Investing In The

Middle Kingdom The Hillhouse

Way
May 2010

Hillhouse Capital

Introduction
Invested and committed capital 3.8B$ as of Mar. 2010
Hard closed and returned capital 400m$ to investors end of 2009
52% annualized returns since inception Aug. 2005 to Mar. 2010
Concentrated portfolio
Almost exclusively plain vanilla stocks
Never use leverage
Portfolio is more geared towards domestic consumption investments rather than
exports
Focus on long term analyzable opportunities

Hillhouse Capital

Investor Profile by Assets of GAOLING

(As of 03/31/2010)

Hillhouse Capital

Investment: The Hillhouse Way

Deep fundamental bottoms up research

Global industry research

Bottoms up China research

Focus on fundamental risks: where we can lose money

Long term investment orientation
Value-added to like-minded entrepreneurs

Trusted partner yet maintain intellectual independence

Team-based research process

Cross coverage: senior/junior

Rigorous Investment Committee Meetings

Gatekeeper model

Focus on people and organization behind the business

Only look at areas that we have an edge: factors that we can understand,
appreciate, monitor and to some extent influence and add value
Hillhouse Capital

Common mistakes of investing in China

Parachute Investing
Short Term Orientation
Get overly excited by short term growth
Casual/intuitive investors, herd behavior from wsj headlines: e.g. migrant
workers create huge unemployment social unrest but actually brought back
skills and lifestyle to hometown; decoupling of tier 2 cities from coastal cities
Relationship is over-rated
Optionality-hypothesis and monitoring
Make concentrated bets and fall to in love with them
Perform well and then become overly conservative

Hillhouse Capital

Yantai Changyu Pioneer Wine

(200869.CH)

5th Value Investing Congress

May 5, 2010
Lei Zhang


The old gate of Changyu Company

Hillhouse Capital

Changyu advertisement on
Novel Magazine in early
years

Hillhouse Capital

May 5, 2010

AGENDA

Hillhouse Investment Thesis

Industry Demand Outlook

Changyus Products

Distribution Network

Management

Investment Considerations

Hillhouse Capital
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May 5, 2010

INVESTMENT THESIS: YANTAI CHANGYU PIONEER WINE

High Growth, High Potential Category
Early Stage Product Adoption
Levered to Income Growth and Health
Trends
Domestic Production Base

Well Positioned Product Portfolio

Depth In Mid/Premium Products
Higher Barriers to Entry, Less
Competition
Greater Profitability/Returns

Typical Hillhouse Investment

Dynamic Growth Industry
Unique Capabilities
Aligned Management Team
Attractive Valuation

Aligned Management Incentives

Broad and Significant Management
Equity Ownership After MBO
Performance Based Compensation
Disciplined Use of Cash

Best In Class Distribution Network

Broad Coverage, High Degree of Control
at Local Costs
Weak Competition
Scalable Infrastructure
Hillhouse Capital
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May 5, 2010

AGENDA

Hillhouse Investment Thesis

Industry Demand Outlook

Changyus Products

Distribution Network

Management

Investment Considerations

Hillhouse Capital
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May 5, 2010

OVERVIEW OF CHINESE CONSUMPTION OF PACKAGED

BEVERAGES
Domestic Production Volume, Liters Per Capita (2007)(1)
Yellow Rice Wine 1.0
Grape Wine 0.6
100%

38.1

34.8

Other (incl. RTD Tea) 9.1

Liquor 3.7

11.0

Total = 84 (2)

80
Carbonated 7.7
60
Milk 11.0
Fruit/Vegetable Juice 8.0
40

20

Beer 29.5

Bottled Water 13.4

Soft Drink

Alcoholic Beverages

Dairy

Hillhouse Capital
Notes: (1) Assumes 1 kg of production weight = 1 L of volume for all beverages;
(2) Total volume in 2007 = 111B Liters; Doesn't account for import/export but should give good directional feel for relative size
Source: Wind EDB

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May 5, 2010

SPIRITS AND BEER DOMINATE CHINESE PEOPLES STOMACH

IN TERMS OF ALCOHOL EQUIVALENT CONSUMPTION VOLUME
Domestic Consumption Volume, Liters Per Capita (2007)(1)

100%
90

34.8

Grape wine 0.6

Yellow rice wine 1.0

ABV
12%

Blende
ASP
(Rmb/L)
41

Alcohol
adjusted
ASP
(Rmb/L)
344

Yellow rice wine 0.2

16%

33

209

Spirits 1.7

45%

60

133

Beer 1.2

4%

155

3.1

Grape wine 0.1

Spirits 3.7

80
70
60
50
40

Beer 29.5

30
20
10
0

Raw volume

Alcohol equivalent volume

Wine being the

most expensive
to get drunk

Hillhouse Capital
Notes: (1) Assumes 1 kg of production weight = 1 L of volume for all beverages; (2) ABV =alcohol by volume
Source: Euromonitor Alcoholic Drinks China", June 2008

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May 5, 2010

GRAPE WINE ADOPTION AT EARLY STAGE PENETRATION,

OCCURS AT RELATIVELY HIGH LEVEL OF DISPOSABLE INCOME
Healthier Alternative To Beer and Spirits For Those Who Can Afford It

8
Beer (LHS)
6

0.4
Grape Wine (RHS)
4
Spirits (LHS)

0.2

0
D1
DI / capita
(RMB)

0.6

3,500

D2
5,946

D3/4
8,104

D3/4
8,104

D5/6

D5/6

D7/8

D7/8

D9

L / capita / year (Grape Wine)

L / capita / year (Beer and Spirits)

China: Per Capita Annual Purchases of Alcoholic Drinks of Urban

Households by Income Deciles (2006) (L)

0.0
D10

11,052 11,052 15,200 15,200 20,700 34,834

Hillhouse Capital

Source: China Statistics Year Book 2007

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May 5, 2010

AGENDA

Hillhouse Investment Thesis

Industry Demand Outlook

Changyus Products

Distribution Network

Management

Investment Considerations

Hillhouse Capital
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May 5, 2010

BRAND IS OF OUTSIZED IMPORTANCE, STRONG SIGNAL OF

QUALITY TO UNEDUCATED CONSUMERS AND GIVES FACE
Particularly Relevant For Gifting and Event Driven Premium Segment
Key Purchase Criteria of Grape Wine Consumers in China

80%

Consumers are too new to the category to really know what

quality is or be able to have a nuanced sense of taste

64
% Respondants

60

which leads to consumers being extremely reliant on

brand and (high) price as proxies for perceived quality

43
38

40

20

14

13
7

Quality /
taste

Brand
name

Price

Date Availability Habit Advertising Friend

Promo Package

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Source: Chinainfobank
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May 5, 2010

AGENDA

Hillhouse Investment Thesis

Industry Demand Outlook

Changyus Products

Distribution Network

Management

Investment Considerations

Hillhouse Capital
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May 5, 2010

RETAILERS CARRING WINE ARE COMPLEX TO REACH IN CHINA

On-trade Channel

Restaurants and
Hotels

Off-trade Channel

Bars and night

clubs

Super markets /
chain stores

Convinience
alcohol stores

//

Products Sold

Mid to high end

Mid to low end

Low to high end

Low end

Mid to high end

Consumers

Mainly government
or business people,
competing with
Spirits

Business people
/younger people,
competing with
imported spirits
and beer

Mid-high income
level people /
households; for
drinking at home
or for gifts

Mid-low income
level people,
competing with
beer and lowend spirits

Government /
enterprises
purchase, for
business or for
welfare;

Entry Barriers

Monopolized by
distributors
supported by local
gov;
High//

In store sales
people needed

Monopolized by
distributors
supported by local
gov; potential risk
to get bad debt
High//

In store sales
people needed

Branding is key;
advertising and
promoting
support;
Not on-premise
purchase;

Small and
dispersive
Shelvies
occupied by
;

Sales team to
set up contacts
with purchase
people in
gov/enterprises;
Advertising and
promoting
support

High markup taken

away by retailers;
only large
distributors with
product portfolio
coul afford

High markup taken

away by retailers;
wine distributors
hard to make profit

Profitability

Higher than ontrade channel;

Higher than ontrade channel;

client
procurement
costs could be
high

Hillhouse Capital
Source: China Sugar & Liquor Yearbook 2007; interviews with Changyus distributors and winemaking people from Great Wall

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May 5, 2010

BETTER COVERAGE + GREATER CONTROL BY WORKING WITH

SMALLER DISTRIBUTORS AND DEVELOPING DIRECT SALES
Tremendous Advantage In Building Brand and Educating New Consumers
Changyus Distribution Network

Changyu HQ

Distribution Benchmarking

Regional
Sales Office

District
Sales Offices

(38)

(350)

Direct Sales

Distributors

(Weihai, Yantai,
Shanghai)

(3,886)

On-Trade1

Institutional3

Off-Trade2

Individual

Company

Salesforce

Distributors

Customer
Concentration

Changyu4

3,000+

3,886

4% (Top 5)

Great Wall

600

400+

40% (Top 10)

Dynasty

423
(total)

200+

35% (Top 5)

Imports

Most give exclusive rights to one or a

handful of regional agents/distributors

Strong distribution and marketing capabilities

create tremendous option value for future
products and/or distribution partnership deals

Group Bulk Purchase

Note: 1Restaurants, hotels, bars, nightclubs; 2supermarkets and specialty stores; 3corporate, SME, government; 4includes ~1,500 contracted employees
Source: Interviews with various distributors, Interviews with with Changyu, Great Wall and Dynasty management

Hillhouse Capital
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May 5, 2010

AGENDA

Hillhouse Investment Thesis

Industry Demand Outlook

Changyus Products

Distribution Network

Management

Investment Considerations

Hillhouse Capital
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May 5, 2010

MANAGEMENT ALIGNED WITH EQUITY HOLDERS THROUGH

CO-OWNERSHIP AND PERFORMANCE BASED COMPENSATION
Management Shares 5% of Profits In Excess of Yearly Target Set By Board2
Yantai Changyu Pioneer Equity Shareholding Structure

80

24%

Middle Mgmt (12)

5.4%
40

22%

B-shares
33.9%
Illva Saronno
Investment Co.
16.6%

Senior Staff (46)

8.6%

Management

50%

International
Finance Corp.
5.0%

Senior Mgmt (14)

9.6%

60

20

6%

SASAC Yantai
6.0%

100%

A-shares
15.8%
Govt

Strategic Investors

Public Investors

Shareholders realize tangible value, dividend payout ratio has averaged greater than 90% since 2004

Notes: Partial MBO in 2005 gave 72 members of management a 24% stake in Changyu held indirectly through Yantai Yuhua Investment; 2Minimum
yearly hurdle rate of +15% net profit growth, target varies depending on market conditions, was +20% for 2008
Source: Company filings, Interviews with management

Hillhouse Capital
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May 5, 2010

STRONG GROWTH POST MBO WITH HIGH CASH FLOW

AND RETURN ON EQUITY PROFILE
12 Year Listing History Since 1997
Changyu Financial Overview (97-08)
CAGR
('05-08)

4,000

Revenue

2,000

20%

Net
Profit

RMB (mn)

3,000

42%

1,000

ROE
FCF / Earnings

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

12%
-43%

15%
8%

16%
-3%

10%
125%

13%
-11%

8%
-45%

10%
189%

12%
97%

17%
92%

19%
76%

29%
77%

35%
107%
Hillhouse Capital

Notes: Calculated as net profit / period end equity

Source: Company financials, Hillhouse analysis

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May 5, 2010

CHANGYU B-SHARES HAVE MASSIVELY OUTPERFORMED

THE MARKET OVER THE LONG RUN
Trades at 42% Discount to Changyu-A

200

IRR

IRR

3M

1Y

IRR

IRR

since
since
10/27/00 9/26/97

HKD / Share (log scale)

100
50

Changyu-A
HKD 55.58

50% -31% 25%

65% -29% 43%

31%

20

Changyu-B
HKD 32.06

185% -34% 15%

9%

10
5

SZ B
HKD 4.14

3/27/09

9/12/08

3/14/08

9/7/07

3/9/07

8/25/06

2/17/06

8/5/05

1/21/05

7/23/04

1/9/04

7/11/03

12/27/02

6/21/02

12/7/01

6/1/01

11/17/00

5/12/00

10/22/99

4/23/99

10/9/98

4/10/98

0.5

9/26/97

Hillhouse Capital
Notes: Does not include reinvested dividends; Shenzhen-B share index set equal to Changyu-B issue price on 9/26/97
Source: Wind, Hillhouse Analysis

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May 5, 2010

THANK YOU!

Hillhouse Capital
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