Investors bullish on China even as Beijing’s tech clampdown weighs on IPO exits

FILE PHOTO: A woman rides a Didi shared bicycle past the headquarters of Didi Chuxing in Beijing, China November 20, 2020. REUTERS/Florence Lo/File Photo

Investors continue to be bullish on the potential of China’s venture capital market in generating “outsized returns” even as Beijing’s regulatory clampdown is expected to bring more turmoil to late-stage companies and their institutional investors.

“If you continue to seek growth-level returns, China remains a very attractive market in Asia compared to the rest of Asian economies, especially for tech and new economy where it can generate outsized returns,” said a China-focused LP, who declined to be identified due to the sensitivity of the issue.

“There are increasing risks from a regulatory standpoint, but it depends on how the government will take it forward… The opportunities don’t seem to have died down,” said the LP.

From Ant Group’s halted $35-billion listing in November 2020, China’s series of regulatory crackdown measures has expanded to target behemoths like e-commerce giant Alibaba, food delivery firm Meituan, ride-hailing leader Didi Global, and more recently social and gaming major Tencent, after a state media article described online games as “spiritual opium” and led to the firm’s stock tumble.

“I think that the recent antitrust probes into tech giants in China are no different from what is going on anywhere else in the world,” said Chibo Tang, managing partner of VC firm Gobi Partners in Hong Kong.

“Tech giants with such large influence in single sectors or markets can potentially leverage their scale to squeeze out new entrants, which is counterproductive for governments seeking to promote innovation and healthy competition,” said Tang.

Following a staggering $2.8-billion fine on Alibaba for its anti-monopoly violations in April, authorities in China aggressively stepped up antitrust efforts across industries that had thrived during years of relatively laissez-faire market regulation.

Beijing’s moves rattled sectors including food delivery with antitrust investigations into companies like Meituan; video game streaming, where it blocked the $5.3-billion merger between Tencent-backed DouYu and Huya; as well as its $120-billion private tutoring market, with the launch of new regulations threatening an industry that private equity (PE) and venture capital (VC) investors had bet billions of US dollars on just last year.

“The entry barriers for most of the aforementioned sectors are quite low, which has led to such fierce competition over the years. For many of the sectors, competing on price and subsidies has been the answer to scale, but not sustainable growth,” said Tang.

“With an increased emphasis on antitrust at the end of these cycles, entrepreneurs and startups will hopefully be forced to drive towards sustainable growth much earlier in their development. This would of course be much healthier for the market as a whole,” he added.

Global investors unfazed

As domestic investors believe in the longer-term potential of the Chinese economy, investors outside of China also seem unfazed by regulatory uncertainties, with a general optimism on the country’s position as the second-largest venture market after the US.

“It [Regulation] is one of many risks in any country that we invest in,” said Mukul Chawla, Temasek’s joint head for telecom, media and technology. “It’s not just in China that we are mindful of regulation and changing regulation. I don’t believe it changes our stance on China in any way.”

Singapore’s sovereign wealth fund Temasek Holdings, an early backer of Ant Group and Didi, counted China as the largest domicile of its portfolio in the financial year ended in March with about 27% of the investor’s underlying assets.

In its annual report in mid-July, Temasek saw its investments in China rise by S$14 billion (almost $10.4 billion), while its net portfolio value reached a new high of S$381 billion ($281.8 billion) in the 2021 financial year. In February, Temasek-backed video-sharing platform Kuaishou Technology raised $6.2 billion in its Hong Kong listing as the world’s top-earning IPO in the first half of 2021.

“We continue to invest. We continue to consider regulation as it comes forth… and our stance on China remains unchanged in our optimism,” said Chawla.

Large or small, cross-regional investment houses share the same view, especially on the ground that the direct targets of Beijing’s regulatory crackdown do not fall into the scope of most early-stage investors.

“There will be no significant effects on Chinese PE-VC investments,” said Randolph Hsu, founding partner at Ondine Capital, a VC firm that invests in Greater China and Southeast Asia.

The space where there is China’s heightened scrutiny over tech giants, its move to terminate the DouYu-Huya merger, and a round of penalties targeting suspected monopolistic practices “is not the playfield for PE-VC at all, said Hsu.

“We understand the anti-monopoly investigations against tech giants will certainly bring market turbulence in the near term. But in the long run, it will benefit the general public and create new opportunities for China’s tech/Internet companies.”

IPOs on hold

However, the specters have certainly loomed large after the disastrous meltdown of Didi, whose $4.4-billion New York listing was followed by the release of a new cybersecurity draft in China, raising concerns over future Chinese listings on Wall Street.

The Cyberspace Administration of China (CAC) on July 10 issued a proposal, in which the authority indicated its consideration of implementing reviews of IPO plans by companies that hold personal information of over one million users in China.

The proposal, which triggered billions of US dollars market value slide for Didi and other Chinese companies, marks the government’s attempt to exert more control over its homegrown tech companies.

If introduced, the rules will enable Beijing to step up scrutiny over domestic businesses that are structured as the so-called “Variable Interest Entities (VIEs).” For years, the structure has allowed Chinese companies to pursue foreign financing or a listing on a stock exchange outside of China through an offshore shell firm – often in tax-friendly places like the Cayman Islands – since the first such case by Internet firm Sina Corp in 2000.

“From the perspective of regulating securities, the Chinese law is not applicable to overseas-listed Chinese firms, because the listed entities are essentially offshore shell companies… But the regulators’ concerns over cybersecurity and the protection of Chinese citizens’ personal information could effectively help justify its regulations on these stock issuers,” said Xia Hailong, a lawyer at Chinese law firm Shanghai Shenlun.

“Generally speaking, I think the two main areas that we will continue to see China’s increased regulatory crackdown are antitrust, as well as the overall Internet field, including finance and securities,” said Xia.

A handful of Chinese tech firms, such as medical data group LinkDoc Technology, e-commerce platform Meicai, and podcast platform Ximalaya, have either postponed or shelved their initial plans of a US listing following the Didi debacle.

“We have received a lot of calls from LPs just over the past weeks on… [questions like] how it is impacting the exit environment,” said the aforementioned China-based LP. “The truth is: It is impacting directly. Companies [Investment firms] cannot exit, so a lot of LPs don’t know when and how they can get their investment returns, at least for now.”

While the recent regulatory developments have little impact on general partners (GPs) investing in early-stage startups, growth-stage investors, who “tend to look at exits more critically,” might find it “concerning,” said the LP.

Beijing’s plans to restrict overseas market debuts also lead to rising concerns from policymakers in the US, where boards including Nasdaq and the New York Stock Exchange (NYSE) have booked a record $12.8 billion in fundraising by Chinese listings so far this year, according to Refinitiv data.

In response to the risks associated with the China-based VIE structure, the US Securities and Exchange Commission (SEC) Chair Gary Gensler said in a statement on July 30 that he had asked staff to “engage in targeted additional reviews of filings for companies with significant China-based operations.”

“I think any GP or large investor is going to be more cautious looking at any Chinese stock,” said Eric Rosenblum, managing partner at Foothill Ventures, a Los Altos, California-based tech VC that invests in seed and Series A rounds.

People were “comfortable with certain structures that have been allowed to persist” to pave way for Chinese listings in the US, said Rosenblum. “Even though on paper, it seems unsustainable. Everyone agreed to basically just turn a blind eye and say this is okay.”

“The rules will be re-examined and re-established. Until that happens, there should be a period of anxiety when no one is sure what the next shoe to drop is going to be,” he said.

Singapore Reporter/s

In Singapore, we are looking to double our reporting team by this year-end to comprehensively cover the fast-moving world of funded startups and VC, PE & M&A deals. We want reporters who can tell our readers what is really happening in these sectors and why it matters to markets, companies and consumers. The ability to write precisely and urgently is crucial for these roles. Ideal candidates must have to ability to work in a collaborative, dynamic, and fast-changing environment. We want our new hires to be digitally savvy and ready to experiment with new forms of storytelling. Most importantly, we are looking for hard-hitting reporters who work well in a team. Collaboration and collegiality are a must.

Following vacancies can be applied for (only in Singapore).

Following vacancies can be applied for (only in Singapore).   

  • A reporter to track companies/startups that have raised private capital, and have the potential to become unicorns. SEA currently has over 40 companies with a valuation of over $100 million and under $1 billion.
  • A reporter who can get behind the scenes and reveal how funding rounds are put together, or why they’ve failed to materialise. She/he in this role will largely focus on long-format stories. 
  • A journalist to track special situations funds, distressed debt and private credit (from the PE angle) across Asia.

Singapore Reporter/s

In Singapore, we are looking to double our reporting team by this year-end to comprehensively cover the fast-moving world of funded startups and VC, PE & M&A deals. We want reporters who can tell our readers what is really happening in these sectors and why it matters to markets, companies and consumers. The ability to write precisely and urgently is crucial for these roles. Ideal candidates must have to ability to work in a collaborative, dynamic, and fast-changing environment. We want our new hires to be digitally savvy and ready to experiment with new forms of storytelling. Most importantly, we are looking for hard-hitting reporters who work well in a team. Collaboration and collegiality are a must.

Following vacancies can be applied for (only in Singapore).

Following vacancies can be applied for (only in Singapore).   

  • A reporter to track companies/startups that have raised private capital, and have the potential to become unicorns. SEA currently has over 40 companies with a valuation of over $100 million and under $1 billion.
  • A reporter who can get behind the scenes and reveal how funding rounds are put together, or why they’ve failed to materialise. She/he in this role will largely focus on long-format stories. 
  • A journalist to track special situations funds, distressed debt and private credit (from the PE angle) across Asia.