It is easy to understand why Chinese tech stocks look so tempting to so many value investors.
The share prices of China’s tech giants have plunged since Beijing launched a crackdown on the sector’s high fliers. Alibaba Group Holding Ltd. , the Amazon.com of China, is now trading 35 per cent below where it stood a year ago. Shares in Tencent Holdings Ltd. , the sprawling tech conglomerate, and Meituan, the food-delivery giant, have also fallen way below their peaks earlier this year. Yet in all these cases, revenues continue to surge ahead.
If you buy the notion that Beijing’s goal is to humble the tech sector but not demolish it, these stocks may now qualify as bargains. But that is, at best, a risky bet. Investors should think long and hard before devoting any large portion of their portfolios to the apparent deals. If you decide to do so, you should be willing to commit your money for a long time.
The biggest worry for prospective shareholders is that it is not at all clear where China’s crackdown on private industry will end or, for that matter, if it will end.
Regulators fired the first shot last November when they quashed the enormous US$34-billion stock debut of Ant Group, the payments affiliate of Alibaba, just days before it was scheduled to take place.
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More recently, Beijing has devastated the country’s private-tutoring industry with new rules that essentially turned the once-booming business into a non-profit sector. It also fined Alibaba, pummelled ride-hailing giant Didi Chuxing for supposed data offences and probed Meituan for allegedly abusing its dominant market position.
Chinese President Xi Jinping’s reformist zeal keeps expanding and finding new victims. In recent days, his government has imposed strict limits on how long minors can play video games, intensified a crackdown on the ride-hailing industry and banned 1,793 “self-media accounts” owned by independent online influencers.
Some commentators see the recent flurry of moves as a way for Beijing to keep a lid on growing social unrest, the result of rapidly rising economic inequality within Chinese society.
Others view the crackdown as a pre-emptive assault on tech billionaires and anyone else who could emerge as a potential rival to the Communist Party.
Still others point to the financial troubles at China Evergrande Group, a major property developer, and ask whether China’s leadership is eager to assert control over the economy because of worries about the cracks now appearing in the country’s massive property sector.
Whatever his exact motivation, Mr. Xi seems determined to push the Communist Party back into the centre of China’s cultural and economic life.
On Aug. 17, the party’s financial and economic affairs committee, which he chairs, asserted that it was necessary to “regulate excessively high incomes” to ensure “common prosperity for all.” Since then, the country’s biggest companies, including Alibaba and Tencent, have fallen over themselves rushing to donate the equivalent of billions of dollars to advance the common prosperity agenda.
Until the political turmoil settles, it will be impossible to put a firm value on Chinese tech stocks. But that doesn’t mean investors have to fly completely in the dark. Aswath Damodaran, the valuation guru and professor of finance at New York University, has constructed stock-pricing models that attempt to calculate the range of potential values for some of China’s leading tech firms under varying political regimes.
In a blog post earlier this month, Prof. Damodaran looked at how Tencent, Alibaba, Didi and online retailer JD.com would fare in three scenarios: one in which Beijing returns to being an economic benefactor to these companies, one in which government restrictions act as a net negative for the tech sector and one in which Beijing becomes an active adversary of the tech giants.
As you might expect, the range of potential values across the three scenarios is huge, but in the current scenario – the one where Beijing acts as a net negative for China’s tech giants – the four companies look only somewhat cheap. Alibaba, for instance, is undervalued by 12.7 per cent in this scenario and Tencent by 8 per cent, while Didi and JD.com are within spitting distance of fair value.
Most of these stocks have risen slightly since Prof. Damodaran made his calculations. That would seem to suggest investors are being quite optimistic about how China’s crackdown will evolve. The problem is that there is no apparent reason for them to think so. Nothing has obviously changed in Beijing’s position.
Investors should keep the risks in mind. Thanks to the recent crackdown, these stocks now look slightly – but only slightly – cheap. True bargain hunters will want them to get considerably cheaper before betting much money on Beijing’s unpredictable policy shifts.
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