Tencent vs. China – The authoritarian moment pt. II.

Tencent’s treatment will help predict what happens to everyone else. 

• Of the two possible motivations that lie behind the increasing regulatory clampdown on the Chinese technology sector, it is the fate of Tencent that will demonstrate most clearly what the Chinese state is thinking.
• Tencent is no stranger to regulatory heat and its earlier brush with the state has taught it how to best mitigate the far more serious threat that it and everyone else now faces.
• The Chinese state has long meddled with the gaming sector but its most serious intervention came in 2018 when for a period no new licenses for games were issued.
• This was partly due to a shake-up of government departments but also due to rising concerns that some video games contained content that was addictive, violent, or not adhering to core socialist values.
• By the end of 2018, Tencent had successfully navigated this issue and had learned a lot about how to successfully keep both the government happy and its business humming along.
• A lot has changed between then and now and while Tencent has kept studiously in the regulator’s good books, it has grown a large and mostly unregulated digital financial services business.
• Tencent does use the variable interest entity (VIE) structure to enable it to list overseas but unlike many of its peers, it is only listed in Hong Kong.
• Furthermore, in the recent clampdown, the regulator has left Tencent largely to its own devices despite being the biggest and most obvious target after Ant Group (see here).
• There are a few potential motivations that lie behind the current crackdown on big tech.
  • First, consumer protection and data security: The digital economy has emerged extremely quickly in China which has had very few checks and balances placed upon it so far.
  • China argues that overseas listings and overseas shareholders represent a risk that sensitive data could fall into the hands of unfriendly powers.
  • This combined with uncontrolled lending and unscrupulous practices raise the need for businesses that offer financial services or hold data on their customers to have some degree of oversight.
  • While one can make the case for some oversight on financial services the idea that the use of foreign listings and shareholders represents a risk of data leakage has no merit in my opinion.
  • Consequently, I think that almost all of the regulatory intervention is about control and geopolitics.
  • Second, control. The big technology companies are now so influential that they have the potential to impact the public discourse as well as the economy.
  • This really came to a head when Jack Ma criticised the banking regulator in 2020 and the state decided that it was time to remind everyone who really is in charge in China.
  • This “national security” is so important that if the economic development of these companies and digital services in China is impacted by its actions, then so be it.
  • This is evidenced by the fact that the actions of the Chinese regulator have hammered the valuation of Chinese technology companies making it harder for them to attract capital.
  • This will mean fewer resources being made available for investment and less cash flow to invest in R&D going forward.
  • This is a boon for the USA in its mission to stem the rise of China as these draconian regulations are going to hurt technology development in China handing an advantage to the USA.
  • Third, geopolitical wrangling: of which its growing rivalry with the USA is main the event.
  • I think that it is quite likely China does not like to see its national champions preferring to list overseas as this casts a shadow over national pride and undermines its reputation as a good place to grow and invest in technology.
  • Consequently, this could be why China has taken such draconian actions on companies that are listed in the USA in a bid to incentivise them to delist and come home.
  • The big question mark is whether China considers Hong King to be home as it is widely open to foreign investment and has to use the same VIE structure that US-listed Chinese companies do.
• Tencent is ripe for regulatory intervention but so far it has been left alone.
• Should this continue, then this would support the notion that the main motivations of the Chinese state are control and geopolitical wrangling.
• However, should there be an intervention (which I am expecting at least in the financial services piece) this would indicate orderly and regulated financial services sector is also a motivation.
• This is why I think that how the regulator treats Tencent will be a key indicator of its motivations which will greatly help in predicting what happens to other technology companies going forward.
• Tencent is down 30% from its all-time high of HKD775 set earlier this year but the overhang of draconian regulation may cause it to fall further.
• If Ant Group is anything to go by, then Tencent’s business could be hit very hard indeed, and its ability to offer compelling financial services greatly undermined.
• Tencent represents an existential threat to the state-controlled banking sector and forcing its financial services business to become just another bank like Ant Group will force it into the arms of the legacy banks.
• This combined with their extremely low valuation and 7% dividend yield is why I have a position in the Chinese banks.