Summary

RedTech Advisors addressed the regulatory risk facing Chinese internet companies by analysing the government's motives in the ever-widening crackdown, forecasting the next regulatory moves and explaining how investors can navigate the risks.

China's regulatory risk has historically fluctuated; for example, Weibo, Baidu, Tencent, and Bytedance, have been subjected to regulatory scrutiny since 2011. This time, however, it appears to be more pervasive and permanent – starting with Ant and extending to other hotspot industries – making regulatory risk a constant concern. The type and severity of risk varies over different categories, and includes antitrust, content, expansion, data security and most concerning, reform risk that has affected the education, healthcare, and Fintech sectors. By adopting a principle-based reform rather than a rule-based approach, as used in other jurisdictions, the regulator’s reach has expanded and become rather subjective by nature.

Ant was used as a case study to discuss the validity of China's regulatory pushback. Whilst it was unjustified, it was understandable given Ant's problematic lending scheme, which took on very little risk and at the cost of the government-owned banks. However, Ant's difficulties are more systemic, with China's plans to adopt a digital currency and universal QR codes, raising doubts about its future operating space. Some believe that the majority of China's antitrust framework is comparable – albeit more rigorous – to that of other jurisdictions. Others would argue that the regulator’s final legislation is a worst-case scenario and considerably more restrictive than anticipated. It is clear from the market’s reaction, however, that investors’ inherent dislike for regulation was intensified by the government’s approach. The regulator's schedule for a six-month rectification campaign may provide reason for cautious optimism.

RedTech Advisors also predicted some of the industries that will be subject to probable regulatory changes. The community group buying sector is one such area, since the regulator is concerned about small merchants who may suffer, and as a result cause social and political difficulties. Another sector is online healthcare, which, as with education, the government believes should be non-commercial by definition. While the online component offered a potential remedy to an inefficient healthcare system, investors would suffer heavily if profit motivation was removed.

Companies that are in a better position given the regulatory risks include Tencent, Meituan, Boss Zhipin and Full Truck Alliance. Although Tencent and Meituan may lose out if regulators limit gaming players or subsidies respectively, and will be drawn to diversification, incentivised product development and reduced costs. Tencent, for example, are expanding Fintech, advertising, cloud, and SAAS platforms. Boss Zhipin and FTA are unlikely to draw regulatory attention given their smaller market capitalisations. Furthermore, according to RedTech's SME surveys, Boss Zhipin has a favourable industry moat. Similarly, while FTA has a sizable market share in online facilitation, this only contributes to 3% of GMV in China's transportation and cargo industry.

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