Investors ‘Sell’ Chinese Tech Stocks as Beijing Continues Crackdown

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An investor looks at screens showing stock market movements at a securities company in Nanjing in China's eastern Jiangsu province on July 6, 2020. (Image: STR/AFP via Getty Images)

The Chinese Communist Party’s crackdown on the country’s tech companies has wiped out a trillion dollars from global stock markets. And as Beijing continues to tighten its noose over tech firms, investors are becoming increasingly wary of betting their money on such stocks.

In an interview with the South China Morning Post, Manuel Muhl of DZ Bank, a Frankfurt-based lender, said that the downward pressure on Chinese stocks may not come to an end until Beijing restores investor confidence in the securities.

Last month, Muhl had downgraded China’s internet platform sector and became the only analyst in the world to give a “sell” rating on big Chinese tech firms like Tencent and Alibaba. More than 50 securities analysts maintain a “buy” or “hold” call on these stocks.

“For the sector to hit bottom, and potentially recover, the government needs to restore the trust that it has destroyed… This can only be achieved by reaching a point where they can publicly state that their crackdown has reached its goal and that they are done for now. When will that be? The Didi IPO, for instance, has angered a lot of investors and unveiled corporate governance issues in the entire sector. This has damaged a lot of trust in Chinese ADRs (American Depository Receipts),” Muhl said in the interview.

Political risks dampen investment

Chinese ride-hailing company Didi had raised a record $4.4 billion from its IPO on June 30 at $16 per share. The company was valued at $68.49 billion, the biggest U.S. listing by a Chinese firm since 2014. Two days later, Chinese regulators launched an investigation into Didi, citing violation of national security and data privacy laws. The share price tumbled and Didi is currently trading at around $7.5. Global investors have since taken a cautious approach to Chinese tech stocks.

Cathie Wood’s flagship Ark Innovation ETF has cut down exposure to Chinese companies to zero from eight percent in February. Paul Marshall, the co-founder of the $59 billion hedge fund Marshall Wace, warned clients in a letter that U.S.-listed China shares are now “uninvestable.” David Tepper’s Appaloosa Management dumped Qiyi and Baidu shares while reducing Alibaba holdings by half.

George Soros’ Soros Fund Management dumped several Chinese stocks in the second quarter including Baidu, Tencent Music Entertainment, Vipshop, and iQiyi. Activist investor Dan Loeb of Third Point cut down his JD.com holdings by 12 percent. Both Soros and Loeb’s funds had taken a position in Didi.

China’s tech crackdown came to the fore last year when Alibaba founder Jack Ma gave a speech that October apparently criticizing the country’s financial system. Since then, Beijing has increased scrutiny on over 30 domestic tech firms which include big names like Baidu, Tencent, JD.com, Didi, and Meituan. 

The CCP and its leader Xi Jinping are of the view that tech companies are becoming too powerful in the country — they could weaken the Party’s monopoly on data collection, as well as aid Xi’s entrenched political rivals. The companies most at risk of attracting Beijing’s scrutiny are those which have high exposure to the public since such firms have the biggest influence among people.

“One thing that Xi [Jinping] doesn’t want are alternative centers of power to be created… It’s what happened in Russia in the 1990s (after the collapse of the Soviet Union)… We saw the creation of the oligarch class, who quickly became political activists… So with the crackdown in China, they are eliminating or cutting down to size the tech billionaires who were getting too powerful and perhaps too popular,” Richard McGregor, China expert and senior fellow at the Lowy Institute, said to ABC News

Many Chinese moguls are connected to the powerful Jiang Zemin faction, which dominated Chinese politics for more than a decade prior to Xi taking office in 2012.  

‘No IPOs for unaccountable actors’

Beijing’s tech crackdown has prompted the U.S. Securities and Exchange Commission (SEC) to take action in order to protect American investors. In a public statement issued on July 30, SEC chair Gary Gensler noted the risks associated with Chinese companies using Variable Interest Entities (VIEs).

China does not allow foreign ownership of companies in several sectors. To bypass this disadvantage, Chinese companies use VIEs. In such an arrangement, the Chinese firm establishes an offshore company outside China, like in the Cayman Islands. This offshore shell company enters into service and other contracts with the China-based operating company and subsequently issues shares in stock exchanges. However, the shell company has no equity in the original Chinese company.

“For U.S. investors, this arrangement creates ‘exposure’ to the China-based operating company, though only through a series of service contracts and other contracts… I worry that average investors may not realize that they hold stock in a shell company rather than a China-based operating company,” Gensler said in the statement.

Gensler directed SEC staff to make sure that offshore IPO issuers clearly disclose the fact that investors are only buying ownership in shell companies and that such companies face uncertainty with regard to future actions by the Chinese government.

On Aug. 17, Gensler uploaded a video to Twitter in which the SEC chair revealed that he has asked the department’s staff to take “a pause for now” in green-lighting IPOs of Chinese shell companies.

He wants American investors to have more information about how such firms are structured. “That means disclosing the political and regulatory risk that the government of China could, as they’ve done a number of times recently, significantly change the rules in the middle of the game,” Gensler said in the video.

Republican Senator Marco Rubio lauded the SEC’s move to protect American investors. In a July 30 statement, he called the SEC action to increase disclosure and transparency of Chinese companies as “long overdue.” 

Rubio called on the Biden administration to support his “No IPOs For Unaccountable Actors Act.” The legislation seeks to prohibit Chinese companies that do not comply with U.S. regulators from issuing IPOs on American exchanges.

“No American’s savings should be used to fund communist China’s rise, and this is the only way we can actually protect Americans and cut off Beijing’s exploitation of our capital markets,” Rubio said in a statement.

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