China Tells Inefficient Firms To Toughen Up Or Prepare To Fail
China is turning the screws on the nation’s companies as authorities seek to take advantage of the global pandemic to strengthen its industrial might. China Tells Inefficient Firms To Toughen Up Or Prepare To Fail
After letting inefficient firms survive for years, Beijing is now allowing them to fail. Bond defaults rose to a record $30 billion in 2020, including high-profile enterprises that had previously counted on the implicit guarantees of the state. Scrutiny and punishment of credit-rating agencies are increasing, while domestic exchanges delisted at least 16 stocks from their main boards last year — the most in data going back to 1999.
The trend is set to pick up in 2021 as China’s central bank tightens financial conditions, making it harder for both state-owned or private firms with inadequate cash flow to survive. An economic recovery and a strong currency are giving policy makers more room to focus on reducing the amount of debt in the financial system, which is at a record 277% of domestic output.
“The good thing is China will keep financial risks under control, but the bad thing is it won’t bail out firms unless they are in an extreme situation,” said Larry Hu, head of China economics at Macquarie Group Ltd. “The government wants to make the most of a solid growth recovery to tighten monetary policy. We may see more companies facing challenges in seeking cash.”
Beijing has in recent months rolled out more measures aimed at increasing the efficiency of the country’s capital markets, as well as the quality of its companies. In December alone, China tripled the maximum prison sentence for securities fraud to 15 years, proposed shortening the delisting process for unprofitable stocks and vowed to improve oversight of the country’s credit-rating industry. China also imposed a cap on bank lending to property developers, a sector that’s laden with debt.
In November, the top securities regulator pledged to enhance scrutiny of China’s initial public offerings, while an October crackdown on the convertible bond market — a financing tool largely favored by small-cap risky issuers — involved publishing 37 directives in a single day.
As China gets tougher on industry, its loosening of control over financial markets will allow investors — rather than the state — to punish poorly-run companies and reward growth. Concern over China Inc.’s reliance on U.S. markets for fundraising may have partly driven that action, as well as the Communist Party’s economic strategy of “dual circulation” that prioritizes strengthening domestic demand.
While the People’s Bank of China is unlikely to hike interest rates in the coming months, it has repeatedly signaled it will moderate the supply of cheap credit. The timing makes sense — booming export growth has given the central bank room to cut back on stimulus measures deployed during the coronavirus pandemic.
But the consequences for the most vulnerable companies can be brutal: Beijing’s commitment to normalize policy was a factor behind a sudden wave of corporate defaults at the end of last year, which in turn froze lending in the interbank market. The World Bank has also warned that excessive policy tightening could be damaging for the global economic recovery.
Funding China’s future growth engines without destablizing its highly-leveraged financial system requires a carefully calibrated rebalancing of the world’s second-largest economy. For China and its companies, a shift of that magnitude can only be successful if those with weak finances and poor returns are allowed to go bust, according to Carlos Casanova, an economist for Union Bancaire Privee.
“Authorities will continue to walk a tight rope between stabilizing growth and reducing economic fragilities,” Casanova wrote in a December note. “For China’s debt restructuring gambit to pan out as expected, the pace of financial reforms must accelerate rapidly.”
China Orders Tech Giants To Unbundle Financial Services
Companies have turned their mobile payment apps into financial supermarkets, offering loans and insurance policies. No more, says Beijing.
In recent years, China’s technology giants have turned consumers’ embrace of mobile payment apps into lucrative ecosystems offering a range of financial services, from personal loans to insurance policies.
Now, Beijing wants to put a stop to that.
On Thursday, China’s central bank and four other regulatory agencies told some of the country’s biggest financial technology firms—including WeChat operator Tencent Holdings Ltd., ride-hailing company Didi Chuxing Technology Co. and e-commerce firm JD.com Inc. —that their apps should no longer provide financial services beyond payments, according to people familiar with the discussions.
During the nearly three-hour-long meeting at the People’s Bank of China’s Financial Market Department, regulators told company representatives that the bundling of several financial services within a single platform obscured how much money was flowing into the various products, creating risks for the broader financial system, these people said.
Regulators’ push to delink the technology companies’ broader suites of financial products and services from their core payments platforms, if carried out, would deal a blow to a lucrative business model pioneered most successfully by Ant Group Co., the financial-services giant controlled by billionaire entrepreneur Jack Ma.
“In the past, payment was the end of all transactions, but now payment has become the beginning of all transactions,” Ant’s then-chief executive Simon Hu told Chinese media last year.
Since then, regulators—citing the systemic financial risks posed by Ant—have halted a planned initial public offering by the company and pressed it to reorganize itself as a financial institution, subject to oversight by China’s central bank.
Following the Thursday meeting with the People’s Bank of China, many of the country’s other major tech firms with financial-sector aspirations may be required to do the same.
During the meeting, the central bank, together with the country’s banking, insurance, securities and foreign-exchange regulators, ordered the 13 technology firms in attendance to bring their online lending and deposit-taking businesses in line with regulatory requirements, according to a statement published by the central bank.
It remains unclear, however, if they will also be required to delink nonfinancial services from their app-based ecosystems. Many of the platforms provide other services, such as ride-hailing or food delivery.
Ant Group and Tencent declined to comment. China’s central bank, JD.com Inc. and Didi Chuxing Technology Co. didn’t respond to requests for comment.
Ant’s Alipay mobile app, which started out as a basic payments platform, has branched out to provide other services to its more than one billion users. One of its most popular features has been its microloans service, accounting for nearly 40% of total sales in the first half of 2020, according to the company.
Ant is revamping Alipay to delink these financial services from its core payments service, two of the people said.
Ant is discussing with regulators the possibility of transferring some of its app-based financial services to another of its apps, called Ant Fortune, which has lain dormant for years—barely updated since the company decided to merge most of its functions into Alipay, the two people said.
Though it raised concerns among financial regulators, Ant’s microlending service supplies millions of individuals and small businesses with short-term loans that were otherwise hard to obtain through China’s traditional banking channels.
Under the arrangement, banks underwrote the debt, assumed the credit risks and collected the interest payments, while Ant pocketed a fee for facilitating the transactions.
As Ant’s pioneering efforts gained traction, they inspired mobile internet companies across Asia to adopt elements of Ant’s approach to financial services—attracting users with messaging or e-commerce services and then offering them a marketplace of wealth management and lending services.
South Korea’s Kakao Corp. , operator of that country’s ubiquitous KakaoTalk messenger app, introduced a service last year under its Kakao Pay mobile payment service that allows users to transfer their cash into a money-market fund. In 2017, Ant invested $200 million in Kakao Pay.
Whether for Ant or the other tech giants, the unbundling of the various financial services will almost certainly deal a blow to the companies’ future profitability and valuation.
“We expect the delinking of Ant’s payment and microloan business to weaken its competitive advantage of cross-selling through its Alipay platform,” Fitch Ratings said in a report last week. Together with other regulatory challenges, it added, the delinking “may moderate Ant’s revenue and profit growth in the near term.”
China’s Emerging Tech Firms Grapple With Losses
Meituan, Pinduoduo, Kuaishou spend heavily to spur new market segments.
The red ink is piling up at China’s emerging technology champions, as these companies spend heavily in a bid to spur new market segments.
Sales are soaring at companies such as food-delivery company Meituan, e-commerce group Pinduoduo Inc. and short-video specialist Kuaishou Technology, after the pandemic helped turbocharge demand for online services. At the same time, these companies are sustaining substantial losses as they prioritize long-term opportunities over immediate profitability—and their shares are sliding.
“We’ll stay patient for long-term results. We will not simply adjust our long-term-oriented strategy or investment pace based on short-term volatility,” Meituan Chief Executive Wang Xing said on the company’s earnings call May 28.
Revenue at the Hong Kong-listed company more than doubled in the first three months of this year compared with the same period in 2020, but losses rose even faster, to 4.8 billion yuan, equivalent to $750.7 million, or a loss of more than 13 cents for every dollar the company took in.
Many American tech companies, from Amazon.com Inc. to newer businesses like DoorDash Inc., have used a similar playbook of spending heavily to grow new businesses. Chinese tech companies—including both publicly traded ones and unlisted startups such as ride-hailing giant Didi Chuxing Technology Co.—often try to outspend rivals, subsidizing their offerings in pursuit of market dominance.
Still, investors are signaling some impatience. The stock prices for Meituan and Pinduoduo are down more than 30% from their highs earlier in the year, while Kuaishou has fallen 50%, all worse than their more established rivals such as Tencent Holdings Ltd. and Alibaba Group Holding Ltd. Tech stocks have been under pressure in China for several reasons in recent weeks, including a shift in investor focus to old-economy businesses, rising interest rates and the government’s clampdown on the sector.
Representatives from Meituan, Pinduoduo and Kuaishou said they have no further comments beyond executives’ remarks at their respective earnings calls, but analysts expect the companies to remain firmly focused on growth. “They will keep expanding, using the operating data to show aggressive growth, and then investors will continue to finance them,” said Ming Lu, head of Chinese equities at Aequitas Research in Shanghai.