Chinese Technology – Selective reprieve

The regulatory shadow mostly passes.

• China has moved to end the uncertainty that has been plaguing its technology sector with a statement that promises an end to the crackdown and recognises the VIE structure used for overseas listings for the first time.
• However, I think that this statement is selective and that for some sectors and companies there will be no reprieve.
• The results of a financial stability meeting chaired by Vice Premier Liu He clearly signal that China has enough of shooting itself in the foot and instead wants to encourage its growth from here.
• The news underpinned a massive rally in the sector with Alibaba and Tencent both moving by more than 20% and on very large volumes of shares traded.
• Chinese State Media reports two important resolutions from the meeting.
  • First, foreign listings: State media states that “The Chinese government continues to support various types of companies to list overseas” in the first official recognition of the variable interest entity (VIE) structure used for overseas listings.
  • Non-Chinese persons and entities are not allowed to own Chinese shares and so companies are set up overseas (VIE) that have contracts with the Chinese company that emulates its financial performance.
  • These shares are listed in Hong Kong directly or as depository receipts that are then traded on the NYSE or NASDAQ and serve as a very accurate proxy for investing in the underlying company.
  • The problem is that in Chinese Law, the VIE is technically illegal but has existed in legal limbo for many years.
  • Hence, one fear recently has been that China would enforce the law and render all shares in VIEs worthless overnight.
  • However, with this statement, the Chinese state has basically endorsed the structure meaning that this risk has been reduced back to the very low levels it was at before the crackdown started 2 years ago.
  • Second, end of the crackdown: State media states that regulators should “advance and complete the rectification work of large platform companies” which I think means that the end of the crackdown has now been ordered.
  • CNBC (see here) seems to think that the Chinese state wants this done as soon as possible but I cannot find any reference to this in the machine-translated version of the statement (see here).
  • This obviously implies that there will be no more new crackdowns and those that are ongoing will be completed fairly quickly.
  • Third, general tone: The statement is full of commentary around protecting property rights, being favourable to the market as well as stability and consistency.
  • This is a strong indication that the Chinese state has realised that its policies have caused great damage to its own technology sector and that it needs to ease up.
• Hence, I think that the end of the crackdown is now being signalled and that the VIE has now been officially endorsed meaning that its future is now secured.
• However, I think that this is a selective reprieve and there are some sectors and companies that are still in deep trouble.
• Hong Kong listings are foreign in China’s eyes and so it is not clear if this vote of support is also extended to those listed on NYSE.
• It also does nothing to reduce the hostility of the SEC towards Chinese companies where it has (deliberately in my view) made new regulations that US-Listed Chinese companies cannot comply with.
• (The regulation demands disclosure of audit documents that Chinese law prevents Chinese companies from disclosing).
• This gives the SEC the power to delist any company that it sees fit and it may well apply this power very selectively.
• This means that the US-listed Chinese companies still have to deal with this issue but those that are dual-listed like Alibaba are in better shape as they have a place to go should they leave the NYSE.
• Tencent is in the best shape of all as it is only listed in Hong Kong which is quite probably the end game for all Chinese companies seeking foreign capital.
• Other areas that are still in trouble are the after school education sector which regulation has effectively put out of business and Didi global.
• While the Chinese state has said that things are not going to get worse, it has not repealed any of the recent regulations.
• Hence, Didi still cannot list in Hong Kong although it may now be able to remain listed on NYSE at the whim of the SEC.
• The Chinese state still has an incentive to see Didi go out of business due to its investments in a rival and its apps remain suspended on the app store.
• Hence, I think that Didi’s troubles are far from over but for Alibaba and Tencent, there is now a route to return to business as normal.
• I have long highlighted the risk of regulations at Tencent’s very large financial services business, but this statement would indicate that this is not going to happen.
• This strongly implies that what happened to Ant Global had very little to do with orderly markets and everything to do with cutting Jack Ma down to size.
• Hence, I am now less worried about Tencent, but the real upside has to be in Alibaba whose valuation has been slaughtered.
• Hence, I am sitting tight hopeful that this is the catalyst for a recovery in the valuation, but it would have been nice to have had the opportunity to double up at HKD40 although my risk management department probably would have nixed the idea.