U.S.-China Phase 1 Deal, Tech Giants And Provincial Governments Partnerships

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ALT Perspective
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Summary

  • The "substantial" Phase 1 trade deal provided the boost to the broader stock market, including the stocks of Chinese companies listed in the U.S.
  • I assess whether we should get excited about the deal.
  • Last week, e-commerce titans Alibaba and Tencent signed a series of cooperation agreements with provincial governments. I provide my take on the boon and bane of such arrangements.

By ALT Perspective

The U.S. stock market rallied last Friday on three key positive developments that Seeking Alpha News Editor Stephen Alpher had summarized succinctly. At the risk of rehashing, for the benefit of those who are unaware, here goes, briefly:

  1. President Donald Trump declared that the U.S. and China have agreed on a "substantial phase one deal" on trade following his meeting with the Chinese government's top negotiator Vice Premier Liu He at the White House.
  2. Both UK and EU officials have indicated a willingness to work towards a Brexit deal, avoiding a "Hard Brexit" scenario.
  3. The Federal Reserve announced plans to start the purchase of Treasury bills to boost its balance sheet and prevent a repeat of liquidity concerns in the banking system.

Certainly, the first point had the greatest impact on the stocks of Chinese companies (NYSEARCA:CQQQ) (NYSEARCA:FXI) but the other two news also helped boosted investor sentiment broadly without a doubt. The Chinese Internet sector representative ETF, the KraneShares CSI China Internet ETF (NYSEARCA:KWEB), had a rather muted response, jumping a mere 1.61 percent following what President Trump had described as a "substantial" trade agreement.

Nevertheless, we have to take into consideration that the lackluster gains of the KWEB ETF, and much of its holdings, came after a terrible mid-week which saw major components like Pinduoduo (PDD) down nearly 8 percent while Baidu (BIDU) was down as much as 5 percent. The remarkable recovery intra-week enabled the KWEB ETF to record a consecutive week of price increase, albeit a smaller one than the previous week.

As explained in a past issue of the Chinese Internet Weekly, I found the KWEB ETF holding the most representative stocks in the sector. A chart overview of the week's share price movements of the top few holdings of KWEB as compared with the ETF itself is provided as follows for convenient reference.

Chart

Data by YCharts

Was the Phase One agreement really a big deal?

Based on a video shown on a Bloomberg article of President Trump speaking, China would buy as much as $40 billion to $50 billion of agricultural products as part of the trade deal. He also revealed that China had made a commitment to further open up its financial sector. There were also brief mentions of progress made on getting China to commit more to intellectual property protections as well as on currency and financial services.

On the part of the U.S., US Treasury Secretary Steven Mnuchin revealed that President Trump agreed to moderate actions such as not proceeding with a hike in tariffs to 30 percent from 25 percent on Chinese goods valued at about US$250 billion originally scheduled to go into effect the coming Tuesday.

In many issues of the Chinese Internet Weekly which began late last year, I had highlighted the plethora of contentious issues that the U.S. wanted China to take action on. Such partial resolution appears to be only helping the discussions to stay cordial and doesn't seem to be effective in achieving what the Trump administration has set off to do from the beginning.

The tens of billions of agricultural products would certainly help the farmers substantially. However, wouldn't that purchase happen in the ordinary course of business if President Trump had not escalated the tensions by raising the tariffs from 25 percent to 30 percent?

On China's promise to further enhance intellectual property protection, it is already something that the government has been working on due to the demands from the local businesses which are increasingly developing strong brands and intellectual property themselves. Telecommunications giant Huawei wouldn't be able to become a giant it is today with advanced 5G technology ahead of global peers if China has not been serious on intellectual property protection.

It helps to understand that it takes time to develop the legal environment, mindset, and enforcement. On 2019 July 4, the United States of America marked 243 years since the Declaration of Independence was adopted in Pennsylvania. Earlier this month on the 1st, China celebrated the 70th anniversary since the founding of the People's Republic of China. Shouldn't we cut them some slack?

On currency and financial services, I feel that it is in China's interest to do whatever it is promising President Trump anyway. China's signature Belt and Road Initiative exemplifies its global ambitions and the Chinese yuan needs to behave more like an international currency if the government wants to reduce its dependence on the US dollar in transactions. The same applies to financial services whereby the country wants to make its financial institutions more resilient with practices in line with established global norms.

In short, President Trump probably shouldn't receive much credit for what the Chinese negotiators promised in the 'deal'. How about the Chinese? I would use the analogy of a finger dipped one-third into a cup of boiling water to represent the additional 30 percent tariffs. Now, that finger gets a chance to be lifted a few percentages in length away from the boiling water. Does it help? Sure it does but does it make any difference to the pain level experienced by the finger? Probably not much. Tellingly, the People's Daily, recognized as the ruling Communist Party's mouthpiece, warned against complacency given that a high level of uncertainty remained as to whether the two sides could come to a long-term resolution to the trade conflict.

That said, I do not want to pour any more cold water on the progress made and continue to keep my fingers crossed for more positive breakthroughs between the two nations, for the good of the global economy, as well as the direct and indirect impact on Chinese internet stocks.

E-commerce Titans Seeking More Cooperation With Provincial Governments

In July, I wrote a piece partially titled Pinduoduo's Policy Smarts where I covered how the e-commerce upstart's focus on rural consumers has enabled it to ride on the poverty alleviation theme supported by the central government. To augment the argument, I highlighted an agreement that Pinduoduo signed with the Yunnan Provincial People's Government Poverty Alleviation and Development Office to partner in eradicating poverty in the province. Specifically, Pinduoduo would assist poverty-stricken households to cultivate commercially desirable agricultural products for sale on its e-commerce platform that would ostensibly reach a wider market and consequently better pricing and profits for the farmers.

On Friday, the local media reported that the Hebei provincial government and Alibaba Group (BABA) signed an agreement to cooperate in areas facilitating the acceleration of the development of the digital economy in the province during the 2019 China International Digital Economic Expo held in Shijiazhuang. Subsequently, various departments of the provincial government, high schools, and enterprises in Hebei signed specific agreements with the umbrella of companies under Alibaba in a move dubbed the "1+7" cooperation agreement, where the "1" referred to the provincial government and "7" the side agreements signed.

The scope of the cooperation included a financial services platform for the small and medium enterprises, an online industrial innovation center, an all-in-one digital map service for the tourism sector, a demonstration county for the "Intelligent Agriculture" industry, Hebei University's "Smart High School", and the upgrading of the "Hebei Digital Data Commercialization" platform. While details are scant, the names of the projects suggest the leveraging of Alibaba's wealth of data and developments in artificial intelligence to revolutionize the various sectors.

A day earlier, the Chongqing municipal government, Alibaba, and Ant Financial also signed a comprehensive strategic cooperation agreement. According to the agreement, Alibaba will build a regional headquarters based in Chongqing to help the municipal achieve its digital and intelligent transformation goals. The enhanced agreement follows the initial one signed on January 11, 2018, which had already shown results to a varying extent.

While the phrasing used in the Chongqing-Alibaba agreement was different from Hebei, the concepts are actually similar. For instance, the idea is for Alibaba to provide its expertise in helping Chongqing grow its digital economy, build "intelligent" cities, upgrade the manufacturing sector, talent training, and "revitalization" of the rural areas, where the latter typically refers to the adoption of data analytics and possibly artificial intelligence in farming.

In several articles on Alibaba, it is common to come across comments expressing fears of a government clampdown on Alibaba, for fear of it getting out of control, possible displeasure with co-founder Jack Ma, or non-compliance with regulations. Such government-level cooperation agreements would go some way to alleviate the concerns.

After Pinduoduo and Alibaba, another internet titan, Tencent Holdings (OTCPK:TCEHY) (OTCPK:TCTZF) is not going to be left out. The social media and gaming giant signed an agreement with the Hebei provincial government during the same event mentioned earlier held last Friday. According to the agreement, the two sides will tap on Hebei's strengths in policies, talent availability, planning, and industrial resources to leverage the core technology and financial capital strengths of Tencent specifically on the areas of mobile Internet, cloud computing, big data, and artificial intelligence.

While there might seem to have an overlap in the cooperation areas agreed by Hebei with the two tech giants, the development areas help reveal the unique strengths of Alibaba and Tencent. For instance, Tencent will work on enabling and promoting the usage of the ubiquitous and all-powerful messaging app WeChat and mini-apps within the chat app for government services, reducing the need for residents to go to the physical government offices to get things done.

The Hebei government is also very interested in developing its e-sports industry with the help of Tencent, hoping to tap on the emerging field to enhance its cultural and tourism appeal. Specifically, the two parties listed Tencent's League of Legends Pro League and the Honor of Kings Pro League for consideration to be hosted in Shijiazhuang, the capital city of Hebei, and one of the core cities designated under the Chinese government's JingJinJi Plan targeting the areas near Beijing for high-key developments.

There are, of course, still certain fields, such as big data, cloud computing, and artificial intelligence where there are overlaps and it would be interesting to see how the provincial governments manage the relationships between the two tech giants.

A word of caution, though, that the cooperation with the Chinese government is not always positive. Foreign governments like the U.S. might consider the tech giants' involvement as proof of government ties and create fears of data leakage to unintended recipients in the Chinese government. The area of cooperation could also make the companies fall into contentious circumstances. For instance, Tencent had helped the Shenzhen municipal market inspection bureau in the investigation of illegal sales, churning out more than 800 leads, of which 33 cases were of prosecution material, leading to the arrest of 50 people. The total sum involved in the criminal case was reported to be RMB30 million. If someone is out finding fault with the tech giants, they could always be accused of facilitating the Chinese government in ways that are considered unacceptable or perceived to be so by the foreign governments.

Being chummy with the Chinese government also does not shield the tech giants' businesses from the negative impact of regulatory changes and geopolitical tensions. Shareholders of Tencent know very well how badly the company was affected by the suspension of games approval last year. Last week, the furor kicked up in China by Houston Rockets general manager Daryl Morey who tweeted in support of Hong Kong forced Tencent to suspend streaming of the NBA games on Tencent Sports. This would, of course, negatively impact advertising revenue and more concretely, it suffers from the refunds it had to make for the subscriptions if Tencent is unable to claw back losses from NBA or Houston Rockets.

What other risks or benefits do you see? Share with the Seeking Alpha community in the comments field!

This article was written by

ALT Perspective profile picture
19.34K Followers
I am honored to have been categorized as a 5-Star financial expert and ranked among the top 2% of financial bloggers on TipRanks in 2017/18. For a period, I was among the top 3 “Opinion Leaders” for Insider Ownership and Services, as well as top 5 for Long Ideas and Fund Holdings. I am an avid reader of market news and company publications with the aim of improving my investment acumen. I enjoy expressing my findings and opinions through writings. My appreciation and understanding of business strategies improved to a whole new level since completing an MBA (Distinction) from a FT100 MBA school. I have worked in companies with businesses that span multiple industries, according me with the exposure to a myriad of sectors.Check out my Author's Picks and over 190 Editor's Picks, among the highest in Seeking Alpha, if not the most.

Disclosure: I am/we are long BABA, BIDU, JD, TCEHY, NTES. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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