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Wednesday, 09/15/2021 9:23:49 AM

Wednesday, September 15, 2021 9:23:49 AM

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Bear Of The Day: Tencent (TCEHY)
By: Zacks Investment Research | September 15, 2021

I am pitching Tencent (TCEHY), China's largest publicly trading enterprise out of China, as the bear of the day due to geopolitical risk. The significant and highly uncertain regulatory overhang coming out of Beijing has made Chinese tech an uninvestable class of public equities. Despite Tencent's unbelievably profitable growth acceleration that consistently impresses analysts quarter after quarter, the danger surrounding Xi Jinping's recent crackdown on tech has investors running for the hills.

The latest decree out of this increasingly authoritarian communist regime came from the National Press and Publication Administration restricting those under 18 years of age from playing online video games except for 3 predetermined hours per week, which sounds like something straight out of George Orwell's 1984. This business throttling ordinance almost looked to be a direct assault on TCEHY investors, with this gaming giant's operations being the most vulnerable to this new element of Beijing's autocratic control.

Analysts have been downwardly revising EPS estimates on TCEHY for the next few years as they price in the regulatory blows that Xi's increasingly autocratic regime will have on this digital powerhouse moving forward. Tencent has fallen to a Zacks Rank #5 (Strong Sell), and its stock is currently a falling knife that I would want to catch.

Bear Market For Chinese Tech

Hong Kong officially entered a bear market at the end of August as its innovation-powered Hang Seng Index experiences seemingly endless regulation catalyzed capitulation. Beijing has been busy releasing a flood of value-killing statutes that have brought Chinese tech stocks to their knees.

Minors will no longer be allowed to play their favorite video games from Monday thru Thursday and will only be permitted to game with their friends between 8 pm and 9 pm on Friday thru Sunday and public holidays (aka State determined holidays). According to Government officials, this move is an attempt to curb an apparent gaming epidemic amongst the country's youth to "effectively protect the physical and mental health of minors." In reality, the administration is likely just inhibiting the new normal of social interaction in a digitalizing world that the older generations fail to understand.

This ruling is nothing less than ruthless and is just one more element of control that the Party will now hold over its citizens in the world's second-largest economy. Minors will now be required to connect "anti-addiction" systems to their gaming devices. Game producers like Tencent will be prohibited from allowing individuals under 18 to play outside of the predetermined times. This punitive action should be a decision made by parents/guardians, not the State.

Tencent, the largest gaming company in China (over 50% market share), will be losing 10s of millions of daily users, but this didn't seem to shock investors. In early August, the digital gaming enterprise announced that it expected to see elevated regulation over the next couple of months. TCEHY is down 40% from its February highs, with the broader Hong Kong Exchange having lost 18% of its value over that same time frame. The endless flood of tech-focused controls can almost entirely explain both drop-offs.

Chinese legislators also recently approved one of the world's strictest data privacy laws, which would curb tech enterprises' ability to collect consumer data (a precious asset to these businesses). This was just another dagger to the already beaten-down tech sector in the region.

The new privacy laws will be put into place on November 1st and require businesses to collect minimum data, obtain consent for sensitive information, offer easy opt-out options, and direct government approval to transfer data overseas.

As I mentioned above, I wouldn't be trying to catch any of the falling knives in Chinese tech because we have no idea what Xi's end game is here. Whether it is to rid China of US investors, demonstrate to the private tech space who is really in charge, or maybe it is just Xi's administration attempting to match regulations used in countries abroad. The latter is doubtfully considering the 'convenient' timing of these various restrictions, but I still cling to the hope that Xi will eventually loosen his tyrannical grip.

How It Started & Where It Is Headed

Eccentric tech tycoon, Jack Ma, founder of Alibaba (BABA), seems to have catalyzed this endless flow of tech-focused regulation in China.

Xi's regime impeded Ma's fintech giant Ant Group's nearly half a trillion-dollar IPO last year. It wiped out more than $100 billion of its market value with a fresh regulatory overhaul aimed at Ant Group's unique micro-lending methods. This move by Chinese officials appeared to be in retaliation to Jack Ma's (founder and owner of the business) public criticism of the republic's financial system. Jack Ma's denouncement of China's economic practices seems to have triggered this fresh wave of tech regulation in the region. Xi fears that he could lose control of the masses to ostentatious billionaires like Ma.

Another 'timely' restriction came just 2 days after DiDi (DIDI), the Uber (UBER) of China, released its shares to US investors, the Cyberspace Administration in China announced a data-security review of the company that would require them to temporarily halt user growth. DIDI shares have since lost over $50 of their value. In fact, every publicly traded Chinese tech stock has taken a sizable dip since these restrictive announcements became a systemic issue earlier this year.

The progressing Chinese communist regime seemingly headed towards capitalism is now reeling back towards what looks like a government-controlled autocratic economy.

That being said, it is not unusual for the Chinese stock market to see these 20%+ stock market sell-off in any given year. In the past decade, the Hang Seng Index has experienced an over 15% market downturn in all but 2 of those years, entered a bear market (20%+ decline) in 4 of the last 6 years. The volatility that we are seeing in the Chinese market today is not unusual, but the mounting regulatory overhang causing this value deterioration is definitely unique to 2021. As I said, the unusual uncertainty here is what continues to compress Tencent and its cohorts' valuations.

Xi Jinping's rule is reversing decades of progress that China had been seemingly making towards a democratized international growth machine. I only hope that it doesn't turn into a full-on totalitarian nation.

Final Thoughts

There is nothing systemic about Tencent that I dislike. In fact, the business has a very healthy-looking balance sheet, accelerating profitable growth and rapidly expanding margins which appear attractive in the absence of the progressively authoritarian regime in Beijing. The geopolitical risk in the region is just too high for US investors today. The trade war between the US and China has me, and many other analysts concerned that Beijing is attempting to rid its GDP growth powering tech giants of US investors by making these companies uninvestable.

If Xi's administration shows signs of backing off its crackdown on tech, I won't hesitate to buy up shares of Tencent and the rest of Chinese tech, for that matter, but as of now, I am staying clear.

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