The inspiration for this issue’s title was from an article by the media outlet Fairness & Accuracy In Reporting (see the snapshot of the article as follows) on the topic to be discussed. By now, shareholders of Chinese companies should have been well aware that Trump’s Tantrum is an important risk factor to consider in our investment thesis.
Source: Fairness & Accuracy In Reporting
Regular readers of my articles would also be familiar with the common refrain of the negative impact of the rising U.S.-China tensions. Two months ago, in the article titled Chinese Internet Stocks Demonstrate High Resilience But Brace For Correction Anyway, I cautioned:
“Nevertheless, with the powerful rally in recent weeks, I’m not sure whether the upside left is worth the risk of holding on to the shares. As we head into the Presidential election fever, the commander-in-chief is likely to double-down on the China-bashing and that could test the nerves of shareholders with a magnitude more powerful than before. Investors should brace for possible corrections in the share price of Chinese stocks if weak holders get shaken off on harsher rhetoric from the U.S. and China in the coming weeks and months.”
Fortunately for shareholders, despite the harsher rhetoric since the publication, Alibaba Group (BABA) still managed to appreciate 15.11 percent, against a 3.68 percent rise in the S&P 500 index. On the other hand, investors who had thought a correction would be forthcoming with the help of nervous shareholders and waited for a correction to add to their holdings or “back up the truck” were left disappointed.
Finally, on Friday, there was an inkling that things could get worse for U.S.-listed Chinese companies. Before Friday, the equity indices of Chinese companies rallied strongly ahead of their U.S. counterparts. This was in spite of President Trump’s well-publicized demand for the wildly popular video app TikTok to be sold to “very American” companies by September 15 or be banned.
Perhaps it’s because TikTok is owned by privately held ByteDance (BDNCE), market players weren’t that concerned. That is, however, not the case for publicly listed Tencent Holdings (OTCPK:TCEHY)(OTCPK:TCTZF), whose ubiquitous multi-purpose messaging app WeChat was the next Chinese-operated app provoking the ire of President Trump and included in his twin executive orders on Thursday.
Asian markets, in particular in Hong Kong where Tencent has its primary listing, reacted with apprehension and sank. The share price of Tencent plunged as much as 10 percent at one point amid confusion on how far-reaching the order was and whether its other U.S. interests would be affected. In a sign of the market resiliency, the three representative ETFs still managed to close up 1-2 percent higher for the week.
In fact, for those with a longer investing horizon, Friday’s fall was yet another blip. The Invesco China Technology ETF (CQQQ) is higher by 71.29 percent in the past year, even after Friday’s losses, compared with its U.S. peer, the Invesco QQQ Trust (QQQ) which gained 47.34 percent.
The iShares MSCI China ETF (MCHI) is up a respectable 32.37 percent over the past year, double that of SPDR S&P 500 ETF (SPY). The iShares China Large-Cap ETF (FXI) rose a weaker 8.13 percent during the period but still superior to the 5.53 percent enjoyed by SPDR Dow Jones Industrial Average ETF (DIA).
The Chinese Internet sector representative ETF, the KraneShares CSI China Internet ETF (KWEB), performed in line with the broader Chinese ETFs, closing up 1.36 percent for the week. Among the key holdings of the KWEB ETF, the share price of food delivery and lifestyle services platform operator Meituan-Dianping (MEIT)(OTCPK:MPNGF)(OTCPK:MPNGY) was the obvious outlier, jumping 14.44 percent higher and was even positive on Friday when its peers were facing annihilation.
Although buyers of Meituan-Dianping shares last week were not surveyed for their reason of purchase, there were a few possibilities for the hefty gains. First, they could be spurred by a spate of bullish brokerage reports (content in Chinese) raising the earnings expectations as well as target prices. According to the revenue estimates feature accessible by those with Seeking Alpha Premium, 2020 would be a trough in its revenue growth with just a 15.73 percent increase.
Source: Seeking Alpha Premium
Thereafter, with the passing of COVID-19 challenges, the consensus forecast is for Meituan-Dianping to enjoy a whopping 45.79 percent year-on-year revenue growth in 2021 and a lower but still amazing 31.30 percent. By then, assuming the share price is unchanged, the price-to-sales ratio on a forward basis would fall to just 4.69 times, a rarity among high-growth internet companies.
Second, market players could be coming around to appreciating the full potential of Meituan-Dianping’s delivery network. The company is expanding its food delivery role to delivering just about anything. The latter is oftentimes more profitable as the delivery personnel doesn’t have to wait for the meal order to be prepared by the restaurants and be extra cautious with the handling. A parcel or grocery delivery doesn’t take as much effort compared with a meal of hot noodle soup, meaning that more trips could be made.
Third, Meituan-Dianping’s businesses are concentrated on Mainland China. Any threat to the company by the Trump administration would be shrugged off. However, I suspect investors are ignoring the possibility that with the closing of the U.S. markets to Alibaba Group and Tencent Holdings, the duo could compete more fiercely in the domestic market against Meituan-Dianping.
Search engine giant Baidu (BIDU) which often has been regarded as a laggard among the Chinese tech giants, was the surprise runner-up, rising 4.69 percent. Baidu announced that it will report its financial results for the second quarter ended June 30, 2020, after the U.S. market closes on August 13, 2020. Perhaps market players were speculating that Baidu would achieve another earnings beat like it had done so often in the past quarters. In the previous quarter, Baidu posted an earnings surprise of over 100 percent.
Source: Seeking Alpha Premium
The share prices of e-commerce players JD.com (JD) and Pinduoduo (PDD) shed 2.71 percent and 3.92 percent respectively, falling more than the target of the executive order, Tencent Holdings. JD.com was down as much as 6.42 percent on Friday which was puzzling as its e-commerce business was hardly something that would threaten the national security of the U.S., even if it derived some revenue from the country.
An argument could be made that Walmart (WMT) which owns over 10 percent of JD.com might be forced to divest its stake. The two partners might also have to terminate their collaboration in retailing and logistics. However, the big question is what would be the justification for this separation and the potential impact? I doubt it would matter as much as the share price decline suggests, if the Trump administration’s whack-a-mole approach does come to JD.com in the first place.
The same can be said of Pinduoduo. It doesn’t have a backup plan yet, if forced to delist from U.S. markets, unlike JD.com which has a secondary listing in Hong Kong. However, it doesn’t have as many U.S. connections as JD.com has.
It boggles the mind to rationalize why Pinduoduo was sold off last week but it’s not even the hardest puzzle. TAL Education (TAL) has plenty of expansion opportunities in China and is unlikely to have plans to penetrate the U.S. market in the medium term. Nonetheless, it sank 5.81 percent on Friday. The consolation for shareholders is that the stock is still up 58.88 percent year-to-date and 141.35 percent in the past year. Thus, a logical explanation for the sell-off would be profit-taking.
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.
In the subsequent sections, I will argue why the sell-down of Alibaba Group is unjustified.
Could Trump’s WeChat ban be smaller in scope than anticipated?
Since 2018, we realized that many of President Trump’s rhetoric turned out to be more ‘bark than bite’. We have come to appreciate that the harsh words are part of his negotiation tactic to extract concessions from the directed party.
The series of give-and-take leading to the Phase one trade agreement is a case in point. Hence, without debating whether the ‘WeChat ban’ is justified, I argue that the actual outcome would be less of a damage to Tencent and consequently, Alibaba which has been unfairly dragged into the debacle.
Firstly, the WeChat messaging app is an essential communication tool used by the Chinese in the U.S. to keep in touch with their relatives in China. They could be in the U.S. for study, work, tour, or visiting purposes which contribute to the local economy. Are we cognizant of the loss in income as a result of inconveniencing the Chinese that they do not want to come to the U.S.?
Contrary to popular belief, foreigners are able to access WhatsApp in China while on roaming services. Tapping into the WiFi at hotels (perhaps possible elsewhere but I have not tried), WhatsApp is also functional, albeit without the ability to upload/download photographs/pictures, i.e. the text messages still get through. A compromise in this manner could be applicable for WeChat in the U.S. when the ‘ban’ is in place and that wouldn’t be too damaging for Tencent.
Secondly, many American businesses, whether they are importing goods from China or exporting into the country, rely on WeChat to communicate with their Chinese partners. If the Trump administration is truly pro-business, it should come to the realization that a complete WeChat ban could cause serious disruptions and reverse its tough stance.
Thirdly, it’s not known if the Trump administration would demand Apple (AAPL) App Store and Google (GOOG)(GOOGL) Play Store to remove WeChat in the U.S. only or globally. Worse, would Weixin, the supercharged Chinese version of WeChat with a Swiss Army knife style of functionality, also be cleared from the stores?
My take is that Tim Cook would tell Trump the latter two scenarios would be disastrous for iPhone sales. Being unable to use Weixin in China is a more unthinkable situation than not being able to use Google products (Gmail, Google Search, Google Maps, etc.) in the U.S. Thus, if WeChat is only banned in the U.S., is the impact to Tencent worth $35 billion, the market valuation it lost on Friday?
In the same breath, what transpired that resulted in Alibaba Group losing $37 billion on Friday? To begin with, the e-commerce titan was not mentioned by name by the Trump administration.
Perhaps, investors were reminded of the blocking by the U.S. government of a proposed acquisition of global payment service MoneyGram by Alibaba’s Ant Financial (now renamed Ant Group), reigniting fears that Alibaba’s overseas expansion, especially in the U.S., could be in jeopardy. This would exacerbate its precarious ex-China growth story, a topic I discussed last month following a boycott on Chinese goods and services in India.
Although Alibaba Group is already a leading cloud services provider in China, a successive penetration in the U.S. would certainly provide it with much sought after growth. Following Chinese businesses to the U.S. would be a good start. Unfortunately, the Trump administration alluded to the danger posed by the use of cloud computing from Chinese providers which inevitably includes Alibaba Group.
That is a valid concern. However, was that growth opportunity priced into the shares prior to Friday’s plunge? If not, isn’t it fair to say the ‘correction’ was unjustified?
Furthermore, the WeChat ban distracted investors from various bullish developments. For instance, the Caixin China Manufacturing Purchasing Managers’ Index (‘PMI’), a private survey which gives an independent snapshot of China’s manufacturing sector, rose to a nine-year high last month. This is perhaps not surprising as China is serving as a ‘refuge’ for global companies with the coronavirus outbreak well under control in the country.
Source: Wall Street Journal
Alibaba Group also received attention from a revelation by Daniel Loeb’s Third Point via the hedge fund’s second-quarter letter that it invested in the e-commerce giant. The letter cited a bright outlook for the Chinese e-commerce market as well as Alibaba’s prospects for the cloud computing business as a rationale for an entry.
Somewhat trivial but the loss of WeChat/Weixin for Starbucks (SBUX) is a boon for Alibaba Group which has enhanced its cooperation with the beverage giant over the years. The revoking of privileges for Hong Kong following the city’s imposition of a national security law could impede the penetration of Amazon (AMZN) and Google in the areas of e-commerce and cloud computing. Alibaba Group is a natural beneficiary.
Are there any other silver linings or less-than feared issues for Alibaba Group you have in mind? Share them with the Seeking Alpha community via the comment field below!
Disclosure: I am/we are long BABA, BIDU, JD, TCEHY, TCOM, 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.
Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.