They're gonna break up Jack Ma's Alibaba...
Americans worry about "too big to fail;" Chinese worry about companies that are "too big to censor." So they (finally) took action against Jack Ma before it's too late...
Happy New Year! A weekend deep dive to start 2021!
You might have seen in the news that Jack Ma is in trouble and Alibaba is facing regulatory scrutiny in China. The news cycle has long passed, but I recently talked to some friends in China who offered some very interesting insights on the matter that I think would be nice to share with you. Here are some punchlines:
Alibaba and Ant Group will likely be broken up into at least 3-4 companies. The $37 billion IPO of Ant Group (supposed to be the world’s largest in history) won’t happen until at least 2022.
The antitrust investigation for Alibaba is a fairly reasonable routine “health check-up” that one shouldn’t over-read. The typical lack of transparency from China fuels conspiracy theories, but the regulators just genuinely want to understand Alibaba and Ant Group, which have simply grown to be too big and complex to be properly regulated.
The Chinese government seems to be prioritizing the control of their tech giants, so they don’t grow too large and pose existential threats to their governance. Solving that is more important than letting them compete with the Americans, who should also prioritize the well-being of their people and roll out proper regulation and antitrust actions against the American tech giants.
As you see, we make some strong predictions here – derived from a mixture of “insider information” from government officials and rumors picked up in the policy discourse. It sounds sketchy but is kind of the only way one can really get a glimpse into what’s actually happening in China nowadays. Most of the Western news outlets have done a good job reporting the basic timeline, but there are a few things that we believe are wrong or deserve clarification.
Recap of Jack Ma’s “downfall”
On 10/24, Jack Ma attended a summit in Shanghai and criticized that the regulatory system was stifling innovation and must be reformed to fuel growth. Chinese banks, he said, operated with a “pawnshop” mentality, along with other criticisms. The speech became viral on the internet, and soon the regulators called off the IPO listing of China’s most successful and highly valued fintech unicorn startup – Ant Financial Group – owned by Ma and Alibaba.
Ant Group was about to be listed in a record $37 billion deal. It would have been the world’s largest share offering in history.
This was far from being the end. The government soon started bring on a more serious antitrust investigation, as reported by NYTimes:
The country’s market watchdog said on Thursday that it had opened an investigation into whether the e-commerce group Alibaba had engaged in monopolistic practices, such as restricting vendors from selling merchandise on other platforms. Separately on Thursday, four Chinese financial regulatory agencies, including the central bank, said they would meet soon with Ant Group, Alibaba’s finance-focused sister company, to discuss new supervision.
One important point to realize is that Ma’s reputation amongst the Chinese people has been steadily deteriorating, as reported by NYTimes:
But lately, public sentiment has soured and Daddy Ma has become the man people in China love to hate. He has been called a “villain,” an “evil capitalist” and a “bloodsucking ghost.” A writer listed Mr. Ma’s “10 deadly sins.” Instead of Daddy, some people have started to call him “son” or “grandson.” In stories about him, a growing number of people leave comments quoting Marx: “Workers of the world, unite!”
Alibaba’s transformation to become a threat to the Chinese economy
Doesn’t Alibaba help small businesses? Ma says repeatedly that his mission is to empower small businesses through e-commerce. Sure, a large number of jobs were indeed created by Alibaba, but only under Alibaba’s umbrella. Physical stores and businesses that are still closing down, much like how Amazon has been a great shock to the Main Street businesses in America.
This is not to mention that Alibaba’s profit-making operations have indeed started to hurt consumers. For example, Ant Group is believed to have used fintech products like Huabei, a virtual credit card service, to encourage poor and young people to build up debt. Or, its recent introduction of grocery delivery services is seen to be taking a large number of farmers and local markets out of business.
In an analogy – it is one thing for Amazon to acquire Wholefoods and consolidate its market share so that it can sell more vegan food to the affluent middle class, but another to let American farmers go bankrupt or encourage students to take on more debt…
Alibaba started in the 90s as an online platform allowing vendors to cheap, bogus products to consumers, and it has now evolved into a benemoth that is essential for everyone’s daily life, all while also acquiring most of the necessary financial licenses to operate as a shadow bank and arguably the largest private financial institution in China through Ant Group. You can imagine why the public outcry and regulatory scrutiny have been going up, probably rightfully so.
Are Alibaba and Ant Group actually legitimate threats to the Chinese economy?
The short answer is: regulators feel that Ant Group is a threat, but they don’t know the business well enough to draw any definitive conclusion.
Frankly, nobody else knows either. Many have written about the complex and even dangerous business model of Ant Group. WSJ quoted David Dai, senior research analyst at Sanford C. Bernstein who came up with a $210 billion valuation for Ant in November 2019, that:
Ant’s businesses are very complex, with a variety of products spanning financial services and technology. You can’t get a full picture from either a financial or a technological perspective.
A piece of analysis in Forbes says that:
Ant is creating the conditions for a repeat of the same sort of “sub-prime” credit crisis that triggered the 2008 financial debacle in the U.S.
From those in the investment community to regulators, nobody knows what Ant really does, what assets and liabilities it has, and how much systemic risk it poses to the Chinese economy.
When in doubt, call it off. It’s not so much that the regulators identified the exact risks posed by Ant, but rather that they simply didn’t feel comfortable letting it happen.
Americans talk about “too big to fail” all the time – the Chinese worry about companies that are “too big to censor.” We know the Chinese government can control Alibaba in an abstract sense, but that’s not enough. If you’re growing to be too big and complex to be understood and properly regulated down to the weeds, then that’s a problem as well.
Are the Chinese regulators doing the right thing?
One theory floating around, particularly amongst those who dislike the Chinese government, is that the regulators are targeting Jack Ma and the other tech giants because the Chinese economy isn’t doing well and they need scapegoats to blame on. Or, more extremely, that the government is staying true to its socialist ideals and is starting to seize private assets of successful businesses. These views are likely overblown and incorrect.
Because there’s little transparency into the actual happenings in Chinese politics, it’s easy to resort to conspiracy thinking. It’s just an unfortunate reality, but no matter how you view the Chinese government, the regulators who are bringing Jack Ma in for questioning are actually doing it in a decently fair and genuine manner. They genuinely want to figure out what is going on with this company and how to better regulate it.
One should think of this as a routine health check-up for a complex company and not over-dramatize the intention behind it.
Why didn’t the regulators act earlier?
One question on your mind may be: If Ant Group or Alibaba have been posing systemic risks, why didn’t the regulators act earlier? If you only happened to realize their risks after Jack Ma’s unfavorable remarks, then you were quite incompetent previously!
Well, it’s not all the regulators’ fault. Again, Alibaba and Ant Group were just simply so big and complex. Because so, it was hard for any regulatory agency to single-handedly launch an investigation. If China’s S.E.C. brings in Alibaba for questioning, the company would say that “oh so much of our business lines actually don’t fall under your regulatory purview, so leave us alone…”
Hence, this time, it was actually 4 agencies together bringing in Alibaba and Ant Group for questioning: China’s equivalence of Federal Reserve (central bank), F.T.C. (market regulation and antitrust authority), S.E.C. (securities regulator), and FDIC (banking system regulator). Previously, there was simply not enough political will for them to work together; the problem wasn’t urgent enough.
What’s next for Alibaba?
Yes, it’s a routine check-up, but it’s also a long overdue one, which means that it will likely result in more dramatic consequences and longer time horizon than most other routine check-ups for companies.
Bill Bishop, a famous American journalist in China, wrote in his newsletter that:
Jack Ma will be lucky if Ant Group is able to IPO by the end of Q2 2021, and given the likely impact of the new rules I would not expect Ant to get anywhere near the valuation it would have gotten if the IPO went off as planned. There are a lot of powerful interests who were going to profit from the IPO, they can not be happy that the central government quashed it, but what are they going to do? Risk prevention is a core part of political security, as is proper obeisance to Party policy, and in Xi’s China political security and political discipline trump princeling and SOE profits.
Bishop’s outlook is too optimistic in the views of my Chinese friends, who believe that there is no way that Ant Group can do an IPO anytime in 2021. Any major action from the company will be at least 2-3 years out, if Alibaba behaves well.
Much more pessimistically, a breakup of Alibaba and Ant Group seems almost inevitable. Together, they will likely be broken up into at least 3-4 companies.
This is a strong prediction that only time will tell whether it’s correct…
Lessons for the American regulators and tech giants?
Who would’ve thought that China would be taking on its tech giants earlier than the U.S.? With all the whispering about antitrust actions against Facebook and Google, not much seems to be happening substantively.
American tech giant executives like Mark Zuckerberg keep making the argument that their companies need to remain big and monopolistic in order to stand up against their Chinese comeptitions, which are presumed by them to be a threat to American freedom and security.
What the antitrust lawsuit against Alibaba indicated, however, seems to be that China’s not that interested in allowing Alibaba to grow infinitely large in order to replace Amazon (or likewise Tecent to replace Facebook). The Chinese government seems to be prioritizing the control of their tech giants, so they don’t grow too large and pose existential threats to their governance. Solving that is more important than letting them compete with the Americans.
The “China threat” arguments made by the American tech tiants are thus getting increasingly more bogus, along with other reasons.
The Chinese are doing the right thing prioritizing domestic governance. American regulators, therefore, should also realize that they need to properly regulate their tech giants because their first duty should be to maximize the well-being of the American people, before worrying about the “hypothetical enemies” like Alibaba.
Note: If you’re not sure whether Americans should break up the tech giants, I encourage you to read Columbia law professor Tim Wu’s The Curse of Bigness: Antitrust in the New Gilded Age – a short 154-page read but a masterpiece on the justification for antitrust actions against big tech.
I’ve also said in my previous emails that it’d be nice to write down a few short-term predictions we have for 2021 and see if they match with what acutally happens, hence testing our thinking. So let’s see how our predictions about Alibaba pan out.
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