China Internet: Hogs or Horses?

The number one rule of doing business in China is that you need to follow the leader. Not anyone, not even Jack Ma, is exempt. This should have been the single clearest message from the Alibaba debacle last year.

I still remember the last time Western investors panicked about the death of private enterprise in China. In 2017, Wu Xiaohui, the chairman of Anbang, vanished, just months after leading negotiations to buy out Starwood Hotel Group in a US$14bn deal. That is probably a more apt comparison to Khodorkovsky: Wu lived and died by political machinations. In Jack Ma’s case, technology and other private companies in China thrived despite government’s historical preference for SOEs and the public sector. But Jack Ma’s case also uncannily timed to a historic moment for private enterprise: the IPO of Ant Financial, what would have been the largest tech IPO. If Anbang represented Icarus moment for outbound capital deals, Jack Ma’s example signaled a shift of policy towards the internet sector: from one largely of laxity to increased regulation. The Didi moment is a further development, signaling the end of a golden era for foreign ADR listings.

But if private enterprise is alive and well even after what happened to Anbang and Fosun in 2017, (Anbang certainly didn’t bring down the entire insurance sector, and Fosun is still very much alive and well), there should also be no doubt about the direction of private enterprise today. Just because most Western investors are massively overweight China internet (China major internet companies comprise nearly 40% of MSCI China) does not mean that we should overdramatize the significance of these moves; the largest 12 internet companies employ just over 1 million people in the economy (of 750 total workforce). We must remember that private enterprise is 80% of urban employment in China, 90% of job creation, and that we estimate the tolerance for unemployment rates in China would be around 7% before we might start to see civil unrest. At the same time, China is deleveraging, we’ve seen credit spreads increase significantly on the SOE side, and high profile defaults of behemoths like Evergrande. This is certainly not a moment of trying to nationalize, or shift support over to the state side of things. More than anything, it reads as an overall push to reduce risk across the board and where it has accumulated the most.

Already, the regulations on internet have had positive impacts. Many internet companies are already getting rid of the 9-9-6 work policy (employees working 9am – 9pm Monday thru Saturday). On Wednesday, the WSJ reported that Alibaba and Tencent are considering moves to gradually open their services to one another.

In China, there is a saying about raising hogs and horses. Hogs are raised fat for the slaughter, it goes, and horses are raised strict so they don’t run wild.

The ethos of Chinese policy is that one company’s hubris and greed can sacrifice a country’s safety and stability. It is the government’s role to anticipate and redirect energies in line with its grand strategy, so that the country can become stronger together, and no one entity can put the rest of the country at risk. When I was at Yale, it was often discussed that perhaps the West, after the Cold War, has lost its grand strategy, partly due to shorter and more divisive political cycles and partly due to complacency. The Chinese do have a roadmap for the country’s strategic direction, with one man to oversee this direction for the foreseeable future. If the risk for China is micromanagement, the risk for the West is the tragedy of the commons.

At the time of Anbang, currency weakness was a major concern for the government; capital outflows were a threat to the stability of the country. Anbang was a surgical strike intended to serve as a moral example; after this many overseas deals were pulled and with little resistance. From this perspective, this is a high ROI move; maximum compliance, minimum intervention.

Besides the issue of foreign listings, the two key issues today are national security and data security. In the case of Didi, transport is a matter of national security, and Didi, or Uber, would have the most comprehensive data on any country. It is understandable that the government would not like a foreign government to be entitled to this data in any way. The second issue is around data privacy. This is not unique to China; governments all over the world are now finally catching up to the reality that these companies are not start-ups anymore. They are some of the most powerful organizations in the world. It wasn’t until recently that people began to object to the scope of influence that Facebook or Twitter had over election outcomes. The intersection of the two issues of national and data security is also not unique to China. Last year, the US raised national security concerns about the sale of Grindr, a gay dating app, to a Chinese company, which was then forced to sell it back to a US company. China may be taking the lead on internet regulation, but the West will not be far behind. The irony is perhaps that only a government which possesses so much data on its own people can understand the extent of the power that can be wielded when these platforms amass so much unobstructed data, and the potential for such data to fall into the wrong hands – especially when listed on a foreign bourse. Indeed, only a government which truly controls propaganda understands the real danger of “unbiased algorithms”. The status quo of Chinese companies listing in foreign countries with shareholders or governments who might be entitled or have access to their data is certainly a condition that we have just taken for granted – just like the unimpeded rise of internet monopolies. They are certainly overdue for some reining in.

After all, even the best racehorses have been broken and bridled. We remain out of large internet players, but we believe that we are closer to the end than the beginning.

By Alice Wang, Portfolio Manager at Quaero Capital, with contribution from Dr Xuxin Mao, Principal Economist at the National Institute of Economic and Social Research (NIESR) in London