Lei Zhang: Founder and CEO of Hillhouse Capital (Talks at GS)

I have the pleasure today of introducing Zhang Lei. Zhang Lei is the founder and CEO of Hillhouse Capital, Gaoling. Hillhouse was one of the first investors in China to invest in the internet space and is today considered one of the most successful managers of funds in the world. Since founding the company in 2005, with $20 million of seed capital from Yale University Endowment, Lei has grown Hillhouse funds to over $60 billion in 15 years. Please join me in welcoming Zhang Lei. OK, so with that as a start, let's go back to the days when you were in school. And as I understand, you actually were an entrepreneur, even at the age of seven, renting comic books. So what do you think of entrepreneurship?

Is that something you can learn, or is that innate?

When I started off my business, I had no idea what I wanted to do. But when I got this only one investor who believed in the vision, the vision was, you know, just do things that you think make sense. Unfortunately, in this world, many things don't make that much sense. So that's actually a pretty high bar. Let's first say, 'You only do small, early-stage venture.' I think, well, on one hand, you could argue that we have the most flexible mandate in the world. But on the other hand, I would say we have a very high bar that you have to do things that make sense, that you truly believe in. I think that's point one of entrepreneurship: doing something you truly believe in, not because other people are doing it or not because it's hot.

It's somewhere like because everybody wants to be in the game. Second, I was born in a small town called Zhumadian in Henan Province. My home is actually pretty close to the train station, so we got a bunch of kids sitting together, renting comic books to the people who are waiting in the train station. We were kids. You rent five books, you can get some street food afterwards. You know, fortunately back then the business was doing well because Chinese trains were always slow, always late. Not like today, right? But, you know, looking back, I think the whole, you know, how much change and how many new opportunities being created in China over the last 30 years, it's unbelievable. And you can talk about the opportunities, but I think the one thing I want to focus on is really about the people, the drive, the energy that people want to do something, change, and change for the future, change for the better.

So I've always been inspired by the entrepreneurs' relentless pursuit of what they believe in.

And did you have that element, that quality in you at an early age where you're hungry, you wanted to go for change? Is that in you earlier on in your years or did you learn it from someone else?

It depends on who you ask. If you ask my mom, you learn it from her, right? But I think, I don't know, I wasn't a great student when I was in—up until a year before the college entrance examination. So I wasn't sure even what I wanted to do when I was in college and graduate school. But there was something that really got me interested is really, I just feel much more connected with people who have a lot of passion in what they do. And that turned out to be entrepreneurship.

So Lei, let's just go to Hillhouse, right? So Hillhouse, the name came from the street where, when you were working at Yale Endowment, it was called Hillhouse Avenue, as I understand. But in Chinese, it means where you're standing tall, standing high, looking at a commanding position and down, and so you can see very wide. So is that affecting how you're making investments? What type of investment strategies are you adopting? Is it the East or the West?

We would argue that it's a good combination of the Western philosophy and also particularly some of the investing principles and Chinese philosophy. Here I don't have to tell you all those Western philosophies, particularly learned at Yale, about being a long-term investor, being thoughtful, and being equity-oriented, really believing in entrepreneurship. But when you think about the Eastern philosophy, the Chinese philosophers, I talked about how Taoism believes in, really, wu wei, and Buddhism that believes in, there's thousands of drops of water, you only need one bottle to quench your thirst, right? And there is also, like, like, Chronicle of Times that talked about the idea of the trees, the peach trees, plum trees don't talk, but people beat a path to find them.

So if you do good things, do great things, entrepreneurs will find you and work with you. That's how Hillhouse is set up. I think it's interesting. We manage $60 billion. Our investment team actually is relatively small.

How many people do you have?

45 people, relatively speaking, for our size. The reason why is we don't have a massive coverage team. We believe you do the right things, you build your reputation, you stand up for the value that you believe in, and entrepreneurs will beat a path to find you. So I think that's a similar philosophy. That also helped me to keep staying grounded, to be a true entrepreneur and true investor, so that I don't just become a pure manager. So those are the thinking behind how we build the organization to look for things that are meaningful to what I believe.

Yes, and let's just look at, you look at thousands of companies a year. You pick a select number of companies that you think will be the winners in the future. What qualities are you looking for in people that attract you? And what qualities do you avoid when you're making investments?

Well, I think you can talk, there are many great qualities, you know, the persistence and smarts and really teamwork, all those. I think there are so many things we can talk about, and most of them are not mutually exclusive, but I would emphasize a couple of things. One is empathy. I think the ability to connect with people who are different from you, and I think that we see great entrepreneurs somehow will always have that unbelievable empathy to their customers, to their employees, even to their competitors. And the best entrepreneurs do not necessarily view competitors as a zero-sum game, and they think about how competitors work together to nurture the market. I think that having that vision, what I, in Chinese, I think there is a better word for it, they call it...

I don't know how to translate.

It's like you can read the room, right? They can read the world.

Yeah. You can see the trend. You know, I look for that, you know, like whatever the word, how to say that in English. But I'm just looking for that. I think that's the ability to say, "You know what? Even my competitors, I kind of view them as very positive forces to my business." So that's, I would say, that's something I particularly appreciate. And secondly, I would say that the beauty of, you know, the lifetime learner, somebody who just loves learning, not because I want to learn to make the most money, just because I love learning to be a better person every day. So I see the best entrepreneurs as just amazing learners, even with all the success they've had, keep on learning, intellectually curious, and so driven.

Not by, uh, necessarily scores of victories, but because of the nature of learning and, and the ability to pursue the truth and finding out about the truth, obviously also added with the humility of pursuing truth but also knowing that you never always owned the truth, but always wanted to be one step closer to the truth. I think having that... Finally, I will see a person who can build a culture so that the culture... I've seen many different types of cultures in Chinese companies, and some of them you can say like wolf, could be a lone wolf or wolf pack, but it's a wolf culture. Wolf culture. Wolf culture, it's very aggressive and win at whatever cost. But you have the other side, it's like family culture.

Oh, everybody's a family member. Very nice, you know, like, feeling good. But I'm not sure those are the two cultures I particularly like the most. The culture that attracts me the most of an organization is the entrepreneurial, to build a culture like a sports team. It's like, 'I want to win.' It's not like, 'Oh, I'm family, everybody feels good,' you know? It's like, 'I want to win, but I want to win in the sports arena, play by fair play, play by rules, play by team, and also knowing that I can lose in any particular game, but I can be better next game.' That's just hard. I see that. I start to see that develop by the newer entrepreneurs to have that sports team culture. That I'm looking for. So I'm looking for the empathy, lifetime learner, and a culture of sports team.

You have a lot of very exciting examples about the changes that you're investing into. So first of all, the first question is, what are the changes you're seeing that are happening? What are the trends you're observing? And second, how are your portfolio companies or investee companies investing in change?

Yeah, one of the most exciting things of investing in China is that you're always embracing changes. And one of the most fascinating changes in the past had been on the consumer internet. I think if you look at the evolution of the Chinese technology companies, the first wave came from, you know, PC internet companies, the likes of Baidu, Tencent, Alibaba—the BATs. But you're literally looking at the core essence of the BATs. They are really just connecting. So then, Baidu connecting people and information, Alibaba connecting people and goods, and Tencent connecting people and people. And you could argue that in today's world, maybe Toutiao connects you to people and information in a different manner—instead of search-based, recommendation-based.

Or you could say Meituan connects you beyond goods now into services. But in essence, it's about connection and making that connection work. I think now we're entering into really the second wave, what I call Innovation 2.0, is that it's not just about connecting anymore. It's not about 'Internet Plus' anymore. It's about 'Plus Internet.' It's about the majority of the Chinese companies who are leveraging technology, internet, AI, to be the innovation drivers. They are traditional companies. They could be traditional companies leveraging SaaS and software. They could be a pharmaceutical company leveraging biotech and life science. There's just so many more innovations happening beyond the top

20% of the companies. So I think that's one of the most exciting things you could... In Chinese, they call it 'industrial internet.' I'm not sure that's totally right.

Yeah, I'm not sure that's right. Okay, so I think the idea is getting innovation to penetrate into all kinds of different businesses and make the traditional businesses and other businesses to be the drivers is very interesting.

Can you share with us an example? Because I understand, you know, you did a huge acquisition of one of the largest shoe retailers in China called Belle, and so you made a lot of changes there as well, which has to do with technology. Can you share with us that example of, of what you did there and what you're seeing the trend is in the marketplace?

Sure, sure. So Belle was not in a good shape. When you think about it, it's a shoe retailer and being eroded by multiple headwinds. The internet guys are eating their—Alibaba and JD—and taking the e-commerce away from the offline retail. And also, the whole world is, is moving away to a much faster trend of fashion. Before we bought it, the company was in decline for like 14, 18 quarters of decline. Now, year three into our ownership, the company had been generating double-digit growth. What happened was, we actually, we look at the company, we see, 'Oh, actually, this company has so much assets and data and knowledge and people that they don't necessarily view that as assets. They didn't know that.'

For example, every day, they have over 100,000 employees servicing potentially 30 million people, visiting, over 150 million items being sold in their 20,000 shops throughout China. But this is the scale of the business. But all those customers to them are faceless. They don't understand who they are, they don't understand their purchasing behavior, and all those employees are demoralized because they have to, they basically become just the box movers and filling the forms. So we, thinking about, we look at this to say, how do we actually make our employees, make our store clerk to be the, best UI, UE, to be the best user interface and user experience? How do we develop tech tools? So we're actually using many software companies where now Belle is actually now one of the largest tech buyers of all the software companies, many of them,

from our portfolio companies that are helping them to make the employee more productive, as a result, make them feel more helpful to the consumers. Right. One example we talked about is that, for example, we put some RFID in one of the brands called, which is, so that we could know what particular SKU is being viewed and touched, let's say 30 times a day, but no purchase. Never purchased. So we know right away in the center, to know, the factory to know, 'Oh, maybe this pair of shoes looks sexy but not comfortable to wear.' We can fix it right away instead of waiting until the end of the season and discount it and don't know why. So now we can respond much faster. As a result of that, we also brought our internal consulting team, which is a team coming from Danaher.

So we brought in, called, a lean manufacturing practice, Lean, into the Belle manufacturing. So as a result, we are able to reduce—not reduce the cost, actually, Belle was already an amazing, mass-scale, low-cost producer because they are the world's largest shoe manufacturer. But what they're not as good at is how to make it much more flexible manufacturing so that we can produce and put into the stores on every four pairs instead of every 4,000 pairs. So that system helped us reduce the inventory time by more than 30 days. That's all capital. That's like our working capital, free cash flow.

Shorten.

Yeah, shorten, yeah. Then increased, helping us, using that free cash flow, to invest in brand and better quality, and more importantly, we actually have less inventory to discount so that we protect our brand better. So we respond to consumer needs better. This sets the foundation for our future mass customization. Hopefully, we will be able to really customize in the future as well.

So let's change gear a little bit here and let's talk about what you do outside of Hillhouse, which is, or in Hillhouse for that matter, philanthropy. You have a very strong focus on education. We heard about your experience at Yale. You also started Hillhouse Academy with Renmin University. So share with us what you have been doing in philanthropy and why education is a special focus for you.

I think there are no better thing of investing than investing in education. We always said that investing at a Hill House level, we always, while we're joking internally, saying the best investment is the investment that you don't need to think about exit. I think there are no education exactly like that. Because you can just keep on compounding with human capital that people can really invest in education the best way that we can actually bring up the next generation, particularly relevant to today, when there's so much technology gap between who have and have not. And actually, one of the reasons I'm here is yesterday, two days ago, I was in Hangzhou with our board meeting at Westlake University, which we- Xihu.

Xihu Daxue, of which I was a founding donor, and we started, I wanted to mention Westlake because this is a new phenomenon and that within, I'm the chairman of the development committee of the board also, within a couple of years, we were able to raise over almost like five billion RMB from the Chinese entrepreneurs. It's almost like 800, 900 million U.S. dollars. Actually, if you count on the other committed capital, it's over a billion dollars. Very short period of time. And being able to do that is signaling that Chinese entrepreneurs, Chinese entrepreneurs are young. Most of them haven't thought about this. But I'm signaling the potential of change from being a dynastic culture to the culture of being able to give back and building the community and making contributions.

I think there are so many things that the early entrepreneurs who have been successful in their, been successful in their career and also be the role model for the future of philanthropy.

So with that, thank you very much, Lei, for your very precious time and for being here with us today.

Okay, thank you very much.