For many investors, China’s crackdown on its internet sector represents a fundamental shift away from the government’s previous ‘hands-off approach’ towards its burgeoning tech industry. The first major sign of this shift occurred last November, when regulators pulled the plug on the IPO of Ant Group – a fintech offshoot of tech giant Alibaba.
The resulting anxiety has rattled the Chinese equity markets since, with Chinese internet stocks having underperformed the broader market indices this year. However, my team and I believe the market reaction to be overblown. In our view, the internet sector in China running strong and being strengthened by the pandemic. As long-term and on-the-ground investors, we now see select opportunities, as valuations are beginning to look more attractive.
In our view, the fundamentals that have driven the performance of China’s internet platforms in the past remain intact. These firms should continue to benefit from a shift in growth drivers to consumption and services in China going forward.
Let’s take a look at a position we hold in one of our portfolios – a leading food delivery company that serves more than 550 million customers across China and has a staggering 7.1 million merchants on its platform. The company grew the number of high-quality restaurants selling food through its platform during the pandemic, while also managing to increase the average value per order by 7% in 2020. This has demonstrated to us that the internet sector will continue to have a strong future in China.
The crackdown on ‘Big Tech’ has already been happening across most developed markets. Facebook and Google, for example, have both been investigated and fined by regulators. More recently, a group of developed countries that includes the US and the UK reached an agreement to level a global minimum tax on internet companies.
There’s a global trend for regulations that govern the internet sector to become more transparent and sophisticated. And as China matures as a country, its laws and regulations must also advance and begin to catch up with the global standard.
Looking back at previous regulatory actions, businesses tended to revert to normal – and share prices recovered – once the regulatory overhang was clarified and removed. We saw this happening in 2018, when gaming companies were subjected to tighter regulations.
In our view, Chinese internet companies will adapt to this change and continue to evolve and grow, unleashing innovation and creativity along the way. Most internet platforms are private companies and the private sector is a key pillar to China’s growth. It represents more than 60% of China’s GDP and nearly 90% of employment. We believe the government has no intention to undermine the sector, but instead wants to promote its healthy growth, efficiency, and sustainability from a long-term perspective.
Much is being said about China’s crackdown on its tech industry. And yet, behind all that noise, there’s nothing new about what China has done. Many governments around the globe are pushing for stronger legislation and more aggressive enforcement of antitrust law. China has merely been playing catch-up with the developed world after years of loose regulatory oversight.
There’s a growing consensus around much of the world that internet platforms have enjoyed a consequence-free environment for far too long. Many governments want to put in place stronger regulations for ‘Big Tech’, but there’s a significant variation in the nuance, speed and intent of regulatory response across regions.
Tighter regulatory scrutiny for China’s internet companies has formed a significant factor in their underperformance this year. The first shot across the bow was the last-minute postponement of the Ant Group IPO in November 2020 (Alibaba’s fintech arm), which was followed by broader anti-trust investigations into Alibaba’s e-commerce operations.
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