China’s tough stance on technology companies

What should investors make of China’s crackdown on its technology companies?

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Given their everyday presence in our lives, many of you will already use the products of US technology giants such as Facebook*, Google* and Amazon*. You may, however, be less familiar with China’s technology giants such as Alibaba* and Tencent*, whose company share prices have, until this year, risen so much that they have made their founders billionaires.  But since the start of the year, the values of these companies have fallen quite dramatically.

The reason? Increasing regulatory intervention from China’s policymakers, which has not only affected China’s technology companies, but has also been extended to its education sector and other areas such as gaming and food delivery.

The crackdown has taken several forms. For example, DiDi’s* main app, China’s equivalent of Uber*, was pulled from app stores in early July, while games developer, Tencent*, was accused of exacerbating the harmful effects of gaming on children. What appears to be happening here is a real change in the way the Chinese authorities are thinking, rather than a series of one-off events.

We agree with other commentators that the outlook for the sector may have materially declined as a result of this, given the lack of transparency and likely lower future profitability of these companies but we don’t think it’s in China’s interests to destroy its tech champions.

Rather, we believe the most likely scenario is that these moves are about ensuring firms are better aligned with China’s social and political goals. These include promoting social welfare of school children (e.g. reducing the hours of private tuition in addition to mainstream education), as well as banning gaming for minors and protecting sensitive data from foreign ownership.

Caution still prevails

So, from an investors point of view, we must ask, given the share price falls, at what point could these stocks become interesting to investors? Investor sentiment towards China’s tech sector seems rock bottom. There are even signs that bad news isn’t moving share prices much. Last week, for example, China issued a five-year blueprint for regulation of tech and other sectors and China’s stock market was barely affected. This may suggest that much of the bad news has already been discounted.

Furthermore, companies aren’t waiting idly by for the regulator to introduce more draconian measures. In fact, we are seeing some companies adjust their own behaviours to get ahead of the regulator. For example, Tencent* introduced new limits on children’s time on video games, hours after the state media described online games as ‘spiritual opium’. Weibo* also removed an online list which ranked celebrities after state media were critical of celebrity culture. This self-correction is consistent with the Communist party’s encouragement of ‘self-criticism’.

That said, we still favour some caution at this juncture. The lack of regulatory and political transparency remains, while we have no clear idea of what impact these moves will have on the profitability of these companies for the next few years. Anything – from a temporary regulation blitz to sending a strong message, to turning large parts of the private sector into state-owned enterprises – is possible, in our view.