The most important event of the first quarter for our team was the Chinese New Year Spring Festival. The year of the Rooster symbolizes fidelity and punctuality, with its early morning crowing perceived as a call to action – urging us to roll up our sleeves and get to work. The holiday also rings in the busy season for us, with new deals commencing in earnest, annual budgeting finalized, and strategic planning meetings.

Macro discussions at this time last year centered on debt in the system, fiscal stimulus, and money flowing offshore. This year the focus remains on debt, asset price inflation, retail sales gains, and the stabilization of the RMB as capital outflows slow. Debt as ever remains the X-factor that weighs on valuations, perceptions and the risk premium many associate with China. The observers we trust the most believe this is not a systemic concern, but for every two in that camp, there is a Cassandra with the opposing view. What all should agree on is that the effects of last year’s stimulus measures are indisputably material. Retail sales running at double-digit gains continue to mirror the underlying trends we see in our portfolio companies, and in the pipeline businesses we are targeting. Chinese New Year sales reached RMB 840bn, up 11.4% year-over-year, with tourism up similarly to 100bn from 90bn last year. Overall, China’s long-term growth trajectory remains on track, namely:
(i) transitioning China from an export and investment-led growth model to one empowered by the domestic consumer, (ii) promoting global trade and commerce through initiatives such as One Belt One Road, and (iii) further liberalization of the capital markets. The recent announcement that the US will soon restart beef imports to China, which were initially halted in 2003, will provide an attractive alternative for Castle Snack’s to source more competitive pricing for raw beef for its beef jerky.

Capital controls have limited our ability to distribute investment gains, but money staying onshore has created demand for investment, including a surge in the number of domestic IPOs. Bloomberg reported that outbound takeovers by Chinese companies buying offshore assets are down 67% this year due to capital controls, the biggest drop since the financial crisis. Regulators continue to place obstacles in the way for getting funds offshore, which has helped the RMB stabilize to a far greater degree than anticipated. It has also made for very high breakup fees, something, to reassure, we very much have in place with exits we are working on.

Our industry is evolving as well. There is a notable uptick in demand for private equity from domestic entrepreneurs and founder/managers, which we believe will continue to serve China’s capital markets and our strategy well. Venture still attracts the most mindshare, and probably the most capital as well. However, in the more mature private equity strategies, we believe control continues to stand out as offering the best risk-reward, and we remain an early mover. Skillset and focus is winning out versus the pure capital, relationship-driven approach, and younger team members and management are at a distinct advantage as opportunities and structures evolve very quickly, especially onshore.

We are seeing a few key reoccurring themes and trends which continue to drive our investment strategy. Firstly, we remain focused on building scale through platforms and believe that rollup strategies work. Secondly, we will keep fighting for control. The more control we have, the better the outcome will be and the easier we find it to make improvements and scale our businesses. Thirdly, move quickly. China is the world’s most dynamic economy, and everything moves faster. Changing management, rationalizing product lines, or implementing change is better done fast and swift. Lastly, be mindful of leaving cash on the table. We were early to exit an investment we held in Hangzhou Kings at well above cost due to concerns over our status as a foreign shareholder. We chose to exit rather than propose creative structures to our LPs that could, perhaps, have retained our involvement despite layering on structuring risk. Hangzhou Kings went public domestically this quarter, and after trading at near its limit nearly every day since, the current valuation of the company would have implied more than 12x our invested cost. As we plan for future exits, we will work to educate our investing partners on where we may be able to take prudent risk to capture upside in situations where often structures require more work to understand.

That leads to the greatest challenges we face in our portfolio: modernizing thinking, continuing to execute, and accelerating the pace of all that we do. China today is about the new taking over from the old, modern outpacing traditional, China’s youth consuming much differently than their parents, and young managers moving faster and more creatively than their 45-year-old-plus peers. We believe that our ability to quickly modernize, whether in Castle Snack’s manufacturing operations, Yao Taitai’s products and packaging, or Yeehoo’s distribution, is truly where we can move the needle for our partners.

This Chinese New Year, we celebrate the 15th anniversary of China’s accession to the World Trade Organization. GDP per capita now exceeds US$8,500, up from US$1,200 in 2001, and the World Bank classifies China as a middle-high income society. Morgan Stanley believes China will achieve high-income status by 2027, yet China only ranks as the 75th richest nation per capita on earth. There is still a long way to go.

Highlights from our businesses
The strength of the Chinese consumer delivered for our companies this year, dwarfing any drag from the more sluggish aspects of the broader economy. Our businesses continued to grow revenue, with profits rising and the following notable accomplishments:

– Yeehoo ranked as China’s top babywear brand, tripled its November 11 Single’s Day e-commerce revenue, and attracted numerous suitors
– Castle Snacks completed two further acquisitions and reached domestic-IPO scale
– Lao Heng He quadrupled e-commerce sales growth, and doubled its traditional channel sales, two of our most important KPIs

Exits and distributions
We had success translating momentum into exits and generated distributions from several of our businesses during the year, which in total should return limited partners a substantial amount of capital. In most cases, comparable valuations for our businesses rose considerably, which will drive further uplifts in valuation. While we generally do not underwrite based on multiple arbitrage, we believe it presents us with tremendous optionality for additional upside.

Capital committed to new investments
We committed more than $100 million to new investments during the year. We were most aggressive in buying snack food companies, with the acquisition of Yao TaiTai, Orchard Farmer, and LifeFun. We also closed our investment in Honworld.

While this represents a growing amount of investment for us, it is still small compared to the size of the opportunity we are addressing. Far too small in fact. In critiquing our own performance, we believe that we have left too many opportunities sitting on the table, where we could have leveraged our platforms and driven growth at reasonable valuations. In babywear, for example, there were several large acquisitions we should have made, where investment and execution risk could have been mitigated by leveraging our market leadership. We missed similar opportunities in snack foods. We will work to better present these investments to our investing partners in the future, and ensure that we do not miss chances like these again.

Pipeline and investment focus
You will hear more from us about baby- and kids-related businesses, snack foods and condiments. Our team has strong conviction that our foothold in these sectors is an enormous opportunity to put more capital to work and deliver investment gains. We have about a half-dozen new platform concepts under serious consideration in areas like early education. We believe that we can leverage the large base of VIP customers we have built up through our Little Star Brands platform and provide Chinese families with more professionally run, higher quality educational services to compliment the clothing and supplies that our brands provide. We look forward to discussing similar ideas in travel, cosmetics, and other sectors with you soon.

Risk factors
We begin the year with more of the same concerns over a potential credit bubble, the weakening RMB, and the increasing the risk of some form of trade war. Domestic politics will also be a factor as the quinquennial process of making leadership appointments, including Xi Jinping’s likely successor, will occur.

Goldman recently postulated that a hard landing is likely over the coming three years. Morgan Stanley takes a different and very bullish view on China, believing that a shock will be avoided and a focus on domestic consumption and services will lead to high-income status by 2027. So, Goldman fears a crisis, Morgan Stanley urges focus on the long term positives, and, at Davos last year, George Soros said he was no longer expecting a hard landing, but already “observing it”! From what we see in our businesses, we believe that a series of soft landings occurred in 2008-09, 2012-13, and 2016. Together, these may be the speedbumps that slow growth, lower valuations, accelerate restructuring, and prevent the economy going off the rails. For now, we concur with Morgan Stanley (“[they are] able to navigate [it]”).

As for our investment strategy, we believe that for so long as China remains underdeveloped, with a high savings rate, reasonable asset prices, and a growing middle class of aspirational consumers, the opportunity to buy good consumer-focused businesses with the potential for growth at reasonable prices is compelling. We remain convinced that putting capital to work and mitigating risk through our operational efforts, disciplined focus, and ability to leverage control is a wiser course of action versus remaining underinvested.

Potential surprises
Readers of our year-end letter (and of Nostradamus’ works) want predictions. Below is a recap of how our forecasts from last year fared, and the trends we believe remain in place based on the feedback we receive from our businesses, management teams and dealmakers:

Last year we forecasted that the impact of one-child reform would kick in. And it has. CLSA recently reported that China’s birth rate recovered to 12.95% in 2016, the highest since 2001. Expect the birth rate recovery to continue near term with 18-20 million new-borns in 2017-2020 – a “mini baby boom” that will drive consumption. We also predicted liberalization of the Hukou System would fuel further urbanization and internal migration, which was premature but remains low-hanging fruit to drive future consumption, and we believe it will occur soon.

We believed that the upper middle class would surprise and deliver non-linear growth rates of premium consumption in areas such as healthy food, overseas travel, education, healthcare and higher quality apparel. This trend continues. Each of China’s online shoppers will spend US $473 on foreign goods this year, up from $446 in 2015. Luxury brands like LVMH, are reporting “better momentum after a tough 2015” as are Re?my Cointreau and Kweichow Moutai. “Re-shoring” of luxury is accelerating as China cuts duties on luxury goods imported through official channels, and cracks down on “daigou” (overseas personal shoppers unofficially bringing back grey-market goods). This dovetails with our channel checks that show better sales domestically, but weakness in places that cater to daigou, like Hong Kong.

We were correct in foreseeing that the weaker RMB and lower equity valuations would fuel M&A. The demand to acquire good companies we control is positively impacting our portfolio, although the weaker currency has led to outflows for China-focused fund managers, and macroeconomic concerns for investors globally. We expect the currency will continue to experience a managed decline, and that it is the volatility, not the absolute level, of the RMB that most concerns policy makers. The market will grudgingly conclude that China has the growth, reserves, policy tools and force of will to bring the RMB in line with fundamentals while avoiding overshooting to the downside.

We also called the narrowing of the valuation gap between domestically listed A-Shares and Hong Kong-listed H-Shares, especially in the consumer sector, although our belief that this would be fueled by a rebound in the valuations of H-Share consumer stocks, which traded sideways, was a bit off. For the coming year, we anticipate that the stock-connect, which provides domestic Chinese investors access to reasonably-valued Hong Kong listed companies and, indirectly, foreign currency exposure, will become too tempting to resist and offer reasonably priced yield, versus the very expensive growth on offer elsewhere.

We overstated the risk that businesses and startups in China “losing more to sell more” would rattle investor confidence. Enough unicorns were minted to prove us wrong. Going into the New Year, we still see an overabundance of capital searching for a home, especially in early-stage venture-land. Growth is overvalued, but expect nonsensical start-up valuations and the general dodginess in industries like peer-to-peer lending to persist for a while longer. Domestic equity valuations will also remain high. While the local markets are imperfect, the trend toward higher quality listings, better regulations, greater institutional participation and more overseas involvement combined with China’s extremely high domestic savings rate will keep valuations robust.

Priorities
Finally, we would like to recap our priorities for 2017:

First, we will continue making distributions and complete further closings for the exits we commenced in 2016. We believe we can do this while ensuring that these companies continue to grow.

Second, we aim to sell down our last two remaining investments in LCP-II, our vintage 2008 fund. To this end, we are off to a good start in 2017.

Third, we will optimize our remaining investments in LCP-III to achieve higher valuations, generate distributions and achieve industry-leading returns.

Fourth, we are taking advantage of the platforms we currently own to invest more capital, with a target of exceeding the $100 million we committed last year into further snack foods, sauces and baby/kids-related businesses and one new platform.

Fifth, we continue to build Lunar’s franchise and reputation.

As we enter the year-end holiday season, the world’s two largest economies will generate tremendous levels of shopping both online and offline, bringing the sheer scale of China’s consumer growth into sharper focus.

Double 11 – The online Chinese consumer is as healthy as ever
Sales during November’s “Double 11” promotion reached 120.7bn yuan, or US$18bn, up 32% YoY. Chinese shoppers were enticed to build their shopping carts early, and in return were promised discounts and lightning-fast delivery. The first Double 11 order on TMall was received 13 minutes after the purchase was processed online.
In the USA, an impressive US $3.34bn was sold during Black Friday, with Cyber Monday generating US$3.45bn in sales. Together they total less than 40% of what Double 11 achieved in a single day. Again – less than 40%. Moreover, 80% of Chinese purchases were made via mobile phones, compared to approximately 32% for US consumers.
We believe these numbers will continue to rise, even from such a staggeringly large base. China and the United States are both consumer societies and we are seeing Chinese express individually, spend savings and seek out a better life through shopping. China also has room to grow by tapping into less urbanized and rural customers. During our recent AGM, Alibaba executives discussed their plans to bring an additional 500 million rural Chinese online through mobile phones, regional drop-centers and better logistics. Page 3 Confidential

Lunar brands performed in all categories
Our Yeehoo babywear was the clear market leader with sales of more than RMB150m. Yeehoo staffed more than 1,150 workers across three 8-hour shifts to ensure that orders were fulfilled and customer satisfaction remained high. Our snack food businesses, Yonghong and Yao Taitai, also showed strong growth, showing that strong traditional brands can tap online channels for new growth.

The uplift from e-commerce and the strengthening economy overall should make for a strong year end. The middle class continues to rise, consumption grows, policies are favorable and a weakening RMB probably is having a stimulative effect.

We look forward to updating you in more detail at year-end.
 

在致力于将经济重心由出口及制造业转移之际，中国仍然保持着不断提高的可支配收入及较低的失业率，使人们对于消费业的增长前景越来越乐观。中国超过2亿中产阶级正在逐渐开始追求高端的产品，以及以健康、家庭和社交为核心的生活方式。

为改善生活质量而消费

麦肯锡最近的消费者信心调查显示55%的中国人相信他们的收入在未来五年内将得到明显的增长，而美国和英国数据仅32%和30%。同时，中国人的生活压力也由于购房等原因变得越来越大。

由清华大学发起的一项调查证明了中国人正在承受巨大的生活压力 – 88%的受访者认为自己“十分疲惫”，53%对自己的精神和身体健康不满意。另外，60%的白领认为自己的压力大多来自于购房以及还贷。

因此，中产阶级愈发关注身心健康，关注优质的产品和服务，以及营养均衡的饮食。尽管西式快餐过去在中国市场有着非常强劲的增长，今年来却逐渐下滑，因为消费者已经开始意识到“垃圾食品”所带来的危害。同时，传统碳酸饮料也正在遭受来自各种果汁产品的冲击。

营养与保健食品“十二五”发展规划正式出台，标志着政府也已经意识到民众健康意识的觉醒。著名市场调研公司英敏特预计维他命与营养补品市场将于2017年达到53亿美元，超出10年前的两倍。市场趋势促使越来越多的食品企业开始研究如何吸引关注健康的消费群体。在我们的旗下企业中，姚太太和永红都在推出健康概念的新产品以满足消费者的需求。

边购物边享受家庭时光

尽管中国已经超越美国成为世界最大的电商市场，实体店仍然是顾客消费体验不可或缺的一部分。购物休闲体验（retailtainment）成为了中国越来越重要的概念。2/3的消费者认为外出用餐和购物是与家庭共度美好时光的最好方式之一。因此，那些集购物、餐饮和娱乐为一体的购物中心成为了这种趋势的最大受益者。

奖励计划提升顾客忠诚度

越来越多的中国消费者开始只关注少数几个自己熟悉并欣赏的品牌，并体现出对顾客奖励计划的重视。因此，顾客奖励计划成为了解决中国消费者忠诚度问题的重要途径。另一方面，为了得到更高的顾客转化率，这种趋势也会在短期内为企业带来较大的营销成本。在云月的旗下企业中，小星辰品牌集团是最早推出品牌忠诚度计划并建立VIP顾客数据库的企业之一。通过这些措施，我们可以根据顾客的具体情况有针对性地进行产品推广。

总之，我们相信中国消费行业的前景。旗下企业优化运营的潜力、顾客消费习惯的变化以及中国消费者对生活品质越来越高的要求对于我们来说意味着未来几年内巨大的机会。

美国50后、60后群体的成长历程带动了美国跨世纪的产业变革; 而在中国，90后对消费的影响正在伴随其成长轨迹而递增：他们正在拥有越来越多的可支配收入、越来越高的生活标准以及对未来的期望。

以前，社会经济和政治不稳定因素酝酿了中国超高的储蓄率。今日，这些影响因素逐渐淡化，人们的消费习惯在重塑。90后一代人在独生子女的光环下长大，享受着更高的生活标准，以及父母随手就给的零花钱。这一代人随后进入了职场，并开始分配他们自己越来越高的收入。他们极度依赖网上消费和国外产品消费，表现出对潮品、奢侈品、新产品的极高消费欲望。随着90后开始成为父母，我们预期他们的习惯仍然会侧重于消费，而不是储蓄，这对我们的婴童服装平台-小星辰以及高端休闲食品平台- Castle Snack的销售增长非常有利。

中国90后的消费模式可总结为6个方面: 1）娱乐和社交， 2)好故事和能引起共鸣的产品及品牌， 3) 受日本御宅文化影响的消费4）与众不同的消费体验，5）信用卡主导的超前消费， 6）通过手机等移动平台的消费。根据北京大学和网易的联合研究，90后首选的消费是服饰，鞋和首饰，并且他们愿意为计划外的旅行、高端首饰和装饰品买单；他们的消费决定更容易受商业领袖、学者和名人的影响。

在云月旗下品牌根据消费者的喜好本土化以及开拓销售渠道的过程中，中国消费人群的偏好变化扮演了重要角色。在云月的生态圈里，英氏和姚太太在电子商务方面的成功证明了我们对于市场动态的合理把握。

姚卫忠花了半辈子的时间经营他在杭州的家族休闲食品企业，如今已经精力不济。由于22岁的儿子对打理家族生意没有多大兴趣，姚卫忠需要新的资金和专业知识来保持公司的发展。

因此，现年48岁的姚卫忠选择了越来越多的中国企业家走过的一条路：他把自己在姚太太公司的控股权出售给了一家私募股权投资公司。

他在去年12月把这些股份卖给了总部位于上海的云月投资公司(Lunar Capital Ltd.)。“公司遇到了瓶颈，”姚卫忠上周接受电话采访时说，“我到了这个年纪已经没有足够的精力，我的孩子不愿意接手生意。我也不能强迫他喜欢。”

从金融中心上海到煤炭资源丰富的山西省，面临接班问题和经济放缓双重挑战的中国企业家越来越愿意把公司的多数股权转让给收购公司。这表明市场发生了根本性的转变，从1994年中国对私募股权投资公司开放以来，为了能分享中国经济高速增长的成果，凯雷投资集团(Carlyle Group LP)和KKR集团(KKR & Co.)等公司有时不得不放弃坚持持有所投资公司控股权的条件。

企业重组

通过买下企业控股权，收购公司可以运用他们在发达国家市场沿袭了几十年的模式：收购价值低估的公司，通过削减成本、更换管理层和调整企业战略，扭转经营状况，而不会受到根基深厚的创始人的阻挠。

“毫无争议的是，这种收购控股权的做法在中国效果更好，回报率更高，”云月投资公司合伙人苏丹瑞(Derek Sulger)说。他表示现在依然很难找到大宗交易，尤其是在科技和教育等热门领域，所以私募股权投资公司转而把注意力放在了消费和零售行业小公司的交易上。

根据《亚洲创业投资期刊》(Asian Venture Capital Journal)的统计，涉及控股权变更的交易占去年中国私募股权交易总价值的34%，比2014年高出一倍以上。这家私募股权研究机构估计，不包括所谓的套利交易（通常涉及公司退市然后转到估值较高的市场上市），“控股权”交易金额从2014年的49亿美元增长到去年的68亿美元，创下历史记录。尽管如此，这类交易只占到中国私募股权交易总价值的13%。

无人接班

苏丹瑞说，他正在与至少10家中国企业进行收购谈判，这些公司的创始人或经理都打算退休或者出售控股权。其中有一家位于山西的休闲食品生产商，公司创始人的儿子去了加拿大读大学，在香港的一家投资银行工作过，现在就职于香港最大的会计师事务所之一。

“一个孩子从少年时期就离开中国，在温哥华地区的里士满长大，就读于多伦多大学，然后回国经营山西农村地区的家族企业，你怎么能指望这样一个孩子高高兴兴地接班？”苏丹瑞说，“这些企业创始人都是自尊心很强的人，他们希望看到自己的企业继续蓬勃发展，即使他们的子女不愿意接手。”

苏丹瑞说，“他们真正需要的是接班问题的解决方案，他们知道自己将面临这个问题。”

“夕阳产业”

中信资本控股有限公司(Citic Capital Holdings Ltd.)驻香港的合伙人信跃升(Eric Xin)说，他的公司正在与一家有20年历史的纺织企业谈判，这家染织企业主要向中东地区出口产品。由于该公司面临近年来销售额下降、劳动力成本上升和人民币升值的多重压力，现年46岁的老板想全部售出股权，搬到英国生活，打算让他的一个儿子在英国受教育。

“这是一家处于污染行业的工业企业，”信跃升说，“子女不希望从事这些夕阳产业，他们想当银行家和金融家。”

在许多情况下，促使中国企业家出售股权的纯粹是经济因素。2014年，中信资本收购了床垫制造商金可儿上海床具有限公司(King Koil Shanghai Sleep System Co.)的控股权。信跃升透露，中信资本在2013年末首次结识这家公司时，最大的股东并不想直接出售股份。半年后，由于该公司酒店业务的销售业绩每况愈下，库存越积越多，利润率降低，老板终于改变了主意。

云月投资的苏丹瑞说，他在寻找基本面稳健、可以通过专业化管理来解决经营难题的企业。苏丹瑞表示，以中国休闲食品企业为例，净利润率通常在4%到6%之间，只有海外竞争对手利润率的一半左右。

价格降低

中国对收购公司开放的最初几年，在能够获得控股权的少数情况下，这些公司不得不支付更高的价格。根据彭博汇编的数据显示，随着越来越多的公司进入收购名单，涉及所有权变更交易的企业价值中位数已经下降到过去12个月利润的7.2倍，远远低于2014年的11.6倍和2013年的17倍以上。

苏丹瑞说，企业老板也越来越愿意承认，他们需要私募股权公司的帮助来度过经济低迷时期，在市场营销、品牌推广和产品研发等领域掌握新的技能。

贝恩咨询公司(Bain & Co.)大中华区私募股权基金业务联席主席韩微文说，许多小企业老板从来没有应对过削减成本或进行彻底重组的困境，“这关系到降低成本、运营效率、转变业务模式和改变自身。他们从来没有做过这种事。”

反过来说，与经常发挥更积极主动的作用相比，许多收购公司也没有培养接管和重组中国企业所需的技能。韩微文说，“他们还要培养自身的能力，真正了解一家中等规模、创始人做主的私营企业如何运作。”

精神追求

姚卫忠在杭州接受采访时称，出售姚太太公司控股权（交易金额不详）的决定，让他可以专注于自己擅长的领域，比如在哪里采购产品中使用的坚果、果脯和添加剂。苏丹瑞表示，在云月投资给这家公司带来的诸多变化中，电子商务平台可能在未来创造高达20%的销售额。

对有些中国企业家来说，出售股权的主要动机是他们自己想追求更平静的生活。苏丹瑞提到，他正在谈判的两家公司老板都想退休，注重佛教等精神追求。

“由于中国经济增长现在有所放缓，你要用更睿智的方式经营企业。你必须更注重成本和电子商务等方面，”他说，“中国也面对着很多生活方式的问题。很多企业创始人想到温哥华生活和工作，很多人想投身于其他领域，比如研究佛学，还有很多人只想退休。” 撰文/Cathy Kit Ching Chan 翻译/孟洁冰 编辑/张晗

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