China vs USA – War of numbers

US delistings now very unlikely.

• The impasse over audit inspections by US regulators of US-listed Chinese companies seems to have been resolved in a clear sign that China has more to lose from delisting Chinese companies than the USA does.
• The row over audit inspections has been going on for more than ten years with the USA requiring that companies listed in its territory should submit their audits for inspection by regulators every 3 years.
• However, in China, it is illegal for documents to be sent to the USA for inspection which has led to this unresolved problem bubbling away below the surface for years.
• However, the trade war (which has evolved into an ideological struggle) has brought this issue back to the surface with the USA deciding in 2020 that the time had come to enforce its requirement.
• Enforcement entails the delisting of any company that does not submit its audits for inspection within a reasonable time frame.
• Over the last decade or so around 200 Chinese companies have been listed in the USA in order to benefit from the largest, most liquid financial market in the world as well as its tendency to offer superior valuations.
• Many of these companies have used the foreign money raised to develop and grow their businesses at home, demonstrating that China has benefited more from being listed in the USA than the USA has benefitted from having them there.
• The combination of a draconian regulatory crackdown and strict Covid regulations have hammered the Chinese technology sector leading to the Chinese government realising that it has gone too far.
• China fully intends to become the dominant technological superpower but has now realised that hammering your own technology sector and driving your best entrepreneurs overseas is not the way to do it.
• Smelling blood in the water, the USA regulators recently decided to enforce their requirement (Holding Foreign Companies Accountable Act 2020) which has put China in a difficult position as it needs foreign capital far more now than it did 18 months ago.
• It is the weakness that I suspect has led to the deal being struck on 25^th August where the documents required by regulators will be made available for USA inspection in Hong Kong.
• This is a good compromise as Hong Kong is technically part of China meaning that national security concerns around exporting sensitive documents can be overcome.
• Hence, this looks like a workable solution to me that I think will result in this issue finally being put to bed after many years of negotiation.
• The net result is that private companies listed in the USA are likely to remain so, but state-owned enterprises are likely to delist in order to avoid inspections that China thinks would compromise its national security.
• This has already happened to some degree, and I expect that it will continue.
• This removes another negative for investing in Chinese companies which I think continue to look extremely cheap in some cases.
• One of these is Alibaba which transacts more products than Amazon and has higher margins but trades at a tiny fraction of the multiple.
• Furthermore, sooner or later China will have to give up on its Covid zero policy or face years of economic pain which I think is a much greater threat to the rule of the Chinese state than admitting that it got Covid wrong.
• This will be the trigger for a turnaround in the Chinese technology sector, but I have no idea when this will happen.
• Until then, I think that it will bounce around current levels meaning that patience will be required.
• As a long-term investor in Alibaba, I am happy to wait as I think this is a question of when not if.