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The Taming of China’s Tech Titans
- By Yanru Chen, Credit Analyst, Emerging Markets Corporate Bond Research Team
- April 15, 2021
China’s crackdown on several of its leading technology firms introduces a new set of variables for investors to consider, ranging from imposed capital requirements to forced asset divestitures. However, the restrictions have yet to affect the companies’ credit profiles, and their hard-currency spreads remain relatively tight. Hence, the state’s heightened oversight—and the increased uncertainty regarding its future steps—has raised the probability of asymmetric credit performance due to the pronounced headline risk. This post touches upon certain aspects of these companies, such as market dominance, capital accumulation, and anti-competitive practices, that continue to draw government scrutiny and may indicate the level of risk that lies ahead.
The regulatory scrutiny of China’s tech titans intensified last year with the abrupt suspension of Ant Financial’s $37 billion IPO.1 The would-be issuer, one-third of which is owned by Alibaba, is the world’s largest fintech and payments platform with more than 770 million users, most of which use its Alipay payment service. Shortly after the IPO was suspended, China’s State Administration for Market Regulation (SAMR) cited anti-competitive and monopolistic behavior as it announced a draft of regulatory guidelines aimed at curbing the expansion of the country’s dominant “platform companies.”
The BAT Triumvirate
China’s BAT group of companies—Baidu, Alibaba, and Tencent—dominate vast segments of its key tech and financial sectors: they accounted for an estimated 70% of China’s ad revenue and approximately half of its venture capital investments in 2019. Furthermore, the duopoly of Alibaba’s Alipay and Tencent’s WeChat Pay control 90% of the mobile-payments market (Figure 1), while Ant Financial’s Yu’e Bao money market fund was previously the world’s largest with more than $250 billion in assets.
Figure 1: The Payments Duopoly of Ant Group and Tencent
The companies’ in-house payment systems are a key aspect of their dominance as they often bind partners to a single ecosystem and exclude rivals. China’s prior crackdown on peer-to-peer lending signalled the government’s growing discomfort with the ramifications of the platforms’ ability to bypass traditional financial institutions and access consumers. For example, the integrated and ubiquitous nature of Ant Financial’s two major micro-lending platforms—Jiebei (Just Borrow) and Huabei (Just Spend)—may have prompted concerns that they are fueling credit-driven consumption with adverse social consequences.
“Undisciplined Expansion of Capital”
The effect of the accumulated capital by the platform companies is also apparent in their voracious acquisition streaks. Since 2009, Tencent spent $152 billion on acquisitions, while its peer Alibaba spent $110 billion (Figure 2). The combined spending amounted to more than 10% of the total M&A in the global tech sector over the same timeframe.2
Figure 2: The Deal Volume for Alibaba and Tencent
The phrase “prevent the undisciplined expansion of capital” has been used to characterize the nature of China’s crackdown, and we believe the crowding-out effect of these all-encompassing ecosystems is one of the government’s key concerns.
Other cited anti-competitive behaviors include exclusivity agreements, which prevent retailers from selling on rival platforms, or the reprioritization of listings when retailers cross platforms. Given the lack of alternative channels, merchants may also be forced to accept punitive terms from the platforms. For example, Galanz Group, the world’s largest microwave maker, accused Alibaba of directing traffic away from its store, leading to a sharp sales decline, after it started selling on a rival site. Therefore, regulators monitoring the imbalance of power between medium to small enterprises and the dominant platforms may press the latter to lower or eliminate the cost of switching venues.
The End of Unbridled Expansion
In March 2021, SAMR announced fines on 12 technology companies in relation to 10 deals that demonstrated illegal monopolistic behavior, according to the agency. Baidu Inc., Tencent Holdings, Didi Chuxing, SoftBank, and a ByteDance-backed firm were among the companies fined. Each company was ordered to pay RMB500,000—or the equivalent of about $77,000. While the fine was symbolic, the government also announced that it may require tech companies to spin off their proprietary customer data into a separately owned, joint venture with government ownership. Despite the significant implications of the restructuring on the platforms’ operating and growth models, the credit spreads of those companies with outstanding hard-currency debt remain near their post-pandemic tights.3
China’s latest anti-competitive investigation into Alibaba culminated with a $2.75 billion fine, which represents about 4% of its 2019 revenue and is less than half of the maximum 10% penalty allowed under Chinese law. Alibaba’s equity gained on the news, while its credit spreads maintained their relatively tight levels.
In terms of scenarios going forward, we believe the government’s most stringent move would be a forced break-up of the conglomerates, though the probability of this outcome is low given their significant labor forces. Therefore, we think it is more likely that fines and other punitive measures will be used to curb the companies’ growth. Capital raising and M&A activities might be highly scrutinized and regulated as well. Indeed, in mid-April, Ant Financial was asked to form a financial holding company and abide by capital-ratio requirements similar to those of a traditional financial institution.
With the days of unbridled expansion in the past, we expect the platforms to face additional, taller hurdles in expanding their ecosystems in the future. China’s regulators are currently assessing whether a $6 billion planned merger between three live-stream gaming companies under Tencent’s umbrella violates the country’s anti-monopoly law, which would be the first time the law is invoked in its internet sector. The combined company would have a market share of about 80%, and Tencent would own 67.5% of the entity.
For its part, Alibaba will reportedly be forced to sell its media assets, including the South China Morning Post, which is Hong Kong’s flagship English news publication. Alibaba also owns major stakes in influential media outlets, such as Weibo, a Twitter-like service, and Youku, one of the country’s largest video-streaming services, that could also come into regulators’ purview.
The Juxtaposition Between Fundamental and Headline Risk
At this point, we don’t see a significant threat to the credit profiles of the platform companies. Tencent’s cash and short-term investments covered 87% of its total borrowings at the end of its fiscal 2020, while Alibaba reported that its cash and short-term investments were nearly four times its total borrowings.
However, the Chinese government’s increased oversight of the platform companies has brought headline risk to the fore, and it’s a risk that relatively tight credit spread can no longer wholly compensate for. In that context, we’ll not only continue to monitor our underweight positioning in terms of the platforms’ credit fundamentals, but we’ll also view it from certain aspects, such as anti-competitive practices and capital accumulation, that may prompt China to take additional action to tame its tech titans.
This material reflects the views of the author as of April 15, 2021 and is provided for informational or educational purposes only. Source(s) of data (unless otherwise noted): PGIM Fixed Income.
1The IPO would have valued Ant Financial at more than $300 billion.
2M&A data according to Bloomberg.
3Of the 12 companies fined, only Baidu, Alibaba, Tencent, and Softbank have outstanding hard-currency debt. Their aggregate total is slightly more than $88 billion outstanding.
Yanru Chen
Yanru Chen, is a Vice President and credit analyst for PGIM Fixed Income's Emerging Markets Corporate Bond Research Team based in our Singapore office. Ms. Chen focuses on Asian corporate bonds. She began her career as a Fixed Income Research analyst with JPMorgan's North American Credit Research department. Prior to joining the Firm in 2013, Ms. Chen was a Structured Finance Credit Valuation Specialist with Deutsche Bank Singapore. Previously, Ms. Chen was a Portfolio Management Analyst at Credit Suisse New York's Portfolio Management Group, covering the bank's exposure to high-yield and distressed credits. She received a Bachelor's degree in Political Science and a Bachelor's degree in Business Administration from the University of Michigan at Ann Arbor.
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