Alibaba: Antitrust Conclusion Proved Naysayers Wrong
- Economic data releases for China reaffirmed the recovery is on track, leading the forecast of China's GDP based on PPP to jump above a one-fifth share of the world.
- The massive block trade of Tencent shares brought Mainland bargain hunters out in force, supported by several less obvious positive outcomes from the stake reduction by Prosus.
- Tencent's savvy investment acumen continues to be validated with each successive IPO of its private holdings.
- At the risk of being labeled a Panglossian, I highlight several positives from the release of the penalty decision document on Alibaba's antitrust investigation.
- Evidence kept mounting to refute unwarranted and exaggerated claims of persecution by the authorities of Alibaba founder, Jack Ma.
By ALT Perspective for Chinese Internet Weekly
The long-anticipated conclusion of the antitrust investigations on Alibaba (NYSE:BABA) is finally upon us. Learning from the past volatility created on the stock following the previous announcements of regulatory actions on Alibaba Group, the authorities shrewdly released the findings (contents in Chinese) after both the U.S. and Asia markets closed on Friday.
As the report was dated April 6, 2021 (assuming it was not intentionally done so), it demonstrated the deliberate delay for analysts and investors to have ample time to digest the detailed investigation results leading to the quantum of the fine. As interested parties ponder on the impact of the latest development on Alibaba Group, this column will as well, in the subsequent sections. Allow me to review the week as usual.
The economic recovery in China continues to hum along
Early last week, while the Western world was celebrating Easter, the Chinese were off as well, commemorating the Qingming Festival, a moment when posthumous respect and filial piety were offered to ancestors, departed relatives, or parents. Nonetheless, the quiet start belied an otherwise eventful week for investors in China equities.
The well-followed Caixin China General Services PMI released on Tuesday morning kicked off a series of buoyant news. The privately compiled business activity barometer showed China's service sector expanded at a stronger pace in March, with the index coming in at 54.3, up from 51.5 in February, and surpassing the consensus forecast for 52.7.
The March reading marked the 11th consecutive month in expansionary territory. Business optimism regarding the 12-month outlook for activity hit the highest in just over 10 years buoyed by hopes of a strong recovery from the COVID-19 pandemic. The influx of new orders overwhelmed companies, with the increase in the number of workers still unable to fulfill the demand, resulting in the rise in backlogs. This reflects how robust the economic rebound has been.
On Wednesday, the International Monetary Fund [IMF] gifted investors a confidence booster, raising China's GDP projection to 8.4 percent for 2021, a 10-year high, despite acknowledging that private consumption has been slow to recover. The solid growth rate is on top of the positive 2.3 percent growth it achieved last year.
Although the United States posted a negative GDP growth in 2020, the IMF is still expected its economy to expand slower than China at 6.4 percent this year. With that revised forecast, China's GDP based on Purchasing Power Parity [PPP] is expected to jump above a one-fifth share of the world by 2025, up from sub-10 percent two decades ago.
Massive block trade sale of Tencent shares by Prosus
Mid-week, Tencent investors were greeted with a bombshell that substantial shareholder Prosus N.V. (OTCPK:PROSF)(OTCPK:PROSY) would sell 191.9 million shares of Tencent Holdings (OTCPK:TCEHY)(OTCPK:TCTZF) worth $15.5 billion. Although that's a large sum, the transaction would shave off a mere 2 percent of the 30.9 percent stake in Tencent held by the subsidiary of Naspers Ltd. (OTCPK:NPSNY)(OTCPK:NAPRF) to 28.9 percent.
Prosus Chief Executive Bob van Dijk explained the block sale was to "increase our financial flexibility, enabling us to invest in the significant growth potential we see across the group, as well as in our own stock." I don't suppose we need to second-guess the intention of a company whose $32 million investment in Tencent two decades ago have ballooned to a $239 billion valuation, in case anyone is concerned if the move was related to the recent tightening in the regulatory environment towards the Chinese internet giants.
It might be worthy to mention that the last stake paring was in 2018, which was also a 2 percent reduction. At that time, the proceeds were valued at only $9.8 billion. Since then, Tencent's businesses and market cap have continued to grow.
The good news? The pricing for the block trade was set at HK$595 per share, the top of an indicative range of HK$575 to $HK595, despite the massive quantity being offered. The sale was the second-largest block trade in the world according to data compiled by Bloomberg. This signaled a very healthy appetite for the shares of Tencent.
Also, Prosus pledged not to sell "further Shares for at least the next three years, in line with its long-term belief in the potential of the Company's business," removing any potential overhang of additional sales until 2024. In addition, with Prosus (and its wholly-owned subsidiary, MIH TC, which is holding the Tencent shares) ceasing to be controlling shareholders, naysayers would no longer be able to raise the concern that the Chinese government will be harsh on Tencent because it is controlled by foreign interests.
This train of thought came about due to Alibaba Group, which has been plagued with the issue since its IPO in 2014. Critics promulgated the idea that because the major shareholders of Alibaba were not Chinese - SoftBank Group Corp. (OTCPK:SFTBF)(OTCPK:SFTBY), a Japanese multinational conglomerate holding company, has a major stake - Beijing would not allow the internet titan to prosper. However, as we all know very well now, Alibaba Group has multiplied its revenue manifolds and its assets grew tremendously.
I have previously explained how I referred to the trade data from the Southbound Stock Connect program to gauge the sentiment by the Mainland Chinese investors on Hong Kong-listed shares such as Tencent. Their behavior matched my expectations, with the value of the "Buy Trades" nearly triple that of the "Sell Trades", a solid indication of their overwhelming eagerness to pick up Tencent shares on the cheap at the expense of weak holders. Note that a day before the news of the block trade surfaced, the value of the buy-sell trades was roughly matched.
Trade data from the Southbound Stock Connect (April 8, 2021)
Source: Hong Kong Exchange
Amidst the cloud of uncertainty, rumors of two companies backed by Tencent evaluating public listings went under the radar. South Korea's Krafton Inc, better known as the publisher of the blockbuster battle royal game PlayerUnknown's Battlegrounds (PUBG), submitted its application for an IPO on Korea Exchange last week. Tencent is the second-largest shareholder with a 15.5 percent stake held through an investment company.
Bloomberg reported on the intention of Beijing MissFresh Ecommerce Co., an online grocery delivery startup, to list in the U.S. This comes despite the heightened scrutiny and stricter audit requirements from U.S. regulators. A steady pipeline of public listings from entities in which Tencent Holdings have a stake reaffirms its sharp investment acumen.
Continuing on this topic of Chinese companies going public, we have the pending IPO of China's top ride-hailing firm demonstrating the frenemies relationship between Tencent and Alibaba. Didi Chuxing is backed by the two internet giants as well as SoftBank. It is targeting a valuation of at least $100 billion via the initial public offering.
Heading the other way were Baidu Inc. (BIDU) and Trip.com (TCOM). The Chinese search engine leader completed its dual-listing exercise in March. On Friday, its Hong Kong shares were added to the widely-benchmarked Hang Seng Composite Index as well as several other Hang Seng indexes, including the Hang Seng TECH Index, the Hang Seng China Enterprises Index, and the Hang Seng Internet & Information Technology Index.
The leading Chinese online travel agency followed in the footsteps of its major backer Baidu to have a secondary listing in Hong Kong. As much as US$1.4 billion could be raised from the offering, providing it with funds to ride on the pickup in travel given the vaccination rollout around the world.
Ironically, despite China being labeled an authoritarian regime, local officials have to resort to incentives from offering boxes of eggs to shopping coupons in spurring the citizens to undergo vaccination, rather than simply ordering them to do so. The longer the population takes to reach herd immunity, the later China would allow the resumption of regular travel. Perhaps that's why TCOM still fell a hefty 7.4 percent despite the positive dual-listing news.
Bargain-hunting into Baidu stock
On the other hand, Baidu managed to close flat for the week. The Archegos saga leading to the dumping of large blocks of BIDU shares has seemingly been over. It's the bargain hunters' turn to push up the stock. The Invesco China Technology ETF (NYSEARCA:CQQQ) which has Baidu as the third-largest holding ended the week down 0.8 percent.
I would like to caution readers to avoid the anchoring bias when analyzing whether Baidu is a buy now. BIDU is down around 38 percent from the peak of $354.82 established less than two months ago on February 19. Today's price thus appears to be a good entry point for those waiting on the sideline.
However, it should be noted that the rapid climb in the stock from the sub-$150s level was likely a result of Bill Hwang's highly leveraged purchases for his family office Archegos. Until there is another Bill Hwang, Baidu share price is probably going to take a long time to reclaim that high watermark.
Don't get me wrong, I am not saying buying BIDU shares now is not wise. I added to my position last week myself for fundamental reasons elaborated previously. I just hope those doing so are cognizant of the circumstances leading to that previously inexplicable price jump in January-February and not expect a quick return.
The iShares China Large-Cap ETF (NYSEARCA:FXI) which counts Alibaba as its top holding at 9.1 percent of the portfolio fared slightly worse than the CQQQ ETF, dropping 1.9 percent. It was dragged down by the weak performance of second-and-third-largest holdings Tencent and Meituan (MEIT)(OTCPK:MPNGF)(OTCPK:MPNGY), which declined 5.3 percent and 4.6 percent respectively.
The X-trackers Harvest CSI 300 China A-Shares ETF (NYSEARCA:ASHR) had a middling performance, losing 1.6 percent for the week. Alcohol firms fared poorly last week while insurance names were also off following a tightening in regulations. The two sectors feature heavily on the ETF.
The KraneShares CSI China Internet ETF (NYSEARCA:KWEB) dropped a steeper 3.4 percent relative to the broader Chinese ETFs due to its concentration of internet stocks. The sector fell out of favor globally amid a reversal of the work-from-home trade and heightened scrutiny on the monopolistic practices of online platforms.
Shares of KE Holdings were dragged down by the clampdown in the property market
Among the key holdings of the KWEB ETF, the share price of KE Holdings (BEKE) sank the most, falling 8.3 percent for the week. Market players could have been concerned about the impact of the property cooling measures on China's largest online/offline platform for housing transactions and services.
Since March, 22 major cities in China have implemented fresh policies to limit housing land sales to thrice a year. Coupled with stricter borrowing limits, China's property developers have lowered their sales targets for this year. The Chinese government wants to prevent the property market from becoming overheated, especially with the coming flood of liquidity resulting from the U.S. stimulus plans amounting to trillions of dollars.
Nevertheless, Wall Street analysts are more sanguine about BEKE's prospects. Credit Suisse initiated coverage of KE Holdings with an Outperform rating last week, while Bank of America Securities upgraded BEKE to Buy from Neutral in March. The consensus price target stands at $77.31 currently, implying an upside of 38 percent from the last traded price.
That record-breaking fine on Alibaba Group for monopolistic practices
Chinese regulatory officials had apparently recognized the wild swings in BABA share price caused by their previous untimely and unclear announcements of investigations into Alibaba Group. This time around, they released the findings culminating from their months-long anti-trust exercise at the end of the trading week globally, providing market participants and the media plenty of time to analyze and make informed choices.
Although the headline figure of 18.2 billion yuan (US$2.8 billion) fine looks intimidating, the amount represents only 4 percent of Alibaba's 2019 revenue in China. According to China's anti-monopoly law, businesses that abuse their dominant market position could be fined up to 10 percent of the revenue for the fiscal year preceding the year when the decision is made.
Thus, the record penalty meted out looks huge only because Alibaba Group is such a behemoth. For all the serious allegations of malpractices leveled on the e-commerce and cloud titan, being fined less than half the highest possible quantum reflects the measured manner that the authorities are acting to address the complaints made by Alibaba's rivals.
The fine on Alibaba is also just half that imposed on the former record holder, Qualcomm Inc. (QCOM) in terms of percentage. In February 2015, the world's leading cellular chip maker was fined 6.088 billion yuan (around US$975 million at the time) for monopolistic practices against Chinese consumers. The penalty amount was calculated based on approximately 8 percent of Qualcomm's sales in China in 2013.
During a press conference held by the authorities, a top official involved explained that the fine meted out on Qualcomm was reduced by two percentage points due to its cooperation with the investigation. That could also have applied to Alibaba Group, with reports of founder Jack Ma flying frequently in his Gulfstream jet to Beijing in the past months to meet with the regulators. Incidentally, the "discovery" of Jack Ma's movements helped to put many malicious speculations of his fate to rest.
Source: Google (screenshot taken on April 10, 2021)
Qualcomm, in its own press release, postulated that the lenient penalty reflected the Chinese regulator's "acknowledgment of the value and importance of Qualcomm's technology and many contributions to China." Again, Alibaba could state the same to justify its far-from-maximum fine.
However, I believe its executives would be wary of appearing contemptuous and would take pains to admit wrongdoings in official press releases instead. It's not a time to take credit and appear tough.
Most importantly, the voluminous documentation on the penalty decision proved critics of the regulatory crackdown on Alibaba Group wrong. The reasons for the investigation and the mandated rectifications were clearly outlined, rendering accusations of an unjustified and arbitrary castigation on Alibaba Group triggered by the brazen reprimand of the regulators by its founder, Jack Ma, baseless.
Another major relief for shareholders is the lack of orders for Alibaba Group to divest non-core assets. Previously, there were speculations that the regulators would demand such disposals.
With this, are the authorities sounding the "all-clear" signal? Well, it depends. Alibaba Group is ordered to undergo a "comprehensive rectification of its business practice" (my translation) and submit an internally-derived compliance report to the State Administration for Market Regulation [SAMR] for three consecutive years.
There is no guarantee that Alibaba can make adjustments to the satisfaction of the regulators. SAMR might also find issues with the self-generated compliance reports. Nonetheless, suffice to say, the greatest heat on the company has been alleviated.
As explained in a past issue of the Chinese Internet Weekly, I found the KWEB ETF holding the most representative stocks in the sector. As such, an 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 especially for the stocks mentioned in this article.
This article was written by
Analyst’s Disclosure: I am/we are long BABA, BIDU, TCOM, TCEHY, BEKE. 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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