The Chinese tech sector has been shaken up yet again by another crackdown by the controlling Chinese Communist Party (CCP). Should investors treat this latest move by the CCP as a warning sign, or is it an opportunity to purchase Chinese tech stocks at a discount?
It is now evident that no Chinese company or CEO is too big or too important in the eyes of the CCP. The first major tech crackdown was targeted against Jack Ma’s Ant Group IPO in autumn 2020. This would have been the world’s largest IPO of $37bn, but instead it was called off. A month later, another company owned by Jack Ma Alibaba (NYSE:BABA) became a subject for an antitrust investigation led by Chinese authorities, which later issued a $2.8bn fine to the company. Alibaba shares are still trading 16% lower since the antitrust probe was first announced.
In spring 2021, the CCP announced that the Chinese government will impose restrictions on the $120bn industry of online and offline tutoring for school children. These measures are an attempt to push down the cost of raising a child and boost birth rates, but could also reduce the annual revenue of tutoring companies by 70-80%. The industry, which flourished during the pandemic, saw the shares of some of the major US listed players plummet: since March 25, the day before the news broke out, TAL Education shares (NYSE:TAL) dropped by almost 64%, New Oriental Education (NYSE:EDU) shares fell by 57% and Gaotu Techedu (NYSE:GOTU) shares are trading almost 82% lower, as of 15 July 2021.
The latest example came just one day after the 100th anniversary of the CCP. The ride-hailing company Didi Chuxing (NYSE:DIDI), China’s answer to Uber, became the subject of a cybersecurity breach investigation led by Beijing three days after Didi’s US IPO on June 30. Didi shares are currently trading 23% lower than its IPO price, as of July 15, after having recovered some of the losses.
US measures against Chinese tech
Following the Didi crackdown, China’s top government body, the State Council, announced that it would impose new restrictions on overseas listings, aiming to protect the storage of sensitive data. Later the Cyberspace Administration of China revealed that Chinese companies that possess the data of more than 1m users will be obliged to complete a security review before issuing shares overseas.
The CCP is not alone about eyeing Chinese companies listed in the US. In December 2020, the US congress passed an audit law that could force these companies to delist, unless they comply with the US accounting rules. The companies would get three years to comply, which is unsurprisingly opposed by Beijing given their concerns over management and personal data being compromised. The Didi saga has served as a catalyst for the US lawmakers to build up more pressure on the US Securities and Exchange Commission (SEC) to speed up that process.
Who should invest and why?
Investing in Chinese companies listed in the US has always involved certain risks. Apart from the recent regulations coming from the Chinese and US authorities, shares in these companies, which are privately owned in China, are often issued for a holding company based in a tax haven, such as the Cayman Islands. This structure has a high degree of complexity, and therefore, higher risks.
However, for investors with a larger risk appetite, it is difficult to ignore Chinese tech companies. China, being the second largest economy in the world with a population of almost 1.5bn people, has on-average contributed to about one-third of the global growth share between 2000 and 2019. In 2020, thanks to its robust handling of the Covid-19 outbreak, China was the only major economy to exhibit positive GDP growth. China is also underway to transform its economy from being reliant on manufacturing to be service and consumption driven, like developed economies. This rebalancing has been showing solid results since 2011, when services and consumption have outperformed manufacturing and construction by the GDP share. Rising domestic consumption would be beneficial for many Chinese tech companies, increasing their revenues and margins. Asia Pacific, in general, is predicted to account for 50% of the global GDP and 40% of the global consumption by 2040, and Chinese stock market provides investors with exposure to catch this trend.
Moreover, many Chinese tech companies currently have low valuations, unlike their US counterparts, offering investors the potential of a generous compensation for the risks, especially if handled strategically.
Some companies to consider
Vipshop is an online discount retailer that has adopted “flash sales” within its business model. Vipshop offers highly discounted items, including apparel for women, men, and children, handbags and shoes, cosmetics, home goods, among others, in limited quantities and only while the stock lasts. The company mainly operates through the platforms in their app, website and mini apps, which generated almost 98% of net revenues in 2020. Vipshop also owns 550 offline stores in China which brought in the remaining 2% of the net revenues last year. Vipshop mainly works directly with brand owners and has a diversified brand base, with no such brand exceeding 3% of the total revenues in 2020.
In 2020, Vipshop had 83.9 million active customers, with 8.3 orders per active customer on average. The net revenues accounted for RMB 101.9bn ($15.6bn), an 8% increase YoY. The cost of revenues is, however, a large expense resulting in a gross margin of 21%. In the same year, net income increased by 48% YoY to RMB 5.9bn ($905m).
Vipshop shares suffered in the aftermath of the Archegos Capital collapse in March 2021, currently trading just below $20, which is 65% below its peak prior to the selloff. Since the selloff was not related to the fundamentals and future prospects of the company but rather to mismanagement of the Archegos Capital assets, Vipshop has very attractive valuation metrics at the moment (P/E = 13.6 and P/S = 0.72).
Autohome provides an online platform for new and used car dealerships. It has three revenue streams: (1) Media services that accounted for 40% of net revenues in 2020 mainly include advertising services for automakers and regional marketing campaigns conducted by certain automobile brands; (2) leads generation services (37% of net revenues) that comprise dealer subscription services, advertising services for individual dealer advertisers and used car listing services; and (3) online marketplace and others (23% of net revenues) which consist of data products, the new and used vehicle transactions, auto financing and others.
In 2020, the company delivered RMB 8.7bn ($1.3bn) in net revenues, 3% higher YoY, with net income amounting to RMB 3.4bn ($522m), a 6% increase since 2019. Revenues from online marketplace and others had the largest increase of 34.4% from RMB 1.5bn in 2019 to RMB 2.0bn ($307.2 million) in 2020 mostly driven by data products. The data products are the result of leveraging Autohome’s AI, big data and cloud capabilities, as well as AR and VR technologies.
Since the peak in February 2021, Autohome shares have been undergoing a correction, currently trading 55% lower at $63 per share. However, now the share price has reached an important support level, which could potentially reverse the descending trend. In addition, given Autohome’s high margins, it has very attractive valuation metrics (P/S = 5.8 and P/E = 15.4).
Baidu started off as a developer of a search engine in China in 2000. Today the company offers a wide range of services, including targeted advertisement, several video streaming platforms, cloud services, such as PaaS, IaaS and SaaS. Moreover, Baidu has developed a cloud-to-edge AI chip, first introduced in 2018, specifically designed for its computing environment. The company is also an autonomous driving market leader in China in terms of the number of test miles and number of test licenses, and has launched robotaxi services to the public in Beijing. In addition, Baidu runs online health services, among others.
In 2020, Baidu delivered RMB 78.7bn ($12.0bn) in revenues with no changes YoY. The major share of Baidu’s revenues came from online marketing (84%; RMB 66.3bn or $10.2 bn), while the cloud services brought in 12 % (RMB 9.2bn or $1.4bn). The cloud services saw a rapid YoY growth of 44% thanks to the rapid adoption of Baidu’s cloud service and products. The online advertising revenues, however, dropped by 5% YoY, due to negative effects of the Covid-19 outbreak and marketing budget cuts across industries. In addition, Baidu invested almost $3bn in Research and Development in 2020 to maintain its competitive edge.
Baidu shares have also undergone a correction, trading at $186 which is 47% below the peak in February 2021. They also were sold off during the liquidation of the Archegos Capital assets. Like Autohome, Baidu’s share price is currently at a major support level, meaning a potential buying opportunity at an attractive valuation (P/S = 3.8 and P/E = 8.7).
While Chinese US-listed tech companies are certainly a risky trade due to the regulatory concerns coming both from the US government and CCP, they provide investors with an opportunity to diversify their portfolios and gain exposure to the fast-growing Chinese market. Since many tech companies in China have undergone a significant correction in the recent months, this might be a window of opportunity for investors with a larger risk appetite. Such risk-taking could be rewarded given the attractive valuations of these companies.
Disclaimer: this article is for informational purposes only and should not be interpreted as financial advice to purchase or sell any of the aforementioned securities. The author carries no responsibility for any inaccuracy in the data.