The China Tech Crackdown: Is It A Buying Opportunity?
September 10, 2021
The Ant Group’s IPO, which was preparing to dual list on the Shanghai and Hong Kong exchanges, was pulled last year amid concerns from regulators in China. More recently, ride-hailing app Didi (NYSE: DIDI) was removed from China’s App stores, in fact, just days after its blockbuster-sized listing at the New York Stock Exchange (NYSE). And of course, Alibaba (NYSE: BABA) has been in the crosshairs of China’s regulatory bodies for some time. In fact, Alibaba was probed by China’s antitrust body and fined a record $2.8 billion in April.
There’s some murmur that this all started because of Jack Ma’s (Alibaba’s founder) vocal commentary about China’s regulators stifling competition. Some argue that it is a signal to China’s innovative and booming tech industry that disagreement with the government’s positions won’t be tolerated, irrespective of their tech chops or successes. Then, there’s the argument that this is yet another prong in the US-China geopolitical battle. The reasoning is based on the consideration that many Chinese tech companies head to the US shores for listing, and these stocks tend to be owned by US-based investors. Thus, inflicting pain on these stocks is a way to win a round of the geopolitical battle.
As with many things, there’s often no black and white answer. But it appears there are at least two considerations (aside from geopolitical) that might be driving the crackdown.
One is around data security or sovereignty. It appears that the allegation against Didi is around “illegal collection and use of personal data.” I haven’t dug into the details of this particular case to know all the nuances at work. However, I know that companies like Apple (NASDAQ: AAPL) and Tesla (NASDAQ: TSLA) have long been required to conform to local Chinese data collection and storage laws.
The Alibaba Case
The Alibaba case is an interesting one. Back in 2018, Associated Press had reported that several Western brands had landed on the wrong side of Alibaba because they refused to sign exclusive distribution agreements with TMall. Apparently, brands that refused to sign these exclusivity deals saw their TMall traffic fall dramatically!
Exclusive deals are an interesting angle, especially if you are a marketplace that wants to strengthen network effects. Bring the best sellers to the market. Sign exclusivity deals. That helps with bolstering traffic to the site. Rinse and repeat. Effectively, network effects will muscle out the competition, giving the marketplace operator more pricing power!
Now by no means are exclusivity deals an Alibaba-only phenomenon. Sellers sign these deals for many reasons, but doing so because of the threat of a backlash is extreme. Of course, we don’t know if these allegations are true. Still, stories are floating around, and Alibaba was indeed issued the record fine for abusing market dominance.
As investors, the natural question to ask is: are Chinese tech stocks now cheap? Has the market overreacted to the regulatory push from China’s authorities? As with most things investing, the answer probably is — it depends.
Since I spent time talking about Alibaba, let’s just think about it. The big question might be: is the past trajectory a reliable indicator of how the future might unfold? Will the next generation of innovators eat Alibaba’s lunch? Or is the renewed focus from China on competition going to hurt Alibaba? As China’s tech sector evolves, I expect to see many disruptive innovators emerge. Some of them will indeed challenge the big incumbents of today.
All that noted, Alibaba’s stock, for instance, is currently trading close to its 52-week lows. The valuation is compelling on many accords. This is a company with still a long runway for growth and some big ambitions.
Perhaps the risks are now higher. Maybe this deserves your attention if you are a higher reward, higher risk type of investor. At the very least, Alibaba (and maybe others) deserve a spot on your watchlist.