• As part of the Clean Network Initiative, President Trump issued two executive orders on 6 August 2020, prohibiting all US transactions with Bytedance and Tencent.
• At this juncture, we think that the likelihood of a blanket ban on both companies is small as that would entail severe repercussions for both countries, as well as the global economy.
• However, should the bans be enforced, the impact on China’s tech sector should be minimal as most companies are domestically driven.
• Overall, we continue to hold a positive view on China’s tech sector and the Invesco China Technology ETF (NYSE:CQQQ) over the long-term.
On 5 August 2020, the US Department of State announced that it has outlined plans to expand its Clean Network Initiative. The initiative was first launched on 29 April with the goal of “safeguarding the nation’s assets, including citizens’ privacy and companies’ most sensitive information from aggressive intrusions by malign actors, such as the Chinese Communist Party.”
The next day, President Trump issued a pair of executive orders, banning all US transactions with Bytedance, the company which created the viral short video app TikTok, and Tencent, the owner of the WeChat app. The bans will take effect 45 days after the date of the order.
The orders were issued on the grounds that both apps, which are developed and owned by companies in China, poses significant national security risks to the US. It is alleged that both apps automatically collect vast swaths of information from its users, which can potentially be used by the Chinese Communist Party (CCP) to track the locations of federal employees, blackmail, and conduct corporate espionage. Both companies and the CCP have denied all allegations.
The announcement of the ban added more pressure to the already strained relationship between US and China, sending share prices of most Chinese tech companies tumbling, as investors fear that similar restrictions will soon be imposed on other Chinese tech companies. Tencent (HKEX:700) suffered one of the largest declines, with share prices falling by as much as -10% the day after the order was issued (Figure 1).
Figure 1: Share prices of Chinese tech stocks dived after the ban was announced
Blanket ban on both companies unlikely to materialise
The ban on Bytedance and Tencent today draws many similarities to the Huawei ban back in May 2019, during which the US Commerce Department placed Huawei on the Entity List, restricting US companies from conducting business with it.
Much like before, the scope of the ban today remains extremely vague. At this juncture, it is unclear as to exactly what transactions are covered. Although the wording seems to suggest that the ban will apply to all transactions with both companies including their subsidiaries, we think that this is excessive and thus extremely unlikely to materialise for the following reasons.
First of all, both companies have sizeable investments in many other businesses. Tencent, for instance, is estimated to have stakes in over a few hundred companies, many of them American. Notable names include Riot Games, best known for the multiplayer online battle arena game League of Legends, and Activision Blizzard, one of the largest video game publishers in the US. Cutting off all transactions would have serious consequences for global markets.
Secondly, WeChat is an invaluable medium of communication between China and the rest of the world. US companies, such as Apple and Walmart use the app as a marketing tool to reach Chinese consumers. Walmart even has its own mini-program, which allows customers in China to place orders and make payments all within the app itself. Losing the ability to use WeChat will certainly undermine the ability of US companies from accessing the largest consumer market in the world.
Ultimately, we do not think that there will be a blanket ban on both companies, as the move will indubitably result in severe repercussions for both countries. A more likely scenario could come in the form of softer restrictions, like one which prevents government employees from downloading the app, or one that only applies to sensitive transactions taking place in the US.
Overall impact on China’s tech sector is likely to be limited
However, assuming a worst-case scenario, under which tensions escalate to a point where the US makes the unlikely decision to impose a blanket ban on all Chinese tech companies, we still believe that the impact on China’s tech sector is likely to be limited.
Even though Chinese tech companies have grown to become some of the largest in the world, many of them are still domestically driven. Tencent, for example, generates just 4.4% of its FY2019 revenue from international markets, a fraction of its total revenues. The same is true for Alibaba, as international commerce only accounts for 6.6% of its total revenue in FY2020. This goes to show that the sheer size of China’s population is large enough to support its tech companies, even without relying on foreign markets.
Chinese tech companies today are at the forefront of innovation, developing products and services that cater to the needs of an increasingly digitalised world. Considering their structural importance to the global economy and the competitive advantages possessed by them, we do not see a significant risk to their operations stemming from the rising tensions between US and China at this point in time.
As investors begin to price in an economic recovery and the possibility of a vaccine by the end of the year, valuations of Chinese tech companies have risen steadily over the past couple of months, lowering their upside in the near term.
Nevertheless, we still continue to hold a positive view on China’s tech sector and also our recommended ETF – the Invesco China Technology ETF (NYSE:CQQQ) over the long-term. We are confident that Chinese tech companies, as innovative as they are important, should be able to achieve higher earnings growth and deliver handsome returns for their shareholders.
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