Three weeks ago, I dove into an ongoing war of words between the United States and China. In my article, I explained that U.S. technology companies could face new pressures in China.
I wanted to follow up on that story.
The reason: Shares of one of the hottest recent initial public offerings just plunged 25% after China engaged in another round of crackdowns on domestic technology companies.
On Friday, Chinese regulators banned new registrations for the DiDi ride-sharing service. DiDi, China’s largest ride-sharing service, listed publicly on the New York Stock Exchange last week. American investors poured $4.4 billion into the stock. It was the largest IPO by a Chinese company since Alibaba listed in 2014.
Shares jumped from the IPO price of $14 on June 30 to more than $18 in a matter of days.
But on Tuesday, shares plunged.
The company said that the government’s action could “have an adverse impact on its revenue in China.” Given that DiDi generated 88% of its fourth-quarter revenue from Chinese customers, this could be a significant blow in the short term.
I want to talk more about this event, what it means for Chinese companies listed on U.S. markets, and share an important reminder about IPOs in any market.
Cracking Down on DiDi
The news is a blow to a company that has more than 377 million clients in China.
The Chinese government says that its goal is to “prevent the expansion of risk” as it conducts a “cybersecurity review” of its operations.
The fact that China decided to suspend the company’s registrations is interesting. It hasn’t been implied that China did so because it listed publicly in the United States (and will thus need to file documents with U.S. regulators). It’s certainly important.
In March, the U.S. Securities and Exchange Commission (SEC) set new rules for dual-listed companies like Alibaba, Baidu, and DiDi.
The SEC could kick those companies off American stock exchanges if they fail to comply with American auditing standards for three years in a row. The rules also require that companies not be owned by a foreign government and not have Chinese Communist Party members on their board of directors.
The bill that set the framework for the regulations – the Holding Foreign Companies Accountable Act – was signed into law by then-President Donald Trump in December. The rollout for the bill started in March.
The law angered Chinese officials.
“It is clearly discriminatory against Chinese companies, it is wanton political suppression of Chinese companies listed in the U.S.,” a spokeswoman at China’s Foreign Ministry said in March.
But its enactment has complemented a significant crackdown on technology companies.
Chinese regulators canceled the highly anticipated IPO of Ant Group, a massive financial technology company linked to Alibaba, in November 2020. They also fined Alibaba $2.8 billion and claimed that the company acted as a monopoly.
Market Power and Pride
In addition to the DiDi crackdown, the Chinese government said that it would increase the regulation of companies that list their shares on overseas stock exchanges.
Chinese regulators said they plan to punish illegal securities activities. That includes embezzlement, false financial audits, market manipulation and fraud. This has been a significant problem in overseas markets.
A prime example of this fraud is the collapse of the Chinese coffee chain Luckin Coffee. As China’s tech boom hit full stride in 2017, American investors were buying up Chinese-listed stocks in a frenzy. We saw huge gains in stocks like Alibaba, Baidu, Tencent and more.
But Luckin Coffee had a special place in investors’ hearts. The coffee company was compared to Starbucks. In fact, it was opening up stores faster than Starbucks and growing revenue at a frantic pace. It became a public company in mid-2019 and was listed on the Nasdaq.
It turned out to be a house of cards. The company engaged in widespread fraud. It invented fictitious customers and fake receipts for the purchases of raw materials. The stock fell more than 90% after it was delisted by the Nasdaq.
A Warning
Rising geopolitical tensions between Beijing and Washington, D.C., have muted expectations in the near term. A week ago, the nation’s ruling Communist Party celebrated its 100thanniversary. During the event, Chinese President Xi Jinping took a series of broad swipes at the United States.
Xi made various statements suggesting that Western nations are working to reduce their reliance on Chinese tech companies and blocking technological integration between China and the rest of the world.
“We must jointly oppose anyone engaging in technological blockades, technological division, and decoupling of development,” Xi said. As the world’s largest buyer of semiconductor chips, China is deeply concerned that it might not be able to procure the technology it needs to grow at its current pace.
But China has a state-run economy, so government influence is significant.
The ongoing crackdown of Chinese tech firms isn’t just about U.S. audits, centralizing access to raw materials, or cybersecurity.
There are analysts who suggest that Chinese leadership is worried about monopolistic behavior as tech firms expand their influence in culture and the economy. Some look at the immense power generated by Amazon, Apple, Facebook, and others in the U.S. and the inability of the U.S. Congress to regulate their market power.
Right now, this ongoing saga has hit Chinese-listed stocks. Baidu was off 4.5% as of this writing on Tuesday. Alibaba shed 3.4%. JD.Com dropped 4.9%. And bargain investors should remain very cautious about any of these big companies.
All three stocks are trading in the Red Zone on TradeSmith Finance. As far as DiDi goes, we still lack enough information on the company to make an informed decision.
Now is a good time to remind investors that an IPO is a selling opportunity for many venture capital and private investors. It’s important to take a step back and allow the market to make a decision on the health of these companies.
Investors would be smart to give this situation time to stabilize and wait for momentum to return to Chinese stocks.
I’ll be back tomorrow to discuss two other big risks to the market that require your attention.
