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Chinese Stocks Performance
Most Chinese tech companies listed in either the U.S. or Hong Kong experienced a disastrous wave of panic selling, pushing prices to a record low. The Hang Seng China Enterprises Index, which tracks Chinese companies listed in Hong Kong, underwent the biggest drop since November 2008. Analysts have termed this drop to be “scary” even in this extremely volatile market. The Index was down by 7.2% on 14th March 2022 and another 6.6% drop on 15th March 2022.
After a solid performance in 2020, most overseas-listed Chinese tech companies have been on a constant decline in the last year. The market cap changes from February 2021 to March 2022 have been immense for the 11 largest and best-known Chinese tech companies with Alibaba’s market cap slashed by 66%, Tencent by 50%, and PDD, the rising e-commerce platform, by 82%. Several notable names fell by double-digit percentages — JD.com by 7.14%, Hello Group by 5.74%, Baozun by 10.43%, iQIYI by 16.74% and Zhihu by 16.14%. The MSCI China Index has seen its valuation more than halve from a Feb. 2021 peak. The gauge is trading at about 9 times its 12-month forward earnings estimates, versus a five-year average of 12.6
Recently, JP Morgan Chase downgraded several Chinese tech stocks starting with JD.com, China’s largest direct retailer, from overweight to underweight and slashed its price target from $100 to $35. This was in harmony and came in as a response to valuations falling in the sector as well as due to a tougher macroeconomic environment.
Reasons for Plunge in Chinese Tech Stocks
The recent plunge in Chinese tech stocks has been such that investment banks like JP Morgan Chase and Goldman Sachs is now calling Alibaba, Tencent and Meituan “uninvestable” over the next 6 to 12 months. Russia-related risks, the domestic spread of Covid-19, and strong market regulations are apparently the biggest contributors that have caused this downfall in the market.
Firstly, among the geopolitical stress between Russia and Ukraine, the US and other European nations would impose sanctions on China, which would further squeeze the economy at a vulnerable time. Secondly, China has shut down the tech manufacturing hub of Shenzhen for more than a few weeks to combat the domestic spread of the Covid-19 virus. Even though this might not have a direct relationship with the performance of the stocks, it leads to supply chain and geopolitical concerns that drive manufacturing away from China and could pose itself as a weight on the Chinese economy. Lastly, a spate of recent regulatory developments is making traders wary of investing in Chinese stocks. Tencent Holdings Ltd., the owner of the super app WeChat and one of China’s biggest tech companies, has been facing a large fine for violations of China’s anti-money laundering rules, which has pushed the stock down by more than 10%.
A plunge in Chinese technology stocks slid after the US Securities regulator played down the prospect of an imminent deal to keep local firms listed on the American Exchange. The Securities and Exchange Commission identified several Chinese firms which face the risk of being delisted from the US, as a part of a crackdown on foreign firms that have refused to open their books for scrutiny to US regulators. The SEC added Baidu Inc. to their list recently for barring audit disclosure. Despite all these reasons, certain analysts view that Chinese tech stocks are no longer profitable. Investors are on a thirst for returns and it has become much harder for such companies to display green bottom lines as they are constantly being squeezed by regulations, domestic economic slowdowns and other political factors. Moreover, the macroeconomy has become weak, particularly domestic consumption and as these companies operate in Mainland China, the lack of consumer demand is hurting them constantly.
Measures to boost Chinese market and the rebound of Chinese tech
Stock prices in Hong Kong and China showed significant rebound in their performance after China’s State Council promised to drive the financial markets by easing certain regulations on technology companies, providing support for property developers and overall, boosting the entire economy. Following this announcement, China’s benchmark CSI 300 Index gained 4.3%, Hong Kong’s Hang Seng Index jumped 9.1% and the Hang Seng China Enterprises Index surged 12.5%, in March 2022. It also shot up the share prices of China’s two largest tech companies, Alibaba Group Holdings and Tencent Holdings, by more than 20%. We are seeing clear structural changes in China’s industrial policies and regulatory stance, especially within the tech sector. In the short run, it might have caused pains in the form of slower growth or increasing costs, but it has helped to create long-term benefits such as healthier competitive environment, higher ESG standards, and ultimately, more sustainable growth. Investors also got an optimistic signal when the Chinese Vice Premier held a meeting to stabilize the capital market and asked for more coordination and restraint from regulatory crackdowns, which instantly led to the rebound of these stocks. Big brother, “Beijing”, tried to calm the panicking stock market with this meeting and urged other government agencies to coordinate with the financial regulators before announcing measures that could disrupt the market.
Is Chinese market a safe place for Pre-IPO companies?
Beijing is currently stepping up its oversight on the flood of Chinese listings in the US, which are mostly tech companies. The State Council also announced that the overseas listing rules for domestic companies will be made even stricter and will tighten restrictions on cross-border data flows and security. The crackdown on tech is a common trend and market analysts view that it could not only threaten the IPOs in the pipeline but could also pressurize the popular Chinese ADR market. Chinese regulators are eyeing a rule change that would allow them to block a domestic company from listing in the U.S. even if the unit selling shares is incorporated outside China. The move could be a huge blow for Chinese companies which have clamoured to list in New York in recent years. There could be fewer and slower new listings in the U.S. due to the government crackdown.
Investors might have to reconsider before placing their bets on Chinese tech start-ups as certain new regulations have been imposed on mainland companies looking to go public in the US. Most analysts were of the view that Chinese companies looking to raise capital might face greater uncertainty about their path to getting listed on public markets which could result in lower valuations. Apart from these technical complexities, the new regulations could mean that similar IPOs in the future will likely need to go to Hong Kong. Faced with the potential of lower returns — or the inability to exit investments within a predictable timeframe — many investors in China are holding off on new bets. Chinese IPOs in the U.S. were headed for a record year in 2021 until Chinese ride-hailing company Didi’s listing in late June on the New York Stock Exchange drew Beijing’s attention. Within days, China’s cybersecurity regulator ordered Didi to suspend new user registrations and remove its app from app stores.
The move revealed the enormity of Chinese companies’ compliance risk within the country and marked the beginning of an overhaul of the overseas IPO process.
What does it mean for IPOs in China?
The path to an IPO in the Chinese market looks uncertain. For Chinese companies applying to the US, they must expect stricter regulations from both sides and a higher degree of scrutiny in the market. Moreover, it could also lead to a potential downfall in the company’s valuation and dampen investor sentiment, thereby making it more difficult for such companies to raise funds in the US. According to the Hong Kong Exchange website, more than 140 companies have filings for Hong Kong IPOs. This just makes us conclude that the Hong Kong market might be an alternative for Chinese companies to go public and might best suit the sentiment of investors. Even though the markets have been brought under control, it might not be the perfect platform for companies to go public at this time in the economy.
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This article has been co-authored by Ishaan Poddar, who is in the Research and Insights team of Torre Capital.