Wave of regulation of “tech companies” – what’s behind it?
Not only in China, but also in the US and even the EU, governments are concerned about the ubiquitous power of Big Tech. The influence of their platforms on elections, the security of vast amounts of consumer data and the exploitation of workers are increasingly putting these companies under the spotlight of authorities. In the US, congressional hearings have been held and antitrust lawsuits filed, so far without far-reaching consequences. In China, on the other hand, the government is tightening the reins and the political system allows for quicker action.
Four pillars of stability
Beijing is concerned about the four pillars of stability: banking, antitrust, data security and social equality. The state intervention started last November when the mega IPO of fintech giant Ant Group, which is one-third owned by Alibaba, was abruptly put on hold. This was due to statements by Jack Ma, who had publicly criticised the political leadership regarding the banking system and possibly exerted too much influence (or risk) on precisely this system.
The government is also targeting other fintech companies, including Didi (Uber of China), Tencent (China’s largest social media company) and Baidu (Google of China). Shortly after Didi’s IPO, the Chinese regulator announced it would investigate the company for “national security” reasons and is now imposing various penalties. The government has also launched an “antitrust” investigation against Tencent and Baidu and fined them for various past offences. The latest announced sanctions against tutoring companies have again surprised investors. In a sweeping overhaul, China prohibits companies that teach the K-12 school curriculum from making any profit in order to maintain social equality.
President Xi Jinping does not seem to care if stock investors, many of them foreigners, lose billions of dollars. He knows that China’s middle class will back him and support this crackdown. In the future, investors may have to realise that the four pillars are part of President Xi Jinping’s vision.
VIE structures
The variable interest entity (VIE) structure has been used over the past 20 years to allow Chinese companies to list in Hong Kong or the US, giving them access to a shareholder base outside mainland China (offshore company set up). The use of VIE structures is also coming under increasing scrutiny by the authorities. China prohibits foreign investment in certain industries, such as the internet, telecommunication etc., which are considered sensitive to national security.
A different take on technology
China does not crack down on all its tech companies. For example, Huawei still seems to enjoy the full support of the government. China also aims to build a world-class domestic semiconductor industry and investing huge sums of money even in speculative start-ups. It is not technology that China is crushing, it is the consumer-oriented internet software companies that the Americans call “technology”. Why do Americans equate “tech” with companies like Google, Amazon and Facebook? One reason is that the American internet industry is something the US is top ranked. In contrast to the hardware industry, the Asian competition in the consumer software space is not quite as strong yet. With their network effects, vast amounts of intellectual property and strong brand value, successful software companies achieve high margins. And since the West often tends to equate profit with value, the software industry is seen as an industry champion that creates tremendous economic value for a country.
Perhaps China sees things a little differently. It is possible that in eyes of the Chinese government such companies do not really contribute to value creation.
The crackdown on China’s internet sector may be part of the country’s new national industrial policy. Instead of allowing local authorities to pour resources into whatever they think will generate rapid growth (the strategy of the 1990s and early 2000s), China is now trying to direct the country’s industry towards what they believe will serve the “nation as a whole” – which is, geopolitical as well as military power.
For warfare, you need a lot of military equipment, i.e. engines, fuel, technology, etc. On top, one needs chips to operate and run the hardware because military technology is increasingly software-driven. You also need surveillance capabilities to keep an eye on your opponents and to maintain social and technological control.
After the Cold War, priorities in the West shifted from survival to entertainment and consumption. China has never made this transition.
China’s leaders have been committed to economic growth, but this growth has always been centred around comprehensive national power.
Young Chinese may be increasingly willing to “make money” and “have fun” but Chinas political elite is not there yet.
When China’s government defines what kind of technologies, they want the country’s engineers and entrepreneurs to work on, they don’t want them to spend their time on things that are “just” for fun and convenience.
They looked at their consumer internet sector and decided not to continue “wasting” capital and highly skilled labour on an industry that does little to achieve their long-term goals.
Investment policy conclusions
For investors, caution remains the order of the day for the time being. The current situation remains unpredictable; new sanctions can be imposed at any time, also in other sectors such as healthcare (social equality). For companies in the internet and similar sectors, numerous challenges remain and a quick recovery doesn’t seem very likely. Moreover, investor confidence needs to be regained – the damage done is high. Likewise, the worsening tone between China and the US harbours uncertainty. It is quite possible that China will block VIE structures in the US in the future. However, China still needs a lot of foreign capital to achieve their strategic goals, so it is rather unlikely that the VIE structure will be banned for existing companies. existing Company is prohibited.
China nevertheless remains the growth engine of the global economy, accounting for over 60% of GDP in Asia ex-Japan and over 40% of global GDP. It is quite possible that most Chinese companies will understand the government’s message and implement it accordingly, and thus continue to flourish in the years to come. Accordingly, the current valuations are also attractive. Investors who are not yet exposed could begin to gradually build a position.
Contact: Claudio Henseler, Investment Services
Telephone: +41 58 680 60 73
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Disclaimer: Produced by Investment Center Aquila Ltd.
Information and opinions contained in this document are gathered and derived from sources which we believe to be reliable. However, we can offer no under-taking, representation or guarantee, either expressly or implicitly, as to the reliability, completeness or correctness of these sources and the information pro-vided. All information is provided without any guarantees and without any explicit or tacit warranties. Information and opinions contained in this document are for information purposes only and shall not be construed as an offer, recommendation or solicitation to acquire or dispose of any investment instrument or to engage in any other trans
action. Interested investors are strongly advised to consult with their Investment Adviser prior to taking any investment decision on the basis of this document in order to discuss and take into account their investment goals, financial situation, individual needs and constraints, risk profile and other information. We accept no liability for the accuracy, correctness and completeness of the information and opinions provided. To the extent permitted by law, we exclude all liability for direct, indirect or consequential damages, including loss of profit, arising from the published information.
