Chinese Ecosystems – Metcalfe’s benefit

A move that might actually benefit China.

• The forced opening up of the Chinese digital ecosystems forces the incompatible systems to work together which will make the overall opportunity for all players that much larger.
• Alibaba, Tencent, ByteDance, Baidu, NetEase, Huawei, and Xiaomi were all summoned to a meeting at the Ministry of Industry and IT where presumably they received a dressing down and marching orders with regard to their lack of interoperability.
• The Chinese internet can basically be carved up into two main camps (Alibaba and Tencent (Baidu dropped out some time ago)) which compete head-to-head and have no interoperability.
• Nowhere is this incompatibility more clear than in payments where AliPay does not work on any Tencent services and WeChat Pay cannot be used on Alibaba e-commerce platforms.
• Both companies have been given their marching orders and both companies have said that they will comply with almost immediate effect.
• In this climate, it has been made abundantly clear what will happen to anyone who decides to defy the orders of the MIIT which come indirectly from the CCP.
• Hence, the next few weeks are likely to see much greater interoperability come to the Chinese internet which in contrast to the market, I think is a good thing for all concerned.
• This is a result of Metcalfe’s Law of Networking which has been proven time and again to work well in real examples.
• This general rule states that the utility of a network increases by the square of the number of devices that are attached to it.
• Hence, it is clear to see that one large network will create far more value than two smaller networks that together have the same number of devices as the large one.
• This is exactly what exists in China and by introducing interoperability, it is likely that both Alibaba and Tencent will create more value for each other than they would do on their own.
• This is a very rare example of where a regulatory or state intervention is likely to have substantial economic benefits for all concerned.
• The one caveat to this is that almost everybody in China already uses both networks and so the benefit may take a long time to show itself.
• Hence, the market’s reaction makes no sense as it has sent the shares of both Tencent and Alibaba down when arguably, they should have gone up.
• I suspect that this is more about the sheer terror that shareholders of Chinese internet companies have whenever the state says boo.
• Regulatory risk is very real in China and the CCP is demonstrating that it is quite comfortable with damaging the outlook for its own industries in order to ensure that it remains in control.
• That being said I continue to think that the regulatory storm has largely blown itself out on Alibaba and that the company has emerged pretty much unscathed.
• I think that it will end up losing its 30% stake in Ant Group but I had long ago written this down to zero and I can still see value in the shares.
• This is in contrast to Tencent which has a huge financial services business which if Ant Group is anything to go by, will end up being crushed by the state and turned into just another bank.
• Consequently, the only technology stock I hold in China is Alibaba which is doing an excellent job of testing my faith in the story at the moment.