The government crackdown on Big Tech in China has caused a cratering in tech stocks, and Chinese tech is the only sector worth watching for a significant segment of U.S. investors. If you are looking to tap the "China growth" story, tech is the way to go.
It has not been pretty portfolio reading this year. The CSI Overseas China Internet Index, which tracks Chinese Internet companies listed internationally, is down nearly 41% since a peak on Feb. 17.
No one has been spared the selloff because no company is above Communist Party reproach. The impetus has been the regulatory crackdown on ride-hailing app operator Didi Chuxing (DIDI) and two other recent U.S. listings of Chinese companies. At the start of this month, they were prevented from signing up new customers days after listing. That's because the Communist Party showed sudden, newfound concern about the security of data for Chinese companies that list overseas, as I explained at the time.
Investors should be particularly concerned about consumer-related tech companies that gather huge amounts of data on the use of their products.
The EV sector had an "extremely strong recovery" in June, Société Générale's China team note, with shares up between 38% and 50%, so companies in the sector have been blindsided by the activity against Didi.
Nio, the largest of the bunch by market capitalization, has fallen 19.5% in July alone and 32% since February. It boasted the highest 2020 unit sales of domestic EV brands, at 43,728, although that left it in second place by some stretch behind Tesla TSLA and its 137,459 vehicles sold in China last year.
Xpeng, which at US$36.7 billion is half the market size of Nio's US$70.1 billion, is off 12% in July and almost 31% from its high in January. The company sold 27,041 vehicles last year. The numbers for both Xpeng and Nio constituted a doubling over their sales in 2019 and the pace continues to pick up.
Xpeng earlier this month raised US$1.8 billion in a listing of its shares in Hong Kong, where they trade under the ticker 9868. The shares are down 8% from their secondary offering price of HK$165. Unusually, Xpeng's sale of shares in Hong Kong was also an initial public offering (IPO) because the company conducted not a secondary listing but a "dual-primary listing." That means it is subject to the rules of both U.S. and Hong Kong regulators, which would make life a lot easier if it were to leave U.S. markets altogether.
The dual-primary structure makes it simpler for Xpeng shares to be included in the "stock connect" schemes that link the Hong Kong and mainland Chinese markets, allowing investors to trade shares between the two jurisdictions. Brian Gu, the company's president, said Xpeng is hedging geopolitical risk with the dual listing while also wanting its "customers to be our shareholders." Chinese brands tend to trade at higher valuations nearer to the home where they have name recognition.
Li Auto is the smallest of the trio, at "just" US$27.4 billion in market cap. Its shares have held up better than its brethren, with the company delivering double the number of new vehicles compared to last year. It should sell 181,000 models in its 2023 year, CCB International forecasts, up from 32,624 in 2020.
Li Auto was trading at similar prices to its February peak before the action against Didi. Its shares have dropped 13% this month.
Eye on Tesla
China already has shown it has a watchful eye on what Tesla (TSLA) does with the data it gathers on Chinese customers. Tesla in May said it would set up a data center in China, its second-largest market behind the United States, to store its data locally.
There are other signs of how concerned the Communist Party is about foreign companies getting their hands on Chinese data. Some government workers had been told not to park their Teslas inside government compounds, Reuters reported in May, due to security concerns over the cameras in the cars. Teslas are banned from entering military compounds in China for the same reason.
Around 600 Chinese companies are listed in the United States, with a total of US$2 trillion in market capitalization. It is unclear as yet how regulators will handle the policing of their data, but there's a good chance they will need to submit to a cybersecurity review.
The Cyberspace Administration of China said on July 10 that it will now require all companies looking to list overseas to submit to a cybersecurity review if they have the personal information of more than 1 million users.
It is also unclear whether China will continue to tolerate the Variable Interest Entity, or VIE, structure it has allowed so far. Chinese companies that list overseas often do not actually do the listing themselves. They create a Cayman Islands company to list in the United States, an entity that has a contractual deal with the Chinese company to receive all its economic benefits.
This loophole has been exploited to allow overseas investors to own stakes in touchy industries such as telecommunications and the Internet, where there are strict caps or bans on foreign ownership. If a lawyer really wanted to get in an argument with the Chinese Communist Party, he or she could argue that the new rules don't actually apply to the Chinese company because it is not seeking to list. Its far-off Caymans affiliate is and therefore is outside the scope of Chinese regulators.
All Chinese Internet companies listed overseas such as Alibaba Group Holding (BABA) , Pinduoduo (PDD) and JD.com (JD) are listed via VIE structures. They account for around US$1.6 trillion of that US$2 trillion total.
"There is a possibility that the 10 July measures, covering virtually all Internet firms seeking an IPO abroad, could evolve into a review of the VIE structure: both in terms of its legality and its future," the SocGen team say. While this may not result in a total ban on VIEs, there may be a transition to a different "framework," SocGen says.
It's unclear what that would be. But Chinese regulators have made it clear they will make decisions that are unpopular with the market without warning when it comes to a topic of high concern such as data.