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.
Ant Group’s IPO is likely to return to the market in due course, but at a much lower valuation after significant restructuring, with a better balance in the risk and reward between Ant (as an originator of credit) and the banks (which bore the risk). Alibaba has also been issued with a record fine for abusing its market dominance, albeit that RMB18.2bn/US$2.7bn - calculated as 4% of 2019 revenues – is not very material for a company that had over US$70bn in cash and equivalents on its balance sheet.
While Alibaba was an obvious target, as the largest tech company in China, anti-trust investigations have brought the broader e-commerce and fintech sectors under intense scrutiny. Smaller fines have been issued to competitors such as JD, Meituan and Pinduoduo for the practice of forced exclusivity agreements with merchants, and community group purchase offerings (a fast growing e-commerce model that has seen accusations of price dumping in an effort to grab market share).
Having invested in Chinese internet companies for well over a decade, we have closely followed the extraordinary growth of these highly innovative companies. There have been periods of tighter regulatory scrutiny before, specifically for online gaming and internet search companies, and it is reasonable to expect investor sentiment towards the sector to turn more positive at some point in our investment horizon.
It feels premature to be trying to call that moment, particularly given more recent investigations into online education, entertainment, and the general handling of consumer data. However, history tells us that the market tends to overreact to regulatory concerns. The other point to draw out is that the authorities’ focus is on discouraging anti-competitive behaviour, ensuring a level playing field for market participants and protecting consumer interests, not on trying to break up large internet companies. There are potential winners out of this process as well as potential losers.
In recent years, concerns have grown over the large internet platforms’ ‘walled gardens’, designed to discourage users from switching apps. For example, Tencent’s social networks make it harder for users to access rival apps from the likes of Alibaba, ByteDance and Baidu, while directing traffic to its own group investee companies, such as JD and Pinduoduo.
Regulatory scrutiny is tending to decrease the barriers to entry that these platforms have created. This makes life easier for those internet companies less reliant on platform benefits, that have built their businesses around the inherent attractions of the product or service they offer. One company which springs to mind here is NetEase, whose DNA is all about generating engaging content for its users and has coped admirably over the years in its intense rivalry with Tencent in the online gaming industry. Another clear example is JD.com who have grown their e-commerce business tremendously, despite the dominance of Alibaba, by owning its own logistics and thereby having more control over the customer experience.
We wouldn’t want to over-emphasize the opportunities in the ‘winners’ from regulation as we believe there are at least as many opportunities in the market’s overreaction to what is perceived as negative newsflow. The platform companies currently under the spotlight continue to have very strong competitive advantages. For example, Tencent’s WeChat remains ubiquitous, with pioneering initiatives such as its mini-program ecosystem challenging traditional e-commerce models.
With share prices in some parts of the sector currently in a lull, we remain alert to emerging opportunities where valuations are increasingly compelling.
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.
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.
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