Week 27: Chinese IPOs, Global Ownership, and The AI Race

Briefing: With all of the recent news on Didi, the Chinese version of Uber, it’s a good time to revisit the challenges and opportunities related to investing in Chinese companies. Similar to the US, China is a highly sophisticated global technology leader and many investors have successfully participated in the rise of Alibaba, Tencent, JD, and so on. Investors have had to ignore the quirks of the Chinese investment legal structure, which we’ll cover in more detail. As we enter the age of AI, China is a major contender as a global AI superpower

China IPOs 
Last week Chinese ride-hailing company, Didi, raised $4.4 billion via their IPO in the US on the Nasdaq stock exchange. Didi’s scale is massive. According to their S-1, Didi processes 41 million transactions per day and has nearly 500m annual active riders. The Chinese government had previously asked Didi to delay their listing, which obviously did not happen. Citing security concerns, the Chinese Government forced app stores to delist Didi until further notice which has caused the stock price to drop significantly.

Chinese firms have raised roughly $76 billion in the U.S. over the past decade through their IPO process. Last year’s Luckin Coffee IPO turned out to have significant issues with fraudulent accounting which resulted in a roughly -80% drop in the stock price. Also last year, the highly anticipated Ant Financial IPO was blocked by the Chinese government due to speeches made by Jack Ma. Jack had indicated several times leading up to the IPO that Ant Financial was going to significantly disrupt the Chinese banking system, which did not go over well. Investors who want to purchase exposure to companies in China must accept the risk that those companies operate at the discretion of the Chinese government.

Chinese Regulation and Global Ownership
Note that I mentioned above that US investors own “exposure” to Chinese companies, and not shares in the company themselves. By law, foreigners are not allowed to own Chinese companies. When you buy shares in Alibaba, you own shares of a VIE (variable interest entity) headquartered in the Cayman Islands. This loophole often keeps skeptical US investors from investing in Chinese companies, yet it has not stopped Charlie Munger from participating. In our opinion, Munger’s actions are a rough, but fair shortcut for assessing unique inherent risks like this ownership loophole.

While the loophole is now under question following the recent issues with Didi, it does not appear that the loophole will be closed. Closing the loophole for foreign ownership entirely would almost certainly destroy hundreds of billions of economic value, if not trillions, overnight. Investors must trust that the Chinese government does not want to pull the rug out from under US investors.

Investing in Taiwanese companies also comes with China related risks. This is particularly worrying to just about every engineer and tech executive in the world because Taiwan’s TSMC produces roughly 90% of the world’s most advanced semiconductor chips used in GPUs and products like the iPhone. At the same time, China maintains a standing threat of invasion of Taiwan, which would be a disaster for the entire global economy.

AI Superpowers & Computing Power

Growing new hive minds. The UK grocery robotics company, Ocado, released an amazing video recently detailing how their “hive” of robots operates. It’s a short video. With 2,000+ robots in their warehouse, all of the robots are connected to a single “brain” that interacts with inventory and customer requests in real time. Robots can’t interact with their “hive” without sensors, communication boards and many other different types of specialized chips. When we see this video, we see more evidence of the near exponential demand of semiconductors, which makes it an excellent investment theme in our view. Technical innovators like Ocado, which seeks to replace traditional grocery stores and shelved warehouses, are creating the future in real time.

If you’ve followed the narrative of the book AI Super-Powers in the past, you know that the US and China are rapidly advancing their AI capabilities. China has a clear advantage over the US because they are willing to collect any data they want to train their models. To be more specific, China has little to no privacy laws related to collecting data on its citizens. Kai-Fu Lee, the author, argues that access to data sets is the primary driver of AI innovation and eventual market dominance.

Risk v. Reward

Despite the potential for accounting frauds, foreign ownership loophole issues, Chinese government intervention and the threat of invasion of Taiwan, investors today recognize that participating in China’s leading technology companies is a major growth opportunity as well as a classic diversification strategy. There is a clear opportunity for investors to participate in the growth of dominant global technology leaders. It’s up to each investor to decide whether the China-specific risks listed above are more theoretical or practical.