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Explaining the Chinese Stock Market Crash, and exploring potential opportunities.
DISCLAIMER: This research report is not a recommendation to buy, sell, or take any positions. None of the opinions in this article represent FLY: Malaysia. This is simply an analysis that serves as something purely for education purposes on the recent events in China.
Alibaba (an e-commerce platform), Tencent (video game site) and Didi (China’s Uber), are some of the biggest names in the chinese equities market, and for the past several years, foreign investors have been pouring funds into Chinese tech stocks and have had seen big returns on their investments,
(Source : SP Global Market Intelligence)
But this summer, those shares listed in New York and Hong Kong saw sharp selloffs and it had little to do with their business performances.
(Source : Yahoo Finance)
The Chinese government, or the Chinese Communist Party (CCP), has taken a series of actions against big tech firms, from clamping down on alleged monopolistic behaviour to tightening rules on data security, which have sent shock waves throughout international markets.
In July alone, food delivery app Meituan, Tencent, Alibaba, and short video app Kuaishou lost about $344 billion of market capitalization or about 20% of their combined market value.
In this research report, we’ll consider the stocks that fell, and the potential reasons behind it, as well as considering its future outlook.
Didi: A Lack of ‘Check and Balances’?
In July, Didi went public on the New York Stock Exchange in a multi-billion-dollar IPO that was completed in just a few days. The catch was they had not received the full sign-off from the Chinese authorities. China’s cybersecurity watchdog had warned Didi to delay its U.S IPO due to data security reasons, however, Didi pressed ahead and managed to raise $6 billion on its first day of trade.
But retribution came swiftly for Didi as China’s regulators launched a cybersecurity probe and suspended their app, citing that the company, which collects a range of user data, had not complied with China’s data protection rules. Shortly after, Didi’s stock plummeted by 50% from its peak, losing $22 billion of market value.
Alibaba and the Authorities
At the 2020 Bund Summit, Jack Ma launched a blistering attack on the Chinese financial system and the government for lacking innovation. Before Ant Group could make it to its public listing (which it was expected to be the world’s largest public listing, with expectations that the company could raise up to $47.5 billion) the authorities launched an antitrust probe into Ma’s other company, e-commerce giant Alibaba, for “suspected monopolistic practices” – leading to a record fine of $3.8 billion.
Its monopolistic practice was the “choosing one from two” practice, where merchants who wanted to sell their products on Alibaba had to sign exclusive agreements, which banned them from offering their products on rival shopping websites.
Tencent: A history of run-ins with the CCP
Back in 2016, Tencent copped a 500k yuan (RM330,000) penalty for anti-competitive behavior for its takeover of streaming company China Music bank. This acquisition gave Tencent a huge advantage over its Spotify-like music streaming competitors as it attained about 80% of exclusive music library rights in China.
The competition regulator ordered Tencent to give up its exclusive music rights within 40 days and Tencent surrendered by issuing a statement stating it will “comply with all the regulatory requirements, fulfill our social responsibilities and contribute to healthy competition in the market”.
In mid-July 2021, regulators blocked a merger between DouYu and Huya, two of China’s biggest live-streaming video game sites of which Tencent is a stakeholder. If the merger had been allowed to proceed, Tencent would have attained a majority stake in the combined business.
In early August of 2021, when a state-owned Chinese newspaper labelled online gaming as “opium for the mind” and “electronic drugs”, gaming giant Tencent saw a massive selloff in its stock, with a 50% decline in the share price from its peak.
Tencent, also the owner of social media and messaging platform – WeChat – has come under pressure to address its anti-competitive practices and security issues. Recently, Tencent in response to new regulations, introduced new rules, including stricter curbs on younger gamers where they are allowed to play an hour per weekday, and no more than 2 hours during holiday periods.
China’s tech giants fall under the regulator’s enforcement mainly on:
Upon closer inspection at the three corporations, there appears to be a running theme as to why they are scrutinized by the Chinese authorities.
(a) Clamping down on possible “monopolistic practices”
Tencent, the largest social media platform in China with approximately 45% of the total mobile gaming market in China as of 2019, provides users with access to a broad range of internet services in a single package (WeChat for games, e-commerce, food deliveries, ride-hailing, event-ticket purchases). With WeChat functioning as a suite of apps, users can do much of their online business in one place. All the payments can be made via WeChat Pay. This results in small and midsize app developers in China being unable to promote their services. This may be the reason why the government blocked the Douyu-Huya merger deal. Douyu and Huya, two of the largest video streaming companies in China, would have had a total combined market share of 70% if they had merged and would have indisputably strangled the competition.
(b) Violating data collection, usage, and protection and illicit content
Didi provides 20 million rides a day in China to users who sign up through the app using a phone number and password (Murayama, 2021). They also collect data from 100 billion kilometers of Chinese roads per year. Given that Didi’s huge collection of data poses the risk of data leakage to other countries, Beijing wants its data-rich tech firms to list domestically instead of overseas for national cyber security
On top of this, China’s internet regulators imposed fines on tech companies like Kuaishou Technology, Tencent’s QQ, Alibaba’s Taobao, Weibo Corp, and Little Red Book, as its illicit and suggestive content involving children (Huang, 2021) was circulating in these sites. Reportedly, sellers would use unethical means to sell goods including suggestive photos of child models, manipulated gifs and videos of exploited minors, under-aged live streams, the quality of online education platforms, violent and sexually explicit animation, online communities, and celebrity fan clubs.
It’s not just the tech giants….
The Chinese Government has banned tutoring for kids below the age of 6 as well as curriculum tutoring during vacations (Stevenson, 2021). In addition, they made a statement that companies that teach the school curriculum must be non-profit and are not allowed to take foreign capital or go public. As a consequence, the shares of Chinese Education companies like TAL Education Group, New Oriental Education & Tech Group (EDU) have plunged dramatically. The government stated that the private tutoring sector adds an undue burden on kids and students, charges exorbitant fees, deter families from having more children (by increasing financial hardships for parents), disrupting normal school education, and creates a societal fracture. Consequently , curriculum tutoring firms are looking to remodel their business or may even switch to an entirely different industry altogether.
With not just the tech giants under increased scrutiny, it’s worth looking into the possible factors behind the increased scrutiny. One, China’s crackdown could also be viewed as an attempt to fix social problems, safety issues, and social inequality. For instance, the delivery company Meituan is under fire from regulators to guarantee that their riders get a minimum wage, insurance, and more lenient delivery deadlines, after copping heavy criticism on social media for their treatment of workers. In a statement, Meituan said it will “resolutely implement” guidelines issued by China’s market regulator to “effectively enhance labour rights”.
The Chinese Communist Party is centralised and its influence has permeated into the systems of government and society at large. It is worth mentioning that the government maintains a balance between capitalism and socialism. According to Asialink Business (n.d.), China, in fact, employs a socialist market economy, in which a dominant-state-owned enterprises sector exists in parallel with market capitalism and private ownership. It was an initiative to actively encourage the creation of more jobs and allow private enterprises to expand in the country. Through this, we observe that the government indeed is trying to maintain an equilibrium between liberal economic reforms while still remaining in control.
View on China’s future outlook in the face of crackdown
The government seems to have no intention of completely stripping Tencent and Alibaba of their power, instead, it just wants the expansion of operations to be within its control and power. Likewise, China has no reason to oppose domestic content companies from buying foreign players as it may serve to boost their global influence in the future. For example, before the crackdown, Tencent planned to acquire the British video game developer Sumo Group for $1.27 million and there were no media reports of Beijing intervening to halt the decisions of acquisitions of business overseas (Reuters, 2021).
As mentioned, Tencent and Alibaba are some of the most innovative companies in the world right now, China may want to foster the continued innovation of these companies, and in that regard, it could be seen as an opportunity to buy on weakness. For instance, institutions have taken the opportunity to buy Chinese stocks in which funds focused on them have seen net inflows of $3.6 billion, of which $300 million has gone into China tech funds, despite the mounting concerns about harsh regulation (Cheng, 2021).
It’s worth noting the dilemma China is in. If it were to overly regulate its economy, it may dampen innovation and growth, thereby stifling the potential of these companies. On the other hand, if the economy were to “liberalise” and be less restricted , it may lead to the untightening of the CCP’s grip.
State-owned or state-funded enterprises are expected to see a greater share of economic output as the government invests heavily in such enterprises. According to Semiconductor Industry Association (2021), in 2020, China further expanded its semiconductor preferential tax policies, which include up to a 10-year corporate tax exemption for semiconductor manufacturers, which could be valued at over $20 billion. China spent a record $33 billion in industry subsidies in 2020, eager to shore up key sectors including semiconductors and defense in a heated technology race with the U.S. Analysing the data, we can expect to see sustainable growth in state-run semiconductor companies such as , SMIC (Semiconductor Manufacturing International Ord Shs). This is due to the fact that China plays an important role in the Global Electronics Supply Chain. In addition, the semiconductor sector is the second-largest final consumption market for electronic devices embedded with semiconductors; the indigenous Chinese chip industry accounts for only 7.6% of total global semiconductor sales. Other than semiconductors, China also invests heavily in AI startups which have surged forward with a fund of $30 billion since 2016 (Yamada, 2021).
View on Future Threats: Regulatory
Since China is a country with a significant amount of regulation, investors should perhaps consider a few key regulatory risks.
Firstly, the intensified anti-trust crackdown. In China, the government will undoubtedly stop any unfair monopolistic practices to ensure long-term health for state-run or smaller companies. Nevertheless, it is very unlikely that the dominant positions of Alibaba and Tencent will be affected significantly by the crackdown as discussed in the section above.
Secondly, the data security risk. As evident from the case of DIDI, the government will ensure the Chinese companies are not accessible or prone to leaks as they globalize, but are only accessed and used internally.
Third, the delisting of China stocks on the US market under The Holding Foreign Companies Accountable Act (Karpal, 2021). According to the law, the market requires that companies publicly listed on the US Stock exchange should not be controlled by any foreign government. If the US is not able to audit specified reports for three consecutive years, such companies will be banned from trading and delisted from US stock exchanges. It’s worth noting that China certainly will refuse the US audit inspections on their companies due to two main factors.
i) Infringement on China’s national sovereignty
Audit inspections by the US may allow a foreign regulator to enforce foreign law against the Chinese people.
ii) Infringement on China’s state information.
China has a very expansive definition of state secrets in any transactions with a state-owned enterprise or data collection regarding the states’ information. Hence, China has taken the position that the disclosure of audit inspections by US regulators would cause harm to China.
Conclusion
The unpredictability of the crackdowns does support the notion that Chinese companies are risky investments due to the uncertainty. Chinese markets have performed much worse than most of the other stock indexes across the globe. The Hang Seng index has dropped 5.9% since January, wiping out all its gains year to date. Meanwhile, the Shanghai Composite has lost 0.5%. In contrast, Australia’s key index, the ASX 200, has surged to record high levels, jumping by more than 12% in the past 8 months.
Again, while this is not investment advice, it’s always worth going back to the fundamentals namely to consider the Chinese Government. As a one-party socialist state, it bears to remember the philosophy of socialism and the objectives of the CCP. Some investors may say that the CCP has wiped out billions of values of their stocks overnight, and while this is true, the CCP’s perspective, it wants to make sure that these companies are working not just in their own interests, but also in the government’s interest and China at large.
Nevertheless, analysts have noted sustainable growth in the long term in the Chinese market as China puts their efforts into providing subsidies in state-owned and smaller companies, whilst big companies like Tencent and Alibaba may bounce back quickly from the crackdown. Compared to the US stock market with little government intervention and whose main price movers are profit margins, comparing the two markets are like comparing apples and oranges.
Nevertheless, anytime one invests it’s always good to conduct your own due diligence.
References
asialinkbusiness.com (2021). China’s Economy. [online]. Available at:
<https://asialinkbusiness.com.au/china/getting-started-in-china/chinas-economy?doNothing=1>
Cheng, E. (2021). China may be cracking down, but investors put $3.6 billion into Chinese stocks last week. CNBC. [online].Available at:
<https://www.cnbc.com/2021/07/30/investors-bought-chinese-stocks-despite-regulatory-concerns.html>
Huang, Z. (2021). China fines Tencent, tech giants over child exploitation. The Edge Markets. [online] Available at:
<https://www.theedgemarkets.com/article/china-fines-tencent-tech-giants-over-child-exploitation>
Kharpal, A. (2021). Chinese tech stocks hammered as U.S. law threatens to delist firms from American exchanges. CNBC. [online] Available at:
nikkeiasia.com (2021). China’s tech crackdown widens to Tencent from Alibaba. [online]. Available at:
<https://asia.nikkei.com/Business/China-tech/China-s-tech-crackdown-widens-to-Tencent-from-Alibaba>
reuters.com (2021). Tencent snaps up British video game developer Sumo in $1.3 bln deal. [online]. Available at:
<https://www.reuters.com/world/uk/tencent-buy-british-video-game-company-sumo-13-bln-deal-2021-07-19/>
Semiconductor Industry Association. (2021). Taking Stock of China’s Semiconductor Industry. [online]. Available at:
<https://www.semiconductors.org/taking-stock-of-chinas-semiconductor-industry/>
Stevenson, A. (2021). China moves against private tutoring companies, causing shares to plunge. The New York Times. [online]. Available at:
<https://www.nytimes.com/2021/07/26/business/china-private-education.html>
Yamada, S. (2020). China AI startups surge forward with $30bn funding since 2016. Nikkei Asia. [online]. Available at:
Researcher(s): Jih Yih and Thomas Ng
Reviewer(s): Muhammad Bahari and Faith Tan
Editor(s): Natalie Seah
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