After a tumultuous period for U.S.-listed Chinese companies, many U.S. investors are finally concluding that Chinese companies aren’t worthy of a place in their portfolios.
On July 30, the U.S. Securities and Exchange Commission (SEC) issued a broad halt on new Chinese IPOs listing in the United States until risks posed to investors can be better understood and disclosed. And that’s easier said than done.
It’s a truly shocking development. Several months ago, it was difficult to imagine what could derail the flow of foreign capital into Chinese stocks.
The catalyst was the Chinese Communist Party (CCP) and its regulatory regime. The beginning could be traced to last fall after regulators scuttled a planned IPO for Ant Group, the digital payments application, and attempted to rein in Alibaba founder Jack Ma. While Ant never IPO’ed and thus no retail investors were directly hurt, its early institutional investors (including U.S. investors such as Carlyle Group and Silver Lake Partners) are stuck without an exit as Ant has been forced to restructure and subject itself to an onerous financial regulatory framework—all of which could vastly diminish its value.
Then earlier this summer, the CCP cracked down on ride-hailing company Didi Chuxing days after its New York listing, launching an investigation into the company and removing its app from Chinese mobile app stores. This action was led by China’s cybersecurity agency in the name of “safeguarding national data security.” Data security has become a new slogan for cracking down on Chinese tech giants.
Political and structural issues aside, owning a piece of the leading ride-sharing app in the world’s most populous country was intriguing to many U.S. investors. No matter, the sudden broadside by the CCP severely damaged investor returns—its shares are down 27 percent in the past 30 days since its IPO, and that’s after a 4.6 percent one-day gain on July 30.
Then in July, Beijing regulators homed in on the private education and tutoring sector. For the uninitiated, many prominent Chinese private education companies are listed in New York, including New Oriental Education, TAL Education Group, and Gaotu Techedu. As readers can understand, private tutoring and after-school education is big business in China, where competition for university admissions is often intense.
The CCP issued a series of rulings beginning in mid-July that education companies engaged in teaching or tutoring academics can’t be for-profit corporations, meaning they must become nonprofit groups. In addition, China banned IPO listings of and ownership in such education companies by foreign investors or other publicly traded entities. In one fell swoop, the CCP completely terminated the business model of an entire industry.
Among the three major Chinese tutoring companies listed in New York, their investors have lost a combined $18 billion in value since July 22. In other words, the three companies are worth 68 percent less today than their combined value as of a week earlier.
JP Morgan analysts were succinct while trying to strike an optimistic tone. “It’s unclear what level of restructuring the companies should undergo with a new regime and, in our view, this makes these stocks virtually uninvestable,” according to a Financial Times report.
Days later on July 26, regulators issued a policy in the name of uplifting consumer and worker rights, specifically food delivery drivers, in another effort to rein in the logistical technology companies. Meituan, the Hong Kong-listed mainland food delivery company, saw its stock tumble upon the news. Shares of Meituan have fallen 21.3 percent since July 23 in Hong Kong trading.
“The announced guidelines present risks to the core food delivery business and could weigh on market sentiment,” Morgan Stanley analysts wrote in a note to clients on July 26.
In the same week, Beijing fined Tencent for anti-competitive behavior in how the entertainment giant structures its music rights, ordering Tencent to end exclusive rights deals with artists and record labels. The action sent Tencent shares crashing during the week.
Speculation of further clampdowns has tanked U.S.-listed Chinese stocks broadly. The S&P/BNY Mellon China Select ADR Index, which tracks U.S.-listed Chinese ADRs, has declined 24 percent from March 31 to the end of July.
These recent developments have finally awakened U.S. regulators.
“I have asked staff to seek certain disclosures from offshore issuers associated with China-based operating companies before their registration statements will be declared effective,” SEC Commissioner Gary Gensler said in a July 30 statement. The SEC also recognized the structural issues inherent in most listings of Chinese technology firms and their potential risks.
This order by the SEC is too little, too late. Billions of dollars of value have been wiped from U.S. retail and institutional investors.
For years, we’ve argued in this publication that investing in Chinese stocks bears significant and unquantifiable risks. Besides macro, business, and market risks, there are also governance and political risks that could be knowable and unknowable. Investing in Chinese companies is different than investing in almost every other market.
Let’s examine a few fundamental reasons why someone picks a particular company to invest in. There are basic factors to consider—the company’s business model, its industry outlook, its barrier to entry, the quality of its management, its financial health, and macroeconomic trends impacting its business, sector, or the country it operates in. In addition, the investor must consider regulatory risks facing the company and its industry from the government within the jurisdictions of its operations.
It’s this latter risk that is considerably outsized with any Chinese company. The company must do the bidding of the CCP when the Party comes calling to hand over data or private information of its user base or even spy on its users. That’s certainly bad, but at least the risk can be understood and quantified.
But the CCP has demonstrated—in its recent crackdown of the tutoring sector—that it can bring down an entire industry and all companies within it in one order. We’re not arguing here that the CCP would deliberately kill successful companies or industries for no reason, but there’s certainly an impetus for the regime in Beijing to exert greater control over their direction and strategy. But from the perspective of foreign investors, the CCP’s whim is an existential risk that could strike any time without warning.
I’m not sure it’s a risk that can ever be adequately disclosed, quantified, or measured. At least not to a degree that should satisfy the SEC, whose role is to protect American investors. Outside of companies in obviously precarious industries such as gambling or vice, investors certainly didn’t consider a company’s viability in such a manner.
In hindsight, perhaps we may have all underestimated the existential risk that the CCP poses.
Chinese Companies Becoming Increasingly Uninvestible (theepochtimes.com)
Understanding Beijing’s Disaster Response to the Flooding in Central China
July 23 marked the third day of major flooding in the Chinese city of Zhengzhou in Henan Province. Based on my observations on how the Chinese regime handles natural disasters, authorities would use the first three days to gather data before releasing an official statement.
However, top officials would censor information and create their own propaganda narrative in the name of “maintaining social stability.” This model of official response, along with the media propaganda, will continue to exist in the communist regime.
Beijing’s Propaganda Routines on Floods
The Chinese Communist Party’s (CCP’s) propaganda focuses on three points: to emphasize the severity of natural disasters; to publicize the regime’s initiative in emergency rescues; and to underestimate the death toll.
Disasters have occurred frequently in various parts of China in recent years, and the first thing that local governments do is to attribute the disasters to nature. Flood disasters have been publicized as “record-breaking rainfall,” “once in 50 years,” and “once in a hundred years,” and so on. This time, authorities described the Zhengzhou disaster as “once in 5,000 years historical record rainfall”—even experts try to justify this claim. On the website of the Henan Provincial Department of Water Resources, scientists offer an explanation with probabilistic algorithms.
However, Chen Tao, the chief forecaster of the Central Meteorological Observatory, refuted the so-called “disaster of the millennium” at a press briefing held by the Central Meteorological Observatory on July 21, according to Chinese news portal Sina. Chen said, “From the perspective of atmospheric science research, we began to rigorously record meteorological data after 1950. Since then, we are able to collect a relatively accurate and complete scientific record of rainfall. So far, the entire rainfall amount covers around 70 years.”
Zhengzhou Floods: What Are the Man-made Factors?
When encountering natural disasters, the Chinese regime looks at three issues: whether the early warning mechanism is activated; whether the disaster is natural or man-made; and accountability.
Accountability is determined by how the first two issues are handled and the number of deaths. But, there’s always room for interpretation.
The disaster warning determines the fate of the officials. During the 2008 Sichuan and 2010 Yushu earthquakes, the lack of an early warning system became a major focus of accountability.
When torrential rain and flooding first occurred in Zhengzhou this time, the Meteorological Bureau was accused of not warning the public. However, people soon discovered that the Meteorological Bureau had in fact issued a warning. The “Meteorological Disaster Warning Signal” was issued by Li Kexing, the director of the Zhengzhou Meteorological Bureau, at 9:59 p.m. on July 19. The warning circulated on the internet, which proved that the Zhengzhou Meteorological Bureau had indeed issued an early warning and advised the public to stop gatherings, and close schools and businesses.
The real issue is that local authorities have ignored the waterlogging problem for the past 20 years—Zhengzhou is known as the “sponge city.” The waterlogging is a man-made disaster caused by successive government projects.
A collapsed dam is another man-made factor in the Zhengzhou floods. It’s noteworthy that authorities produced conflicting reports on the situation. The Emergency Management Department issued a report on the failed dam, the Guojiazui Reservoir in Zhengzhou, at 1:30 a.m. on July 21. But, the Ministry of Water Resources issued another report saying that as of 7 a.m. on July 21, “there was no breach of the dam, but only large-scale erosion of the surrounding slopes [landslides].”
A video from the site showed that Zhengzhou’s Jingguang Expressway Tunnel was suddenly inundated and witnesses said that it happened in less than five minutes.
On July 21, state-run media Xinhua quoted Xi Jinping as saying, “Some rivers have exceeded the warning levels and some dams have been breached.”
This statement carries two significant pieces of information: first, the local authorities reported the situation to Xi and admitted that the dams failed; second, Xi had warned local authorities to pay attention to rumors of flood discharge.
It’s important to know that Chinese netizens called it a “flood discharge” and not a “dam breach.”
There is a huge difference between a dam breach and flood discharge. It’s hard to hold anyone accountable for a dam breach as there are causes beyond human control other than the poor quality of the dam. Flood discharge, on the other hand, relies on the decision-making of local authorities, balancing the pros and cons of flooding one place while preserving others based on the water level.
Death Toll Determines Disaster Levels and Officials’ Posts
On July 23, the regime announced that more than 50 people died in Zhengzhou’s floods. The day before, the local government reported that there were 33 deaths and 8 people missing. It’s believed the the death toll will continue to climb.
According to a report by Radio Free Asia, there’s a large number of online messages from people looking for their missing loved ones in Zhengzhou and the neighboring areas. One website listed information on more than 130 missing persons. People are still gathering around the disaster-stricken Jingguang Expressway Tunnel looking for their loved ones.
Based on my years of experience, formulating a quota for the number of casualties has been a tradition in the regime since the Mao era.
I was in China during the Qingshuihe explosion incident—a chemical plant exploded in Qingshuihe district of Shenzhen city in 1993. A reporter at the scene took nearly 80 photos of the deceased. Even though the death toll exceeded that number, the Ministry of Propaganda reported that only 3 people were killed by the explosion—2 deputy directors of the Public Security Bureau and a director of the local police station. The figures were fabricated because it was stipulated at that time that accidents involving more than 10 deaths were considered to be very serious, and those in charge would be held accountable. Now it seems that the quota may have been reformulated.
The CCP censors information and prevents rumors from spreading online. I’ve observed that authorities always set the tone for the disaster, and catching rumormongers becomes a main focus on disaster management. The Henan provincial government issued a notice on the recent flooding, reminding the public to ignore rumors and not to spread them—this is an actual warning from the top.
Another government routine is fundraising. However, people are more reluctant to make donations to the Red Cross and government agencies because during the Sichuan earthquake in 2008, these organizations were accused of embezzling funds.
Conclusion
Some experts believe the Zhengzhou floods will not be the last disaster in a Chinese city. There’s an article that’s been circulating on Chinese social media titled, “Look at the Ancients, Look at the Present Again: The Flood in the Central Plains in the Eyes of an Expert.” The author participated in the evaluation of the 2015 National Smart City Constructions. There is a passage that readers should keep in mind: “On top of the loose soil, there is only a shallow layer of cement topped with tiles for appearance purposes only. I have traveled all over China—east, west, north, and south. These face-saving projects are everywhere. Heavy rainfall, especially a 100-year flood, will hollow out the loose soil underneath.”
In other words, as long as you live in a Chinese city and there is a heavy rainstorm, severe flooding could happen at any time. People must be prepared to deal with the situation and shouldn’t rely on Beijing’s disaster emergency model.
Understanding Beijing’s Disaster Response to the Flooding in Central China (theepochtimes.com)
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