- “Xi Jinping and Washington’s China hawks unite against Chinese tech IPOs in US.” – Financial Times Headline
Beijing’s crackdown on one of China’s giant technology firms – DiDi, the “Uber of China” – impacts more than just that company (and its investors). It signals an escalation of what we may start to think of now as a Cold War between China and the United States. At issue is global financial supremacy.
Who Is DiDi?
DiDi Chuxing Technology Co has not been a household name here in the U.S. – until this month.
DiDi is a “ride-hailing company” — and much more… It has expanded into a wide range of related and semi-related businesses, including bike sharing, on-demand delivery services, automobile sales, leasing, financing, and maintenance, fleet operation, electric vehicle charging, and co-development of vehicles with automakers. (By the way, the founder, Cheng Wei, is an alumnus of Alibaba and Alipay, which became the Ant Group – more evidence of Jack Ma’s spiritual significance for the rise of the Chinese tech sector. DiDi’s suppression can be seen as a sequel to the even harsher “rectification” of Ant — but that is another story, covered in several previous columns.)
Like China, DiDi is huge. In fact, to call it the Chinese Uber is to understate the business case that DiDi promoted to investors in its IPO. It had about $25 Billion in revenue in the last 12 months (vs about $11 Billion for Uber). DiDi claims its user levels and market penetration are currently 4 to 6 times larger than Uber’s. It claims 15 million active drivers. (Uber has about 3.5 million.)
DiDi looks like a classic “Fast Follower.” Uber proved out the model for consumers and investors, and DiDi can take advantage of the market clarity to expand quickly and overtake the former leader. And DiDi is a Chinese Fast Follower, with a huge home market in which it can grow to a giant size protected from foreign competition. It also benefits from the emergent culture of rapid service innovation that has propelled Chinese Tech into the first rank.
This has brought DiDi much acclaim. According to the NY Times, “Didi has been celebrated for years in China as a homegrown innovator and industry pacesetter.”
On June 30, taking a natural next step, DiDi raised $4 Billion in its Initial Public Offering, which took place not in China but on the New York Stock Exchange. It was the largest American IPO for a Chinese company in 7 years. The stock moved up the normal 15% the first day, setting a market value of $80 billion.
The company is well-backed and well-credentialed, financially speaking. In fact, Uber itself is a major shareholder (with 12.8% from having sold its own Chinese operations to DiDi several years ago). The largest investor is Softbank (21.5%, a powerhouse in the venture capital world, which is also the largest shareholder in Jack Ma’s Alibaba). And DiDi’s IPO was handled by an investment banking dream team of Goldman Sachs, Morgan Stanley, and JP Morgan.
For about 48 hours, it looked like another Chinese success story.
The Hammer Comes Down
But it seems that someone in Beijing is not-pleased. On July 2, the Chinese government called an abrupt halt to DiDi’s business development plans (temporarily?). The company was directed to stop signing up new customers, pending its “rectification.”
DiDi’s newly issued shares dropped 30%. Investors here were unsettled (to say the least) by what seemed like a due diligence failure of the first order, an undisclosed business-critical risk factor, emanating (predictably?) from a regulatory regime known for sometimes rough and capricious measures. Did DiDi know this was coming? The reports are contradictory. It will likely be litigated.
In any case, the company was informed by the Chinese authorities that it was in “serious violation” of…what exactly? … something to do with data security… and ordered to put its business on hold. Specifically, in addition to the halt on recruiting new business, Beijing imposed the following measures.
- The company’s main consumer ride-hailing app – similar to the Uber app here — was removed from mobile stores and platforms
- 25 other apps – including its car-pooling app, its finance app, and its app for corporate customers – were also deleted
- The company was fined for antitrust violations (pertaining to an older matter, thrown in now for good measure it would seem)
The hour may have been late (the Beijing call came at 10 pm, reportedly). The rationale may have been unclear. But compliance was mandatory.
- “None of these commands offered any detail about the specific data and security problems that aroused officials’ concerns. In a statement that was posted after midnight on Chinese social media, Didi said it would “sincerely accept and resolutely obey” the demands.”
The question now: Is this a fundamental threat to DiDi’s basic business model? Or a temporary measure to signal Beijing’s authority, not really intended to permanently restrain the company? That, too, is unclear.
The immediate damage was not limited to DiDi’s shares. The Nasdaq Golden Dragon Index of 98 Chinese companies traded in New York fell in lockstep, down 14% in a week, losing $130 Bn in value.
In Shanghai, the market lost about $200 billion on July 2 when the DiDi announcement was made public there. The Hong Kong exchange — heavy with companies dual-listed in New York – was harder hit, losing something like $500 billion dollars in value over the week.
How should we think about this? In particular, how should we view the motives of the government, since Beijing is clearly calling the shots now?
Three readings suggest themselves:
- it is simply a bad decision by the authorities, based on political concerns related to the CCP’s stay-in-power agenda, and a mismanagement of China’s true economic interests – a strategic mistake;
- it is a rational regulatory policy, clumsily executed; or
- it is a calculated confrontation with the U.S.
1. Government Paranoia and Stupidity
Perhaps this is another Beijing Blunder – by a regime that seems to be quite prone lately to blundering (Hong Kong, Xinjiang, wolf warrior un-diplomacy, the mishandling of the Covid origin investigation…). According to this view, kneecapping DiDi is the latest misguided attempt by a nervous ruling Party to assert its control over a burgeoning entrepreneurial tech industry that it really doesn’t understand. If so, it would be a strategic error. By suppressing the most dynamic and innovative sector of the Chinese economy, it tends to defeat China’s larger purpose of achieving technological and economic parity with the West. China needs these unruly, hyper-creative companies, and the rule-testing entrepreneurial spirit that animates them. But the government can’t seem to abide this. Hence, these fiascos in the name of “financial regulation” – like the halted IPO for Ant, or the now tainted IPO for DiDi.
2. Good Policies, Clumsy Execution
Or — perhaps we should set aside our prejudices against the CCP’s style, and admit that – in many of these cases – the policy objectives are reasonable. Tightening rules on data security, strengthening consumer privacy, and reining in anti-competitive practices of Big Tech… Well, aren’t we embroiled in very much these same issues here in America? We have our own concerns about the unregulated power and overreaching tendencies of our Big Tech firms, like Amazon, or Google. Facebook has been criticized for alleged sins similar to the charges leveled now at DiDi. Even the shut-down of the Ant IPO last November — as harsh as it was – can be seen as a rational response to significant risks that were developing around a frenzied deal that seemed to be spiraling out of control. In short, Beijing made have done the right thing — however clumsily.
In this more optimistic interpretation, China has taken the lead in confronting some of the complications of rapid technological change. Within a more authoritarian political system, they are able to be more decisive than we can be.
- “The U.S. and China will eventually find it’s in their interest to cooperate in reining in companies that seek to amass—and profit from—more and more data. ‘China, the U.S. and other economies will benefit from these giants, but also continue to be in confrontation with them,’ said [a well-placed Chinese official]. ‘They could not deal with the problem alone. This is an important area for cooperation.’”
Maybe we should admire the Chinese regulators for the ruthless dispatch with which they grasp a problem, and speedily take corrective actions that we need much more time struggling with our “democratic inefficiency” to achieve here. In this view, it is not the outcome, but the peremptory and sometimes brutal manner in which the policy is carried out that we may take issue with. But after the dust settles, the result – we may admit — might not be so bad. Analogies with the different responses to the Covid outbreak in the two countries – and the different outcomes – come to mind.
3. A Declaration of (Cold) War
I favor a larger, and rather darker view. Both stupidity and brutality play a role in this – as they do in many things China has done lately in the Xi Jinping era. But this can also be seen as a calculated step towards open confrontation with the U.S. financial system and its regulators here. There are ominous implications for the global financial system that transcend differences in style or judgment.
The Financial Cold War, which has been brewing for a while, was openly declared some months ago, neither in China nor in New York, but in Washington D.C. – when both houses of Congress passed unanimously the Holding Foreign Companies Accountable Act. This law requires, among other things, that all foreign firms listed on U.S. stock exchanges need to comply with the audit review process overseen by the Public Company Accounting Standards Board (PCAOB). This agency was created by the Sarbanes-Oxley Act of 2002, and all U.S. public companies are required to comply, as are companies in almost every other country that trade in New York. China has said it will absolutely refuse to allow its companies to cooperate. They are the only country in the world that has taken this position.
Skipping over the details (which I have laid out in a previous column), the bottom line is that in less than three years the U.S. will most likely eject from the New York stock market hundreds of Chinese companies currently trading there, with a combined market value of something like $2 Trillion. This will impose a significant financial penalty on these companies, raising their cost of capital and denying them access to large segments of the global financial system.
[How much of a penalty is open to question. An older study of foreign companies listed in New York – from all countries – found a valuation premium of nearly 40% associated with cross-listing on a major exchange here. This predates the emergence of China’s cross-listing trend, and so pertains mainly to firms headquartered in developed markets.
A more recent study of the effect of PCAOB (non)-compliance suggested a 5-7% valuation “haircut” for Chinese firms associated with press releases indicating delays or failures to cooperate with U.S. regulators.
In any case, the cost of capital for Chinese firms is significantly higher than for U.S. firms. Raising the “regulatory risk” factor in China, and/or losing access to American capital markets, would certainly increase the gap.]
Beijing is presumably prepared to pay this price (or to allow Chinese companies and investors to pay it). The move against DiDi shows that China would prefer to discourage Chinese companies from listing their shares in New York. It appears that Beijing has decided on a pre-emptive strike against the PCAOB, Congress, and Marco Rubio.
This hardening of positions will not be easily reversed. As the Financial Times put it, Xi Jinping and Senator Rubio are now in agreement – in favor of a dissolution of many of the financial linkages that have developed over the last two decades between the Chinese private sector and the Wall Street. Indeed, just this week, we learn that ByteDance (TikTok) – another Chinese tech giant with global reach – has bent the knee to Beijing on this very point, and “postponed” its plans for a U.S. listing. Across the broad China-Tech landscape there is a general cooling down of animal spirits. Many of the “founders” have seen what happened to Jack Ma, and are stepping aside, lowering their public profiles. Chinese Tech companies have gotten the message.
The side question related to DiDi is: Where was the “due diligence” on this deal? It seems clear that Chinese regulators had briefed the company on their unhappiness with a “premature” listing. The investment bankers should have seen this coming. For investors to lose $23 billion in value before the checks have cleared (so to speak) is a pretty big miss.
- “Failing to disclose prior awareness of market-moving regulatory decisions could make Didi and the banks that arranged the initial public offering — Goldman Sachs, Morgan Stanley and JPMorgan Chase — vulnerable to investor lawsuits and regulatory problems in the United States.”
We’ll hear more about this soon. (That’s the implication of the ByteDance story.) Cue the lawsuits.
As to the longer term outcome…
If the result of this trend is the substantial disconnection of China’s private sector from Wall Street – whether it comes from the enforcement of America’s regulatory requirements under the Holding Foreign Companies Accountable Act or from new Chinese regulations discouraging companies from listing in New York – the big loser will be China and Chinese companies. It will raise their cost of capital, decrease liquidity and increase volatility of their shares, and likely increase the “China discount” on their valuations. It will hamper Beijing’s geopolitical aspirations to play a large role in the global financial system, which depend on whether they are willing to play by international rules. This break would be a big step away from that commitment.
This is becoming clear to the broader market. The Golden Dragon Index is down 37% in the last 5 months, as the regulatory pressure has grown. The S&P 500 index is up 10% in that time – so the net result is that Chinese shares in New York have dropped by half relative to the overall New York level – definitely a bear market in Chinese equities.