Letter # 49

July 2 was a typical Friday evening for most companies, save one. The Cyberspace Administration of China (CAC) warned Didi Chuxing (Didi; China’s answer to ride-hailing app Uber and Lyft) that in one hour it would publicly be ordered to stop signing new users ⁽¹⁾. Didi was subsequently also asked to remove its app from app stores in China as it had violated laws on collection and use of personal data. By Tuesday, CAC announced that it would tighten regulations over companies listing abroad, especially, over cross-border transfers of sensitive information. Prior to this, CAC had never invoked the ‘cyber security review process’ introduced just over a year ago.

FT states that according to procedure, companies should volunteer for a review of their procurement and supply chain if their operations are of critical importance to national infrastructure. If Didi ‘voluntarily’ submitted for clearance, it would come as a surprise that it chose not to wait for the clearance before proceeding with the USD4.4bn IPO, which got listed just a couple of days before the crackdown. Didi’s ADR is since down more than 27% from highs and now trades below its IPO price i.e., over USD20bn in lost shareholder value in less than one week.

Chances are that you have already read all about it. While CAC’s action could have surprised a few, it would not have surprised Nian Guang Jiu. Richard McGregor writes about Nian and the way China operates in his book, The Party: The secret world of China’s communist rulers.

Nian was first jailed in 1963 for engaging in illegal speculation, i.e., running a private food stall in his hometown Wuhu in Anhui. During the Cultural Revolution, a few years later, his capitalist rap sheet alone was enough to put him behind bars again.

When freed in the late 1970s, Nian opened a shop selling roasted sunflower seeds. He did not have a good education while growing up and was nicknamed the ‘fool’. He chose to name his product  Idiot Seeds. Within a few years, Nian had a thriving business with more than 100 employees.

This success got the Anhui party chiefs petrified, who thought that they might be committing political error by allowing Idiot Seeds to flourish. They sent a report to Beijing asking whether they should shut the shop down, which eventually landed on Deng Xiaoping’s ⁽²⁾ desk in 1984. Soon after, Deng replied that, “in keeping with wild economic experimentation he was encouraging at the time, closing a business might make people think the open-door policy had changed.” Nian’s Anhui Fool Group (no typo) survived. But, by 2008 when Richard met him, he had morphed from a subversive capitalist into a state-sponsored business celebrity, parroting official propaganda.

Richard writes that after coming to power in 1949, the Party closed private businesses and confiscated their assets. The suspicion harboured towards entrepreneurs lingered long after Deng’s market reforms in the late 1970s. When Jiang Zemin ⁽²⁾ allowed entrepreneurs to join the Party in 2001, it created a rare public split among the Party’s leadership.

The Party’s distrust of private sector was never about money, nor the flagrant contradiction between individual wealth and Marxist pantheons. Everyone agreed on the need to turn profits. The real issue for the Party was the threat that foreign and local private sector might become its political rival. The unprecedented partnership between a Communist party and capitalist business holds; it remains an uneasy, unstable and unholy alliance, but an alliance, nonetheless, writes Richard. The book published more than a decade ago makes a lot of sense in the current context.

And, there are more stories. China National Petroleum Corp (PetroChina) is best described as the ExxonMobil of China. Paul Schapiro of Goldman Sachs wrote this around the time when PetroChina was gearing up for listing: “The best way to describe PetroChina was that it was the Ministry of Petroleum.” But, as it was getting repackaged to be sold off to foreign shareholders, PetroChina shed close to 1mn jobs and the Ministry of Petroleum disappeared altogether, leaving the company with little direct oversight from the government. When capitalism is the need of the hour, communism can clearly wait! That and oh yes, there was a subtle difference–PetroChina was getting listed in the mainland and in Hong Kong, not in the US.

As Richard Baum, another China scholar, puts it, “state sovereignty, territorial integrity and economic development are all priorities of the state; but all are subordinate to the need to keep the Party in power.” If the Party fears that foreign or local private sector might become a political threat, they will be reined in. And, if the Party fears that Chinese entities wanting to list in the US would have to share audit files with US regulators, then the whole process of US listing could be stifled.

You can very well be a capitalist operating in my country, BUT it must be on my terms is the thinly-veiled message. Or as Richard so succinctly puts it, “the Party is like God. He is everywhere. You just cannot see him.”

In comparison, another IPO will likely list this month, but in India. What started as Foodiebay in 2008, later rebranded as Zomato, would likely list for over USD10bn! A truly home-grown company with orders per month approaching 55mn and transacting users likely to cross over 14mn, started just as restaurant listing business, and entered food delivery as late as in 2016. But now, of its USD394m consolidated revenue, 82% comes from food delivery, 14% from dining out and the balance is contributed by classifieds and loyalty programme.

The second largest shareholder in Zomato, at 16.5% pre-money, is Ant Financial. Ant Financial (or Ant Group as it is now known) is an affiliate company of China’s Alibaba Group. India, just a year ago, had an acrimonious altercation with China at its north-eastern border, which resulted in public outcry calling for banning China manufactured products in India.

Whereas India has done nothing to stifle the IPO of a company that has a large holding from a Chinese company, readers would recall that it is the same Ant Financial whose IPO (in China and Hong Kong exchanges) was suspended in November last year citing ‘possible failure to meet disclosure requirements.’ Reasons could have been different then, but the message was the same: You can be a capitalist operating in my country, but IT MUST BE ON MY TERMS!

This behaviour has several implications for India, both business wise and for equity markets. Superior operating efficiencies have enabled China to become the manufacturing hub of the world; it’s difficult to entirely replace it. But, increasingly, businesses have started to realise how China operates and are looking to diversify; hence, the ‘China plus one’ strategy. Industries (like chemicals and textiles) in India are already benefitting from this. India benefits by having a superior and predictable regulatory environment. Increasingly, the Government of India is realising the benefits of lending a helping hand to several industries (hence the PLI schemes).

What has started with ‘China plus one’ for business procurement, will likely soon extend to the financial realm as well. Though the size of Indian businesses is much smaller compared to Chinese businesses, domestic demand in India is still high. Financial investment from foreign players (via FDI, FPI, etc.) should dramatically increase in India over time.

Notes:
(1) Didi caught as China and US battle over data | Financial Times (ft.com)
(2) CPC leadership history: 1949 to 1976 – Mao Zedong, 1976 to 1990 – Dang Xiaoping, 1990 to 2002 – Jiang Zemin, 2002 to 2012 – Hu Jintao, 2013 to now – Xi Jinping

Disclaimers:
Information in this letter is not intended to be, nor should it be construed as investment, tax or legal advice, or an offer to sell, or a solicitation of any offer to make investments with Buoyant Capital. Prospective investors should rely solely on Disclosure Document filed with SEBI. Any description involving investment examples, statistical analysis or investment strategies are provided for illustration purposes only – and will not apply in all situations and may be changed at the discretion of principal officer. Certain information has been provided and/or based on third-party sources and although believed to be reliable, has not been independently verified; the investment managers make no express warranty as to its completeness or accuracy, nor can it accept responsibility for errors appearing herein.