China is the world's second largest economy. The shares of successful technology companies are therefore represented in the portfolios of many global investors. In recent months, however, several regulatory measures have caused share prices to plummet, especially for stocks from the internet sector. The start was made in November last year with the surprising cancellation of the IPO of Alibaba 's subsidiary Ant. New guidelines for online platforms and investigations into anti-competitive behavior against Alibaba followed. In April, Alibaba was ordered to pay a fine of USD 2.8 billion.
Further measures that shook investor confidence then led to a veritable sell-off in Chinese technology stocks. These included investigations into mobility service provider Didi, the Chinese version of Uber , for data breaches just days after the company listed in New York. A few days later, the company's app was banned from app stores. The ban on private education service providers generating profits and attempts to combat gambling addiction among young people also caused losses.
What is the background to the wave of regulation?
It has been known since the end of last year that the Chinese government wants to tighten the previously rather lax regulation of large internet and e-commerce companies. To this end, the Chinese competition authority has been strengthened and rules have been established to identify and eliminate monopolies. At the same time, fintechs like Ant are to be considered financial institutions with comparable capital requirements in the future.
Ant's IPO was postponed until these rules are implemented and the company is restructured. In addition, practices identified as anti-competitive have been banned. This is directed, for example, against Alibaba , which de facto forces traders to sell their products exclusively on its platforms. Alibaba was also the first company to have to pay a fine for competition violations (equivalent to 2.8 billion USD, but a manageable sum for Alibaba ).
However, similar proceedings are still ongoing with many competitors. Acquisitions in the tech industry are subject to closer scrutiny. Companies that do not comply with their reporting obligations for takeovers must expect penalties. These measures have been met with great concern by investors. For them, the question is whether stronger regulation can have a lasting impact on the business of the large internet platforms and to what extent this is a power-play between government and business.
The importance of the large internet companies for the national economy has grown rapidly in recent years. This makes the corporations more difficult to control. In addition, the government felt challenged by the open criticism of corporate giants like Alibaba founder Jack Ma.
What does this mean for investors?
As in China, measures to limit the market power of large internet platforms are also being discussed in the West. However, the communication and approach of Chinese regulators is much less transparent. For example, the regulations are often formulated so vaguely that there is a lot of room for interpretation. On the other hand, proceedings, such as the one against Alibaba , are often concluded relatively quickly, whereas in the West they often last for years.
Even if further measures follow in the coming quarters, the regulatory cycle in China could therefore end sooner than in the West. The massive sell-off in Chinese tech stocks can also open good entry opportunities in our view. In 2018, for example, shares of online game developers came under heavy pressure after China suspended the approval of new online games. However, Tencent's shares, which plummeted, recovered relatively quickly afterwards.
At current price levels, the market is pricing in a pessimistic scenario for the major internet companies. It is true that the growth of the companies is being slowed down by these regulatory measures and margins could fall somewhat. Nevertheless, these companies are still among the strongest growth companies worldwide. The government wants fair competition that strengthens innovation, secures employment and establishes China as a technological counterpart to the US.
Large technology companies are indispensable for this. In our view, leading Chinese technology companies with strong balance sheets and positive free cash flows offer long-term opportunities at the current share price level. We are therefore holding on to such positions in the portfolios of the Polaris fund family.
