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SARS and slowdowns hit the headlines. But China is still growing and modernising fast, inviting British companies and the London Stock Exchange alike to tap its new breed of entrepreneur. Robert Tyerman uncovers the smallcaps seeking a slice of the action

On Monday 13 October, at the High Tech Fair in the southern Chinese city of Shenzhen, China's Ministry of Science and Technology will unveil plans for a United Kingdom 'Innovations Park' at Cambridge. The park is intended to serve as an 'incubator unit' for smaller, high-tech companies from the People's Republic.

If it works, the project should encourage additions to the 150 or so Chinese companies already operating in Britain and drum up interest among UK capital providers in what Chinese companies, outside the established utilities and banks, have to offer.

As yet, most of the mainland Chinese companies with a British presence have been small-scale traders – as well as two firework makers – but now more technologically-oriented concerns are keen to test the water.

They include the ambitious Shenzhen-based Konka digital TV specialist, which 'wants to sweep the board in Europe as the Koreans did before', according to Phillip Davies of Britain's inward investment agency, InvestUK. This is part of a growing two-way traffic.

China, with its 1.25 billion population and enviable economic growth rate of over seven per cent a year, seeks to integrate itself more into the capitalist world while holding on as much as possible to its own priorities.

These include feeding its people, freeing its entrepreneurial talent and making up for lost time by cherry-picking what the West has to offer and retaining as firm a grip on the state as possible.

In less than 20 years as a post-Communist economy, China has established itself as the most popular place for corporate foreign investment, beating the USA into second place as companies pour £6 billion a year into the country. By the end of July, £280 billion of outside capital had established 440,000 foreign-owned enterprises in China.

This mostly reflects direct investment projects. They range from Unilever's Walls ice cream factory in Beijing to a new £800 million investment by Britain's P&O into a container terminal in the port of Qingdao and a consortium, including design company Arup, designing a National Swimming Centre for the 2008 Beijing Olympics.

But there is more to the Chinese market than projects. Even foreign investors are no longer simply backing cheap-labour production for export but addressing a booming Chinese home market, too.

Earlier this year, the Sars scare, fears of economic overheating and a log-jam of planned flotations on local stock markets brought a pause in investment activity. But the longer-term trend is still inexorably upwards.

Tapping the talent

Simon Littlewood, chief executive of Aim-listed China-oriented investment group London Asia Capital, argues that many local entrepreneurs are making fortunes, as software and high-tech companies double turnover year after year and still fail to meet surging demand. Other UK corporate investors note that small and medium-sized private companies in China are maintaining annual profits growth of 30 to 50 per cent.

The launch of the Cambridge project follows the visit of a top-level mission from the London Stock Exchange to Beijing, Hong Kong and elsewhere in China. Its purpose has been to tell Chinese company directors and their advisers about what the London market – both the full LSE and junior partner Aim – can offer.

Charlotte Crosswell, the LSE's head of international developments, told a Chinese conference what help London could supply on corporate governance. She also staked a claim for London as a more competitive listing market than New York, with its rigid 'GAAP' accounting requirements.

One of London Asia's investments, Beijing Success Technology, a provider of analysis tools and data services to investors in China's domestic stockmarkets of Shenzhen and Shanghai, chalked up £1.2 million profits in the year to June. The company has been talking to London brokers about a possible float on Aim, though it has toyed with Singapore, where London Asia director Victor Ng recently floated environmentally-friendly boiler concern Devotion and attracted 120 times the money being raised.

Cathay Corporate Management, whose British holding company CYC Holdings, formerly known as CyberChina, is itself listed on Aim, hopes to tap this mood soon by floating at least two Chinese enterprises on British markets. One is involved in marketing petroleum catalysts, the other specialises in inputting ultrasonic data and, says Cathay's Michael McAllister, a third is waiting in the wings.

Littlewood claims there are now no fewer than 16 million day traders in the People's Republic. However, local Chinese markets can be extremely volatile.

Moreover, there are growing signs of temporary illiquidity on local markets as Chinese investors baulk at supporting massive infrastructure-linked issues, such as Yangtse Electric Power Corporation's plan to raise £800 million for the Three Gorges Dam, the world's largest hydro-electric power project.

The future excitement lies in smaller, often still private, entrepreneurial concerns, where, claims Littlewood, companies such as London Asia can buy long-term stakes on price/earnings multiples of three to five.

Dozens of Chinese and Chinese-linked companies are listed on Wall Street. Hong Kong, part of the People's Republic but with a special status, also lists many.

Unless the London Stock Exchange's present mission to woo smaller companies attracts more listings, UK investors seeking a 'pure China play' without simply buying specialist investment trust shares, will have limited choice. Five mainland Chinese companies have London listings, all in commodities and utilities.

China Petroleum & Chemicals, Zhejan Power Company, Zhejan Expressway, Jiangxi Copper and Beijing Datang Power are large undertakings. But they are hardly the most calculated to set investors' pulses racing from an economy which is growing as China's is.

Chinese factory output rose 16.5 per cent in the year to July, with exports up 33 per cent in the first seven months of the year at £142 billion, and imports 43 per cent higher at £140 billion. First-half house sales rose 45 per cent year-on-year to £16 billion, while demand for cars is soaring.

All this has made China a crucial element in the demand for and price of many raw materials. Aim-listed Celtic Resources bases its Kazakhstan molybdenum investment on China's surging demand for stainless steel, of which molybdenum is an ingredient.

This rate of growth has prompted fears of overheating (as well as several corporate scandals), while the USA accuses China of pegging its currency, the Yuan or Renmimbi, at too low a rate to the US dollar, thus exacerbating the US balance of payments problems and 'exporting deflation'. China hands say Beijing is unlikely to budge, without hefty blandishment.

But overall growth figures hide huge discrepancies between different sectors and regions. South China and other favoured areas are growing fast, with Shanghai's memories of its latest property bubble still vivid, but outlying areas are lagging.

High-tech and financial services companies are thriving, but some of the less well-adapted heavy industrial concerns of the old command economy are struggling. Agricultural productivity remains woefully low.

China plays look forward

The few 'China plays' now listed in London are often loss making or barely profitable at present. Doing business in China requires patience, especially in handling bureaucracy and cultural adaptation; 'face' is so important, says one player, that you should never let your name be second on a document for signing.

It is a case of being in the right place when today's spadework pays off. That will start to happen in two years, predicts Littlewood.

London Asia Capital, which paid an initial £163,000 in cash and shares for 25 per cent of Beijing Success with an option to take that to 51 per cent, says there is no shortage of able and ambitious entrepreneurs in the People's Republic.

The company says it pays to trawl in 'second-line cities', with fewer rival foreign investors. It expects to be able to float companies in China as well as London from 2005 onwards.

London Asia, which turned a £1.5 million loss into a £76,000 profit in the six months to last November, has backed Bialchi, a Chinese company publishing documentaries about China for foreign consumption. The group, which has taken 40 per cent of a Hong Kong investment firm headed by barrister CK Cho, wants to buy intellectual property from the West and strike licencing deals with UK publishing houses.

London Asia, whose shares have recovered from below 5p to 20.5p, also has 25 per cent of Temima, a would-be investment bank, for which it needs to show £4 million assets to obtain a licence. It wants to handle flotation and fund management.

Temima has a stake in Europasia Education, another ex-dotcom shell, which seeks to cash in on the Chinese thirst for languages and commercial training. Chairman James Holmes says the company runs courses enabling students to study for degrees and MBAs from the universities of Sunderland, Northumbria and South Queensland.

Europasia puts out training programmes and a 'Friends-style' sitcom on radio, attracting four million listeners, and has an educational web site with 50,000 hits a week. The company runs its own university at Shen Yang, with 700 students.

'It is a volume business', says Holmes, who says students pay £2,000 a year – 'half the UK level'. Floated on Aim at 5p, the company, which lost £2.7 million last year, recently raised £336,000 at 1.05p and is a long-term gamble on a booming sector.

The same applies to CYC Holdings, which blamed a temporary hiatus in investment activity and decision making for its £126,000 loss in the six months to April. Trading on Aim at a lowly 0.49p, the company sees eventual profits from floating Chinese companies it is nurturing on western exchanges.

Zinc from China's potentially huge Caijiaying deposit is the attraction for another Aim-listed company, Griffin Mining. Chaired by Australian financier Mladen Ninkov, Griffin estimates it has 1.2 million oz of zinc metal and 500,000 oz of gold in Caijiaying's Zone Three alone and wants to drill other zones.

Griffin, which lost a reduced £145,000 last year, recently raised nearly £3 million in two placings at 12p and 14p, but that has not reversed the shares' recovery from a bombed-out 3p to 18.38p now. Ninkov hopes for production in 2005.

Mining also interests Aim-quoted ARKO Energy, Aim-listed vehicle for Hong Kong entrepreneur KC Chin. ARKO made £3.6 million pre-tax in the nine months to December and is involved in the major Suizhou silicon project in Hubei province, as well as quarrying, mining, shipping and power generation.

Another miner is Caledon Resources, formerly an online auctioneer. The company is pursuing gold projects in southern China's Guangsi province and observers say deal are afoot.

Surrey-based Faupel Trading, chaired by former Hong Kong taipan David Newbigging, has been designing, importing and distributing textiles from China for more than 50 years. It has suffered from the woes of the textile sector, losing £875,000 last year, but it has been slimming down and economising and its Aim-listed shares have lately rallied from 15p to 24p.

It is a long game in China. But there will be some big winners.