The effect of China’s corporate crackdown on South African investments
“This is a show of force from the Chinese government, saying, ‘We’re going to reel in these tech giants and their unruly behaviour,’” says Prof. Michael Sung, founding co-director of the Fudan Fanhai Fintech Research Center at Shanghai’s Fudan University. “Because now they’re big enough to have systemic risk.”
The crackdown poses a threat to the way that China’s tech sector has historically enlarged itself and has potentially serious consequences for wider investor confidence.
With the crackdown on corporate tech, educational reforms and demographic growth rate concerns, we look a bit deeper into the Stock Giants.
Naspers, Prosus, and the decline of Tencent
Tencent, the Chinese internet giant and the largest contributor to the profits of South African-listed Naspers and Prosus is off more than 40% from its highs earlier this year. This decline in the market value of Tencent has weighed on the share prices of Naspers and Prosus and caused investors to question the investment case for these companies. In an effort to ostensibly increase oversight and promote fair competition, China instituted sweeping reforms across a variety of sectors over the past few months. But these moves have brought about uncertainty and caused global investors to flee from companies with exposure to China.
Alibaba, Ant, and the disappearance of Jack Ma
The recent wave of regulatory investigations was ignited in November of 2020 when Ant Group, the digital payments company affiliated with Alibaba, was blocked from becoming a listed company in what would have been the world’s largest IPO in history. This came shortly after Jack Ma, the founder of Alibaba, delivered a speech in which he appeared to criticise the Chinese authorities for its heavy-handed approach to financial sector regulation. Ma disappeared from public view for several months as an investigation was launched into Alibaba for anti-competitive behaviour regarding its e-commerce platforms. Alibaba had lost over $270 billion of its market value by the end of 2020, and when Ma resurfaced in a short online video, its stock jumped by more than 7% on the same day. Alibaba was subsequently slapped with a $2.8 billion fine for violating China’s market regulations.
Didi, Tencent Music, and for-profit education
The next wave in the regulatory crackdown came in June 2021 when Didi, a ride-hailing app popular in China, came under the scrutiny of Chinese regulators for its pricing and competitive practices. In July 2021, shortly after the company went public on the New York Stock Exchange, the Cyberspace Administration of China ordered app stores to remove Didi from its platforms citing issues with how it handled sensitive user data.
A few days after the Didi debacle, a division of Tencent trading separately as Tencent Music was informed that it had 30 days to relinquish the exclusive rights it held with certain record labels. Tencent owns the top three music streaming services in China and enjoys approximately 80% market share. The actual impact this will have on Tencent Music is not yet clear, but the exposure in the larger Tencent group is relatively minor (we estimate only around 4% of Tencent’s earnings to be directly at risk).
Apart from this announcement, scrutiny around mergers and acquisitions has also increased. Two Chinese video gaming streaming platforms, Huya and DouYu, abandoned a proposed merger after regulators blocked the deal. Tencent owns 37% and 38% of Huya and DouYu, respectively. Again, the direct profit impact on Tencent is negligible, but the trend is concerning to investors seeking clarity and certainty from the regulatory regimes in which their companies operate.
Perhaps the most radical recent action taken by Chinese regulators is the decision to effectively ban for-profit education in China. As a result of the news, the shares of New Oriental Education and TAL Education, whose whole business models depend on for-profit education in China, suffered 70% to 80% share price declines in a matter of days. The controversy around this action continues to play out daily.
Why the crackdown?
Part of the motivation for the crackdown revolves around the power of big tech companies and the influence they have over their users through their platforms and the personal data they have access to. Monopolistic behaviour arises when too few players dominate a market. The Chinese Communist Party (CCP) feel that large technology companies could exploit Chinese consumers and that they should be reined in. Similar concerns exist in the United States over the might of its own giant technology firms, although the impact of regulation has not been as abrupt or as forceful as in China.
One explanation for the more forceful action by Chinese authorities is that China is playing regulatory catch-up, particularly with regards to its internet sector. The CCP will need to balance its desire to keep local giants under control with the desire to compete as a technology leader on the world stage. Reforms in the education sector may however have more to do with China’s demographic headwinds than corporate crackdown.
In the early 1980’s, China imposed strict population control measures whereby parents were allowed to have only one child, with a few exceptions. This became known as the one-child policy and, as expected, lead to a dramatic decline in the population’s fertility rate. China’s fertility rate dropped from over 6 births per woman in the mid-1960’s to around 1.6 in the 2000’s. The one-child policy was finally abolished in 2015 in favour of a “two-child policy” after it became clear that the consequences of a rapidly ageing population spell doom for the long-term future of the Chinese economy. China’s fertility rate has not increased by much since the one-child policy was abolished. The government has recently introduced a “three-child policy”, but there is reason to be sceptical of the significance of this policy.
According to Chinese consumers, the number one barrier to having more children is the cost associated with raising them. The CCP likely sees the ban on private education as a way to ease the burden of education costs on parents, thereby encouraging them to have more children. The success of China’s attempts to solve its demographic problems will take decades to play out.
Where to from here?
Autus Fund Managers has been lowering the funds’ exposure to China since last year when the regulatory issues became a concern. We have had no exposure to the worst-hit companies (including Didi and the education companies), and we have no intention to enter into speculative positions where this level of uncertainty exists. However, we do not believe that complete disinvestment from China is appropriate or necessary at this stage. With a population of over 1.4 billion people, China still has a lot of potential for companies that have experience operating in the domestic environment.
The demographic headwinds are not necessarily unique to China, and some industries could even benefit from an ageing population. Although Beijing may struggle to find a balanced approach to implementing stricter regulation, it is unlikely to destroy its national champions in the process. Furthermore, the intensely negative reaction of the market could turn into a buying opportunity for long-term investors.
Only time will tell how these companies will emerge from the prevailing difficulties. As always, calculated risk-taking and fundamental stock-picking is the approach we will continue to take when it comes to investing, including investing in China.
In times of great uncertainty, one thing that you can be certain of is that our team at Autus Fund Managers are continually working together to safeguard the long-term success of the company and its stakeholders.