By iFAST Research Team
ON July 25, China’s anti-trust watchdog State Administration for Market Regulation (SAMR) ordered Tencent Holdings Ltd to relinquish its exclusive music licensing rights and fined the company 500,000 yuan or US$77,141 (RM325,826) for violations during its acquisition of China Music in 2016.
Consequently, this triggered a huge sell-off in China Tech stocks. On July 27, Tencent fell -7.7%, while Alibaba Group Holding Ltd and Meituan fell -6.4% and -13.8% respectively, causing the Hang Seng Tech Index to drop by -6.6%.
The sell-off continued on the next day (July 28), as Tencent, Alibaba and Meituan fell another -9%, -6.4% and -17.7% respectively, dragging down the Hang Seng Tech Index by -8%.
Over the past 3 trading days, Tencent, Alibaba and Meituan suffered cumulative losses of -18%, -13.3% and -30.7% respectively.
Hang Seng Tech Index is now -42.9% from its February peak, and trading at the lowest level since July 2020.
Meanwhile, tech stocks dragged the broader Hang Seng index lower and wiped out its year-to-date gains.
Attractive valuations, strong forward sales and earnings growth
Despite the barrage of bad news, we continue to hold a positive view on China’s tech sector and we view the recent sell-off as an opportunity for investors to accumulate more shares.
Firstly, we think that investors should not be overly worried about the increased regulation on China’s tech sector.
The government has made it clear that the main purpose of the increased regulation is to safeguard consumers, and to promote healthy competition and the sustainable growth of China’s technology sector in the long run. They are not meant to stifle the growth of tech companies, like what the US is trying to achieve.
It has also acknowledged that tech companies have played a crucial role in stabilising the economy during the pandemic, as their digital services have allowed businesses and individuals to carry out their daily activities with as little disruption as possible.
Through this, it is evident that the government recognises the value these tech companies have as the country undergoes a massive digital transformation.
Most importantly, investors should know that the majority of the successful Chinese tech companies are where they are today mainly because of network effects (eg WeChat’s ecosystem) and superior product offerings, rather than significant anti-competitive behaviour, which is what the government is trying to deter.
Secondly, the loose regulatory environment in the past has allowed these companies to grow into the behemoths that they are today.
However, as many of them are now systemically important to China’s economy due to their involvement in financial services (eg Alipay, WeChat Pay), some form of regulation is necessary to ensure that they do not take on excessive risk.
As a matter of fact, China is not the only country that is trying to regulate big tech companies. Over the past few years, there has been increasing calls for greater regulation over big tech companies from policymakers in the US and Europe given the significant role these companies play in the economy and in our lives. From this perspective, we think that China has perfectly legitimate reasons to do so as well.
Lastly, we think that the anti-monopoly laws could be a way for China’s government to preserve the country’s innovative spirit by protecting young companies, giving them a chance to develop.
This is very similar to what the government did in the past for today’s big tech companies, during which it shielded them from the threat of foreign competition, contributing to their rapid expansion.
In terms of fundamentals, China Tech still paints an attractive long term growth story, with sales and earnings per share (EPS) expected to see double digit growth in the next few years.
In terms of valuations, after the -42.9% retracement, Hang Seng Tech Index is now trading at around price-to-earnings ratio (PER) 2023 18.7X, representing an upside potential of more than +80% based on our fair PE (price-to-earnings ratio) multiple of 35X (refer t0 Table 1).
Investors to take the opportunity but be mindful
The purpose of increased regulation is meant to safeguard consumers and promote healthy competition within China’s tech sector, not to stop its growth.
We are confident that the recent sell off is largely sentiment driven, and factors, such as the increased regulation, pose limited risk to the long-term growth story of China’s technology sector.
The China Tech sector would be a great addition to any investor’s tactical portfolio as it gives investors exposure to companies with potentially exponential growth
Now that the Hang Seng Tech Index has retraced -42.9% from the peak, existing investors who are proponents of China Tech can take the opportunity to average down.
Volatility is part and parcel of investing, more so if the investment is in high growth tech stocks.
Once again, however, investors should be mindful of the higher volatility and drawdowns that the fund may entail, and should keep the allocation to within 20% of portfolio in order to manage the overall portfolio volatility. – July 29, 2021
iFAST Capital Sdn Bhd provides a comprehensive range of services such as assisting in dealing, investment administration, research support, IT services and backroom functions to financial planners.
The views expressed are solely of the author and do not necessarily reflect those of Focus Malaysia.
Photo credit: Counterpoint
