- There was a plethora of bad news in the past week. I offer my take as to why market players brushed each one of them off.
- The Chinese President made further declarations related to the Chinese internet sector but I explain why it’s music to the ears of investors clamoring for more clarity in the policies.
- Alibaba pledged US$15.5 billion in support of China’s ‘Common Prosperity’ push, a staggering sum of ‘donation’ but I explain why shareholders should be careful about a possible double-counting of expenses.
- I elaborate why President Xi’s declaration that China will establish a new stock exchange is an assurance for investors wary of the country shifting away from capitalism.
- I end the article discussing if we are past the peak of pessimism.
We have a flurry of seemingly negative news last week. Ironically, in a complete reversal of the panic experienced in July-August, the Chinese internet sector continued to rally. Are sellers exhausted? Has everyone with the impetus to sell their Chinese holdings done so?
The bear may pounce again when it is well rested. For now, let’s review the plethora of bad news in the past week in chronological order and I offer my take as to why market players brushed each one of them off.
China slashed gaming time for children to just three hours per week
Minors (defined as those under 18 years old according to China’s laws) will be forbidden to play video games for more than three hours a week. Specifically, they are limited to playing for an hour a day – 8 p.m. to 9 p.m. – on only Fridays, Saturdays, and Sundays. Even on public holidays, they are also restricted to playing for one hour, at the same time.
Gaming titan NetEase fell more than 6 percent in pre-market trading on Monday. Video streaming platform operator Bilibili which has a side business as a mobile game publisher saw its shares declining 3 percent before the market opened. Global gaming stocks were not spared too. Shares in Ubisoft and Embracer Group each dropped 2 percent.
Yet, the mentioned gaming stocks and the world’s most valuable game company, Tencent Holdings, ended the week with gains. I wrote previously how Chinese internet stocks suffered from multiple punches on essentially the same development. Perhaps investors have read that article and realized the folly.
Recall that a state media outlet had in August decried online games as “spiritual opium” and singled out Tencent’s “Honor of Kings” in an op-ed that called for more curbs on the gaming industry. Shareholders feared the article would herald a regulatory crackdown and sent Tencent stock plummeting. Rival NetEase endured a heavier beating though.
The sellers were proven right but having already reacted based on the media commentary, market players appeared unwilling to dramatize upon the fact. After all, company executives had attempted to put the ‘damage’ to proportion.
James Mitchell, Chief Strategy Officer of Tencent, revealed during the earnings conference call that in the second quarter, under 16-year olds accounted for only 2.6 percent of the company’s China game grossing receipts, and under 12-year olds accounted for a mere 0.3 percent. Charles Yang, Chief Financial Officer of NetEase, offered an even greater reassurance for his company, also during the second-quarter earnings call – under-18s accounted for less than 1 percent of NetEase’s total games gross billing.
That is to say, even if the Chinese government had barred the children from playing altogether, the steep slumps in the share prices on the news wouldn’t have commensurated with the financial fallout.
On a side note, although Yang did not name the company, it seemed he alluded to Tencent when he said “different companies might have disclosed different data, but according to [Chinese] law,” minors are defined as those below the age of 18. With Tencent only revealing data for under-16s, Yang had ostensibly thrown down the gauntlet to its rivals to follow his suit and unveil the financial impact for under-18s instead.
Nevertheless, shareholders weren’t in the mood to nitpick and rather occupied themselves with scooping up gaming shares on the cheap. Although the shares fell initially, TCEHY and NTES eventually closed the week 7.0 percent and 0.2 percent higher.
Greater scrutiny and penalties on e-commerce platforms
Also on Monday, the Chinese market watchdog announced its intention to impose harsh penalties on online marketplaces like Alibaba Group’s Taobao, JD.com, and Pinduoduo if they fail to confront violations of intellectual property rights [IPRs] on their platforms. According to the documents (contents in Chinese) published by the State Administration for Market Regulation (SAMR), offenders could be ordered to compensate IPR holders for the damages suffered and even have their operating licenses revoked.
While the measures sound frightening, the e-commerce stocks were seemingly oblivious and continued their upward march. Perhaps shareholders were cognizant of the fact that the policy notice was categorized as “solicitation of opinion” and the actual implementation may differ in severity. Nevertheless, with the deadline for the submission of opinions set as October 14, 2021, we might expect the news coverage of the final form to spark a round of sentiment hit.
Xi Jinping called for more guidance and supervision of internet companies
We are not done with Monday. Chinese President Xi Jinping praised the antitrust campaign against the internet sector as “beginning to bear fruit.” This can be construed as his support for a continuation of the crackdown and could have triggered another round of indiscriminate selling.
That did not happen, however, as investors became more discerning about what exactly had been said beyond the headlines which might be sensationalized for clicks. Countering claims of Beijing being capricious, Xi called on the Communist Party of China [CPC] to step up on the guidance and supervision of internet companies with “clear rules, effective regulations, and greater policy transparency.” This must be music to the ears of investors who have clamored for more clarity in the policies.
Meanwhile, even though Meituan warned that it may have to “make changes to its business practices and may be subject to a significant amount of fines,” its share price continued to march upwards.
Chinese ride-hailing firms ordered to fix misconduct by year-end
Hot on the heels of a medical pricing reform plan announced on Wednesday as part of a campaign to make healthcare in China more affordable, Chinese authorities summoned executives from 11 companies, including DiDi, Meituan, and Alibaba’s ride-sharing and navigation unit Amap, for a reprimand. The ride-hailing platform operators were criticized for their disruptive competitive practices and violations hurting the interests of drivers and passengers.
The reaction to the share prices of the affected stocks was a yawn. If the news had emerged a few weeks earlier, it could have exacerbated the sell-off in the tech sector. Investors might have reckoned the internet companies have already been sold off on an expected tightening in the regulatory environment and realized it didn’t make sense to punish the stocks again for essentially the same issue.
Furthermore, the operators were given around four months to carry out self-inspections, rectify the problems flagged, and submit compliance plans. This was unlike in July when the regulators demanded the app stores disable the downloads of offending apps and ordered the suspension of new user registrations with immediate effect. There were also no financial penalties meted out.
DiDi and JD established worker unions in a watershed moment for China’s tech sector
Also on Wednesday, reports streamed in that Chinese ride-hailing giant DiDi Global Inc and JD separately formed unions for their staff. The moves were hailed as groundbreaking as company-wide organized labor is extremely rare in the Chinese tech sector.
Given the tendency for unions to extract higher compensation and benefits from the employers that could hurt the bottom line, it’s surprising market players looked the other way and their stocks were spared of panic selling. Again, as I postulated in the previous section if the news surfaced in August, the market reaction could have been quite negative instead.
Shareholders probably took it positively that the companies would be regarded in a better light in front of the regulators with their proactive initiatives. Investors might have also been comforted that China’s unions are rarely aggressive and instead focused “on matters such as alleviating employee grievances and promoting work safety,” according to Aidan Chau, a researcher at the Hong Kong-based China Labour Bulletin.
Alibaba pledges US$15.5 billion in support of China’s ‘Common Prosperity’ push
To round up the week of ‘detrimental’ news on Chinese internet companies, we have Alibaba Group announcing its RMB100 billion (US$15.5 billion) commitment to finance 10 initiatives promoting ‘common prosperity’ in China, supporting a nationwide push towards a fairer society. Critics might construe this as a ‘forced donation’ and raise concerns about the impact on Alibaba’s future earnings growth.
However, judging by the ho-hum movement of BABA stock, market players were apparently in disagreement with the negative take. This came even as an influential liberal Chinese economist cautioned against “excessive government intervention and the erosion of the market economy” in China. We could guess why this was so by looking deeper into the pledge.
Of the big sum, only RMB20 billion was allocated for a dedicated fund designed to reduce income inequality in Alibaba’s home province of Zhejiang. The remaining amount would cater for initiatives such as technology innovation and the creation of ‘high-quality jobs’ that could boost the company’s prospects.
For instance, Alibaba said it plans to introduce more healthcare services on the cloud, tapping digital technologies to bring urban medical resources to more people outside the major cities. Any spending on this endeavor should be regarded as an investment for its health care unit Alibaba Health.
The support for small, medium, and micro-sized enterprises on their entry into overseas markets that Alibaba deems as “one of its key initiatives” is expected to bring additional business for its Alibaba.com and AliExpress platforms. Its support for agricultural industrialization – partnering with local governments to help them scale and commercialize their agricultural businesses – should benefit its grocery units Taoxianda, Freshippo, Nice Tuan, and Sun Art retail shops.
Source: Alibaba Group
Part of the RMB100 billion commitment will be utilized to improve the welfare of gig-economy workers – such as food-delivery riders, couriers, and ride-hailing drivers – including “everything from insurance coverage for occupational accidents to personal development training courses.” These workers’ benefits would have to be implemented anyway with the authorities paying more attention in this area in the past months.
Hence, the US$15.5 billion pledge should be viewed in the context of spending that might have been incurred even without Chinese President Xi Jinping’s ‘common prosperity’ exhortation. Furthermore, it came ahead of Alibaba’s Philanthropy Week, the fifth annual one by the way, which will include several charity fundraising drives. Investors need to be careful of double-counting in the expenses.
The Chinese President showed his capitalist colors again
The series of regulatory crackdowns on businesses across industries have led to comments that China is turning away from capitalism or rather the so-called socialism with Chinese characteristics. Some even claimed that China is outright back to practicing communism.
President Xi’s declaration that China will establish a new stock exchange, this time right in the capital, Beijing, must have surprised the naysayers. The disclosure made via a video address at the opening of the China International Fair for Trade in Services (CIFTIS) marked the second time Xi had personally directed a stock market initiative.
In 2018, he unveiled a tech-focused board for startups on the Shanghai Stock Exchange. Officially known as the Shanghai Stock Exchange Science and Technology Innovation Board and commonly referred to as the STAR Market, it was aimed at channeling investment into China’s high-tech companies to help the country navigate the tech competition and U.S. restrictions amid the U.S.-China trade war.
In theory, under communism, the ownership of land, factories, companies belonged to the state. As Mark Skousen, one of the “Top 20 Living Economists” puts it, “there was no share of ownership to be bought and sold, and hence, no stock market.” If Xi’s China is indeed practicing communism, he wouldn’t be announcing a second stock exchange under his belt. Shrewd investors must have figured this out and bargain hunted last week, helping to fuel the rebound in Chinese stocks.
Savvy investors fueled the rebound in Chinese stocks
Consequently, the representative ETFs of Chinese companies achieved another week of outperformance over their U.S. counterparts. The Invesco China Technology ETF led the pack again.
The market has probably reached a stage whereby Stephanie Link, chief investment strategist at financial advisory firm Hightower, puts it – there’s money to be made on “incremental less-bad.” Risk-takers likely thinking the same as Link in “always trying to find things that people hate” are continuing to keep the rebound alive.
The Chinese Internet sector representative ETF, the KraneShares CSI China Internet ETF (KWEB), saw gains that surpassed the broader Chinese ETFs once more. The KWEB ETF closed up 9.0 percent for the week, adding to the 9.6 percent climb the previous week.
Among the key holdings of the KWEB ETF, the share price of Full Truck Alliance soared again, jumping 25.0 percent, defying skeptics amid ongoing regulatory uncertainties. Bilibili came in at a far second but still achieved a respectable 14.0 percent for the week.
As explained in a past issue of the Chinese Internet Weekly, I found the KWEB ETF holding the most representative stocks in the sector. As such, an overview of the week’s share price movements of the top ten holdings of KWEB (as of Friday) compared with the ETF itself is provided as follows for convenient reference especially for the stocks mentioned in this article.
Are we past the peak of pessimism?
One recurring theme that ran through my mind as I penned this update was whether we have passed the peak pessimism for Chinese internet stocks. They have gone from being sold down for every small conceivable reason to appearing like Teflon despite negative developments. The answer might be found in the mandatory filings revealing institutional holding in Alibaba shares.
The season for filing the Securities and Exchange Commission’s (SEC) Form 13F, a quarterly report that is required to be filed by all institutional investment managers with at least $100 million in assets under management, is over. Thanks to that, we now know the dumping of Alibaba shares by institutional investors accelerated in the second quarter.
The holdings by institutional investors of BABA’s American depositary shares (ADSs) accounted for 24.3 percent of its total shares at the end of June, shrinking 8.6 percentage points from a quarter earlier. The reduction nearly doubled the decline of 4.6 percentage points at the end of March as fund managers were concerned about an exacerbation in the regulatory crackdown in China.
Their fears materialized and their stake cuts spared them from further losses that shareholders endured in the past two months. We will have to wait until mid-November for the next round of filings to know which other funds capitulated. For fund managers with strong stomachs, they could nonetheless be compelled to pare their stakes in Chinese equities when they face rising redemptions from clients spooked by the unabated regulatory uncertainties, a scenario identified by analysts at Morgan Stanley.
Worse, there are already indications that institutional investors are not only selling out their Chinese holdings – many are even going one step further. According to a recent Bank of America survey, shorting Chinese stocks has become one of the most crowded trades among fund managers.
In August, when the Chinese internet ADRs were already badly bruised, critics saw it fit to bring up the Variable Interest Entity [VIE] structure to cast further doubts in skittish shareholders’ minds. I wasn’t sure if it was the works of short-sellers though I reckoned it would be helpful to lay out the circumstances for readers. Hence, the motivation to discuss in greater depth the VIE topic in my previous article. For readers keen on the issue and trust the feedback provided by an appreciative subscriber, you are welcome to check it out.
As the valuations of the large Chinese internet names like Alibaba and Tencent remain in the hundreds of billion dollars, the so-called powerful Redditor-traders probably aren’t able to play up BABA and TCEHY as they did for meme stocks like GameStop Corp. and AMC Entertainment Holding to squeeze out short-sellers.
Nevertheless, with the seemingly indiscriminate selling in August, Chinese stocks plunged into oversold territory. BABA stock suffered from the worst drawdown since its initial public offering [IPO] in 2014. Subsequently, we saw a rebound in the sectorial stocks.
Whether this is just a technical rebound or a more sustained recovery is anyone’s guess. Considering that the deeply corrected stocks could potentially have factored in the regulatory impacts, it probably is more of the latter materializing with positive narrative streaming in. Another inspiration here is that BABA stock had more serious drawdowns before but it managed to climb back up.
Analysts from China International Capital Corporation Limited [CICC], one of China’s leading investment banking firms, and Founder Securities, a major brokerage in China, cautioned that the momentum on value stocks such as banks and property developers is unsustainable, having returned 27 percent year-to-date. They believed that trading interest would rotate back into the beleaguered tech stocks.
From the comments of my previous articles, it is apparent that many readers are skeptical of whatever Wall Street analysts say. The notion is that the analysts cannot speak freely for fear that their employers could lose the business of the companies they wrote about.
Well, this is not a time to debate whether this is a fair assessment. However, I don’t suppose the analysts had to be mindful when opining on entire sectors. Hence, the warning from CICC and Founder Securities probably should not be waved off. What do you think? My past articles have attracted robust discussions in the comments section. I’m looking forward to your participation!
Author: ALT Perspective, Seeking Alpha