tangzhi also had a long-term vision of his ultimate objective. In about 2000, at its own cost, Shandong Liuhe sent almost all of their middle and upper management staff to business school to get MBAs, and consistently sent people to study in Singapore. Moreover, in order to improve the management of the firm, they launched an Enterprise Resource Planning (ERP) management system while other agricultural and livestock enterprises were still using traditional management methods. "At that time, this vision was uncommon even among the larger enterprises in China."


"This kind of company particularly catches my attention. I think they have lofty ideals and a clear vision, and I highly praise executives like this." Zhang Wei saw entrepreneurship principles in Zhang Tangzhi, specifically, his pursuit of building up a long-term business instead of seeking profits only, which reflects the ideas of Drucker of whom Zhang Wei is a fan. "In the words of Drucker, profits are not your objective, they are a result."


After the investment in Shandong Liuhe, one of Zhang Wei's old friends talked with Liu Yongxing, President of East Hope, about making an investment in the feed industry; Liu said: "This industry is not interesting, not profitable." Therefore, East Hope Group that he established after being carved out from the Hope Group has gradually shifted from the feed industry to the heavy chemical industry such as cement and electrolytic aluminum.


"We felt immense pressure when we heard such a statement. However, we trusted in our own judgment." said Chen Yanli. time proved their judgment correct that the feed industry was in an integration cycle, and a company with an advantageous business model still had growth potential. In 2003 when the investment was made, Shandong Liuhe's revenue was RMB 1.4 billion; by 2011, its revenue had rocketed to RMB 60 billion.


It was unfortunate that because the IPO market was suspended several times, the IPO plan for Shandong Liuhe ultimately failed. Later, with the help and coordination of Zhang Wei, Shandong Liuhe was restructured and listed via stock-for-stock acquisition by New Hope. Even so, Co-Stone Capital's initial investment of RMB 67 million was over RMB 2 billion at exit, producing a return of over 30 times. If Shandong Liuhe was able to successfully IPO on their own, the return would very likely have been even higher.


By considering the industrial cycle and entrepreneurship as key investment criteria, Co-Stone was able to realized returns of over 10 times. However, an accurate understanding of the industrial cycle must be based on in-depth insight into the industry and the macro economy. In particular, the economic transformation of the Chinese market, the explosive growth of the digital economy and new models driven by technological progress have much higher professional requirements than ever.


In 2009, the first year of the GEM board, Co-Stone Capital launched its first limited partnership fund - Wuhu Co-Stone, which raised RMB 400 million and was intended for growth enterprises, particularly "Pre-IPO" projects. This fund maintained the previous investment focus of Co-Stone Capital - other than one M&E company and one pharmacy, all other projects were from the manufacturing industry, including as Tonly Heavy Industries, Kaiyuan Instruments, Huachangda, Jiafa Chemicals, Western Heavy Industry, Kangxin New Material, and others. The average investment amount for individual projects was RMB 40-50 million.


However, while reviewing the investments made under Wuhu Co-Stone, Co-Stone Capital discovered in 2011 that the manufacturing industry experienced an obvious decline on the back of overcapacity. According to the calculations made by Co-Stone Capital at the time, the weighted return on equity in 2010 (net profit calculated based on the shareholding ratio) of enterprises invested by Wuhu Co-Stone increased by 58% compared with the previous year; however, the year-on-year growth rate declined to 36% in 2011, meaning a substantial slow-down of the growth rate. After carefully analyzing individual portfolio companies, the management of Co-Stone Capital realized that, despite the 4-trillion stimulus program, the conventional economic growth trend was slowing.


Tonly Heavy Industries and Kaiyuan Instruments were particularly demonstrative of this trend. Lin Ling, Managing Partner and Vice President of Co-Stone Capital, described that: "Tonly Heavy Industries manufactures vehicles for mining mainly intended for the coal industry. The company grew very rapidly in the beginning. When Co-Stone Capital made the investment, their profit was RMB 20-30 million, but by 2010 when the IPO application was made, their profit had grown to almost RMB 100 million. Unfortunately, the IPO application was rejected. They tried to IPO the following year but from 2012, the performance of the company started to deteriorate due to a steep decline in the coal prices. Because their business closely tracked the overall performance of the coal industry, they were not able to get another review from the CSRC. The company is now listed on the New Third Board."


"Kaiyuan Instruments was comparatively fortunate," said Wang Qiwen, "Kaiyuan Instruments manufactures instruments for testing coal quality. When coal prices were high, such instruments were sold very well.  However, when the coal prices dropped, the customers become very sensitive to the costs of purchasing such equipment. It was fortunate that this enterprise was able to get listed early through an IPO in 2012. However, their profit last year was only several million. We exited soon after the IPO."


When looking back on the original intentions of investing in such projects, Tao Tao said, "it was partially because advanced manufacturing can be easily analyzed, and the core competitiveness can be easily understood. However, this also exposed the problem of our deficiency in industry research."


With this awareness, Co-Stone Capital initiated some changes. In order to "identify industrial investment opportunities under the structural transformation of China's economy," they shifted from extensive research in industrials toward careful selection of key industries and focused their investment research.



First, the regional focus of the investment teams were reorganized based on industry to establish six industry teamsconsumer products, TMT, pharmaceuticals and healthcare, agricultural industrialization, clean-tech, and new materials; meanwhile, they gradually withdrew from the manufacturing industry.


After further review, they eventually disbanded the agricultural, clean-tech, and new materials teams, retaining only consumer products, TMT, and pharmaceuticals and healthcare. "We stopped looking at the agricultural sector after we failed to find a suitable investment target, even after evaluating almost 100 opportunities. Another important reason was that it's hard to authenticate the performance of agricultural projects. We dropped the new materials research due to the highly differentiated products and highly technical nature of each. We found several people with professional backgrounds at that time, but no accurate assessment could be made for products with even a minimal difference from the professionals’ expertise. The environment protection research was dropped because most of the businesses in that sector were highly dependent upon government relationships and grants. We didn’t think this represented a core competitiveness of a company, and it is hard to replicate." said Tao Tao.


Second, in connection with the establishment of the industry teams, the org structure of the teams was filled out so that each project team was fully staffed with an MD/ED, investment manager, and industry researchers. High-level talent was recruited mainly for the MD and ED positions. "Because the initial team members of Co-Stone Capital all came from investment banking, financial, or management background, under the new structure, a lack of professional technical background would be unworkable." Therefore, Co-Stone Capital hired many technical professionals such as Li Xiaohong and Ye Qiwei. In addition to the seven existing managing partners, Co-Stone Capital brought in a business partner, Li Ying from Oriza Holdings, a stated-owned PE in Suzhou.


On the back of this organizational transformation, Co-Stone Capital launched a new fund in 2011 - Everest Co-Stone, and outside of a few manufacturing projects, the fund invested in a greatly increased number of projects in the fields of consumables, TMT, and health care, such as Soling Industrial (a company making vehicle audio-video and navigation systems), Silkroad Vision (a digital 3D rendering service company), Omnijoi (a film and TV program production company), Asymchem and Sunho Pharmaceutical (Pharmaceutical R&D and CMO companies), OPPLE Lighting (the largest domestic consumer lighting company), and Tongfu Food. The RMB 1.418 billion Everest Co-Stone fund invested in a total of 19 projects, with an average of RMB 75 million invested per projects. Tao Tao said: "Everest Co-Stone has a totally different portfolio profile compared with Wuhu Co-Stone. If you show these two funds to other PEs, they will certainly consider that the investments of the two funds were made by different GPs. What happened between the launching of these 2 funds? The answer is clear that the partners of Co-Stone Capital are constantly learning and proactively adapting to new environments and market conditions."



After a company has been selected for investment, the next considerations are the investment amount and the shareholding ratio. Under the strategy of concentrated investment, Co-Stone Capital normally requires a seat on the board of directors to be able to express their opinions on corporate affairs. In January 2014, they invested RMB 54.9 million in Original Force representing a 32.43% stake, exceeding the management shareholding and becoming the largest shareholder.


In order to offer incentives to the management and to meet the requirements for getting listed, Co-Stone Capital later transferred part of their equity interest to the founder Zhao Rui, through which Zhao became the largest shareholder again. Then, with the investment from Tencent and LeTV, Co-Stone Capital cashed out a small portion of their stake. As of right now, Co-Stone Capital still is the second largest shareholder with a 17.33% stake.


Recalling this investment, Lin Ling stated that the investment was made mainly based on the following considerations: "There was a large demand for animation at that time. We evaluated many content companies, but it is hard for pure content companies to prosper, unless they can produce a top-selling product like Pleasant Goat and Big Big Wolf. Original Force took a different approach.  Initially all they had was a technology platform to produce others contents. From there, they are working to generate their own IP based on what they have learned from providing these services to their clients.This approach is interesting, and Co-Stone Capital believes it is worth trying. When the content market is growing, companies providing services to content companies will have opportunities, and this is what Original Force isdoing .


With the latest round of investment made by LeTV in January 2016, the valuation of Original Force has increased by 7 times from the time that Co-Stone Capital made their investment. Lin Ling was surprised: "It is actually beyond our expectation that the valuation of Original Force could increase so quickly. Nevertheless, we believe that Original Force will produce even more surprises. It will take time, of course."


The success of the Original Force investment lead Co-Stone Capital to –delve deeper into the media and entertainment sector. Co-Stone Capital investments in the space include Joyme, Excellent Craftsman, Zichuan Culture, Hengdun Culture, Ergeng Network, among others. In February 2016, Co-Stone Capital invested RMB 100 million for a 5% stake in in MEWE Media, which was founded by the famous host Ma Dong and holds the IP for the top variety show on iQIYI, "U Can U Bibi" . The use of proceeds was primarily intended for building a vertical ecosystem of Internet video content, so as to replicate the ecology effects of MEWE by making upstream and downstream integration and arrangement along the vertical route of content production. Lin Ling considered MEWE Media to be the top content producer of Internet videos, which conforms to the macro trend of "the Internet orientation of video content, the top priority of content, and the quality orientation of Internet-generated content," making it another important entry for the future pattern of Internet + entertainment from Co-Stone Capital’s prospective.


Three systematic assurances for prudent decision-making


Focused investment revolves around large-scale investments in a limited number of projects. Therefore, even a partner’s pet project must be subject to systematic scrutiny, to ensure prudent decision-making.


At Co-Stone Capital, the procedure starts when the project team presents the opportunity to the internal controls department. The project team is responsible for assessing projects from the business and operations perspective. After initial due diligence, the project team presents an investment report to the internal controls team for a financial and legal review. If the investment report requires additional information, the internal controls department may reply to the project team for clarification, or independently perform additional on-site due diligence. After several rounds with the project team, the internal controls department will issue an official report, which is submitted together with the revise investment report to the Investment Committee for discussion and a deciding vote.


Through this mechanism, the internal controls department further enhances the risk control for projects on top of the due diligence performed by the project team, which add another layer of review between the investment committee and the project team. As an extreme example, in order to push through approval for a project, the project team may conceal or obfuscate some critical defect. Therefore, Wang Qiwen, the partner of Co-Stone Capital in charge of the internal controls department, stated that: "We encourage the internal controls department to challenge the investment teams and fully stand behind their decisions. The internal controls department team must have high professional competence, otherwise their opinions would not be convincing."


After reviewing the performance of Wuhu Co-Stone, Co-Stone Capital further enhanced the role of internal control and risk control by engaging professional IPO lawyers and senior accountants to make up the core internal controls team. For many key projects or doubtful projects, members of the internal controls team would make on-site investigation and reviews, and ultimately rejected several projects with good business prospects but had issues that made it unlikely that they would meet the IPO requirements.


In order to more effectively implement prudent decision-making and truly control investment risks, Co-Stone Capital further designed two additional systems.


1) Co-investment by partners. Unlike the common practices of other PEs where partners make co-investment in individual projects, the co-investment system of Co-Stone Capital requires partners to make co-investment in the overall fund as LPs. Generally, when initiating a limited partnership fund, Co-Stone Capital would allocate 10%-15% to be contributed by each partner based on their own situation. "Zhang Wei usually lets others make their subscriptions first, and he would take up the remaining portion. He encourages others to make significant investments." said Song Jianbiao, the secretary of the Board of Directors of Co-Stone Capital.


There are fundamental differences between co-investment in the fund and selective co-investment in projects by partners. First, co-investment in projects is subject to moral risks, causing conflict of interests between partners and LPs of the fund. For example, a partner could make a large co-investment in a high-quality project, but refrain from making any co-investment in the other projects. This is an obvious conflict of interests with the LPs. On the contrary, co-investment in the fund ensures high concordance between the interests of partners and the LPs. Second, this co-investment system solves the cohesion problem among partners by preventing the separation of interests among partners as a result of different partners making co-investment in different projects. In this way all the resources of Co-Stone Capital are focused to provide value-added services for the portfolio companies. Such joint interests also enable all partners to work prudently and sufficiently assess risks in making investment decisions.


Tao Tao analyzed that: "Because of our own investments in the fund, when making investment decisions, we may fight passionately for our own interests without hurting our friendship. Everyone knows that we are concerned with the success of the projects instead of with each other. Otherwise, a different opinion on a project could affect the personal views of each other. For example, I may think that, since you always veto my projects, you have an issue with me personally."


The co-investment system of Co-Stone Capital was started with the Sunward Intelligent project. With the high returns during the contract funds period, all partners proactively made co-investments in the projects. In 2009 when Wuhu Co-Stone was launched, Co-Stone Capital officially established the policy that partners must make co-investment as LPs in the fund, and partners are prohibited from making additional co-investment in projects to avoid conflicts of interests between the partners and LPs.


2) One-person, one-vote system for the Investment Committee. An independent Investment Committee is established for each fund of Co-Stone Capital. Members of the Investment Committee normally consist of five or six of the seven managing partners, and for the investment decisions on each project, the voting is made strictly following the one-person, one-vote rule, and four affirmative votes are required to proceed with investment.


Although Zhang Wei is the largest shareholder and controls the company, he cannot pass or veto a project on his own. The one vote that he has carries the same weight as those of other partners.


From the perspective of risk control, this strict one-person, one-vote rule can greatly reduce project investment risks caused by the preference of the project sponsor. The reason why this rule is stricly enforced is related to the above co-investment system by the partners. Tao Tao analyzed that: "For the investment decision-making system, without the matching co-investment system, it means that we are merely managing the capital of others. Although the one-person, one-vote rule may still be implemented, there is room for backroom horse trading. For example, if Zhang Wei wants to have a project approved, by nature of his position could assert a certain level of influence. However, because everyone has invested their own wealth, a careless decision would affect them personally. As such, there is no room for lobbying for votes."


"When my project was vetoed, I was initially quite upset. However, I knew I must respect this organizational rule, otherwise, it is impossible for us to control risks. Therefore, it is actually a good thing if a project I propose gets vetoed. If my project can be vetoed, it means a project of any person may be vetoed. This builds a platform for honest and open communication within the company." said Zhang Wei.




Focusing on Services


"Strictly speaking, looking at the success factors that determine the success or failure of an investment strategy, company selection accounts for only one third at most. The remaining two thirds or more depends on effective post-investment management." It is said that the real work for PE firms begins when the investment is made. In order to arrive at the end point smoothly, effective post-investment management, including risk control mechanisms and value-added services, is necessary to help invested companies outperform their pre-investment growth trajectories and achieve extraordinary growth.


For Co-Stone Capital and their focused investment methodology, post-investment management is even more important. Tao Tao said: "Actually, we expend most of our energy not on selecting the investment target, but on post-investment management. Providing meaningful value-added services requires the integration of additional resources. One of the aspects in which Co-Stone Capital excels is our post-investment management capability because of our rich experience in this area. "


Post-investment management strategy in conjunction with focused investment


Co-Stone Capital defines its post-investment management style as "focusing on services," which matches with their focused investment strategy. Co-Stone Capital President Xu Wei, who is in charge of portfolio management; believes that this match-up is driven by three factors.


The first is "necessity." A PE firm that has invested significant capital into a project has a compelling fiduciary obligation to diligently manage that investment. The average investment per project for Co-Stone Capital is nearly RMB 100 million, with 70% of projects exceeding RMB 50 million.


The second factor is "possibility." That is, The PE firm must hold a sufficient stake in the company to exert influence on the management. Of Co-Stone Capital’s existing portfolio, 70% of the projects were sole or lead investments, which is indicative of a large shareholding ratio. Furthermore, in three out of every four projects they had either a board seat or a representative within the management allowing them to exercise meaningful influence over the invested companies. In addition, if a single GP manages hundreds of projects at the same time, no meticulous management would be possible regardless of the size of the portfolio management team. Therefore, a true focus on services is only possible through focused investments.


The third aspect is "competence." In other words, the PE firm should have the capability to provide meaningful value-added services to companies.


The value-added services provided by Co-Stone Capital can be broken down into three broad categories: capital management, management consulting, and resource integration.


 With regard to capital management, the investment banking background of the partners of Co-Stone Capital is not only helpful for them to assess the investment criteria and valuation of a company and its potential to IPO, but it also enables them to plan, design and implement equity related initiatives such as capital allocation, corporate restructuring, and management incentives. For example, Zhang Wei's team helped Huitian New Material to complete a restructuring and implement an employee shareholding structure. In the case of OPPLE Lighting, Zhang Wei's team assisted the company to restructure and helped them design a management incentive plan in advance of the IPO process.


For management consulting, Co-Stone Capital entered into a strategic partnership with China Stone Management Consulting Ltd. which was jointly founded by Peng Jianfeng and Bao Zheng, the men who drafted the Huawei Basic Law. Through this partnership, Co-Stone Capital is capable of assisting companies to evaluate and adjust their corporate strategies.. As an example of this, they helped Huitian New Material adjust their strategy, extending their adhesive product line from automobiles only to electronic products and new energy applications.


Through their extensive investment projects and external networks, Co-Stone Capital is able to connect their portfolio companies to needed resources such as professional management and services, either by introducing them through their networks or by making direct connections between portfolio companies.. For example, with Jialin Pharmaceutical, Co-Stone Capital assisted the company to –bring in a new General Manager Liu Wei, who was able to achieve qualitative leaps in the performance of the company. For Shandong Liuhe, Zhang Wei's team spent significant amounts of time resolving conflicts between founding shareholders and shifted focus to the IPO process to align the common objectives of each shareholder. Zhang Xiaocheng, one of the founders of Shandong Liuhe, said: "At a particularly tough period, we asked Zhang Wei to come in as the company President." Zhang Wei, although appreciative of the offer, ultimately brought in Peng Jianfeng as Chairman and Chen Chunhua, professor of the Business School of South China University of Technology, as the new President. The three founders all withdrew from management but retained non-executive seats on the board of directors.


Because the partners of Co-Stone Capital strictly adhere to the co-investment policy, the outcome of every project is intrinsically linked to the personal interests of all partners of the fund. Such bundling of interests further ensures that the partners will use all resources to provide true value adding services. Zhang Wei said: "If we, as partners, make co-investment selectively into projects only instead of the overall fund, everyone would be concerned with only the projects in which they have invested, and it would be hard for the company to leverage the vast resources of the entire team to provide proper post-investment services."



House365.com: comprehensive portfolio management generated returns over 100 times


With the focused investment strategy, certain Co-Stone Capital investments have needed a more comprehensive portfolio management. House365.com was the first project for which Co-Stone Capital needed such a hands on approach. Co-Stone Capital was heavily involved from the establishment of company, assisted the company in formulating their development plans and developing regional markets, ultimately expanding operations to six major cities in east China, and achieving IPO. Co-Stone Capital providedintensive, highly value added services and management throughout the company’s growth and expansion stages.


The investment in House365.com was driven a need by Huashang Media, in which Zhang Wei's team invested in 2006. Huashang Media was the only domestic multi-regional media group operating metropolitan newspapers at that time, and based on the successful Chinese Business View released in Xi'an, it released New Culture View in Changchun, Chongqing Times in Chongqing, and Chinese Business Morning View in Shenyang, eventually becoming a media conglomerate consisting of seven newspapers, five magazines, five websites, and over 10 companies.


Of the advertising revenue sources for regional metropolitan newspapers, top contributions come from real estate, automobile, shopping malls, and classified advertising. In 2007, one third of the advertising revenue of Huashang Media was coming from real estate. Internet advertising was also on the rise at that time, so Huashang Media initially considered carving out real estate advertising to Internet platforms in order to minimize the impact caused by the Internet. In addition, "because real estate was such an important revenue driver, if the business was carved out into an independent company, it would likely have significant challenges to get listed" said Lin Ling who was in charge of the project.


Therefore, Huashang Media decided to make use of their abundant cash position to explore an investment opportunity in an Internet company specializing in the real estate vertical, and the Huashang Co-Stone fund managed by Zhang Wei's team became the standard bearer for this project.


At that time, the top 3 businesses in the online real estate arena, Fang.com, House Focus, and House.SinaHouse.Sina, had a significant market share. Given the huge first-mover advantage for Internet businesses, what was the opportunity for a new player? Zhang Wei theorized that: "The real estate market of China is very huge, and the entire industry is constantly evolving. Therefore, there should be some space for a company focusing on a specific region instead of following the national business model seen in the US." "Fang.com and House.Sina were both listed in the US, but there was no similar subject on the A-share market. This also presented an opportunity", added Lin Ling.


Therefore, they assessed many independent real estate and housing portals in the Yangtze River delta area, and finally selected House365.com founded by Hu Guanghui in Nanjing. In 2007, when Co-Stone Capital recommended House365.com to Huashang Media, the website had only been around for half a year.


Hu Guanghui of House365.com chose Co-Stone Capital because he recognized the value of the resource integration capability they had: "We were profitable in the first year with good cash flow, hence we decided to look at getting listed. We got in touch with three investors at that time, but we preferred industrial funds, which we felt would be helpful for future business expansion or for the development to the capital market. ultimately, we decided to move forward with Co-Stone Capital because of the resources they could make available to us."


After the investment was made, Co-Stone Capital designated Lin Ling as a Vice President of House365.com, and he became involved in the in-depth operations of the company. For the next two years, Lin Ling would make the trip from Shanghai to Nanjing about twice every week to discuss with Hu Guanghui about the business plan and market expansion.


The original intention of Lin Ling was "to find two or three companies in the Yangtze River delta area that could be merged directly into House365.com, because the combination would result in a larger company with higher growth and lower risks. However, it was later determined that there were big problems in this, such as which company would be the core platform and how to resolve the shareholding structure. Without a core platform, it would be very difficult to build a large company because of the integration challenges. Therefore, they decided to keep House365.com as the core platform and look for opportunities for consolidation."


Later, House365.com entered the cities of Suzhou, Wuxi, Changzhou, Hefei, and Hangzhou through acquisition, and became the largest real estate and housing Internet company in the Yangtze River delta area. Because of this, they ate up market share in cities not covered by Fang.comg and House.Sina. "We acquired a company in Suzhou first, and so there is a shareholder (Zhang Hailin) from Suzhou. The Wuxi website was reluctant to sell at that time so we hired away their team. In Hefei, we were not able to find a suitable target so we set up our own website there, and later acquired the largest local community website." Lin Ling still remembers the experience vividly.


While promoting business expansion, Co-Stone Capital also initiated the IPO process for House365.com, and brought in Guosen Securities to run that process.


In 2009, House365.com started IPO preparations. At that time, the government started to implement controls on the real estate industry, so listings of real estate companies were suspended. "Fortunately, off-line stores were developing at a low speed so we made a timely adjustment to exit the off-line business."


In 2010, House365.com officially submitted their IPO application materials, but they still faced two major obstacles. One obstacle is whether the IPO would come into conflict with the real estate control policy, and the other was that most Internet companies were listed outside China, and the regulatory authorities were suspicious of the accuracy of the revenues of Internet companies. On this basis, Guosen Securities performed a comprehensive diligence review of the accuracy of House365.com’s revenue. "For the reporting period, we completely reviewed all transaction contracts with an amount of over RMB 50,000, and multiple iterations of the review documents were submitted to the regulators." The supplementary fundamental work greatly relieved the concerns of the regulatory authority. Meanwhile, House365.com maintained continuous growth during the review process, and the net profit increased from over RMB 30 million in 2010 to RMB 70 million in 2011. Because of this, it successfully passed the CSRC review, resulting in a return of 150 times from the first round of investment.



From Sunward Intelligent and xcar.com.cn to Anhui Quanyi: exploring the value of projects through M&A


M&A is referred to as the "crown jewel" of the traditional investment banking business. In private equity, M&A also is a high-end business at the top of the pyramid. For leveraged buyout (LBO) funds, M&A is integral from the beginning to the end of the investment; while for PE funds focusing on growth investment, M&A may be an important tool for improving the values of portfolio companies, and may also be an important exit method. In their value-added services, the team of Co-Stone Capital with their investment banking background also engage in all aspects of M&A.


After the IPO of Sunward Intelligent, Tao Tao sat on the board of directors from 2007 to 2013 and promoted a joint venture between its main business - medium excavators - and Caterpillar. However, because Caterpillar wanted to sell the Sunward Intelligent brand medium excavators via their global network, Sunward Intelligent would effectively become a comparatively low-end sub-brand within the Caterpillar product line. He Qinghua, the controlling shareholder of Sunward Intelligent was worried about a loss of control, and so the joint venture was not achieved.


In 2010, after the effects of the 4-trillion economic stimulus plan launched by the Chinese government gradually disappeared, Sunward Intelligent sought for breakthrough. To that end, Co-Stone Capital assisted Sunward Intelligent in its acquisition of DeltaHawk Engines, Inc., a US aircraft engine manufacturer. "The eye-catching point of this project is that the fuel for the aircraft engine was common diesel instead of jet fuel so the engines had great market potential for civilian applications." said Tao Tao. However, because the project was in the R&D stage there were many uncertainties. "I designed a transaction framework for Mr. He by which the counterpart issued convertible bonds and pledged patents to Sunward Intelligent instead of a direct acquisition of equity. Through this flexible plan," Sunward Intelligent would be able to convert the bonds into shares if the R&D progress reached expectation; otherwise, they could require the counterpart to redeem the bonds.


In this transaction, Sunward Intelligent made a contribution of RMB 13.974 million for 51% of Hunan Sunward Aircraft Power Machinery Co., Ltd., and provided a loan of USD 2 million to DeltaHawk Engines via this subsidiary for a period of 3 years. Under the agreement, the principal and interest could be converted into shares of DeltaHawk Engines. In addition, according to the transaction plan, Sunward Intelligent had the globally exclusive manufacturing rights for the engine, and could implement batch production as long as they were certified.


From the perspective of the capital markets, while the machinery business was not valued highly by the capital markets, the additional aircraft machinery concept helped support the market value of the company. Sunward Intelligent continued with M&A along this direction, and in 2016 acquired the Canadian AVMAX company for its strength in the transportation industry. For the period from 2011 through 2016, Sunward Intelligent’s share price performed better than SANY Heavy Industry and Zoomlion Heavy Industry (Figure 4).


Figure 4: Comparison between and Sunward Intelligent and comparable companies

 A Private Equity investor managing more than RMB 35 billion invested into 90 projects and only lost




For Huachangda (300278), which was invested in 2010, Co-Stone Capital once again improved the value of the project through M&A.


The primary business of Huachangda is automobile equipment. "When making the investment, we conducted research into the growth potential of China's automobile industry, and determined that the growth had almost peaked. On top of that, although it was easier for companies to get listed, it was a time when competition for pre-IPO investment was extremely fierce among the different PE funds. Even in those circumstances, we stilled made the decision to invest." said Tao Tao. In 2011, Huachangda got listed as expected, but shortly afterward the industry reached a turning point. As a result, the market value of the company took a beating. Although the company was net earnings positive, we still wanted to actively assist the company with their M&A expansion." At the time, one of the acquisition directions discussed by Tao Tao with Huachangda was intelligent automation following the trend of increasing labor costs in China. Tao Tao assisted Huachangda in identifying Shanghai New-Tronics M&E Co., Ltd. which manufactured robotic end of arm tools with a high gross margin of 47%. Although an M&A agreement was concluded by the parties, an accidental leak of internal information materially impacted the stock price, resulting in the transaction ultimately coming apart.


Later, Co-Stone Capital assisted Huachangda in selecting another manufacturer of robot applications - DEMC. The M&A was finally successful, which not only effectively promoted the growth of Huachangda's financial performance, but also expanded their product offering to include robot applications. Co-Stone Capital further assisted Huachangda in two other overseas M&A after that.


With the experience gleaned from these two projects, Co-Stone capital, together with Grand Automotive, raised a special M&A fund in November 2015 of RMB 2.3 billion - Shanghai Aika Investment Center, which acquired 100% of the equity interest in xcar.com.cn from US based CBS.


According to Tao Tao, Co-Stone Capital was already considering an investment in Grand Automotive and had already done due their diligence; therefore, they had a systematic understanding of the automotive dealership business. When they got the opportunity to acquire xcar.com.cn, they communicated with Grand Automotive, and both believed that in-depth cooperation on the project would be mutually beneficial.


Although automotive e-commerce was a huge market opportunity, for Grand Automotive, who at that time owned the largest domestic network of 4S automotive dealerships, it was very hard for it to operate an online channel due to their lack of Internet background. By taking a stake in xcar.com.cn, the third largest domestic automotive vertical portal, it would gain access to a meaningful driver of online traffic, bringing more sales opportunities and and strengthening their negotiating position with other automotive portals. As for xcar.com.cn, during the period when it was held by the multinational company, the cash flows were dividended out and little was reinvested, hence it was gradually surpassed by Autohome and Bitauto. By cooperating with Grand Automotive, they will have access to capital support to further expand and develop new business lines such as automotive e-commerce.


After the M&A of xcar.com.cn was completed in the beginning of 2016, Co-Stone Capital focused on two aspects to improve the company’s competitiveness. First, they spent hundreds of millions of RMB to purchase traffic from Baidu, and second, they explored and implemented strategies to expand all aspects of the automotive after-sales market. "There are significant opportunities at every stage of the entire automotive consumption chain - research, selection, purchase, use, and after-sales - and even when cars break down there will be various financial and insurance opportunities." Implementing all of these plans is a challenge for the M&A and integration capabilities of Co-Stone Capital.


Similar to the automotive after-sales market and real estate after-sales market, Zhang Wei also looked at the drugstore chain market, and sees huge opportunities for on-line and off-line integration. He explained with an example: "If the government encourages e-commerce stores to directly sell prescription medicine, and assuming that prices are only 1/3 of those charged by hospitals, the social insurance expenditure of the government would be greatly reduced, and individual medical insurance payments would also be reduced. Therefore, although directors of hospitals are not motivated to promote such reform, there are other forces in the society to promote the reform." According to Zhang Wei, to a certain extent, the development of chain drugstores is directly connected with medical reform.


Co-Stone Capital started its investment in the health care field from 2013, including New Industries Biomedical (830838) (in-vitro diagnosis), Lonwin (medical imaging), Dakang Health Care (hospital chain for renal dialysis), CONBA (600572) (pharmaceutical manufacturing), and 91160 and PharmPlus (mobile health care), with particular focus on chain drugstores which were not one the radar of the capital markets and was relatively unconsolidated.


Co-Stone Capital discovered that between government controlled medical insurance expenses and the separation between hospitals and pharmaceuticals, the monopoly of the hospital channel in prescription medicine could be broken, and increased competition for providing prescription medicine would become a foreseeable medium to long-term trend. At the same time, there is a rapid trend toward the formation of large drug store chains. With the changing spectrum of human diseases and the expansion of common drug stores catering to emerging businesses such as chronic disease management and preliminary diagnosis & treatment, the status of drug stores chains in the pharmaceutical value chain would strengthen significantly, and the commercial value of large-scale drug store chains will be re-evaluated, leading to opportunities for large-scale horizontal acquisitions and industry consolidation.


Therefore, following the completion of the xcar.com.cn acquisition, in July 2016, together with a management team who had a strong reputation in the industry, Co-Stone Capital invested RMB 1 billion to acquire 80% of the drug store chain Jiangsu Hengtai Health Care. In 2017, they plan to make further investment of RMB 4 billion in this project to expand the platform through M&A. In the future, we will see whether this enterprise develops into another major player in the drug store industry under Co-Stone Capital’s management.


The review system: controlling post-investment risks


Even good enterprises selected carefully and managed diligently after investment may run into trouble during their development. Therefore, risk control is an important part of post-investment management. At Co-Stone Capital, in addition to the routine procedures of PE firms for monitoring the financial conditions of portfolio companies on a monthly and quarterly basis, a comprehensive review will be performed after each fund is fully invested.


According to Tao Tao, the fund review is mainly conducted in several respects: "First, analyze whether the industry of the invested project is properly configured; second, review whether individual projects conform to the investment strategy contemplated when the investment was made and compare to the pre-investment expectations; third, review the content and effect of post-investment value-added services for individual projects; and fourth, plan a systematic solution for projects in difficulty."


During the review of Wuhu Co-Stone in 2011, Co-Stone Capital discovered that the market for conventional industries was going down, and accordingly adjusted the investment and research team and made timely adjustment to the investment direction of Everest Co-Stone which was launched later. In 2014, when the investment period of Everest Co-Stone reached 2 years, the management of Co-Stone Capital performed a routine review on the projects invested under that fund, and detected some potential problems. Later, the Investment Management Department instructed project managers to proactively identify potential problems based on this review and companies which may face difficulties in getting listed. Based on feedback from the project managers, Co-Stone Capital successfully exited four manufacturing projects, one environmental protection project, and one consumer product project. Because the problems were detected in time, and the exit happened while the companies were still growing, Co-Stone Capital suffered no principal losses, and even earned returns of up to 1.5 times in several projects.


Table 4: Information about partial investments under the Everest Co-Stone Fund



Investment time

Investment amount (RMB ten thousand)






Kangxin New Material (600076)

Jun. 2011



Partial exit



Omnijoi (300528)

Dec. 2011



IPO completed



OPPLE Lighting (603515)

Aug. 2012



IPO completed



Silkroad Vision (300556)

Aug. 2011



IPO completed



Dezhan Healthcare (000813)

Mar. 2012



Back-door listing succeeded



Asymchem (002821)

Jun. 2011



IPO completed



Kexin Technologies (300565)

Jul. 2012



IPO completed



Kunshan Kersen Technology Co., Ltd.

Jan. 2014



IPO review passed

30X expected


CONBA (600572)

Apr. 2014


Private placement



Soling Industrial (002766)

Jul. 2011


Fully exited



Xi'an Sitan Instrument Co., Ltd.

Jun. 2011


Fully exited

Source: Co-Stone Capital


With this set of systems from investment decision-making to post-investment management in place, 2016 became a harvest period for Everest Co-Stone: with initial capital of RMB 1.4 billion, the fund invested in 19 projects, all of which have clear exit paths and none of them suffered principal losses (Table 4). By the end of 2016, Everest Cornerstone exited eight projects (including one IPO exit and one exit via back-door listing upon the expiry of the lock-up period), and a total of about RMB 1 billion was distributed, representing 70% of the initial capital, and six projects were in the lock-up period. In addition, one project passed the NDRC review and will be offered to the public, one back-door listing project was under official review; two projects were successfully listed on the New Third Board and recognized capital gains (partially exited one project with the principal recovered), and the private placement into the listed company CONBA booked a gain of 50%.


Exploring the Best Investment Style for Domestic PE firms


With its constantly improving organizational system and maturing investment strategies, the amount of capital being raised by Co-Stone Capital is gradually increasing - Wuhu Co-Stone raised RMB 400 million in 2009, Everest Co-Stone raised RMB 1.4 billion in 2011, Pioneer Co-Stone raised RMB 2.2 billion in 2014, Lingyu Co-Stone raised RMB 3.3 billion in 2016; in addition, in 2016, Co-Stone Capital also won the RMB 11.5 billion Anhui Industry Upgrade Fund sponsored by the Anhui provincial government.


As the assets under management of Co-Stone Capital increased from RMB 400 million in 2009 to RMB 35 billion in 2016, the business environment of domestic PE firms has generally been improving despite several ups and downs. The PE fever has begun to subside and bubbles are better controlled, and a 20/80 structure has emerged in the PE industry, where outstanding PEs with proven investment concepts and performance receive increased attention from LPs. Together with the development of the domestic PE market and the declining rate of return due to the cooling down of the economy, high-risk and high-return PE investment is evolving from a privilege of only a few high-net-worth individuals into an important tool for more and more institutional investors as they seek alternative investment options.


The development of Co-Stone Capital is reflective of this change, symbolized by China Reinsurance Group becoming an LP and shareholder of Co-Stone Capital.


The strategies are validated by investment from long-term funds


For every PE firm, the participation of long-term funds such as insurance companies, social insurance funds, and industrial funds as LPs may be a foundation for continuing their strategies. However, due to the requirements of stable performance, such institutions are very selective. In the insurance industry as an example, in order to pitch insurance funds as LPs, a PE firm has to first be included in the insurance company’s certified partner list. Passing a strict due diligence examination is a prerequisite for inclusion in that list. Once the total investment quota has been determined, the insurance company will allocate to funds to firms on the certified partner list.


The first round of due diligence investigation performed by China RE on Co-Stone Capital was initiated in 2013 and lasted for over one year. Song Jianbiao said: "The due diligence investigation team visited us many times, and the reviewed materials, if stacked vertically, would be taller than the average person." Even the projects invested during Co-Stone Capital’s early contract fund period were subject to careful inspection. In the end, however, Co-Stone Capital was successfully included into the certified partner list.


When China RE was making their fund allocations, four of 8 potential funds received investment, of which Co-Stone Capital received RMB 100 million for Pioneer Co-Stone which was launched in July 2014. When Co-Stone Capital restructured into a joint stock company at the end of 2015, China RE became a shareholder of the newly established Co-Stone Assets Management Co., Ltd.


Another milestone event for Co-Stone Capital was winning the bidding for the RMB 10 billion Anhui Industry Upgrade Fund. The total amount of this fund was RMB 11.5 billion, of which 70% was to be invested in Anhui Province. Co-Stone Capital was responsible for raising RMB 3.5 billion, with the remaining portion to be coordinated and raised by the Anhui provincial government. Han Zaiwu, Managing Partner of Co-Stone Capital, moved to Hefei together with his team.


Through their investments over the past 15 years, the team of Co-Stone Capital gradually refined the investment methodology of "focused investment and value-adding services," and designed a series of corresponding systematic support measures to obtain performance and returns that are much better than other similar funds and winning investment from the best LPs. Now, with abundant capital on hand, Co-Stone Capital is even better positioned to concentrate on their focused investment strategy.


In recent years, they have continuously expanded their product lines by creating specialty funds with specific purposes. For example, they established a private placement fund of RMB 5 billion intended for investment in listed companies, an M&A fund together with Opple Lighting in the typical Chinese "PE + listed company" structure, industry focused funds in specialty fields such as the Lingkang biology & medicine fund, and a New Third Board fund to implement capital management plans for companies listed on that exchange.


In the past, based on their focused investment strategy for their cross-industry comprehensives funds, Co-Stone Capital would focus their investment on several main industries while making appropriate allocation to other industries based on market conditions at the time. After their product line was expanded, this strategy has been correspondingly adjusted. For the investment portfolios of the various specialty funds, the allocation is made based on the nature of the fund and an evaluation of the specific company. For example, while individual investments for PE funds are usually made with high amounts and individual investments for VC funds are usually made with low amounts, industrial funds are allocated with consideration to primary and supplementary projects based on specific sub-sector trends and the status of potential projects.


The experience from mature markets shows that on average 50% of returns normally come from a few key projects. Even with their focused investment strategy which makes large investments taking meaningful stakes, Co-Stone Capital must also carefully prioritize investments to properly allocate between industries and companies in a given portfolio. Take Everest Co-Stone as an example, the average investment amount of individual projects exceeded RMB 70 million, with two projects receiving over RMB 200 million with over half of the projects maintaining a 5-10% stake after dilution. For post-exit returns, the top 3 projects contributed 48% and the top 8 projects contributed 85%.


Today, Co-Stone Capital manages over 40 funds ranging from VC/PE investment and industrial M&A funds to and placement PIPE fund. According to the plan of Zhang Wei, Co-Stone Capital is expected to expand across the investment value chain, which will build a diversified asset management platform combining all the key business lines in the capital market around a core of equity investment.


With a 15 year history, Co-Stone Capital is now reaching a new level. Does the success of Co-Stone Capital represent the potential value of the current Chinese equity investment market? Can their investment methodology be learned and duplicated by others?


Exemplary methodology of Co-Stone Capital


Compared with the US PE market, which developed by leaps and bounds in the1970s, the domestic PE market is still developing its own investment style. What investment strategies are most suitable for the Chinese market? Local PE firms are navigating their own path. Co-Stone Capital, which has operated in the market as sort of a "lone wolf," neither seeks for hot projects nor aligns with other PE firms, and many investors may never hear about the two projects from which they acquired returns over 100 times - Sunward Intelligent and House365.com - and none of any other famous PE firms appear on those company’s shareholder registry. The investment methodologies that Co-Stone Capital is exploring are deeply rooted in the economic environment of China, and have passed the test of time in the market. Co-Stone Capital's methodology of focused investment and providing value-adding services is noteworthy from the perspective of both PE best practices and the macro economic environment.


From the perspective of best practices, PE investment is a high risk, high return business so in order to control risks, the four business stages of fund-raising, investment, management, and exit must be controlled in a strict manner, with investment and management the two core elements. Generally speaking, if a PE fund invests in the right company and manages the project properly, there should be no problem in the exit. With a solid track record of project exits and high returns, fund-raising would not be a problem either. The experience of Co-Stone Capital demonstrates the proper control over the investment and management stages, leading to a high success rate and high returns. Their approach to value creation is of universal value for the whole industry.


Going through the development history of Co-Stone Capital, it is quite clear that their strategies of selecting outstanding projects, focused investment, and providing value-adding services are derived from the domestic environment and the highly regulated A-share market. Because of their investment banking background, the Co-Stone Capital team is particularly concerned with the exit channel on the A-share market when making investments. Therefore, when considering potential projects, in addition to the quality and growth potential, whether the company can endure beyond the economic and market cycles is also an important factor.


Although it seems quite different on the surface, there is little change in the fundamental process for listing in the public markets from 15 years ago when the team of Co-Stone Capital started their business. Proposals to relax listing scrutiny were not put into the national policy agenda until 2016. Additionally, the economic transformation of China and the changes in the macro environment caused by declining global growth and increasing trade protectionism has made it even more challenging to select projects with long-term growth potential.


As China has emerged over the last 30 years there have been innumerable investment opportunities. However, in the industrial field, there are few companies like Huawei that are able to develop independent of the international markets. The Chinese public markets are highly speculative with ups and downs based on current trends, and that dynamic carries through to the primary market, driving many PEs and VCs to chase the current hot projects. However, these investment hot spots rise rapidly and fall just as quickly. Only a few outstanding enterprises can achieve lasting development. In China, the average life of SMEs is less than three years, and many of the hot projects are only able to maintain attention from the hot money funds for less than one year. For PE funds whose investment cycle is normally as long as 5 or more years, they may be in a dilemma when the tides change if they are always in pursuit of the current hot markets.


With the upcoming relaxation of the listing approval process, many pre-IPO opportunities are disappearing. The profits from PE investment will no longer derive from valuation arbitrage between the private and public markets, but from the fundamental long-term growth of enterprises. In order to win this endurance race, PE firms must transform from extensive investment to intensive investment. Such notion of intensive investment is reflected in the selection of outstanding companies, focused investment, and providing value-added services. In other words, Co-Stone Capital's investment style in the Chinese market is a prime example.


At the beginning of 2017, "uncertainty" may be the best word to express the views among investors in the capital markets, nevertheless, there are actually certainties behind the multitude of "uncertainties". In China, private equity investment is becoming an indispensable role in equity investment and in macro assets configuration. In the global low-return environment, the rise of alternative investment options, including PE, is becoming a macro trend. With such certainties and uncertainties, the direction in which domestic PE firms, including Co-Stone Capital, move forward will further improve the systematic design and investment efficiency of the market to achieve more sustainable and optimal performance.


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