China has issued a consultation document considering anti-trust regulations of its internet companies. EFG Private Bank has issued an analysis for investors that argues these stocks remain a buy.
What does the anti-trust consultation document say?
The document provided details for implementation of anti-trust for platform companies based on ongoing development of the industry. It includes definitions of monopolistic behavior, which include irregular pricing, restricted transactions (e.g. Alibaba’s and Meituan’s “2-choose-1” exclusive cooperation requirement on merchants) and bundled sales (mostly used by online travel agencies).
Unlike the discussion of breaking up big tech names in the U.S., there is no such discussions of breaking up Tencent or Alibaba in China now. EFG believes there is no need to do so in China either, as the industry landscape in China internet is much more competitive than that in the U.S.
Some investors have expressed fears that VIE company structures, which are widely used by overseas listed Chinese companies, could be forbidden by Beijing. However, EFG does not see such risks coming from this document. This regulation only requires appropriate filing for proposed mergers and acquisitions with the government, even when a company is under VIE structure.
Why is this being discussed now?
The development of platform internet companies is the mega trend in global technology in the past two decades. The bank expects this structural tailwind to continue to drive global productivity growth and innovation in the coming decade.
Government regulations are needed for all industries to help build a healthier competitive environment, protect minority interests (consumers as well as merchants in the case of platform economies) and drive sustainable growth. Just as the U.S. and Europe are weighing how to regulate companies like Google and Amazon, so too must Beijing figure out how to handle its big tech players.
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Nor is this new or a surprise. This regulation has been planned by the government for a while. China introduced its first anti-trust law in 2008, much later than developed economies, mainly targeting traditional industry players and multinational corporations. This was extended to cover internet companies in January 2020.
On November 6, Chinese regulators held a meeting with 27 internet companies, and put out a consultation document on the 10th. Following the current public consultation, Beijing will seek opinions from other sources such as think tanks and industry executives before releasing a final version of anti-trust regulation, probably by the end of 2021.
It is possible that this anti-trust review is a direct response to the public tussles with Ant Group. The consultation document highlighted some practices by Alibaba that are considered misbehavior like “2-select-1” (exclusivity in merchant partnership) and algorithm-driven price discrimination, and it was released one day before Alibaba’s high-profile Singles Day or “Double 11” shopping festival.
EFG speculates that Jack Ma’s controversial speech in October attacking financial regulators has generated negative views of him in Chinese social media, providing regulators with the opportunity to push forward anti-trust legislation.
What are the implications for large-cap internet names?
Given the difficulty in enforcement, the near-term impact on large-cap internet stocks is based on sentiment and valuation. It will take quite a while to see the actual impact on fundamentals, which depends on the final legislation. EFG says the aim of the regulation is to maintain a fair playing field and healthy industry, rather than kill national champions or harm innovation.
Therefore EFG reckons the new rules won’t impact the long-term structural trends of big internet companies, but it could slow them down and reduce their profitability. Some sharp practices no doubt contributed to the rise of the biggest tech players, helping them build barriers to entry. But these companies are successful because of their strategy and execution. EFG continues to back these names and sees any overreaction in their share prices as a buying opportunity.