China’s ‘Big Tech’ crackdown: Market overreaction creates opportunities

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 IPO of the fintech offshoot of an e-commerce tech giant in November 2020 , which was followed by broader anti-trust investigations into this company’s e-commerce operations.

The 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 the fintech (as an originator of credit) and the banks (which bore the risk). The e-commerce tech giant 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 this e-commerce giant 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 other e-commerce competitors 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).

What to expect?

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.

Where are the opportunities?

In recent years, concerns have grown over the large internet platforms’ ‘walled gardens’, designed to discourage users from switching apps.

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.

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.

With share prices in some parts of the sector currently in a lull, we remain alert to emerging opportunities where valuations are increasingly compelling.

Investment risks

The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.

When investing in less developed countries, you should be prepared to accept significantly large fluctuations in value.

Investment in certain securities listed in China can involve significant regulatory constraints that may affect liquidity and/or investment performance.

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