The China Crackdowns

• 03-Aug-21
• admin

Tech stocks in China have been crashing, possibly with some more ways to go.   This was brought about by government action.   What’s going on?

 

A quick review of what has been happening in the last couple of weeks in China would provide the backdrop to some stunning developments in these stocks:

1. The education sector got hit when the government announced that they may want the highly profitable and widely pursued after-school tutoring system to become a “non-profit” business.   Many of these nationwide gigantic education companies, often listed in the US, immediately lost 90 percent of their market valuation.
2. The cab-hailing service, highly popular and successful in China, Didi Global, was crushed by a regulatory call to inspect its data systems to prevent security leaks.  Its recent IPO, which was less than a month ago, fell apart, losing about 50 percent.   
3. WeChat, the largest social media company, was asked to temporarily suspend new registrations and together with its fellow payments company, Ant Group, also face new rules on seeking foreign IPOs.   Its share price in HK has been declining for nine months.  
4. Food delivery giant, Meituan, has also been instructed to stop soliciting new clients online.  Its share price went from $58 to $28 over the last four months. 

 

After the action against the Ant Group last year, Beijing has been continuing to rein in the giants in China’s technology sector.   Does this seem like hara-kiri?   One would think that the Chinese government would want to do all it can to support its home-grown technology companies and challenge all contenders for world supremacy in an important economic sector.   After all, it is known to be throwing money at the chip manufacturing industry to speed up research so as to catch up with the US and Taiwanese chip foundries.   It does not seem to be consistent policy.

 

Some Western media have commented that this is the latest sign of the CCP’s authoritarianism.  They say it is simply the government in China flexing its muscles and showing to the entire world who is boss. 

 

That may well be.   But there are different ways of interpreting the recent regulatory actions, not least of which is the official point of view.

 

First of all, let’s think about who the targeted companies are.   These are generally humongous, monopolistic companies which are edging up on anti-trust laws / regulations in China.   As a matter of fact, the US is contemplating exactly the same kind of action against American “Big Tech”.   The method is different.  The US government would go through a court, but in China, Beijing does it by decree.   In the US system, of Government versus Big Tech, there is a third party involved – a judicial system, and that is of course, a major difference.   China dispenses with that, and that is their system, whether one considers that to be authoritarian or efficient.  But that’s not the point, as that is execution, important though that is. 

 

The point of similarity is that both governments with their massively different governance approaches, want to have the same deliverable.   Rein in Big Tech.

 

It leads us to the question of why do the Chinese and US government want to do that?   Consumers have flocked to embrace the products invented by technology companies in just half a generation, which has ended up turning tiny dorm-room start-ups into the behemoths they are today.  It made their founders into billionaires at young ages.   So what’s the beef?   Is there a victim here?

 

The first “sin” as identified by what seems to be a backlash, which both governments seem to be paying attention to, is that these Big Tech companies have become increasingly protective of their “turf”.   They are monopolistic.   It means that new entrants, who may invent a better widget, will never have a chance to bring that to market.  In a capitalist economy, Big Tech seems to be cutting off the roads that others can use to follow and overtake them.   They have become anti-competitive, and governments regard that to be an unlevel playing field.  That is the first reason behind both the American and Chinese regulators’ motivation to target these large tech companies.

 

Secondly, when companies get that big, they also control vast amounts of customer data, acquired through registrations and more importantly, from regular usage or traffic.  These huge databases are of course a tremendous asset in the books of the companies and which can also be used for expanding their market reach, as well as anti-competition weapons.   To the extent that these sectors should be kept open to more participants to provide greater choice for consumers, then there would be concern that these databases can be misused, or stolen and then deployed nefariously, against the public interest.   This argument is not unreasonable and it is within good governance for Beijing to call into question what these Big Tech companies are doing about data security.   America is clamouring for exactly the same thing.  

 

Next, both countries have issues with the widening wealth disparity that the founders of these companies represent.  All the founders and top management of the Big Tech companies are in the extremely wealthy elite.  In the case of the US, that is a problem of inadequate taxation, because of both the design of tax systems as well as outright avoidance by the wealthy.   It is leading to social inequalities and a divided society.  In China, some of the wealthy are actually money launderers in the sense that they would evade tax by sending the money out of the country, including through cryptocurrencies.   (The ban on cryptocurrencies by Beijing is not unsurprising.)  This clashes with the drive by the CCP to champion poverty reduction across wide swathes of the country and broad-based wealth creation.   The existence of unequal opportunity that the Big Tech companies (and their owners) represent goes against CCP national social objectives, and this is not acceptable.   Politicians like Bernie Sanders are saying the same thing in the US – “billionaires should not exist”.

 

Perhaps not articulated in the crackdown on Chinese tech companies is also the fact that there has been a trend for Chinese tech companies to seek IPOs in the US.   Other than the founders, there are many institutional shareholders in these companies which are American.  Could it be that Beijing does not want their crown jewels to be partly owned by citizens of the country that is picking a fight with them on trade and technology?  Or that Chinese companies on NYSE/Nasdaq are subject to the whims of American politicians, which means increased leverage in a cold war between the two superpowers.   China may want to turn this around at a time of its choosing (ie now) rather than at some future time, when American interests can turn on key Chinese companies when it is not possible for Beijing to react adequately.  

 

The Tiktok and Wechat sanctions by the Trump Administration in 2020 would be examples of such situations.   Nobody can answer this question of course since we are not privy to the thinking of the Chinese leadership.  But it would not surprise me if the shares that have been sold would be taken over by SOEs in the near future to reduce American leverage.   It would be irrational to think that Beijing would not have learnt from the TikTok and Wechat threats by Trump.

 

It would also not surprise me that the recent actions by China would dissuade aspirants for a public listing from seeking to do that in America.   I could be seriously mistaken but there would undoubtedly be a cooling of desire by the best of Chinese business to seek a Nasdaq listing.  They will have to do that listing in HK, Shenzhen or Shanghai, all directly controlled by Beijing. 

 

Besides the above factors which may lead some to think that the Chinese government is doing something the American regulators would also like to do, there are of course reasons specific to China.  

 

Firstly, there is no question that Beijing wants to impose its leadership role on all sectors of its economy.   American government plays the role of referee; Beijing plays the role of captain.   Nothing wrong with that.   It is just what the two systems are.  

 

There are key economic, political and social goals that are in the CCP’s plans for the country that they do not want unbridled capitalism to distort.   Consider the crackdown on the education sector.   I personally think it makes sense.   Why?

 

The business model of the large Chinees education companies is to exploit the traditional emphasis on education in Chinese culture, add to that widespread parental love desiring to see their children have a better life than their own by getting them into top universities, and then turn the competitive nature of Chinese people against one another to pay for costly after school tutoring.   It is a business model that is extracting blood from many less well-to-do Chinese families.  

 

That is a social problem which the Chinese government is wise to address.  And to also let their education companies’ founders to reflect on how exploitative their business is on Chinese society.   And if that was the crime, the punishment was appropriate.   The billionaires running these companies have been turned into ordinary people almost overnight.

 

The government putting out the orders for Chinese education companies to become “non-profit” has essentially wiped out their entire market value and the founders’ net worth.   The chart below shows how the price of TAL Education Group, the largest education company listed on the NYSE, has gone from its high around March this year, to nearly zero, a 94.19 decline from its price one year ago (an even larger fall from its high).   This is startling.   

 

 

 

 

 

It is also likely that the continuous learning pressure from early morning to the evening, leaving very time for sports, play and relaxation will have deleterious effects on the students’ mental health and physical fitness.   It also places academic achievement, rather than other life skills, on a pedestal.   These traits need to be reversed.   I applaud it.

 

In addition, there is the economic dimension.   The cost of tuition is high relative to incomes.   Most families struggle to pay this extra bill.   It is affecting the decision making of young couples to have more children.   Even after the one child policy has been relaxed, many families are not having more kids because they think they cannot afford to do so.   This is contradictory to Beijing’s efforts to reverse the aging population which will have deleterious effects on future growth.

 

There is also the fact that such a nationwide after-school tutorial system favours those who can afford it.  It entrenches not a true meritocratic system, but one in which family wealth puts their offspring ahead of other more qualified children to benefit from the best of what the country can offer in university education.   It is using money to pave a golden path in life.   While libertarians may not have a problem with that, the socialist government in China does not want this, and is taking action against it.

 

In view of the similarities between China and America in trying to head-off the impact of Big Tech on society and their respective economies, the action of the CCP in the tech crackdown can be understood.   Then on the education business, it is specific to China, and again this seems to have clearly defined objectives.

 

Whether the rest of the world, like us, think the regulation is justified is not for us to say.   Call it authoritarian, paternalism, caring or whatever, it is what the CCP thinks is best for China.   Who are we to disagree?  

 

Will it work?    Time will tell.  Private education may go underground for example.    But what it does say is that for what it’s worth, the CCP is not afraid to take action against some of the biggest businesses in China, which may have a short term impact on its economy (some analysts think it will slow GDP growth by up to 1 percent).  It demonstrates that the Chinese government will not let money stand in the way of its carrying out what it considers as necessary social and economic engineering.  

 

It also demonstrates that its current outlook on the Chinese economy is very positive.   They seem very confident on how the covid19 recession will end, and that the restriction of these booming sectors in China will not damage its overall growth prospects, especially in the trade war against the US.  

 

 

 

Wai Cheong

Investment Committee

The writer has been in financial services for more than forty years. He graduated with First Class Honours in Economics and Statistics, winning a prize in 1976 for being top student for the whole university in his year. He also holds an MBA with Honors from the University of Chicago. He is a Chartered Financial Analyst.