CHINESE SHAPE SHIFTING: RECTANGLES TURNING INTO CIRCLES?

We published a piece last week suggesting that the valuations of some high-quality growth companies were now discounting investor concerns about the Chinese market. In otherwords, a lot of the bad stuff was “in the price” or pretty close to it. The piece provoked a lot of feedback.


Although the piece dealt primarily with valuations a number of you wanted to know more about other topics which have led to the market being derated. Our views on these are summarised below.


Business Regulation


The South China Morning Post is today a particularly interesting publication. Published in Hong Kong, it is now owned by Alibaba, itself clearly under some scrutiny, yet no doubt keen to be seen to say the right thing. So, hardly free and objective paper. All that said, when it reports that China’s anti-trust chief, Gan Lin, has declared an early victory in getting rid of the once-widespread practice of “picking one out of two” merchants within the e-commerce sector”, we are encouraged. Gan goes on, “monopolistic behaviours by platforms and disorderly competition have lessened”. These are not the words of someone preparing for war, but more likely preparing the ground to rebuild, confirming our view that the worst is behind on this.


Another positive surprise came with the little reported validation of Variable Interest Entities or “VIEs”. As a reminder, VIEs use contracts to simulate equity ownership in Chinese businesses which are on the “Negative List” for foreign ownership, which includes the majority of internet businesses. The National Development and Reform Commission (NDRC) and the Ministry of Commerce first released a new version of the Negative List, clarifying the position in favour of VIEs. Then the CSRC clarified the requirements for listing VIEs overseas. All this has, for the first time ever, granted legitimacy to a structure that Alibaba, Tencent, Baidu, Meituan, JD and many others use to tap foreign investors.


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