A letter from a VC to an LP

Text | Jiaxiang Shi

Editor | Jing Liu

At the beginning of the new year, a long PDF file began to circulate in investors' groups. This document titled "2023 Annual Letter (Chinese Version)" is the annual letter that XVC customarily sends to its LPs. Based on the limited perception of "Undercurrent Waves", this might be the most widely spread one in the past few years.

As usual, the letter starts by presenting this year's returns: As of October 31, 2023, XVC's total investment cost was RMB 3.6694 billion, and the book value was RMB 6.7802 billion, with a gross internal rate of return of 27.66%. Compared with last year, XVC's total investment cost increased by nearly RMB 400 million, and the book value increased by nearly RMB 100 million.

Founder Boyu Hu admitted that the gross internal rate of return was lower than at the end of last year, which was related to the difficult external environment. "This year, most of our invested companies did not conduct a new round of financing, so the valuations of these projects remained basically the same as last year." He also said this last year. This means that most of XVC's invested companies did not conduct a new round of financing for two consecutive years.

XVC is an epitome of the golden era of Chinese venture capital. Launched in the second half of 2016, XVC raised a new fund of nearly $200 million as soon as it was established. Boyu Hu once said that the name XVC implies that the new fund can think independently like the independent variable "X".

Although the ability to express is always an advantage for VCs, there are differences in levels. Compared with overly grand or overly microscopic descriptions, Boyu Hu's articles always resonate more: In addition to his better language skills and abstract thinking ability, the more crucial factor might be that he is willing to expose an investor's thinking process. In an era where projects and trends change at breakneck speed, this requires not being afraid of being proven wrong.

XVC has indeed been "proven wrong": In an industry where many people don't think research is important or even necessary, Boyu Hu has always emphasized "research-driven"; however, his past research, which was more focused on things, led Boyu Hu to suffer a setback with "Dailuobo". This seems to be a huge irony. Of course, perhaps more importantly, in an industry where people make money quietly, those who talk more will inevitably face stricter scrutiny.

This year is the eighth year since XVC was founded. For a VC firm, it has reached an age where it must distinguish the true from the false. If XVC is compared with US dollar funds founded in the same period, its performance may not be outstanding, but there doesn't seem to be a significantly better candidate. At least for now, none of the US dollar institutions founded in 2016 seems to have clearly outperformed their competitors in terms of investment and fundraising.

This proves a proverb: Investment depends on timing, and running a fund depends on the vintage year.

Boyu Hu listed four companies in the annual letter: Ba Wang Cha Ji, Yup, Yuanding, and Laifen. Among them, the annualized gross revenues of Ba Wang Cha Ji and Laifen have exceeded $300 million. Boyu Hu once said, "Investment is a game of finding whales." I wonder if these can be considered "whales" in his eyes.

The following article is an excerpt of the important content from the 2023 annual letter, and some of the content is from previous annual letters:

Investing in a Founder Who "Couldn't Read Before the Age of 18"

The most eye-catching case in the year-end letter is Ba Wang Cha Ji. This is also Boyu Hu's most comprehensive description of this counterattack brand. It reveals many unknown stories, and one key piece of information is about the company's founder, Zhang Junjie.

Boyu Hu said that when he first communicated with Zhang Junjie, the latter told him that he had never been to school. His first reaction was that Zhang hadn't gone to college, but later he found out that Zhang had "never received basic education at all" - he was wandering from the age of 10 to 17, so he couldn't read before the age of 18. So much so that when Boyu Hu was writing on the board for them later, Zhang would still write some characters in pinyin.

Even though the catering industry is a down-to-earth one, it is still a legend that a founder with such a resume could stand out in the 21st century.

However, a VC firm will inevitably have doubts about whether to invest in such a founder.

So Boyu Hu said that in subsequent communications, they "kept asking questions". They found that Zhang Junjie had strong self-learning ability and had read many audiobooks. His understanding of business models and insights into management were even better than those of most CEOs Boyu Hu knew.

XVC spent a whole day talking to Zhang Junjie's core team to understand how he observed people, what he did to attract and motivate them, and what mistakes he had made in organization in the past. Finally, XVC unanimously agreed that Zhang Junjie was a confident, intelligent, and humble person with high emotional intelligence. A sign of this was that in the early days of Ba Wang Cha Ji, he successfully attracted several core executives from HeyTea to join the team, including a co-founder of HeyTea.

There is also an episode here. Initially, the company had three founders. Zhang Junjie was the founder and chairman, and the other two partners were the CEO and an executive respectively. The combined shares of the two were more than Zhang Junjie's, and they actually managed the company, but their ideas for the company's development were very different from Zhang Junjie's. Zhang Junjie's ideas were obviously more long-term oriented.

After investigation, XVC believed that Zhang Junjie was more suitable to be the CEO. They spent an entire night interviewing Zhang Junjie and communicating with the new senior executives he planned to introduce one by one. Immediately afterwards, they quickly held a simple "investment decision meeting" on-site and decided to help the founder buy out all the shares held by the other two partners and completely replace the existing management team.

From the first meeting with Zhang Junjie to completing the research and issuing the TS, the whole process only took 7 days. This investment exceeded their investment in Weee! and was also the largest check XVC had written since its establishment.

A Potential Home Run Investment

At a sharing session in March last year, Boyu Hu predicted that by March this year, the total store sales of Ba Wang Cha Ji could reach about RMB 10 billion, and the profit could reach about RMB 1 billion. "After that, it is also reasonable to expect the company to achieve sales of RMB 20 - 30 billion." He specifically mentioned that XVC was the first-round investor, holding nearly 20% of the shares. "So when this company goes public, it can return about twice the total amount of money we've invested historically."

In the past two and a half years, Ba Wang Cha Ji implemented a "super single product" strategy, focusing entirely on fresh milk tea made from original tea leaves, and reducing fruit teas to only products like "lemon" and "coconut" that have no seasonality and are extremely easy to standardize. In the end, the single-store sales of Ba Wang Cha Ji almost quadrupled, and the top 5 single products accounted for nearly 70% of the sales.

With long-term accumulation and sudden emergence, in 2023, Ba Wang Cha Ji's turnover witnessed rapid development. According to their year-end letter, the number of cups sold per store of Ba Wang Cha Ji was already three times that of Starbucks, and the average monthly single-store revenue was twice that of Starbucks. The strategy of stable, rapid, automated production and rapid franchise expansion allowed Ba Wang Cha Ji to earn the money that Cha Yan Yue Se didn't.

In July last year, Bloomberg reported, citing sources, that at least six Chinese chain tea beverage companies were planning overseas IPOs. Among them, Ba Wang Cha Ji had cooperated with Bank of America and Citigroup to explore the possibility of an IPO in the United States; however, the next day, Ba Wang Cha Ji responded that it had no definite IPO plan at present.

At the beginning of this year, Mixue and Guming submitted their first applications for listing on the Hong Kong Stock Exchange, and the case of Nayuki's Tea, the "first new tea stock", came before. This at least proves that Ba Wang Cha Ji may become XVC's first IPO harvest.

It's estimated that Boyu Hu couldn't have imagined that Ba Wang Cha Ji would eventually become one of XVC's representative works - this is also an upside surprise. After all, before HeyTea was favored by investors, offline consumption was not considered to have enough potential for imagination.

"Scarce Characteristics"

This year, the title of XVC's annual letter is "Focus on Finding 'Scarce Characteristics'". In Boyu Hu's definition, scarce characteristics have three elements: PMF (Product-Market Fits) driven by long-term structural changes, the founder, and a self-reinforcing learning curve with limited anti-scale gravity.

Despite the poor market environment this year, XVC's invested companies still performed well. In the first three quarters of this year, the total gross revenue of 37 core projects under management increased by about 60% year-on-year. It is estimated that for the whole of 2023, this figure will reach about $4 billion. That is to say, the average annual revenue of these projects exceeded $100 million.