- Wealth PMS (50L+)
It’s the Great Stall of China. They’re beating up their tech companies and causing the investing world to wonder why they’d drop an axe on their own feet. What happened:
China just cracked down heavily on its homegrown technology companies. It started with the Ant Financial IPO in November 2020; one of China’s biggest tech companies supposed to go public in Shanghai and Hong Kong, fetching $37 billion. The IPO was canceled abruptly by regulators.
And that, it seems, was because Jack Ma, the founder of the giant Alibaba and Ant, had criticized regulators in a speech, saying they focussed too much on risk. The point wasn’t about too much risk, of course. The point was that in China, you don’t criticize anyone in power.
After the Ant IPO, Jack Ma disappeared for three months and returned what seems to be a chastised man. However, the Chinese authorities kept the pressure on. There was a record fine of 18 billion yuan (Rs. 20,000 cr.) on Alibaba, the Jack-Ma-Founded e-commerce giant which has an ADR listed in the US. Why? Antitrust, said the authorities; Alibaba apparently punished certain merchants that chose to sell on other platforms.
Alibaba also didn’t allow consumers to pay using its rival Tencent’s payment systems, to protect its own Alipay system. In return, Tencent’s WeChat app blocked access to Alibaba’s popular e-commerce services. Such concepts are of course undesirable, but in China, everything happens with political motivation; even if such things were earlier known, they might have been ignored – Jack Ma’s criticism possibly caused the change of stance.
The next biggie in line was Didi, China’s answer to Uber. Didi went public in the US raising $4.4 billion, but apparently, the Chinese cybersecurity regulator wanted it to wait. This too qualifies as a form of rebellion in China, and there was a quick reaction: the Didi app was removed from Chinese app stores and there’s an investigation going on to figure out how much to fine the company. The problem? Didi had to ensure the security of its data so that external investors couldn’t request or access it – China’s paranoid about this. In fact, there are rules that even prevent Chinese companies that are listed abroad from revealing data to outside regulators.
Then came another blow: China, like India, loves formal education. Like India, there’s a lot of demand for education in China. Where public schools cannot provide enough, there’s private education. In China, a bunch of education-oriented startups became big from “After School Tutoring” – AFT. The AFT shops have a huge demand due to the relatively difficult entrance exams and the fact that like India, a few exams determine if you win or lose in life.
Huge money was spent – and the tutoring firms even went public. However, Chinese authorities recently clamped down and said this: Private tutoring firms should only be operated as non-profits, and they cannot be listed. If they are listed, they can’t raise more capital or acquire other firms. This hit the sector hard, and the stocks crashed big time. Here’s one – TAL Education Group, listed on the NYSE, down 90%+ from a recent peak:
Similar drops have been seen in GSX Techedu, Gaotu Techedu and New Oriental Education group. The new rules have cratered the stocks, for good reason. If you can’t have a profit, you’re going to be shunned by investors.
Why the sudden rules? There are possibly many reasons:
Also, authorities in China demanded that food delivery apps must pay at least the minimum wage to each delivery rider, and curtail working hours, etc. This effectively provides workers with some more rights – probably something we will see in India too, and we are seeing in other countries – without needing to classify them as employees.
Tencent has rights to over 80% of all music tracks in China and apparently has required copyright holders to give the company a better deal than anyone else. Again, the government cracked down on this as anti-competitive last week, asking Tencent to remove its exclusivity.
The corresponding stocks also fell on this news, and it’s getting a little boring because they’re all falling on such news.
There are good micro-reasons for each of the actions: Controlling anticompetitive practices, keeping costs lower for education, protecting Chinese data, and so on. These are good rules, but it’s not that China is only now aware of the abuses – they chose now to make the rules strict because of other factors. This must have been triggered by the Jack Ma speech that criticized Chinese policies.
The macro, however, is a little complicated. For one, I believe this coincides with a few other measures which are inexplicable – like cutting of export subsidies and introduction of export taxes. Why would China not want to export? They have reached a point, I think, where they no longer need to subsidize exports and do not even want the forex. They now have literally lent money to the US and Europe in terms of owning dollars and euros as assets – and the US and Europe are hell-bent on printing the daylights out of their respective currencies. China can’t do much with the money – whatever they do only brings them more dollars and euros. Getting more dollars is not useful anymore, especially with some serious antagonism against China by the US government.
So, basically, they don’t care about the lack of FDI anymore.
In that context, hitting tech is a planned tactic. Investors that are hurt are largely American (funds, PE/VC players, and even retail investors) so if they choose to take their dollars out, that is not a problem. Not getting more VC money from the US is also a good thing, in that context.
And then, China wants to control its people. If a Chinese company lists in the US, the ability for the Chinese government to be able to control them is a little bit lesser – because the founder can emigrate to the US and still have access to his money. The idea of keeping data security strongly inside China, and not allow foreign regulators to demand China data – this is what any sovereign would want to do, and China even more so.
Another angle is that tech by itself has become a political hot potato. Facebook influences elections in other countries. Twitter has even banned a former US president. They control the ability of political leadership to communicate with the masses. In China, there is no Twitter and all that – but WeChat and other such privately-owned products are huge (even TikTok). The founders of these businesses have money, power, and fame. That is a lethal combination for the government to not have control, at least in China. (Eventually, such powers will be used everywhere, in my opinion)
Finally, China has one major problem with the world – the rest of the world wants some leverage over it. This is culturally and politically unacceptable in that country – they want to produce everything, and the entire supply chain of it, within China. There is therefore no way that anyone can control China by denying it something, and the Chinese authorities want to keep it that way.
One more way to build leverage over China is if other countries chose to hurt their companies. The arrest of Meng Wanzhou, Huawei’s CFO, in Canada over a trade-secret charge, and her subsequent house arrest for over two years has been viewed by China as a political war, since Wanzhou’s father and Huawei’s founder, Ren Zhenfei, has been close to the Chinese government.
There are many conspiracy theories, of course. But there’s very little we will know about the machinations of this country.
We don’t know. But here’s the thing: we will get “lumped” into the EM category with China. India, too, wants to protect its economy. We have high import duties. We have local data storage rules, which has meant that Mastercard, Diners, and Amex can no longer issue new cards in India. We don’t want the Amazon’s of the world to ruin our small businesses, so we have rules for how foreign-owned companies can operate. We require strong regulation of foreign banks, which has resulted in Citibank deciding to move out of India. India’s fight with Twitter is well known. We’re not exactly welcoming everyone with open arms. But it might appear, to a lazy eye, that India is a better alternative to China.
Even China was all nice and warm in the beginning, and only now has it become more demanding. For the foreign investor, it’s not really a place to deploy all the money thinking it will all be perfect. Some might place a small amount of money here, but that’s more in line with how big India is in the investing world (between 2% and 3%) rather than any move from China to India.
Worse, if investors get spooked about China and EM in general, they will yank money out of India too. Let me now show you how small we are in the scheme of things.
Our biggest equity mutual fund is the SBI Nifty ETF, with around 100,000 cr. in AUM. The next highest is about 42,000 cr. (a hybrid HDFC fund) or if you want to be only in equity, 36,000 cr. in the Kotak Flexicap fund.
Two US ETFs – VWO and IEMG – invest in Emerging markets. Each of them has around $80 billion in assets. And each of them has between 10% and 12% in India. Now 10% of $80 bn is $8 bn, which is about Rs. 60,000 cr. only.
Put another way, the Indian components of emerging market ETFs are big enough to be the second and third largest equity funds in India. This is how small India is in terms of investing depth for a world investor. If the markets are spooked about emerging markets, and say 20% of the AUM left these ETFs, that would result in an exit of Rs. 24,000 cr. – this is huge enough to cause a massive drop in Indian markets.
So yes, we might get some visibility, but we are so small that fund outflows will crush our markets in case investors really panic on China’s clamping down.
What is happening with tech stocks in China is probably what will happen elsewhere too – breaking up of the biggest tech companies (anti-competitive, etc), data protection and localization for law enforcement purposes, etc. Markets may be spooked today, but it’s going to happen elsewhere too. Perhaps not yet in India where tech companies have just gotten big enough to be noticed, but it will happen.
The question then is: in the protectionist environment that will take over the world eventually, will India get slightly more attention than before? Maybe that’s the only bet worth taking.
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