USA vs. China – The authoritarian moment.

China shoots itself in the foot.  

• China is moving to punish Chinese companies that are listed overseas or have large foreign shareholders in a damaging move that will ultimately damage the development of technology in China handing an advantage to the USA.
• China is expanding its probe of Didi both in terms of severity and in terms of the companies affected which has sent the entire Chinese technology sector into a tailspin.
• Full Truck Alliance (truck booking platform) and Kanzhun (job recruiting platform Boss Zhipin) will now also be subject to this investigation which aims to “address national data security risks, maintain national security, and protect public interests”.
• This is far more than just a probe as new user additions have been suspended for Didi, Full Truck Alliance, and Kanzhun until some point in the future when the regulator is happy for them to resume.
• It did a similar thing to Jack Ma’s Hupan University and despite Jack’s withdrawal from Hupan, enrolments still seem to be suspended (see here).
• The situation for Didi, Full Truck Alliance, and Kanzhun is far worse because all three of these have recently listed in the US at high valuations that require rapid growth in order to maintain their valuations.
• This move will badly undermine the revenue growth of these companies posing a grave threat to the valuations at which they trade.
• The regulator has also ordered that the Chinese app stores remove the Didi app which won’t affect the users that are already users but will stop anyone else from signing up.
• It will also prevent anyone who upgrades to a new smartphone from migrating their account to the new device without side-loading.
• This won’t work for iOS users and so Apple users will not be able to use Didi on their new devices for the foreseeable future.
• The regulator claims that these actions are to prevent the leakage of Chinese data to hostile powers (i.e. the US) but its reasoning here makes very little sense.
• For example:
  • First, US listing: the only difference between Chinese companies that are listed in Hong Kong and the USA is geography.
  • The disclosure requirements of the USA are not particularly more onerous than Hong Kong and none of these companies have operations in the USA as a result of their listings.
  • Consequently, in terms of public information, there is very little difference, if any, between being listed in Hong Kong or New York.
  • Their servers and operations remain in China and there is no requirement to disclose any of this data to the US government as a result of the listing.
  • Consequently, I think that the concern that sensitive operational data may leak to the USA purely as a result of being listed there has no merit.
  • Furthermore, most of these companies list as depositary receipts which means that the company lodges its Chinese shares with a depositor which then issues receipts denominated in USD that correspond to the local shares held.
  • Depository receipts have lower disclosure requirements than full listings meaning that in some cases more data may be available from the Hong Kong listings.
  • Second, Foreign shareholders: the regulator also highlights a concern that companies with large foreign shareholders such as Didi (Softbank and Uber) or Alibaba (Softbank) suffer from an increased risk of sensitive data leakage to foreign powers.
  • I think that this concern also has very little merit as in no case that I am aware of do foreign shareholders exercise any meaningful control over these companies.
  • Alibaba is effectively governed by a China-based committee (with CCP members) with whom the foreign shareholders are compelled to vote with and Didi is controlled by its two founders.
  • Hence, there could be no leak of data (other than by nefarious means) as a result of foreign shareholders without the consent of groups based in the mainland.
• What this really adds up to is a move by the Chinese government to disincentivise Chinese companies from listing in the USA and for those that are already there to delist and come home.
• The regulator has thrown these companies a small bone in that today is a USA holiday and the shares of these companies will not trade today giving the market a day to digest this latest news.
• This has spooked the entire technology sector in China with Tencent down 3.6%, Meituan down 4.6%, Kuaishou down 5.7%, and Alibaba down 2.7%.
• Didi was already down 5.6% on Friday but the widening of the probe and the greater impact on its fundamentals is almost certain to hammer it hard when it opens on Tuesday.
• The same is likely to be true for both Full Truck Alliance and Kanzhun both of whom have just listed in New York.
• All of these companies have stated that they will completely and strictly comply which is very different from the reaction of US, European, or other Asian companies who typically fight draconian regulation all the way to the courts.
• Consequently, this again underlines the degree to which the CCP has power over the economy and its willingness to undermine the growth of its technology sector for the sake of “national security”.
• This is a very bad sign for the performance of the sector overall.
• This will mean less capital being made available for investment and less cash flow to invest in R&D going forward.
• This is a boon for the USA in its mission to stem the rise of China as these draconian regulations are going to hurt technology development in China handing an advantage to the USA.

Investment implications

• It also greatly increases the risk of investing in China where I have a position in Alibaba and the Chinese banks.
• The Chinese banks are state-controlled and so regulation so far has moved in their favour (see here) which combined with their 7% dividend yield does not compel me to sell them as a result of this move.
• Alibaba, on the other hand, is a completely different matter as it is one of the biggest and best-known overseas listings that China has.
• However, the shares have already been hammered by regulatory issues which I think are largely now behind it (see here).
• However, the risk of Alibaba delisting in the USA is rising fast which means that US-based shareholders would be forced to sell creating an avalanche of shares onto the market which would artificially depress the share price.
• Alibaba’s Hong Kong listing has strong support around the HKD200 level which it is pretty close to at the moment and the fundamentals comfortably support a valuation of around HKD340.
• However, a US delisting could artificially suppress the share price to a level that could be well below HKD200.
• I still think that this is quite an unlikely eventuality as Alibaba has already been chastised by the regulator and has promised that it will behave itself in the future.
• Hence, I think that the regulatory risk is largely behind it, but should it delist, I would look to increase my holding as the forced sellers dump their shares into the market.
• Hence, I am sticking with Alibaba (I hold the Hong Kong listing) as the upside risk versus the downside risk still very much favours a long position.