Over the past few decades, China has focused on economic growth and establishing a formidable physical, intellectual and technological infrastructure that is now predominantly in place. Now, it seems, the government is seeking to reprioritise, insuring that the fruits of China’s labour – namely the economic and business success of the country – are redirected back to serve its people and uplift the large portion of the population in low income categories. This emerging social agenda, a mixture of individual actions and a series of so-called ‘common prosperity’ initiatives, leads to a distinctly uncertain outlook, specifically for foreign investors.
In September this year, Alibaba committed the equivalent of $15.5bn to help promote common prosperity initiatives in China (Source: Alibaba Group). It followed fellow tech giant, Tencent, making a similar pledge of $7.7bn in April (Source: Tencent), going on to announce a doubling of that amount in August – the equivalent of a full year’s profit. It gives some indication of the feeling among business people of what they think they should contribute. Whether that capital is allocated over one, four or ten years, it all comes from the pockets of shareholders’. And most of those are foreign investors.
These redistributions of company profits tell of a change in the operating environment in China, whereby high profitability is becoming something of a target amongst politicians and regulators. In November 2020, Chinese authorities blocked the planned listing of Ant Group, the financing arm of Alibaba. Just before the listing, company executives were summoned by regulators who went on to issue a news release stating: “Due to the material matters reported, your company may no longer meet the conditions for offering and listing”.
In July, the Chinese government announced new rules prohibiting for-profit tutoring in core school subjects the cost of which, they implied, puts undue pressure on families educating their children in a highly competitive environment. They also seemed to suggest that it was partly responsible for hampering population growth. The result was that investors in private tutoring companies – by far the majority of whom are foreign – lost about $100bn overnight. US-listed TAL Education Group released a statement on the 25th July saying the company expected that compliance with the new regulations would have “material adverse impact on its after-school tutoring services[…]which in turn may adversely affect the Company's results of operations and prospect.” The company’s share price dropped 77% to $4.7 (as at 12 Oct 2021) from $20.52 on 22nd July (Source: Bloomberg).
A number of further regulatory announcements and fines have followed and, for the moment, investors perceive the chance of further negative surprises to be higher than the chance of positive surprises in this context.
The effect of the increasingly prioritised social agenda in China has been to produce uncertainty around any sector likely to be affected. Many investors fear that healthcare, housing, technology and property may be vulnerable and, as a result, are divesting their support away.
Although on the surface of it, common prosperity is a noble cause, investors are right to fear the net effect of channelling all profitability back into the hands of the state. China could end up with a clutch of utility-like entities, losing their strong entrepreneurial spirit and competitiveness.
Were the Chinese regulators, government and businesses to start talking to them, foreign investors may feel differently. However, with the continued lack of communication from China, investors remain in the dark as to what may happen next. Fundamental analysis of companies relies on understanding what they are doing today and what they are likely to do tomorrow. In today’s environment, investors are unable to build projections with any confidence.
Many Foreign investors are voting with their feet, directing their investments back to the US or India as a competitive alternative. Their continued flight from China shows they fear the increasingly uncertain political and regulatory environment and need much higher returns to compensate for it.
While there are good reasons to be optimistic about the Chinese consumer market for the longer term, there may have been structural damage to investors’ confidence in investing directly in Chinese companies. They might prefer to utilise that potential by investing in global operators providing exposure indirectly.
Photo by Yang Yang on Unsplash
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