The lone bear on Alibaba and Tencent says Chinese tech stocks’ rout to persist until China can enunciate end of crackdown

For the sector to hit bottom and potentially recover, the government needs to restore the trust among global investors, Muhl at DZ Bank says
China remains ‘a classic stock picker’s market,’ says Capital Group, which manages about US$2.6 trillion of assets

Alibaba

Cheryl Heng

Published: 10:24am, 19 Aug 2021

Why you can trust SCMP

The trillion-dollar rout afflicting Chinese technology stocks may not end until China’s government restores investors’ trust in the securities, as shareholders had been left defenceless by the aftermath of unexpected regulatory crackdowns.

That is the view of Manuel Muhl of DZ Bank, a Frankfurt-based lender, who downgraded China’s internet platform sector last month, making him the only analyst globally with a “sell” rating on the industry torch-bearers Alibaba Group Holding and Tencent Holdings. Alibaba owns the Post.

A loss of trust due to corporate governance lapses in the case of Didi Global, and tightening regulations in China’s internet economy from e-commerce to for-profit off-campus tutoring have thrown a wrench into fundamental stock valuation models.

“For the sector to hit bottom, and potentially recover, the government needs to restore the trust that it has destroyed,” Muhl said in an interview. “This can only be achieved by reaching a point where they can publicly state that their crackdown has reached its goal and that they are done for now. When will that be?”

Alibaba, the biggest Hang Seng Index constituent, slumped 5.5 per cent to HK$162.10 on Thursday, its lowest level since its 2019 listing. Tencent retreated by 3.4 per cent to HK$421.20 after warning shareholders against slowing growth amid increased regulatory scrutiny. The Hang Seng Tech Index lost 2.8 per cent.

Chinese technology and education stocks sank in July, wiping out US$1.2 trillion from their market values at home and in the US, which has bushwhacked money managers and sovereign wealth funds. The probe into Didi Global and a clean-up of tutoring businesses have debunked views that the antitrust clampdown in November was a one-off risk.

Temasek walked into market minefield last quarter with new bets on Chinese education stocks

China is strengthening its data privacy after years of a technology war with the US, while rooting out anti-competition practices by online platform operators to steady the economy. The sociopolitical and economic shifts to fix income inequality and strive for common prosperity, however, are fanning questions about whether the Communist Party is showing its anti-capitalist stripes.

03:22

Crackdown on private tutoring leaves industry, students and parents drawing a blank

“The Didi IPO, for instance, has angered a lot of investors and unveiled corporate governance issues in the entire sector. This has damaged a lot of trust in Chinese ADRs”, or American depository receipts traded in New York, Muhl added. “What we see in the education sector now is nothing short of nationalisation. Investors have lost almost their entire investment in a blink of an eye.”

Muhl downgraded Alibaba to a “sell” with a price target of US$196 for the company’s ADRs, as well as Tencent with a target of HK$490 for its Hong Kong-traded shares. Both stocks currently trade at more than a 10 per cent discount on his targets, putting investors who have heeded his “sell” call in the money.

That makes Muhl the lone bear out of a field of more than 50 bullish securities analysts who have maintained their “buy” or “hold” calls on both stocks despite multiple price downgrades recently.

Holdings of Bridgewater Associates, the world's largest hedge fund founded by investor Ray Dalio, as of June 30, 2021.

“The bad news for investors is that, in the short term, the current wave of regulation is likely to continue and could intensify,” Europe’s biggest money manager Amundi said on August 10. “Recent regulatory changes have emphasised a layer of risk that could impact the investment framework beyond traditional policy drivers such as credit and liquidity/rates.”

This week, the US Securities and Exchange Commission also cautioned investors about investing in US-listed Chinese companies. Investors only own offshore-based variable interest entities or VIEs, an arrangement that Amundi said could come under greater scrutiny and prompt delisting measures.

Legally ambiguous ‘VIE’ structure could spell disaster for foreign investors

“It is also clear that no one has any legal means of fighting these decisions” when they come, DZ Bank’s Muhl added. “Companies can’t file a complaint and investors cannot protect their property rights. Either way, we find it hard to recommend investing in a sector with that much uncertainty.”

More regulatory challenges could be in store, suppressing valuations and elevating risk premiums as regulatory tightening could expand to other parts of the industry like consumer finance, online gaming and mobile apps, according to Los Angeles-based Capital Group, which manages more than US$2.6 trillion worldwide.

That means China remains “a classic stock picker’s market”, with a growing number of high-quality companies and ongoing innovation, money managers Noriko Honda Chen and Viktor Kohn at the asset management firm said in a report this month.

For now, Muhl said calling the bottom is like “catching a falling knife without gloves”.

“A long-term investor might find these valuations attractive, but on the short end we see more downside until the trust is restored and that will take its time,” he added.

Additional reporting by David Yong and Zhang Shidong

This article appeared in the South China Morning Post print edition as: Rout could get worse, warns lone bear on Alibaba, Tencent