What will China’s investment crackdown mean for tech stocks?

Shares in China big tech firms, including Tencent [0700.HK] and Alibaba [BABA], have plunged once again after rumours of a potential regulatory crackdown on raising cash.

According to Reuters, the Cyberspace Administration of China has recently told some companies that it plans to introduce a new mechanism that would require internet firms to obtain formal approval for investment and fundraising plans if they have more than 100 million users or posted revenue exceeding $1.58bn the previous year.

Any internet company operating in one of the sectors placed on the negative list created by China’s National Development and Reform Commission last year will also need to seek a green light when raising funds.

Though the draft rules may still be subject to change, if such a scheme was implemented it would likely curb the growth of China’s tech giants by deterring them from making acquisitions or investments to drive expansion.

 

Tencent and Alibaba stocks dipped since the announcement

The Cyberspace Administration of China was quick to deny the reports. “The information is false,” it said on its official WeChat account. However, even rumours of regulatory changes have caused a dip in big tech stocks.

The Tencent share price has fallen by 5.3% since the announcement on 19 January, while Alibaba stocks have plunged 14%.

In the longer term, the outlook for Alibaba and Tencent stocks looks cloudy, with concerns over China’s economy and the country’s zero-Covid policy adding to the uncertainty caused by the ongoing threat of regulatory crackdown.

Needham analyst Vincent Yu recently lowered his Alibaba share price target to $180 from $230, citing weaker Chinese retail sales and internet regulations as the reasons for this decision.

According to CNN, 46 analysts offering 12-month price-forecasts for the Tencent Holdings stock have a median target of $74.53, with a high estimate of $100.19 and a low estimate of $57.17. In comparison, Tencent’s share price was $59.39 at the close on 27 January.

 

Longer-term impact

Chen Weiheng, partner and head of U.S. law firm Wilson Sonsini's Greater China practice, warned that such a regulation could significantly impact investment in the sector and “even end the era for big internet platform operators to build an ecosystem through investments”.

This is likely to particularly hit big tech companies like Tencent and Alibaba, given the scale of their investment portfolios.

According to Reuters, Tencent was Asia’s third most active investor in the fourth quarter, with investments in 39 companies. It has invested in more than 1,200 companies to date, according to Chinese startup data aggregator IT Juzi. In 2021 alone, it deployed over $20bn across 278 companies.

 

It’s not only China’s largest internet firms that will potentially be hurt by new rules. Chinese startups could also suffer from curbs on investment, given it will be more difficult for tech giants to invest in independent projects — for example Tencent’s videogame streaming platform DouYu and Alibaba’s high-tech grocery chain Freshippo.

Private equity firms may also be nervous about investing in the ‘next big thing’ if regulations mean it will not be allowed to get any bigger.

However, it could leave China’s tech scene much clearer for startups to grow independently of big tech and develop their own innovative and creative ideas.

 

How have China’s big tech firms responded to the news?

ByteDance, which operates TikTok, is reported to have declared that it is dismantling its strategic investment team in the wake of the announcement. Tencent has also divested stakes in firms such as ecommerce player JD.com, though this happened before news about newer regulations broke.

However, the threat of further regulation doesn’t seem to have curbed Tencent’s plans, with a Reuters report stating that the company is preparing to take DouYu International Holdings private and is currently speaking with investment banks.

Tencent is the biggest shareholder in Nasdaq-listed DouYu with a 37% stake, and is looking to team up with at least one private equity firm.

According to Refinitiv, there have been around $13.7bn so-called take-private deals for US-listed Chinese companies over the past two years. That compares with a combined $5.8bn in 2018 and 2019.

 

Alibaba is also considering raising funds for Freshippo at a proposed valuation of $10bn, Bloomberg reported.

Freshippo is said to be working with an adviser on an “exclusive list of potential strategic and financial investors that will be invited to join the funding round”, which is likely to begin next month.

Alibaba is reportedly yet to decide on the size of the fundraising, but it could still retain a major stake.

With China’s internet giants still ploughing ahead with investment plans, it remains to be seen how rumoured regulatory changes will impact big tech stocks in the longer term.