by Thomas Kirchner, CFA
Tech clampdown helped President Xi's grab power.
No need for further aggressive action.
Chinese tech stock likely have bottomed.
It has been about a year since President Xi's clampdown on tech companies began. With Xi having won prophet status in the Sixth Plenum of the CCP, we believe that the worst is over and that Chinese tech companies present a good entry point.
President Xi's Power Grab
We believe that the main motivation behind the tech clampdown is President Xi's power grab. Many tech entrepreneurs are affiliated with the Shanghai clique around former Premier Jiang Zemin. President Xi himself rose up through the CCP ranks as a member of this group but has since split with his own group of supporters. Weakening tech companies meant a weakening of the remnants of the Shanghai clique. For example, Jiang Zemin's grandson Jiang Zhicheng is said to be behind Boyu Capital, a fund that would have made substantial gains from the IPO of Ant Financial. By blocking the IPO, reported the Wall Street Journal, Xi prevented Jiang's clique from making billions of dollars in gains. Boyu has since relocated to Singapore.
The CCP's Sixth Plenum earlier this month put President Xi on an equal footing as a key leader in the continuity of Mao and Deng, as has been reported widely. But more importantly, it also overturned one of the core tenants of Deng's reforms: collective leadership. This opens the door to a Mao-style dictatorship under President Xi. Collective leadership has been a key characteristic of the post-Stalin Soviet Union as well as post-Mao China. Its abandonment is bad news for the freedom and life of anyone not completely subservient to Xi as it signals a return to brutal repression. Xi will seek a third term at next fall's Communist Party conference. All signs point to him winning
The Great Leap from Common Prosperity to Common Poverty
President Xi's policy of “common prosperity” through stone-age communism risks creating “common poverty,” warns one of the few pro-market voices allowed to speak openly, economics professor Zhang Weiying. Social media distribution of Zhang's article was blocked; but interestingly, the article itself remained available on the internet.
Clearly, as much as the CCP spreads an image of harmony and consensus, China is large and opposition still exists within the Party. President Xi may want to create an absolute dictatorship but if he were to pursue overly suicidal economic policies, it will eventually hit CCP officials' personal wallets. After all, many Party officials have accumulated substantial wealth, and not just through amazingly well-timed land or real estate investments, but also in other industries. The technology sector may have been in cahoots with Jiang Zemin's clique, but it remains key for future growth. Even more so if the real estate sector is in decline and less likely to contribute as much to future economic activity as it has done historically. In addition, technology is also crucial to produce modern weapons, which Xi will need to project Chinese power globally.
Therefore, it is unlikely that the clampdown on tech will go much deeper. While there is room for tough regulatory action at the margins, such as with Didi recently, further generalized action against the sector will have more negative effects on Xi's power than it will help.
Mafia state
The counterargument to this optimistic view is the already high degree of violence with which CCP officials dispose of rivals. This allows the party to stifle any complaints about economic policies that turn out to be a disaster without suffering adverse consequences.
Disappearances have become widespread and are no longer limited to officeholders who are little known outside of a narrow circle of bureaucrats. They happen to world-famous businessmen, pop culture idols or tennis players. The recent re-appearance of disappeared tennis star Peng Shuai was contrived so transparently that we wonder whether the actual message the propaganda sent was not that she is fine, but that the CCP has absolute power over the disgraced. Any dictator can murder a dissident, but coercing a disappeared to fake their own re-appearance, that is dictatorship 2.0.
An obviously fake re-appearance is similar to the message Zimbabwe's then-dictator Robert Mugabe sent in January 2000 when he won a lottery that was believed to be incorruptible because its drawing was transmitted on live TV: Mugabe showed that he is so powerful that he can even manipulate a lottery in front of millions of viewers. Clearly, Mugabe did not care for the $2,600 prize, but for demonstrating his absolute control and discourage any wannabe-opponents. Peng's odd re-appearance has a similar feel to it.
Almost forgotten is an account by China Daily from 2011, which pointed out the unusual frequency with which Chinese billionaires die untimely deaths: one died every 40 days on average in the prior eight years. Of 72 billionaires, 14 had been executed after a trial. The others died, in descending order of suspiciousness, of murder (15), suicide (17), accidents (7) and illness (19) [i]. Those who died from illness averaged only age 48, so we may have to reorder that list.
In short, China is run like a mafia state, and hence President Xi has few constraints in implementing and perpetuating economically harmful policies. Further actions against tech companies would be practicable under this scenario even if they turn out to be counterproductive.
Sanity will prevail
On balance, we believe that economic sanity will prevail even while substantial room for abuses remains. Just a few days ago, Bloomberg [ii] reported an upcoming clampdown on Variable Interest Entities (VIEs), something we had warned about a few months ago. However, China Securities Regulatory Commission promptly denied that VIEs were to be banned. The denial leaves open the possibility of other regulatory action short of a ban. We suspect that the Bloomberg report was leaked deliberately to prepare the market for measures that will be less stringent than the worst-case scenario of an outright ban.
We believe that this playbook will repeat more broadly across the tech sector. Therefore, investments are not a binary yes/no decision, but a question of price. And in particular in light of the recent weakness in price and the likely slowing in the clampdown, we believe it is a good time to re-up investments in Chinese tech companies.
[i] Ray Kwong: “Friends Don't Let Friends Become Chinese Billionaires” Forbes, July 15, 2011.
[i] “China to Close Loophole Used by Tech Firms for Foreign IPOs” Bloomberg News, December 1, 2021.
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Thomas Kirchner, CFA, has been responsible for the day-to-day management of the Camelot Event Driven Fund (EVDIX, EVDAX) since its 2003 inception. Prior to joining Camelot he was the founder of Pennsylvania Avenue Advisers LLC and the portfolio manager of the Pennsylvania Avenue Event-Driven Fund. He is the author of 'Merger Arbitrage; How To Profit From Global Event Driven Arbitrage.' (Wiley Finance, 2nd ed 2016) and has earned the right to use the CFA designation.
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