As China’s tech sector gets back on its feet, look beyond internet companies

Beijing’s tone on the tech sector has shifted, focusing on healthy development, and greater regulatory clarity is allowing companies to adjust their business models
However, beyond the usual internet-based companies, those in the semiconductor and electric vehicle sectors are attracting investor interest

Tai Hui

Published: 11:30am, 12 Aug 2022

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Last year was a year of regulatory overhaul for the Chinese internet sector, which triggered a prolonged period of tech stock corrections in Hong Kong and New York. If 2021 was a year of establishing the new regulatory framework, 2022 is a year of implementation.

Tech giants are still being penalised for past breaches, but at least the regulatory uncertainties have been reduced and this could help improve investor confidence in the medium term.

The 2021 regulatory reform came under several broad themes. These included tackling monopolistic behaviour and squeezing out competition; adequate pay and social security coverage for delivery riders; limiting minors’ time spent on video games; and, customer data protection.

Some of these themes can be linked back to the drive for common prosperity. For example, anti-monopoly rules seek to protect small and medium-sized companies, and prevent large businesses from abusing their market position.

These policies are not unique to China. Many economies are looking to, or have already applied, similar policies to reduce income inequality. However, the rapid pace of the roll-out of the regulations in China was often unexpected. In other countries, investors could track the legislative process or legal proceedings to see if new rules would be introduced, and the details of the rules.

Such a process can take months, sometimes years. The rapid implementation in China surprised both domestic and international investors and raised questions about the future prospects of these companies in generating profit. There are also concerns that tighter regulation could discourage innovation and creativity.

China’s e-commerce crackdown puts tech giants in line with national policy

Since the second quarter of this year, Beijing’s tone has shifted and it is now focused on promoting the sector’s healthy development. This was seen as supporting the need for the continuing development of the internet and platform economy, once the problems mentioned above have been addressed.

After all, it’s hard to see Chinese consumers retreating from online shopping and digital payments. This industry can also help boost the economy, which is seeing a slow recovery from lockdowns in the second quarter, as well as a lack of confidence in the housing market amid the recent mortgage crisis.

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Tech companies are also making adjustments. Recent earnings results show that their revenue has been hit hard by the new regulatory requirements as well as China’s economic slowdown.

As regulators’ requirements become clearer, companies are in a better position to alter their business model. Hence, the impact on revenue should fade over time. Moreover, these companies are no longer expanding at all costs. They have been looking for ways to reduce costs to protect profits, implying that their earnings should return to a more positive growth path in 2023.

Hence, for these companies, the near-term challenge is shifting from complying with regulations to coping with cautious consumer sentiment and a slow economic recovery.

Yet, in addition to these internet companies, there are other areas of tech that are enjoying policy tailwinds, as geopolitical tensions have prompted Beijing to focus more on reducing China’s dependence on imported semiconductors and software.

There is also an emphasis on nurturing the electric vehicle industry. China is already the largest electric vehicle (EV) market in the world. In 2021, it had 7.8 million battery EVs or plug-in hybrid vehicles in use, more than the US and Europe combined.

It also has more than 1.1 million EV charging points around the country, more than triple the number in Europe. Not only are EVs an important part of China’s decarbonisation plan, they are also the route to break into the global automobile market, which has been dominated by the US, Europe and Japan in the past century.

China’s e-commerce crackdown puts tech giants in line with national policy

Investors are not only looking at EV companies to take advantage of this development. Components used in EVs are significantly different from those in vehicles with traditional internal combustion engines. Hence, the companies that produce these components, especially batteries, are also attracting attention.

Chinese internet companies still have some adjustments to make before they return to brighter days, but the worst is probably over for investors. And there are new technologies emerging that could take over, generating rapid revenue and profit growth, based on China’s structural trends and industrial policies. This should allow for a more interesting investment landscape in the years ahead.

Tai Hui is chief market strategist for the Asia-Pacific at JP Morgan Asset Management