Earlier this month, when Beijing set up a veto mechanism for overseas IPOs amid a renewed crackdown on home-grown tech, I gently warned that nobody should harbor any delusions about “bargain hunting” in shares of the affected companies.
“This isn’t a falling knife in the traditional sense. It’s not merely a matter of timing it correctly so you grab the handle, not the blade,” I wrote, on July 10. “The fundamentals don’t matter and neither do the technicals. All that matters is the Party.”
Fast forward two weeks and Hong Kong shares crumbled more than 4% in a single session in what some market participants described as “panic selling,” after Beijing barred education companies (or, more precisely, firms that offer instruction in school curriculums) from making profits, raising capital or going public. The companies are also banned from tutoring services referencing school syllabi on weekends and vacations, and aren’t permitted to offer virtual instruction to kids under six.
The sector, Beijing said, has been “hijacked by capital.” Shares of New Oriental, already in free fall, were cut in half again Monday. Koolearn Technology lost a third of its value (figure below).
Chinese “ed tech” (if you like) was a $100 billion space. Now, it may be totally uninvestable. You can take that figuratively, but also literally. The State Council won’t permit overseas investment in companies that teach school curriculums.
Bloomberg euphemistically described the new measures as reforms that will “fundamentally alter the business model.” Forgive me, but for many firms, there is no “business model” now. If you aren’t allowed to make a profit, it’s not really a “business.” It’s a non-profit. By definition. I’m sure that assessment isn’t strictly applicable across the board, but you get the point. This is a disaster for investors.
One such investor is Tencent, which, by virtue of being involved in damn near everything (forgive the colloquial cadence) finds itself perpetually beset. Beijing is casting a wider and wider net, and because Tencent stretched its tentacles into so many businesses, it’s ensnared at every turn. That’s probably not an accident either — after all, Beijing’s regulatory blitz was initially billed as an anti-monopoly campaign. Shares dove 7% Monday.
Meituan, which is also in Xi’s crosshairs, suffered its largest one-day decline ever (figure below) after the State Administration for Market Regulation ordered online food platforms to uphold the rights of delivery employees and demanded they be paid the local minimum income. Tencent is a Meituan backer.
Obviously, that didn’t bode well for Hong Kong shares. It was an especially grim day for the Hang Seng Tech Index which, at various intervals in 2021, has teetered precariously on the brink of an outright collapse.
On Monday, the tech gauge plunged almost 7% (figure below).
The two-session decline nearly adds up to a correction. That is, the index fell almost 10% in just two trading days, putting it at 6,790 on Monday. It was near 11,000 in February.
This comes, of course, on the heels of the Didi debacle. The ride-hailing giant now faces an uncertain fate. Beijing was reportedly considering draconian measures to punish the company for going ahead with a US IPO despite pushback from the state. Bloomberg wrote that “regulators are weighing a range of potential punishments, including a fine, suspension of certain operations, the introduction of a state-owned investor [or] a forced delisting or withdrawal of Didi’s US shares.”
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The level of incredulity among market participants around events like these is a source of continual amusement for me. “Regulations on the education sector were unexpected,” one PM said Monday. “[The] worst-case became a reality,” a large bank declared.
This is one reason why, generally speaking, I take virtually no one in finance seriously. Bloomberg on Monday called this “a stunning reversal of fortune for an industry that had emerged as one of the hottest investment plays in China in recent years.” Alibaba, Tencent, ByteDance, Tiger Global Management, Temasek Holdings and SoftBank are all investors. And they’re all naive. Every, single one of them.
Let me ask readers a question: In a society where school children gather in matching outfits for ceremonies featuring, among other spectacles, choreographed song and dance routines where performers chant “Listen to the Party, be grateful to the Party, and follow the Party,” how realistic was an investment thesis predicated, at least implicitly, on the idea that the government will allow the nation’s youth to be taught by a collection of privately-run, for-profit companies, some of which have overseas listings?
I’ll answer that. It wasn’t realistic at all. In fact, it was a ludicrous assumption. The fact that it went horribly awry over the past several sessions isn’t “a stunning reversal of fortune,” it was the entirely predictable end game. Similarly, this wasn’t “the worst-case,” it was the base case. Or at least it should have been.
When it comes to analysts and market participants more generally, nobody ever learns, stuck as they are in a fantasy where capital is a jealous deity capable of bringing even the most ruthless dictators to heel. It’s conceptually similar to what happens when purported EM “experts” (many of whom have years of experience trading EM FX and debt) take Turkey’s Erdogan at his word.
“One wonders what Wall Street and the private-sector economy will say as the next target appears in regulators’ cross-hairs: Property,” Rabobank’s Michael Every wrote, noting that China is to all set to clean up “irregularities” in the property market over the next three years according to the housing ministry.
I’ve said it before and I’m sure I’ll say it dozens more times: If you refuse to acknowledge the realities of autocratic regimes on the misplaced notion that capital markets can impose “discipline” on dictators, you’ll be perpetually disappointed.
“Of course, it also raises the key question of what an economy reliant on asset-price inflation does when it can no longer occur,” Rabo’s Every said, in the same Monday note. “We don’t know, because nobody in the West ever wants to find out – we have all been totally hijacked by capital in that regard.”
“We know that no one ever seizes power with the intention of relinquishing it.”
-George Orwell
Could this be Xi’s Hitler moment when he decided to make Russia an enemy?
China leveraged it’s relationships with the Western world to grow into a power. I think Xi now recognizes that they have enough power that they don’t need help from Western nations anymore. Being that the party is xenophilic in nature, they are now closing all of those doors they opened. They are innovative and rich enough to build power on their own. At a minimum they are targeting a cold war with the west, I suspect it’ll take active conflict to resolve the Taiwan issue though.
Correction – Xenophobic
They used to be envious of the West, now they are just strivers and hate us.
In time, China going it alone under XI will look more like China going it alone under Mao than the wealthy global trading nation it is today. Too many constraints — geographic, demographic, environmental, political — to achieve global hegemonic status on its own. Not saying Taiwan won’t end up as part of the PRC — and why shouldn’t it? we wouldn’t tolerate an independent PRC-aligned state in, say, Cuba — but before that happens the U.S. should do everything in his power to entice/induce/subsidize the folks behind Taiwan’s IP to relocate elsewhere. Military conflict over Taiwan is a lose-lose proposition and should be avoided: we don’t covet the country’s mountains and beaches, we admire the energy, ingenuity, and entrepreneurialism of its people. The fly in that prescription is, of course, the West’s own go-it-alone knuckleheads — the Trumps, Farages, Johnsons, and Le Pens of the world.
Cuba doesn’t produce anything of value near enough to constitute intervention on our behalf. Other than Russia threatening to stash nukes there 60 years ago, Cuba hasn’t been a threat to us in any form at all. You think oil was worth fighting over? Semiconductors are more valuable than oil especially in a green economy. Taiwan produces 63% of the world’s semiconductors. Semiconductors every single product of value we produce go into. Do you really think we’re going to be “fine” with China controlling 69% of the global chip manufacturing market? At the end of the day, the United States continues to be an Imperialist super power. That didn’t happen by sitting back and letting other nations dictate outcomes.
The fabs are valuable, for sure, but it’s the engineering that produced the fabs and future innovation that are the real prize, and both are portable.
China does seem to be raising their profile in Europe still, as well as Africa.
My only concern is contagion – not from covid, but from a general market malaise caused by a carry over from a sell-off in Chinese investments, cryptocurrencies, SPACs and other “no eps/cash flow” companies.
As an aside, in our local public high school (based in the Rocky Mountains), the students had a choice of Spanish or Chinese! Chinese classes and teachers were paid for by China. Those classes were 50/50 language and “culture”.
LOL
Let’s try to look at this education problem from out of the box. In order to understand what’s behind this regualtion, one should have a look at Chinese society nowadays: both parents work very hard (outdoors) and most of all in order to pay tutoring fees for their child. (Majority has only got one) There is a race going on for the best, the most expensive, the highest level,… of education. A Chinese child doesn’t have any time left to be a “child”. As soon as school is out, tutoring starts. The neighbourhood of tutoring classes is even determinant to chose an appartement. Education has become business and consequently not equally accessible for each child. You may disapprove or not, but you should at least admit that this is not according to socialist principles. Personally I like the idea of each child getting the opportunity to study if he’s capable and intelligent, regardless the bankaccount of its parents and as long as the child is motivated. Raising one child has become a huge assignment for Chinese parents nowadays on all levels. And parents are rushing to do good, better and best for their child. The way it is done nowadays makes it almost impossible and not affordable to raise 2 children. Next to social justice and equality, this might be the second reason for the Chinese government to regulate this sector: Their demographics are not fine (nore are ours) and they want to motivate parents to get larger families. That’s why education should become much more affordable. Chinese government considers all these arguments more important than the welfare and prosperity of capitalistic shareholders. And I must admit that somehow I feel uncomfortable with the idea of a capital driven education system…
I fully agree privatizing education is a terrible idea but China has plenty of ways to compete with state funded programs. The party has no lack of control, which is of course why they are making sure no opportunity for competition exists. The party does not compete, the party dominates. Ideas do not compete, Ideology dominates.
It’s a different and worse situation in the US where legislation continues to undermine public education and allow taxpayer dollars to flow to private enterprise without being held to account for outcomes. Here we have domination of capital over party. Is China right to want to keep this out? I would argue the right answer is moving towards the middle not both ends moving out to further extremes.
Is there a middle that can be found? Is there some type of new socio-economic hybrid waiting to be created? Is there enough time left for humans before nature reboots?
correction: … to study if HE/SHE is capable…
As an aside, my one time publisher told its authors to neutralize gender as “s/he.”
This is what ARK investments says about the item: “Among the likely reasons for these reforms are China’s focus on education as a key strategic priority, the excessive workload of tutoring on students, and the rising cost burden on parents, not to mention reportedly corrupt business dealings favoring wealthy families behind the scenes. If implemented, the changes could improve the quality of life for students and lower costs for parents, an increasingly important consideration given China’s demographic concerns and its new three-child policy. “
As an aside, I just read a piece that speculates that China is cracking down on social media tech (essentially leisure and consumption) and not on tech that has military applications (likely to encourage talent to focus on the latter).
So, we are all in a frenzy because China is taking measures to rein in big tech. Isn’t that what so many of us wish would be done in the US? We cannot do that, the Chinese can.
It was interesting to learn that in the spring the Chinese government warned the for-profit cram school operators that a crackdown was in the works. They guessed not much would actually be done. Oops!
Not much different than Didi going ahead with a US ipo after being warned not to.