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  • KPB & Co Research

There is no question that Chinese tech companies have been hugely successful operating in China over the last 15 years. Alibaba, Tencent, Weibo and many others have built businesses that cumulatively have over US$300Bn in market capitalization. Additionally, Chinese businesses on a whole have been working pretty hard to ditch the reputation of always building "knock-offs", and instead are seeking to be recognized on an equal footing with Big tech in the western world.

Little Competition

Many Chinese tech companies are operating in the same industries as US tech companies, some even have similar divisions, but they don't compete directly. Most of these technology companies have largely stayed in China, where they are protected (whether directly or indirectly) by Chinese regulations. The Chinese authorities have implemented tough regulatory hurdles such as the following:

Full to Partial Block of Services: People domiciled in China cannot access the web pages and apps of US tech companies such as Google, Facebook, and Twitter. For some tech companies that have access to Chinese domiciled customers, they can only offer a slimed-down version of their services.

Restrictions on Cybersecurity: Foreign tech companies often have to share sensitive intellectual property information to the government. Due to the a high degree of corruption in the system, and the weakness of government institutions these sensitive information often fall into the hands of potential competitors, and special interests operating in adjacent industries. In many cases, the sharing of certain information can have harmful impact on other divisions with these foreign companies, divisions that are outside of China, which tips scales in favour of a "no-go-strategy" for china.

Restriction on Cloud Data Services: Chinese authorities have restricted or are considering further restrictions on the cross border flow of information between servers domiciled in China and in other countries. In some instances Chinese authorities require heightened surveillance, and others there is an outright blockade. For instance some firms maybe required to store data locally, which gives the government to power to cease information with little or no warning. The government also exercise control over the ownership structure of the these companies requiring that foreign companies enter into joint ventures with equity caped at 50%.

Investors Outside of China Can Invest in these Companies, but through Special Purpose Vehicles

The top Chinese tech companies are listed on US stock markets, and so are available as investments to anyone with access to us markets, which is almost everybody. Alibaba is on the NYSE, Weibo on the NASDAQ, Baidu on the NASDAQ, and some such as Tencent can be access on over-the-counter markets. The typical corporate set-up of these companies is through an LLC registered in the Cayman islands, to benefit from lower taxes and to escape unnecessary Chinese regulatory scrutiny. So while US investors have to go through hassle to set up shop in China, they face almost no hassle when they want to invest in them after they have been successful.

As we look to these companies as potential investment opportunities, we ask ourselves the question: can these tech companies handle US competition? And how long will the Chinese market remain closed? What we do know is that, the US market has been opened for decades, but none of the Chinese internet giants with billions of capital at their disposal have shown any sign of entry, not even a "crack in the glass".

The dynamics of global trade is at an inflection point today. The Chinese economy is transitioning to more domestically led growth and president Trump is looking for more open and free trade. China became a manufacturing powerhouse, as their cheap source of labour gave them a competitive advantage. This allowed US and European companies to re-locate their production to China and operate at lower cost. As a result result Chinese exports to global markets boomed. As the Chinese middle class became wealthier the cost of labour rose and so today, the Chinese market is lucrative to those who are willing to take the risk. Though it may take while unfold, a trade deal with China that leads to a significant reduction in regulatory hurdles could see a levelling of the playing field as it related the technology sector. In this context the primarily domestically base tech companies will have to compete with global tech companies who have been in trenches for years. How will the manage?

In concluding, if Donald Trump is successful in forcing China to open up their borders to US tech companies, Chinese tech companies would have to grow up quickly, which is not impossible given how far they have come. Furthermore, being domestic comes with certain natural advantages outside of the price relative to consumer value relationship. For instance a customer may purchase a more expensive item just because it was made in China. Nevertheless, there is a degree to which those natural advantages stop and these Chinese tech companies would then have to face the brutal realities of competition.

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