Chinese stocks that are listed in the U.S. have been decimated over the past couple of years after a tech crackdown by Chinese regulators and the U.S. government's passing of legislation to delist Chinese stocks from U.S. exchanges if they don't submit their books for the SEC to review.
However, recently there has been some positive news, and the tide looks to be turning for U.S.-listed Chinese stocks. It was recently reported by the Financial Times that China’s Cyberspace Administration has purchased “Golden Shares” in Alibaba (BABA, Financial)(HKSE:09988, Financial) and has plans to do the same for Tencent (TCEHY, Financial)(HKSE:00700, Financial).
For those not familiar with the term, Golden Shares are shares that grant special voting rights which can out-vote all other shares in certain circumstances. They are typically granted to government organizations and are sometimes used to privatize a government company.
In this case, these Golden Shares reportedly give Chinese regulators a board seat and allow them to review content on the platforms. This may seem negative initially. However, I believe these regulators will now have a financial interest in the success of these companies, thus it could actually be a positive.
The market has reacted positively to the news, as Alibaba’s stock price has increased by over 30% in the past month and Tencent is up 17% over the same period. Thus, in this article, we are going to dive into the details of the Golden Shares issued to Alibaba and Tencent as well as the prospects for these companies; let’s dive in.
Golden Share details
The Cyberspace Administration of China has purchased a 1% stake in an Alibaba subsidiary named Guangzhou Lujiao Information Technology. The idea of this looks to be for the regulator to review the content and better control the internet browser UCweb and video streaming platform Youku, which hosts a range of popular Chinese drama series. As mentioned prior, these Golden Shares include a board seat; the new board member, Zhou Mo, was recently appointed.
Tencent is also expected to have a similar process occur, with Golden shares being purchased from a subsidiary known as Kuaishou, which operates a short-form video platform similar to TikTok. According to people close to the matter, Tencent is pushing for a government entity from its headquarters location of Shenzhen to take shares, rather than the Beijing stated-backed investment fund which purchased shares in Twitter, ByteDance (the parent of TikTok) and Weibo.
SEC making progress
The SEC previously made a hit list of Chinese companies to be delisted from U.S. exchanges if they didn’t comply with U.S. accounting regulations. This initial news sent U.S.-listed Chinese stocks plummeting in the summer of 2022. However, in September 2022, the Pubic Company Accounting Oversight Board was allowed to visit Hong Kong to review the financials of Chinese companies and interview auditors. The final report is still being worked on, but any cooperation between the U.S. and China is positive news. Companies including Pinduoduo (PDD, Financial) have put on hold plans to set up a primary listing in Hong Kong, which is a positive sign overall.
Tencent
Tencent (TECHY)(HKSE:00700, Financial) is a technology titan that owns China’s most popular social chat platform, WeChat, which has nearly 1.4 billion monthly active users. WeChat is basically like Whatsapp combined with a “super app." WeChat has created a platform where developers can build applications on top. This means Chinese consumers can use the platform for a range of extra services such as ordering a taxi and even booking travel. Tencent’s gaming business is a dominant player in the Chinese market and owns local game franchises such as League of Legends and Call of Duty China in additon to its own games. While about half of its revenue comes from gaming, social media and other media segments, it also makes money from fintech, business services and advertising.
Financial recap
In the third quarter of 2022, Tencent generated revenue of $19.7 billion, which declined by 2% year-over-year. This may seem bad at first glance, but this looks to have been driven by mostly macroeconomic factors such as a pullback in advertising spend and China’s gaming curfew policy for minors. A positive is the company increased its revenue by 5% quarter over quarter.
Tencent reported net income of $14.2 billion, which dropped by close to 14% year-over-year. Again, this looks pretty terrible, but I believe it is mainly due to the cyclical decline in the gaming and advertising markets.
The company does have a robust balance sheet with $41.1 billion in cash and short term investments compared to total debt of $51.6 billion, the majority ($45 billion) of which is long term debt and thus can be managed.
Valuation
Tencent trades at a price-sales ratio of 6, which is nearly 90% cheaper than its five-year average.
The GF Value chart indicates a fair value of $66.60 per share, thus the stock is “modestly undervalued” at the time of writing.
Alibaba
Alibaba (BABA, Financial) is the largest e-commerce company in China and specializes in both B2C and B2B e-commerce sales. Someone from the West can even order bulk goods directly from China using the platform. In addition, the company is the largest Cloud infrastructure provider in China with a ~37% market share. The Cloud business offers Cloud computing as a service and is one of the fastest growing industries in the world. In China, the Cloud is still in its early transition phase with technology companies being the first movers. However, a study by McKinsey forecasts that China’s vast manufacturing industry will undergo a digital transformation and unlock major opportunities for Alibaba.
Alibaba also owns one third of the fintech giant Ant Group, which offers the world's largest mobile payment platform Alipay.. Ant Group previously had plans to IPO in the U.S. in 2020 and at a staggering valuation of $37 billion. However, this was halted by Chinese regulators, which was believed to be caused by founder Jack Ma’s comments criticizing the entire financial system for being too risk-averse. A positive for Alibaba is Ma has recently reduced his controlling stake of Ant Group from approximately 53% to 6%. This means Ma is no longer the controlling person of Ant Group. As Ma is now in exile in Japan, Ant Group could have a future IPO, which would help generate billions of dollars in raised capital.
Financial recap
Alibaba reported fairly tepid financial results for the second quarter of its fiscal year 2023. The company generated $28.95 billion in revenue, which increased by just 3% year-over-year. This was driven by lower demand in China’s consumer segment and a zero tolerance Covid lockdown policy which resulted in logistical disruptions. A positive for the company is pockets of demand were seen in areas such as pet care, as the trend of “pandemic pets” still looks to be strong in China. In addition, the Alibaba’s travel subsidiary (Fliggy) reported positive results as Chinese consumers look to vacation more. Its home decor products also reported solid growth, as did its food delivery business. China's zero-Covid policy was also lifted recently, which should be good in the long-term after some initial distruption (China right now is like the U.S. back in 2020/2021 in terms of everyone getting Covid).
Alibaba also reported strong operating income of $14.16 billion, which increased by 4.71% year-over-year. This is slower than prior growth rates of 24% in 2021, but this metric still beat analyst expectations.
Valuation
Billionaire investor Charlie Munger (Trades, Portfolio) previously purchased ~300,000 shares in Alibaba in the first quarter of 2021 for the Daily Journal (DJCO) according to the firm's 13F filings. During that quarter, shares traded for an average price of $245 per share, which is substantially higher than where the stock trades at the time of writing. Munger then doubled his position later in the year as the stock plummeted to less than $145 per share. However, Munger latert sliced his position in half for undisclosed reasons.
Investors should be aware that 13F reports do not provide a complete picture of a guru’s holdings. They include only a snapshot of long equity positions in U.S.-listed stocks and American depository receipts as of the quarter’s end. They do not include short positions, non-ADR international holdings or other types of securities. However, even this limited filing can provide valuable information.
Alibaba trades at a non-GAAP price-earnings ratio of 14, which is 36% cheaper than its five-year average. Its price-sales ratio is 2.54, which is 64% cheaper than its five-year average.
Final thoughts
Tencent and Alibaba are two of the biggest and most important technology companies in China. Both are highly diversified across multiple sectors from e-commerce to gaming and the cloud. Chinese stocks in general have faced a huge amount of headwinds over the past couple of years, but now we are seeing some positive market indicators. The story isn’t over yet, and Chinese regulators taking Golden Shares in these companies means they will have more control then ever. However, this isn't all bad and even has some positives, as their incentives should be aligned and the worry that the U.S. regulators will have more control over these companies than the Chinese regulators can be abated.
