Is The Worst Over For China’s Internet Giants?

China’s largest internet companies have seen their shares tumbling to the lowest levels in at least three years after a government-led crackdown wiped out hundreds of billions of dollars in market value, but it may still not be the time to hunt for bargains as more headwinds are well on the horizon.

The government remains just as intent on curbing the market influence of giants from billionaire Jack Ma’s Alibaba to billionaire Pony Ma’s Tencent, dashing hopes that regulatory overhang would finally be removed after a year-long campaign. Compounding the policy woes are a slowing economy and much tougher fight for consumer wallets, hurting already weaker growth.

“There are still downsides,” says Shawn Yang, a Shenzhen-based managing director at research firm Blue Lotus Capital Advisors. “I’d wait and see.”

Alibaba is perhaps the most exposed to the ongoing risks. The company now trades at a forward price-to-earnings ratio of just 15.9 times for its 2022 fiscal year ending this March, compared with an average P/E of 31.3 times from 2017 to date, according to Ming Lu, an analyst with Aequitas Research who publishes via research platform Smartkarma. The stock may seem cheap given the company’s still dominant position in China’s vast e-commerce market, prompting billionaire investor Charlie Munger to spot a bargain, but the company’s latest earnings results offer good reasons for caution.

Alibaba is grappling with China’s weaker retail spending and fiercer competition from rivals such as ByteDance, which is luring consumers away with live-streamed shopping shows. And after swallowing a record $2.8 billion anti-monopoly fine last April, the company can no longer prevent brands and merchants from going elsewhere and ask them to sell exclusively on its platforms.

Alibaba’s revenues climbed just 10% year-over-year to $38 billion in the December quarter, making for the slowest growth on record since the company went public in 2014. Net income declined as much as 74% to $3.2 billion, partly due to goodwill impartment and decrease of value in its investment portfolio. Excluding those, net income would have dropped 25% to $7 billion. 

“Alibaba’s problem is that, first of all, e-commerce is a very competitive area,” says Alex Wong, director of asset management at Hong Kong-based Ample Finance Group. “And regulations are being targeted; it may not be that aggressive when competing with those smaller companies.”

Hong Kong-listed Tencent, which is scheduled to report fourth quarter results near the end of March, also has its share of problems. Regulators haven’t approved any new games since July last year, marking another long freeze after 2018, when the country paused gaming approvals for almost 10 months as it sought to strengthen control over content and game play. Cui Chenyu, a Shanghai-based analyst at research firm Omdia, says the current halt may relate to authorities’ desire to protect minors and overhaul game play that could lead to addiction. It remains unclear when or if new licenses will be handed out, and there is speculation that the hiatus could extend to the end of this year.

The ongoing uncertainties have only added to market jitters. Tencent plunged more than 5% last Monday, after an anonymous post hinted at another round of crackdowns targeting the company, which prompted its public relations head Zhang Jun to issue an usually aggressive response to deny the rumor. The company now trades at a forward P/E ratio of 24 times, down from a five-year P/E average of 38.4 times.

It remains unclear how long the regulatory crackdown will last. Last week, authorities issued new guidelines asking food-delivery companies to cut the amount they charge restaurants, causing Hong Kong-listed industry leader Meituan to sink 15% and shed $26 billion in market value that day.

Brock Silvers, a Hong Kong-based chief investment officer at Kaiyuan Capital, cited regulatory risks and said his allocation to China’s tech stocks is zero now. Ample Finance’s Wong said he had reduced investments in tech-related stocks. 

“In the past, they were a cornerstone of my portfolio,” Wong says. “But they are not a so significant part right now, and I will wait for a change in the macro environment to add a lot.”