Tencent’s turn in harm’s way amplify China risks

Tencent’s Ma Huateng is having as bad a week as just about any tech billionaire could possibly imagine in 2022.

First came news the e-commerce giant he founded made it onto Washington’s “notorious markets” list, along with Alibaba Group. The US Trade Representative’s office said the AliExpress and WeChat ecosystems “facilitate substantial trademark counterfeiting.”

Next came market-quaking speculation that Tencent is about to join China Inc’s other famous Ma – Alibaba’s Jack Ma – in the regulatory penalty box. Though Tencent denies Beijing is about to pounce, the mini-panic in stocks suggests traders fear the worst.

Then the market rumor mill really kicked into high gear. Some of the chatter surrounded possible scams related to the so-called metaverse, which many consider the next generation of the internet.

Like Facebook in the US, social media and gaming giant Tencent has been looking for ways to get on the metaverse bandwagon to drive the next phase of growth and aggressive investment. Morgan Stanley estimates the market could be worth US$8 trillion in the future.

The China Banking and Insurance Regulatory Commission, though, warns criminals are engaging in myriad metaverse investment schemes and blockchain games. Markets fear Tencent’s enthusiasm for the trend may be drawing increased scrutiny.

All this puts China’s largest companies at the center of a regulatory storm that has markets in a whirl. The more Beijing denies it’s readying another assault on the globe’s biggest internet arena, the more investors brace for fresh blows to financial markets.

It also has investors worried Xi’s inner circle is prioritizing control over China’s most innovative industry over economic growth. The fear is that 2022 will see even more chaotic crackdowns on Big Tech than last year.

Anti-monopoly moves

It “might make investors a bit more reluctant to invest in Chinese internet names,” says strategist Herald van der Linde at HSBC Holdings.

Two weeks ago, Macquarie Bank economist Larry Hu spoke for many when he argued world markets had seen “peak anti-monopoly” policy moves. The idea being that markets could breathe easier as Xi pivots to generating 5%-plus economic growth.

Such optimism is no longer the consensus view. Already, China’s biggest businesses by market capitalization – Alibaba, Tencent and food delivery giant Meituan – lost more than $100 billion of valuation in the space of three days. That, on top of a $1.5 trillion stock rout in 2021.

Last week, markets shook anew after state officials demanded Meituan and competitors slash fees they charge restaurants. There was talk a few days later that Tencent faces a major regulatory dressing down akin to the one suffered by Jack Ma’s Alibaba and Ant Group in late 2020. It inspired a fresh bull market in “sell” orders.

On Thursday, executives detailing Alibaba’s earnings release are sure to face furious questioning about Beijing’s regulatory meddling and the potential for additional actions and fines to come.

In the 15 months since President Xi Jinping’s team scrapped Ant’s $37 billion initial public offering, his Chinese Communist Party unveiled a “common prosperity” campaign. In theory, it aims to curb tech-sector excesses and prod companies to share the wealth.

A big worry is that regulators are making things up as they go along with an eye on scoring Xi a third term as party leader later this year.

“President Xi and the CCP view tech, and private companies as a whole, as a threat to their regime,” says Dan Harris, a founding member of international law firm Harris Bricken. “This, and about a thousand other reasons, is why I will never invest in a publicly-traded Chinese company.”

Big names placing bets

Many will, of course, including some of the globe’s most influential investors. Ray Dalio’s Bridgewater Associates hedge fund, the globe’s largest, continues to up its stakes in China Inc. Those bets include Alibaba, Baidu, JD.com, NIO, Pinduoduo and other mainland tech giants.

Charlie Munger, Warren Buffett’s longtime partner, recently upped his bets on mainland tech companies. As the Berkshire Hathaway vice-chairman puts it: “In China, the companies we invest in are stronger relative to their competition and priced lower. That’s why we’re in China.”

This is in sharp contrast with George Soros, who derides Xi as anti-capitalist in ways the legendary short-seller says will stymie China’s economic future. Xi’s censorship efforts, Soros worries, will stifle innovation if China pivots to a “Sinoverse,” while the rest of the globe inhabits the metaverse.

Soros also worries the outsized role of property markets is a recipe for trouble.

“The model on which the real estate boom is based is unsustainable,” he says. “People buying apartments have to start paying for them even before they are built, so the system is built on credit. Local governments derive most of their revenues from selling land at ever-rising prices.”

Yet Xi’s regulators turning their attention Tencent’s way could send a chilling message. Moves against Ant and Alibaba starting in late 2020 was the “the CCP flexing its muscles,” observes Victor Shih, author of Factions and Finance in China. “It’s about telling Jack Ma who’s in charge.”

Western investors tend to think the boards of China’s tech answer to shareholders. In reality, tech giants now seem to work for their real overlords – the CCP – in Beijing. It’s party powerbrokers that provide, tolerate and maintain the overlapping monopolies under which Alibaba operates. These monopolies can be imperiled at any moment for any reason.

Is Ma Huateng’s time up?

Jack Ma has learned that the hard way. In only the last 12 months, Alibaba’s shares fell 55%. Is it now Ma Huateng’s turn in financial harm’s way? If so, the 34% drop in Tencent’s shares over the last year could be only the beginning of losses to come.

To be sure, China optimists could still be right. As Thomas Poullaouec at T. Rowe Price notes, Beijing has “hinted it would go easier on regulating big private sector players” and that “excessive capital growth may instead be curbed through other mechanisms.”

For now, though, all eyes are turning to the People’s Bank of China to see how it backstops gross domestic product.

Diana Choyleva at Enodo Economics adds that “authorities are worried about small and medium-sized enterprises, which account for more than 80% of urban employment and hold the key to Xi’s pursuit of common prosperity.”

At its first meeting since the holidays, the State Council announced more support for SMEs. But if Xi’s team is about to launch a Big Tech crackdown 2.0, the fallout for GDP could be significant.

In late November, Xi’s party upgraded the State Administration for Market Regulation’s antitrust unit, increasing its latitude to police industry. A month later, media reports indicated that mainland online brokerages may be banned from providing offshore trading services to mainland clients.

It’s easy to see why investors might not buy Tencent’s denials that its fortunes are imperiled by Xi’s maneuvers against the tech sector. In reality, “no one should be surprised” to see China crackdown risks roar back, says Bill Bishop, editor of the widely-read Sinocism China newsletter.

Risks facing Tencent, meantime, are even harder to assess. Tencent shares plunged Tuesday as China’s top bank watchdog warned about illegal fund-raising schemes and scams related to the metaverse. Fair or not, investors were quick to connect the dots to Tencent – and turbulence to come in Chinese markets.

Author: WILLIAM PESEK, Asia Times