Sell In May And Go Away? Assessing Major Risks Of China’s Internet Sector
Last week, the US SEC added over 80 firms, including JD.com, to their watchlist under
the provision of HFCAA. As the delisting has been largely priced in, we still expect the
prolonged lockdown to dampen consumer spending in China. Even with the supportive
regulatory measures to spur the recovery from the pandemic, we do not think the
measures will do much to stimulate consumption in the near term. We maintain
MARKET WEIGHT on the internet sector.
WHATS NEW
• Recent update on HFCAA. To date, the US SEC has added 139 companies into their
watchlist with 116 companies still being able to submit evidence (ie to prove the companies
are not owned or controlled by a governmental entity in the foreign jurisdiction) to dispute
their cases; the remaining 23 companies have been included in the “conclusive list of issuers
under the Holding Foreign Companies Accountable Act (HFCAA)”. Regulators in the US and
China have been negotiating on the audit inspection of Chinese companies that have been
listed in the US for 15 years. China is now the only jurisdiction country to refuse to submit an
independent audit to the Public Company Accounting Oversight Board (PCAOB).
• At the current stage, we understand that the discussion stage was near its final phase with
news saying China had signalled its willingness to compromise in providing their US
counterpart permission to inspect the listed companies’ audited report. From the US side,
the PCAOB mentioned that the speculation on the final agreement with China remains
premature at this stage. Companies under our coverage like JD.com, Pinduoduo and
Trip.com were added in the disputable list which means they still stand a chance to dispute
their listing status. Overall, we do not rule out the possibility that the agreement will be
implemented in the near term with China allowing full audit inspection to PCAOB for selected
companies. There could be a preliminary trial conducted on selected companies before a
full-scale inspection.
• Dual-listed ADRs trading at lower valuations. The imminent delisting risk for the Chinese
American Depository Receipts (ADR) remain uncertain, however we favor companies which
had been dual-listed in HKEX. We notice that dual-listed ADRs (such as BABA and JD.com)
are currently trading at discounted valuations at around 13x 12-month forward PE compared
with the peers in A shares (around 25x) and the Southbound universe (such as Tencent and
Meituan) at about 21x. Therefore, we estimate a 35% upside for the existing secondary
listings stocks in Hong Kong once they become Southbound eligible.
• Various supportive measures by regulators. We saw various supportive policies
introduced by different governmental agencies to alleviate the burden of the SMEs brought
by the disruption from the pandemic. The government has promised to step up policy
support this year for its economy that has been struggling with COVID-19 outbreaks. The
meeting urged the need to maintain the stable operation of the capital market to attract longterm investors, the need to promote healthy development and the rectification of the platform
economy, implementation of comprehensive supervision, and introduction of specific
measures to support the standardisation and healthy development of the platform economy.
We are positive towards the relaxation on the policies towards China’s platform economies.
We expect valuation correction in the internet sector in the near term. Fundamentally, we
expect a recovery in 2H22 when the lockdown eases and we think Meituan is well positioned
to benefit from the relaxation of the lockdown
ESSENTIALS
• Macro weakness will be an economic drag. Beijing had recently announced that it will
temporarily close down 40 metro stations along the six key routes in order to curb the spread
of the pandemic. The above measure was also said to prevent Beijing from entering into the
likes of Shanghai lockdown should the daily confirmed cases go out of control. Given the
absence of news on the easing of lockdown measures, we expect the upcoming retail sales
numbers for April/May to continue to register negative yoy growth following Mar 22 (-3.5%
yoy as the lockdown began in Mar 22). Fundamentally, this will continue to pressure on
consumer sentiment as well as businesses’ daily operations in the near term.
• As such, under our top picks, we advocate companies which are less susceptible to
the lockdown impact in the domestic market, namely Tencent and Netease as they are
supported by strong grossing growth in March/April. On top of that, we expect the resumption
of new game approval to revitalise investor sentiment within the online game sector and
encourage game companies to carry out R&D for new games.
• The HS Tech index and KWEB ETF have declined 32%/34% respectively ytd. On top of
the online game companies we mentioned above, we also advocate investors to stay
selective for companies which have been dual listed in HKEX as well as being key
beneficiaries once the lockdown measures ease such as Meituan (3690 HK).
SECTOR CATALYST AND RISK
• Catalysts: a) Supportive governmental policies, b) increasing online retail penetration driven
by less developed areas and younger generations, and c) continued improvements in
technology and e-commerce infrastructure.
• Risks: a) Uncertain geopolitical risks, b) a challenging regulatory landscape, c) weak macro
environment, d) high user acquisition expenses as well as increased competition as multiple
players seek to increase market share with heavy investments in new retail, and e) local
services strategy dragging down e-commerce companies’ margins and ROEs.