Panel discussion on China tech companies after Tencent's earnings report

Rui Ma, Paul Triolo, Guus Keder, Aw Cheng Wei, Feng Wang, & yours truly

A national, internally-televised meeting of the State Administration of Market Regulation (SAMR), one of the key regulators with jurisdiction over platform companies, produced on Friday, Aug 19 produced a readout.

The part that concerns platforms

要抓紧抓好平台经济常态化监管，加快出台支持平台企业健康发展的政策措施，着力构建以事前预防为重点的监管制度体系，尽快完善早发现早纠正的梯次监管工具。

We should pay close attention to the regular supervision of the platform economy, speed up the introduction of policies and measures to support the healthy development of the platform enterprises, strive to build a regulatory system focusing on prevention in advance, and improve the tiered regulatory tools for early detection and early correction as soon as possible.

Analysis: Positive signals for “platform companies:” emphasis on “regular supervision” indicates disinterest in making blockbuster cases, which is in line with the priority in “prevention,” “early detection”, and “early correction.” “Supportive measures” are in the pipeline.

SAMR is China’s anti-trust authority which slapped the record $2.8 billion fine on Alibaba in April and the $537 mln fine on Meituan in October 2021.

***

I was invited to attend an August 18 panel on the New Business and Valuation Model for China Tech, organized and moderated by Feng Wang, the editor-in-chief of FTChinese.com, the Chinese language site of Financial Times, and hosted by TechTechChina.

Other participants include Rui Ma, veteran investor and analyst & creator of Tech Buzz China; Paul Triolo, SVP for China & Technology Policy Lead, Albright Stonebridge Group; Guus Keder, veteran investor and Partner at Zhou & Masters Consultancy; Aw Cheng Wei, China Correspondent, The Straits Times. The news peg was Tencent’s earnings on Aug.17.

Summary

Analysts had expected flat or declining revenues, given Tencent didn’t get new game approvals and its advertisers had taken a hit in the weak economy and due to regulation. Tencent is now monetizing in its successful investments, cutting costs, and focusing on core strategies such as the industrial internet. Its “To B” services account for over 30% of its total revenue for five quarters now.

Yours truly and Wang Feng point to some examples in Chinese tech companies’ pivot to empower other industries, such as blockchain application by Tencent and mining-related tech solutions from Huawei, which don’t usually make news. Rui Ma and Paul Triolo are very skeptical if the consumer Internet giants could develop sustained, lucrative businesses like Amazon’s AWS and Microsoft’s Azure - at least, it’s too early to tell if they can come up with money-winners and if Chinese business customers are willing to trade labor for tech.

Baidu’s fully driverless robotaxi licenses - the first in China - are believed to be a bright spot after its years of commitment. Guus Keder notes China’s Big Tech is basically playing the role of venture capitalists and mentions a study in Europe that shows American and European venture capitalists are extremely bad at choosing potential winners in hard tech.

Aw Cheng Wei believes WeChat’s video accounts are in a very competitive market, but yours truly points to millions of audiences for the live streaming shows on Friday nights as the potential for ad growth.

There appears to be a consensus that China’s domestic regulatory environment has improved. But as Guus Keder and Paul Triolo point out, the geopolitical climate is tough, and the EU and the U.S. are generally not friendly with Big Tech these days.

Below is a slightly-edited transcript of the hour-long discussion, thanks to Wang Feng’s transcription. If there are any errors, they are with Pekingnology.

***

Rui Ma: I think a lot of the analysts had expected flat or declining revenues, especially when we consider that Tencent has not gotten a new game approved ever since the regulators stop releasing new licenses. Tencent, unlike many of its peers, has not been able to get new approval. It did make sure to say in its earnings call that it expects to in the future. But we don't know when that's coming. I think (of) also the expected weakness on the advertising front because a lot of the big advertisers (for) all tech companies within China - finance and education - have been hit by regulations. Education, especially. These were large advertisers in the last year.

So that decline obviously not a super big surprise either. The company did stress that they're going to continue with cost-cutting.

The company has been very, very active in investing in upcoming companies. In the past, at one point, people called (Tencent) the largest venture capital firm, which I think is a fair assessment. But since last year (Tencent) has also been pretty obviously stating that it was going to start to monetize in some of its more successful investments and then focus on core strategies, now that the economy has slowed down.

So I think the company's still trudging along on its strategy of focusing on the industrial internet, focusing on modernizing its existing properties, increasing investment into things that are already working like the WeChat ecosystem, and then being a little bit more cautious on things that are much more experimental of. It's taking a much more cautious dance versus the past.

Paul Triolo: Yeah, I think as Rui Ma has already pointed out, there are lots going on here in the broader Chinese economy.

Obviously, some of the earnings, I think, reflect the really tough period, the lockdowns, and obviously the economic slowdown that's affecting all the platforms. I think we also have the sort of “common prosperity” and the tech regulatory crackdown. On the hopeful side, it seems like at least from some of the statements over the last few months that at least the tech regulatory rectification campaign seems to (show) that at least the major aspects of it have been completed.

And so I think that probably in the coming months and certainly they run up the Party Congress, you're gonna see some easing or at least no new major new initiatives here. So I think the companies, the big players like Tencent, Alibaba, JD, and others are all sort of coming out of this period of strong economic pressure and then this technology rectification campaign. And so looking ahead, at least there seem to be some of those factors that were impacting their earnings are improving.

Now, on the sort of downside, we're still looking at things like the auditing, and the discussions between the U.S. and Chinese regulators around listings on U.S. stock exchanges. We just did a big note for clients on that trying to assess the probability of an agreement on that. Lots of really thorny and knotty problems related to resolving that. But we still think there is a potential for an agreement before the end of the year, but we've seen some delistings are already on the Chinese side and particularly state-owned enterprises. So there's a lot of sort of flux and pressure and churn on the financial side of things and uncertainty.

And then we add to that some of the tensions recently between the U.S. and China over Taiwan. In general, I think I'm trying to find some stability here, a new way forward here. And so there's lots of sort of positive aspects, I think, domestically in China, in terms of where we go on tech platforms. But also, there's the broader geopolitical climate is still pretty tough, right? Ukraine and other things and supply severe supply chain disruptions that are still at play here. So I think as we look later in the year, there's some hope for more positive signs, but I think there's still a lot of pressure on the downside.

Then finally, I would just say that these, and I guess we'll get into this a little later, but the broader sort of tech regulatory space is generally unfavorable to big tech platforms. We've seen in the U.S. and in the EU major movements, which we can talk about further sort of targeting big tech platforms.

So they're gonna remain under pressure for some time. Different approaches in the U.S. and the EU for example. But today just this week, the FTC, for example, is going after a META acquisition of a VR company - the first sort of major suit that the FTC chairman Lina Kahn has been pursuing.

So I think we're also gonna see this general sense that the big tech platforms need to be brought under some tighter regulatory structure. China is a little bit out in front on that, too, around things like competition in other areas. But I think both from a sort of geopolitical and regulatory point, it's still a pretty tough environment for these companies. And I think they need to figure out new business models and new areas. Cloud, for example, for Alibaba and others has not proven to be very, very lucrative.

Aw Cheng Wei: I so I think that the regulations have bitten harder than a lot of people have expected. The minor protection laws. And the stoppages of licenses have stopped them from being able to release more games which affected the second quarter.

I'm quite surprised by the fall in April to June or in the gaming revenue. Because during this time, China was under - a few major cities were under - lockdown. I felt that this was a time when people would have played more games during this time. So in the end, I think I was quite surprised by that.

So I think then they talk about wanting to cure revenue in short video and I think that they face strong competition in this area. So I'm not very optimistic. In this space, there are really very strong competitors. In the end. I'm just not sure how this would progress.

As for the Southeast Asia perspective, for Tencent, they’re trying to increase its Wechat audiences or user base in Southeast Asia. And I think there is some response, and they're investing in allowing content production in Southeast Asia. So in that sense, they are really an entertainment company. I think that's growth. I think that it does represent a bright spot.

But again it's still very early stages to determine how well they were to further on. But I guess this is still an area that they are going, including growing that China literature, which is something that they're trying to export out as well. Because ebooks have been huge in China and they are hoping to do that for Southeast Asia.

Guus Keder: I think that the whole tech industry is a relatively young industry. New industries will be regulated over time. This has been happening in the U.S. It has been happening in Europe, it's still going on, and it will be going on. Now, it has also happened in China. What surprised me most actually was that the big tech companies in China seem to be caught off guard about this regulation move.

Maybe also the way the Chinese government has implemented that regulation was perhaps a little bit non-transparent. I think going forward, we will see more transparency. I think it's in the interest of the Chinese government to provide that transparency because China needs these platforms. In some way or another, the Chinese government has an interest in keeping these platforms alive and making them part of the Chinese economy.

So I think this regulation will go on, But it needs to become transparent. And the Chinese tech companies need to adapt to this new reality. In one way or another.

The tech companies so far have mainly focused on consumer applications. This is becoming a little bit saturated. Now, what I see happening and what we see happening in Europe is that there are emerging investors, there are emerging companies in the deep tech sector, and that's closely related to the industrial internet sector. And that will be booming over the next decades. And that will maybe not affect consumers directly, but it will affect consumers indirectly. It is in the interest of governments to support this type of move because it's the underlying factor for the growth of the economy over the next couple of decades. So the Chinese government has an interest in supporting that. The U.S. government has that interest, and the EU government has that interest.

That's where I see things going support for deep tech. But on the other hand, to build more games is to put more people behind computer screens and chunk out code. To build deep tech companies. You need real innovation. And I think that's the big switch that needs to be made, not only in China but also in the rest of the world. From chucking out code and games and consumer applications, towards very integrated, very high tech, very deep tech type of applications, where basically the economy becomes fully digital and becomes fully integrated and becomes completely seamless. That's a process that still hasn't started. That's the process that will go on for the next couple of decades. And that's where I see the developments going. And it will happen on all the continents. Right?

Yours truly: I want to start with two anecdotes.

One thing is what Cheng Wei just mentioned. In Chinese it is called 视频号 Shi Pin Hao, basically the video part of Tencent’s WeChat on the (Chinese) mainland here. It's been kind of a phenomenon -usually, on the nights of Fridays, millions watch the live performances or older performances digitalized and put on the service as if it was just happening (real-time) and it was quite a huge thing here.

And I also recall there was one Friday night when there were two superstars live streaming at the same time. One is Taiwanese singer Lo Ta-yu, and the other is Stephanie Sun. And Lo Ta-yu was on the WeChat platform, and Stephanie was on the Douyin platform and it was happening at the same time. So basically it was a rivalry, but it turns out the streaming on the Tencent side went on a lot more smoothly than on the Douyin side.

And another anecdote I want to raise is - this is not very good for Tencent - because I think one of the things that the analysts were quite impressed with was the cost-cutting in the earnings report.

I come across on Chinese social media, on Wechat no less, is somebody posted a notice in one of Tencent’s company canteens/restaurants. The thing with Chinese companies, whether they are state-owned, government-owned, or totally private, is if you mess with employees’ canteens, people get anxious and they just post it out.

The notice says from today on, we will no longer provide free fruit. It's not much, but you can feel — but also to be fair, at the same time, the notice also says that will be lowering the price of our meals accordingly - but to cut off the free fruit supplies, I think that is one of the small stories that you can feel in the cost-cutting process (at least Chinese social media see it that way).

Tencent’s “To B” business has been taking up over 30% of its revenue for five consecutive quarters now. So that is one of the pillars of the income of the entire business. Business services are not as sexy as games and consumer services. But I think this is one of the areas, as you, Wang Feng, just mentioned, they are being pushed, prompted, or prodded by the Chinese authorities.

The tech companies have been, begrudgingly or not, turning into service businesses to empower digitalization, to improve the efficiencies of thousands, millions of companies, small companies, and micro enterprises, and also maybe some traditional industries that people typically wouldn't think of.

For example, I think one of the most memorable examples was Huawei. They established a lot of task forces and one of them was just to assist coal mines. Huawei is known to make ICT equipment and mobile phones. But (there is now) the combination of the technology solutions are with sectors - traditional, heavy, environmentally dirty sectors like coal mines.

Wang Feng: I do remember in one of Huawei’s internal magazines, they featured a miner on the cover of one of their internal news magazines, in English, too, from earlier this year. So I was surprised to read that too. Huawei was so much so heavily invested and involved in mining-related technology. And that's Huawei we're talking about. So indeed, these things don't get covered and noticed a lot by international media.

Paul Triolo: I was just gonna add this. I think those are all great points. I think the challenge here is for these companies like Alibaba and Tencent to transition away from the consumer space where they've been so focused on, e-commerce and gaming, to sort of business-to-business area.

So Alibaba, for example, has consistently, I think, posted losses. I think last year there was a profit from AliCloud that was very small and then I think quickly I think in June they were down like ￥1.3 billion and they also have things like the logistics unit Cainiao which is also operating at a loss.

So I think that the real challenge, it's not that easy to move into these areas to be providing this really high-end sort of cloud services for businesses and more industrial type applications.

And then on the other, the flip side is Chinese companies ready for sort of more high-end, sophisticated type cloud services of also of the type that companies like AWS and Microsoft offer, right? Microsoft and Amazon are examples of companies that sort of transitioned. Amazon in the e-commerce business and then eventually AWS now is a huge money winner for them and very profitable and the same with Microsoft and Azure.

But that took time to do that to make that transition and develop those services and come up with offerings that were compelling. And both Amazon and Microsoft had some advantages there. So I think Alibaba and in particular and Tencent and Baidu are all sort of struggling a little bit with that. Then you have this sort of, as you mentioned earlier, Wang Feng, you mentioned this jumping into these new areas like autonomous vehicles, the tech stack involved there, and that's a tricky one, too. Right?

Huawei has done that in part because of U.S. pressure on other parts of their business lines. But some of those markets are very competitive. And for example, Huawei is competing with a lot of other companies that have been involved in various aspects of the AV technology stack, including Baidu and others.

So I think that the challenge here for some of the Big Tech platforms is as their sort of traditional commercial, the consumer focus businesses come under pressure from all these other regulatory issues, that we've been talking about here. How do they transition? And then at the same time, they're also under pressure in this sort of more investment and hard or core technologies that you mentioned also earlier. They're also designing semiconductors.

So for example, Alibaba is designing server chips. They're manufacturing those at TSMC. Some of those efforts could come under regulatory pressure from the U.S. export controls. But I think that's another area where they're sort of transitioning into.

It's not clear, again, what the commercial gain already is there. Companies like Google and others also design their own semiconductors. And that's sort of the game in the cloud business. And then you can optimize applications to run on those in different workloads.

I think eventually that's what Alibaba wants to do, for example, with those server chips. But again, that's tough. It's very competitive. And you gotta design the semiconductors, optimize that, and make sure that companies understand the advantages of using Alibaba semiconductors in the cloud for example. So it's an area where others have been successful, but it's not easy to do.

And companies that are more consumer-oriented are gonna have some challenges to try to transition into that and their business models and their management need to sort of adjust to that. And that's gonna be a tough process.

Yours truly: To echo Paul, I think I totally agree with what he just said. I feel like a lot of these businesses have, in effect, become - their frontline professionals have become - consultants actually for specific industries and maybe even for specific business settings.

I think I read somewhere that in the eastern port of Zhangjiagang, trading companies of commodities used to face great difficulties in securing credit from banks because the traders don't have many assets to pledge. If you don't have things as collateral, they don't lend to you. With the help of some blockchain technology, I think, one of the digital solutions provided by Tencent and others. The technology can convincingly record and testify to the authenticity of the trades and the flow of goods/commodities. The trading companies could use the blockchain records and get loans from banks for as much as 10 million yuan.

The potential for these companies, I mean tech companies in China, is that they are not just mediums or efficient tools. The introduction of the Internet into China’s industries, be it retail, finance, catering, education, medical service, or technology, was very early. It was brought in before the industries fully developed. These platforms not only serve as mediums or efficiency tools, but also become the industry.

[A bit of background]

Why are Chinese VCs drifting away from their U.S. peers?

Rui Ma: I think many public investors I talk to, everyone sees the opportunity in the industrial internet, enterprise software, etcetera. But it has yet to arrive in a big way, right? So I'm actually much more familiar with the private venture capital side. And we've been talking about SaaS, for example, taking off in China for the past decade. It has yet to do so in a big way. I know you have some unicorns, but if you really get down to the revenue and the actual financial profile of these companies, they lag far behind what we see overseas, right?

I recently tweeted about this, if you're Meituan and you have access to cheap developing developers, why would you buy an off-the-shelf software for your internal workflow? When you can create your own, that's much more customized and really addresses all your needs. It's not economical for many companies to do that in the U.S. because labor’s more expensive and also industries have been around longer.

So there are more standardized processes. But in China, it's not the case, right? So neither of those exist to the degree they exist elsewhere. You have the fact that also culturally, I think it's underappreciated how, again, in the US where I'm very familiar, if you're a Chief Information Officer, you're kind of graded on your budget, and it's looked down upon how well you're doing your job if you have a lot of employees in it. But if you are sort of in the same role in China, you might assess your success based on how many employees you have inside of the company, versus how much you're spending or how much you're saving the company.

Again, because of that labor differential, the cost structure is just entirely different. It's changing. And I think with the economy contracting in certain sectors, it's hopefully accelerating the adoption of software. But I don't know that it's happening in the fastest way, right?

Automation is supposedly a very big sector in China. If you look at this, the economic structure makes a lot of sense, but the reality is that the startup goes and pitches the factory owner about how they can use advanced vision recognition to figure out which workers are not obeying certain rules right on the factory floor. The factory owners are like, why do I need this fancy software? All I need to do is tell the foreman, the factory foreman, that if anyone on his shift doesn't obey the rules - and I find out that - I'm just going to fire him, right? So that's a much more low-tech but effective way to get a lot of the same work done.

So again on paper a lot of these opportunities sound great. And Alibaba, Tencent et cetera have all been very much ahead of the curve and putting it into their blueprint. Started 3,4, or 5 years ago. Alibaba even earlier. Actually, they're really big pioneers in the space, but the market is just not ready yet. For many reasons. It's the technology is the ability to produce this technology is a little bit ahead of the existing demand currently.

Guus Keder: Valuations are determined by future cash flows. That's how institutional investors look at investments. Today, the future cash flows are not very clear. There's a lot of turbulence. I expect that there will be a lot of turbulence in the valuations for the large tech companies.

What they need to do is they need to basically use their platforms to create more value-added services and to create more - not more revenue - but more profit. And they have been chasing users and revenue, but they have not been really focusing on margins and on profits. I think they need to learn how to use their platforms to create more added value for the existing users and for potential industrial users.

I don't really believe that the large tech companies will innovate in the deep tech sectors that we expect to see in the next couple of decades. I don't think they are equipped for that. They don't have the mentality for that. They don't have the business culture for that. They may invest in these sectors once they find companies that have established a foothold and then help to grow these companies. But I don't really think that the big tech companies have the capacity to innovate in these areas themselves.

Wang Feng: But given their dominant positions in China, Tencent, Alibaba, and Baidu certainly have made a lot of investments into these new startups that focus on very deep tech. And it doesn't have to be a very expensive investment too. Some of them could be hidden champions, future unicorns, but right now you see Alibaba, Tencent, and Baidu getting involved in some very, very early stage investments into chips, into supercomputers, into quantum computing.

These stories are still coming out in China. So at least from an investment of view, they seem to be very active in pursuing such opportunities.

Guus Keder: Yeah, I think they're basically playing the role of venture capitalists, and we have recently done a study in Europe. And the result was that venture capitalists are extremely bad at choosing potential winners. Both American investors and European investors. They're all bad at choosing potential winners. It's hard to say who the winners will be amongst those investments that they've made. I think they're playing the role of venture capitalists. They're placing bets, and something will emerge from that. And the more bets they play, the more will emerge from that. But whether they're really smart in the way they invest, if we look at how it's being done by other venture capital investors in other parts of the world, I don't think they have a lead on them. Right?

Paul Triolo: And I would just quickly add on the great comments Guus made. It's not just investment, but there are companies like Alibaba partnering within the AV space for example which we mentioned earlier. So Alibaba partners with Xpeng and they're gonna set up software, a computing center for software for drivers, cars, for example, those are kinds of investments or partnerships. Gonna be interesting to see how those play out in terms of profitability.

And then you have of course Baidu, I think, is a really good example where they admitted tremendous investment in Apollo, which is this platform. And they have now something like - they claim at least 80,000 developers of Apollo and over 200 industry partners.

And so, again, that's a really interesting model there where they're investing in this space. This is also considered hard technology, by the way, hard and core technology, because you're talking about a technology stack that includes semiconductors at the lowest level and video. And others are really big players in that. So these are companies that are building sort of on hardware, building a software platform, and then offering this as part of a business.

We have clients in the spaces which is interesting things like robot taxis and automated trucking services. Those are still not quite there, yet. You've got a lot of issues around them in terms of regulatory issues and infrastructure like 5G and how that's gonna all work together. So there's a lot of investment and sort of partnering and work in this space.

But again, those business models and how those play out are still sort of a work in progress. But I think it's important to note that that kind of platform, and particularly, I would say Baidu in the AV space has really made a huge commitment.

It's gonna be a little tricky to see where the rub is in terms of how they really turn those into lucrative businesses because a lot of these spaces like AVs and the metaverse and all the applications, the business models are still evolving. But those are areas that obviously have high priority too, things like the metaverse, because they also do have industrial applications, for example.

So I think that those companies are moving into those areas, but a lot of questions are still about the business models.

Yours truly: I'll take a driverless taxi from Baidu. They are showcasing that in Yizhuang in Beijing and I think they just got the first licenses in (southwestern) China.

Paul Triolo: I think they can take paying clients too, which is a big deal.

Yours truly: That was pretty impressive. And I think Chinese policies in these areas, in hard tech areas compared to consumer tech, are much more accommodating. The local authorities are willing to take some risks.

I think, coming back to the regulatory environment, actually…

Wang Feng: that's the topic I wanna close on now that we're running out of time. The biggest elephant in the room at least when Chinese tech companies are involved is regulation. Lately, there have been mixed signals all around about when the intensity of these campaigns is going to reduce, or when we might see more or less an end to these harsh crackdowns. Of course, the Pekingnology writer with the pulse on Beijing policies, what are your thoughts?

Yours truly: I was saying, is there some sort of consensus that the “worst” regulatory storm is over? I think I read from the European investment banker who shared a note that there were no major material negative rules for the entirety of 2022. It's been 8 months or 7 months + 18 days now. So that's something.

And I think there was, obviously, the valuations of Chinese tech companies have taken a huge hit. And there are some very popular articles and tabulations on social media. If you compare the valuations of the top unicorns with the highest valuations today, and compare them with maybe a few years ago, you see a big reshuffling and the Chinese ones are falling behind. That touched on a lot of nerves.

Also, I put it out in my newsletter yesterday.

China will NOT break up tech platforms: PKU task force

That's a research task force from Peking University basically that at the end of the day Beijing realizes that it cannot afford to undercut the tech companies too much.

The platforms represent the future of businesses. Any country that wants to persist participate in the global competition must support the development of its own platforms.

And also, I've read all the regulatory documents. There is one thing that Beijing has always been emphasizing, which is to support the “international development” of these companies. And so I think this one goal is quite clear. Beijing wants them to succeed internationally.

Wang Feng: Rui? Any thoughts on regulation?

Rui Ma: I agree. I've been calling it, I think some other analysts call it a rectification instead of a crackdown, which I think is a better word, but the worst, quote unquote, worst of it is over. The large frameworks have already been set in motion.

When we say the worst is over, it's just that we're going from a regulatory environment that was extremely lax. So going from like zero to just getting the basic sense, the 0 ~ 1 is always going to feel the most painful, I guess. Right?

So going forward, I do think it's pretty obvious that regulations will continue. They'll just be more refined because again, the rough tracks have already been laid out. I'm personally really interested in seeing what China does in terms of forward-looking regulations on emerging technologies, such as an algorithm.

Recently, some of the big tech companies have to submit parts of their algorithm. I don't know if that was the entirety. We can't see the exact documents of their algorithms to the government. I know that other governments, especially you know, Europe, and the U.S. also have been talking about doing more about this. But China is the only one that's really going forward and really, really making movements here. So I'm really curious because there are no precedents and we'll see what the consequences are.

(On that note, read this:)

What "algorithm details" Beijing asked for from Chinese tech giants