While the rapid cadence of negative headlines has weighed on sentiment, we offer our thoughts on the above per the following in this flash note:
First, we think that the HFCAA rule implementation still gives room for regulators on both sides to enter into negotiations to work out a possible resolution, as we believe that trading termination should be no earlier than 2024. The HFCAA in itself is not a new development, as it was passed by Congress and signed into law by then-President Trump in Dec 2020. However, we do acknowledge the risk that the current three-year evaluation period could be shortened to two should the Accelerating HFCAA (still subject to a House vote) become legislation.
Second, we believe that the Chinese ADR delisting risk is manageable for a number of large-cap names (e.g. Alibaba, JD.com, Baidu) given that they have already completed their HK dual-listings. A number of these internet dual-listings typically provide for fungibility between the ADR and HK shares. Per Bloomberg, a number of top shareholders of Alibaba’s HK shares are large institutional investors, which could indicate the ability of such market participants to adjust to dual-listed status of companies. JD has also shared that they would consider changing their secondary listing in HK to a primary listing in future if needed.
Third, recent developments do not suggest that the Chinese authorities are looking to dismantle/nullify the VIE structure of its foreign-listed companies, as (a) that would go against the principle of welcoming foreign investment, which will be contrary to the stance taken by senior government officials recently, and (b) there have been more policies recently that have put the VIE structure explicitly into scope. Still, this does not preclude the possibility of VIE-related regulatory changes. In general, we think that directionally such regulations should get stricter/require more approvals, though probably of a milder degree for HK IPOs. This should however be known by the market at this point. We highlight that the STAR board’s first-ever VIE listing was completed in Oct 2020 and Cloud Village (VIE) was also listed on the Hong Kong Exchange on 2 Dec.
Fourth, other Chinese internet companies under coverage have not been placed under similar investigations like DiDi has, nor have they announced imminent delisting plans.
All-considered, despite the recent sell-down, we believe that (a) there are mitigants in place to manage delisting risks, and (b) recent developments are not expected to significantly impact the operational workings nor fundamentals of companies under coverage. Per our previous sector report, the road to recovery is likely to be a long and bumpy one, and we remain selective in our picks for the sector for gradual accumulation. In terms of preferred names, we maintain our preference for JD.com (JD US/9618 HK) and Meituan (3690 HK) while introducing NetEase (NTES US) into the mix.
|Just over the course of last week, the CSI Overseas China Internet Index has fallen 11.6%, sharply underperforming the -2.9% total returns registered by MSCI China. In our view, this can be attributed largely to 4 main events/reasons:|
· On 1 Dec, Bloomberg reported that the Chinese authorities are planning to ban companies from going public on foreign stocks markets via VIEs. There is also the suggestion that existing companies currently listed in the US and HK using the VIE structure need to make adjustments so that their ownership structures are more transparent in regulatory reviews, especially in sectors off limits for foreign investment. The China Securities Regulatory Commission has denied this per its website and on 3 Dec, we note that the China Daily reported that regulations are expected soon for “orderly overseas listings”.
· On 2 Dec, the SEC adopted amendments to finalize rules relating to the Holding Foreign Companies Accountable Act (HFCAA). The HFCAA permits the SEC to ban (foreign) companies from trading and to delist them from US exchanges if the U.S. Public Company Accounting Oversight Board (PCAOB) is unable to audit requested reports for 3 consecutive years, and requires companies to declare if they are owned or controlled by any foreign government.
· On 2 Dec, DiDi announced that it will file for a delisting of its American Depository Shares (ADS) and pursue a HK listing. Its ADS will be convertible into freely tradable shares on another internationally recognized stock exchange at the election of ADS holders.
· Fed Chairman Jerome Powell’s recent hawkish tilt on inflation has also been a headwind to growth/long-duration stocks, and we believe this has also had an impact on the China internet complex.