Chinese tech companies under scrutiny again

The dramatic punishment of ride-hailing platform Didi Chuxing, immediately after its IPO, is the latest example of increasingly strict internet platform regulation in China: only days after Didi’s listing at the New York Stock Exchange, Chinese regulators ordered app stores to remove Didi’s app, citing privacy violations. Behind the targeting of some individual companies is a battle for control over data. Internet platforms see their enormous databases as the foundation of their competitive advantage. Chinese authorities, however, focus at the risks related to big data, as they consider it to be a strategic national asset. They fear that this data could be exposed to foreign governments, especially when companies are listed on stock exchanges overseas. Internet platform regulation will continue to tighten until Chinese authorities are fully convinced they have control over companies’ data assets.

Recently, China also proposed new rules that would require companies holding data on more than 1 million users must now apply for approval from Chinese cybersecurity authorities when seeking overseas listings. These new rules would imply that potential listings of valuable subsidiaries of large online companies, such as Tencent, Alibaba or Baidu, may require these companies to go through more regulatory hoops. At first glance, this would involve higher costs and more uncertainty. In addition, recent cases of government interference have shown that if companies do not comply with the rules, they can be severely punished. That said, some of the mayor Chinese internet companies have sufficient capital to cushion higher costs or potential fines.

The Chinese tech sector has always been under relatively high government scrutiny, given the sensitivity and reach of the sector within the country. With this new wave of regulatory requirements, it could become more difficult for Chinese tech players to grab existing or new growth opportunities. However, the underlying market for these tech companies is still enormous. The usage of internet and e-commerce is still growing at high speed, making the digitalisation trend a very strong driver for tech-related businesses. And even though the Chinese government applies strict rules, it also supports and promotes these companies – as long as they comply with regulation.

So, once in a while, Chinese authorities have to show who’s the boss. This leads to a more negative sentiment and brings along higher volatility for Chinese tech-related equities. In time, such negative sentiment often fades away as investors tend to refocus on the longer-term growth potential of the tech sector. Therefore, we continue to be moderately positive on these Chinese tech companies, although short-term volatility could remain elevated.

Joost Olde Riekerink – Equity Research & Advisory Expert