Tech Cultural Revolution

By Ichiro Suzuki


China’s President Xi Jinping is clueless, as far as the financial markets’ workings are concerned. The tyrant thinks superb engineering skills and entrepreneurial minds in the tech sector are the recipe for a stock market that leaves the rest of the world behind. They are hardly enough. It takes soft infrastructure that he doesn’t understand so hopelessly. Such infrastructure includes a sound legal and regulatory framework that insures property rights of investors of a variety of kinds. Providers of risk capital need an environment that allows them to sleep well, free from worries about their money. Scrapping a high profile IPO two days before the scheduled date is bad enough. The botched sale of Ant Financials shares last November had caused a sharp volatility spike through heightened uncertainty about a regulatory environment on the company. Punishing a company two days after its IPO is worse, for violating a Chinese data law or whatever reasons. Regulators’ denial of Didi Chuxing's place in app stores had abruptly brought down the ride-hailing company’s revenue outlook. It is an act of an outright contempt for property rights that has made investors in DiDi furious. If the authority had acted two days before, not after the IPO, investors in the newly listed company did not have to suffer losses in the public market for a totally unforeseen reason. Then, attacking companies for making money is an absolute horror. In late July, the Chinese Communist Party stunned education tech, or tutoring, companies by telling them to become non-profits. In an even starker contempt for property rights, they were told not to generate profits. Fortunes of the EdTech entrepreneurs had plummeted in just a matter of a few days, by as much as 90% for some. The CCP says that EdTech is creating heavy financial burden on Chinese parents who have been already investing aggressively in their ‘one child’ to make him or her get ahead of their classmates and friends, and the party is probably right on this. For that matter, in the United States, the land of scandalously high college and private high school tuition, on-line tutorial programs are offered for nothing, thanks to Khan Academy that is run as a non-profit organization. While in fact the CCP’s demand may be sensible, it is utterly shocking to deny entrepreneurs’ chances to make money all of a sudden. Should they have anticipated this beforehand, of course they wouldn’t have invested in this sector in the first place. If that was not enough, then a state media outlet suggested that online video games was as addictive and destructive as opium, sending the share price of Tencent into a tailspin. The company immediately pledged a cap on a number of hours people can play. The CCP has shown their displeasure with online gaming years ago, and they have brought it back again at this juncture. While regulations always follow what has already happened in the real economy, it is far too aggressive and insensitive to deny entrepreneurs their aspirations. It may be fair to say their wealth was confiscated. It is abundantly clear that this is a wholesale attack on China’s internet entrepreneurs though the first CCP action on Ant Financials and Jack Ma was considered as an isolated event. The Financial Times estimates that ten largest internet tycoons have lost a total of $87 billion amid this series of upheavals. On the other hand, the CCP remains quiet on hardware companies. This segment may be safe, at least for now. The recent movement is a stark sign of departure from an era that was once considered as the Wild West. Not so long ago, anything could be possibly done, unless it was explicitly banned in a relatively loose regulatory environment. The Wild West environment lured a variety of risk money into the country from around the world for a chance of outsized returns in an economy that was growing at a torrid rate. Those days have become a history. Contrary to commonly held beliefs, Chinese equity markets have been compensating investors poorly due to their inability to keep up with growth rates of the economy. The Chinese markets rose exponentially in a five year period of 2003-07 amid an emerging market boom. This period has proved to be an aberration, far from a norm. However, general participants in the markets continued to hold onto an imagination that the 2003-07 explosive performance was a norm. In fact, the Shanghai Composite Index is still trading 40% below its peak that was witnessed in 2007 though the economy grew exponentially since then. Weak performances rarely make headlines openly, in part because disparaging the Chinese markets would hurt businesses in China for Wall Street banks and other institutions with vested interests. Sate-owned enterprises (SOEs) have never been run for shareholders. From a twisted perspective, SOEs may be run for their largest shareholder that is the Chinese state. The state’s trongest interest does not lie in higher share prices. Concerns of return-seeking investors are secondary to the state, anyway. Before this summer, it was essentially investors in publicly-traded equities that suffered weak performances in China. Then, the CCP’s recent moves are dragging pre-IPO investors into the same camp as those of listed companies. Until the recent past, pre-IPO investments in tech start-ups have generated dazzling returns. Such windows are probably closed for good. The CCP cracks down the entire tech sector, public or private, making them as obedient to the party as SOEs are. Entrepreneurs would be less enthusiastic in creating new things in a more ‘egalitarian’ environment. Providers of risk capital, mostly foreigners, would definitely think twice in financing Chinese start-ups in the face of lowered return opportunities. The market would require higher cost of capital on investments in China. The latest shockwaves have reportedly caused well over a trillion dollar outflow from Chinese equity markets. Destruction of value of this magnitude is hardly witnessed, except for a time of a major macro economic dislocation, i.e. a banking crisis. It looks President Xi is on his way to banning Chinese companies’ listing in the U.S., which pre-IPO investors prefer for an exit. President Joe Biden is no more friendly than his predecessor to Chinese companies in the NYSE and the Nasdaq. These Chinese companies are most likely heading back home to be listed in Hong Kong. On this prospect, shares of Hong Kong Exchange jumped for a moment. However, the HKEX immediately began to head south on a sober long-term outlook of Chinese tech shares. President Xi and the CCP are trying to achieve greater social stability. Corporate China can no longer rely abundance of risk capital that foreign investors have willingly supplied until recently. China has to finance by themselves, without ripping off foreign investors. This is the price China has to pay on the latest tech bashing, and the price could be steep.

About the author: Mr. Suzuki is a retired banking executive based in Tokyo, Japan.