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Fundamentals of Didi are not affected by China Crackdown: Analyst

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Brendan Ahern, KraneShares ETFs Chief Investment Officer joins the Yahoo Finance Live panel to discuss China cracking down on privacy data and the impact it has on some of China’s biggest tech companies.

Video Transcript

AKIKO FUJITA: Well, it has been a brutal week for Chinese tech stocks listed in the US. And we are seeing some of those back in the green today. Didi has seen the steepest losses on the week, just one week after it debuted in the US here. And you see green across the board with Didi up about 3%, followed by Tencent Music, Baidu, Alibaba, and Pinduoduo. KraneShares ETF, KWEB, also getting hit hard on the back of that.

But let's take a look at where it's trading today. Krane Funds Advisors, of course, a global asset management firm known for its China-focused ETFs. And as a result, we are seeing it up about 4% in this session. Let's bring in Brendan Ahern, KraneShares ETFs chief investment officer.

Brendan, I see you sort of just breathing a sigh of relief on this Friday. It has been a rocky week, a number of headlines. Bottom line, Chinese regulators trying to crack down on Didi and its listing in the US, concerns about data privacy, as well as what information can be handed over. And then there's the larger question here about where Chinese regulators are trying to go to in terms of allowing Chinese companies to list in the US. How are you connecting the dots right now? Try to make sense of all that for me.

BRENDAN AHERN: Well, I think we do have to separate Didi from the broader China regulation of the internet space, that Didi got its IPO up, potentially without receiving an implicit approval from the onshore regulators. That regulator's going to be concerned about Didi's, what technology providers is it using, how is it protecting user data. So I think Didi's situation is a little bit separate from a broader regulation of Hong Kong US-listed internet stocks that we hold within KWEB that are very, very critical parts of China's economy. And China's regulators simply saying, you're so important, you're going to have to be regulated. You need some supervision. And I think investors have, kind of connecting the two and driven down these stocks to very low levels, despite very, very strong fundamentals.

AKIKO FUJITA: So let's separate out Didi for a second here. Because you've got now lawmakers over in DC calling for an SEC investigation into whether, in fact, Didi misled investors. And I know you highlighted the fact there were multiple pages in that S1 filing that did highlight the overarching risk that could come with regulation. Has your fundamental investment thesis on Didi changed as a result of what we learned this week?

BRENDAN AHERN: Yeah. Akiko, Didi's IPO prospectus had 60 pages of risk factors, including China regulation. So I think the call for regulatory action, it's difficult because institutional investors who participated in the IPO, they were given those risk factors in advance. The SEC is apt to say, well, you're an institutional investor. You should know what the risks are. And just because the IPO didn't pan out like you would have liked, that's harder. What if it had gone up? Would you still be calling for this? So I think the IPO regulatory situation is a little bit different because of the level of risk factors involved.

At the same time, obviously the timing is very, very poor, coming 48 hours after the IPO. This company is audited by Price Waterhouse Cooper's Chinese affiliate. So there's no question about the quality of the company's audit. It's the same auditors who do the China operations of US-listed companies. So this has nothing to do with an audit issue. It's just very poor from a timing perspective.

AKIKO FUJITA: But is that investment thesis still intact? I know we talked the day that Didi listed. You talked about the growth opportunities in China, which is certainly important given that about 90% of their revenue comes from the Chinese market. Has any of that changed? And for investors, how should they be looking at what that risk premium should look like, now that we know what's come out of China and what regulators are looking at?

BRENDAN AHERN: So Didi's not being allowed to bring on new users. At the same time, this is a company with nearly half a billion current annual users who are still using Didi. That Didi is still doing 41 million rides a day in China. That hasn't changed. And I think, as much as, yes, the stock's come down, when we get the company's Q2 earnings, they might be really, really strong. Time will tell. We can't predict the future. So I don't think the underlying fundamentals of the company have been affected by the regulation. That's very true, what we've seen from the broader China internet space.

When you look at the Q1 2021 earnings from Chinese companies listed in Hong Kong and the US, the earnings were really, really strong. The companies are adhering, adapting to the regulation, and we've not seen them negatively impacted by the regulation. The only caveat, Akiko, would be the online education companies. The two big online education companies, they're apt to see the number of hours that kids can use their online tutoring services, those are probably going to be curtailed. But those stocks are down 70% year to date. But for the broader China internet space, we've not seen the regulatory situation impact the balance sheet nor the income statements of these companies.

AKIKO FUJITA: Let's talk about the broader scrutiny on foreign-listed Chinese companies. And you could argue that the US-listed ones are getting the most scrutiny. Chinese regulators have made it pretty clear this week that they're going to try to close some loopholes, especially for these so-called VIEs that have shell companies outside of China in order to list these companies in places like the US. What does that suggest in terms of the flow into the US? Are we going to see Chinese companies now continue to pull back from the US? Are we going to see these dual markets separate? How should we be looking at what exactly the regulators are trying to get at? Is it about punishing US investors or is it about tightening the screws on their control over these companies?

BRENDAN AHERN: I think it is around the data issue, which you pointed out, Akiko, that in the case of Didi, the regulator doesn't know who it's technology providers are. Are they local Chinese companies? Are they foreign companies? What is the company doing to protect user data in China?

And so in the case of Ant Group, which was also potentially facing regulation about, it called itself a fintech company and was avoiding being regulated like a bank, because that listing was going to be in Hong Kong, the regulator could say, whoa, whoa, whoa, hold on, you're going to list knowing you're about to be regulated. In the case of Didi, by listing in the United States, the regulator couldn't stop it. We also had the 100th anniversary of the party in China. And therefore, they were very hesitant to do something disruptive like trying to stop Didi because of that celebration occurring in China.

So I think the regulator's simply saying that, going forward, you're going to have to receive some approval. We want to know who your technology providers are. I don't think this is the end in the long term of US listing for Chinese companies. In the short term, there's not going to be much of an appetite. But I think in the long run, a lot of global private equity money wants a US listing because of the size and scale of US capital markets. A lot of that private equity money funding Chinese companies, they want a US listing as part of their exit strategy. In the long run, I don't think it changes. Certainly some pretty severe headwinds in the short term.

AKIKO FUJITA: And finally Brendan, what has all this meant specifically for your fund? Clearly you've taken a steep loss this week as a result of all these other Chinese companies getting weighed down by the headlines. Are you reassessing your asset allocations here? How are you scrutinizing what's to come on the regulatory front but weighing that with the growth opportunities that still exist?

BRENDAN AHERN: Yeah, it really is a balancing act, Akiko. We don't know the end game of regulation. We've not seen it impact the companies thus far. And we contrast that with China's urban middle class is spending $7.4 trillion annually. These companies within KWEB, that flows through them. Retail sales online is 30% of all retail sales in China. That number is bigger than the size of retail sales in the United States.

So the fundamentals have never been stronger. KWEB's peg is now below 1. It's very hard to find companies that's growing as fast as these companies. But as much as investors have, based on the sum of all fears pushing down the stock price of these companies, at the same time you contrast that with the long run. Now maybe this is some element of irrational pessimism on their part. Time will tell.

AKIKO FUJITA: OK. We'll be watching that. Brendan, hope you have a good weekend. Brendan Ahern, KraneShare's ETF chief investment officer.

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