In the last three years, the threat of forced delisting for Chinese companies publicly traded in the US was constant. Billions of market cap evaporated while the investment world waited to see if the Public Company Accounting Oversight Board (or PCAOB or the auditor of auditors) can gain the access it needs and defuse this uncertainty.
A week before Christmas, this uncertainty appears to be defused for good. The PCAOB announced, quite dramatically, that it has secured the access it needed to investigate all Chinese firms’ books without Chinese government interference for the first time in history. Companies, like Pinduoduo and Full Truck Alliance, felt safe enough to cancel their backup listing plan on the Hong Kong Stock Exchange (HKEX). Mainland China and Hong Kong have finally turned “green” on the PCAOB’s oversight map.
I have devoted much digital ink writing about this “delisting saga” in the past. Now that this saga is over, for now, I want to share some reflections and learnings from both following this topic closely as a writer and investing during it.
Governments Can Be Both Adversarial and Reasonable
The delisting issue has often been wrapped up as yet-another-example of the growing adversarial nature between the US and China, in the same vein as the trade wars, sanctions, technological competitions, and other facets of an ever worsening relationship. The way this delisting saga ended shows that these two governments can, in fact, “compartmentalize” and cooperate to resolve some issues reasonably.
It is not entirely a surprise that the most reasonably dealt with issue impacts mostly the capital market and the professional investor class – the global, moneyed elites who have the most access to both governments and the most to lose when relationships sour. The manner in which the PCAOB carried out the Holding Foreign Companies Accountable Act (HFCAA), the law that gave the PCAOB the legislative chutzpah to aggressive vet auditors that audit Chinese companies, was also reasonable and professional.
When the HFCAA first passed, it was seen as just another way for an increasingly anti-China Congress to get rid of more Chinese presence in the US. But the bureaucrats of the PCAOB (and I’m using the term “bureaucrats” positively here to describe government officials devoid of political influence) dutifully carried out their work. More than 30 professional staffers went to Hong Kong for nine weeks, and verified its access to two auditors (namely, KPMG Huazhen LLP in Mainland China and PWC in Hong Kong) without Chinese government interference. As the bureaucrats of two accounting firms cooperated with the bureaucrats of PCAOB, while the bureaucrats of the China Securities Regulatory Commission stood by without interfering, a hot button issue between the US and China was actually resolved!
This made me think of something Charlie Munger said in early 2022, when asked about the risk he took on by owning Alibaba ADRs during the Daily Journal shareholders meeting:
“Assuming there is a reasonable honor among civilized nations, that risk doesn't seem all that big to me.”
Looks like Munger’s assumption proved true. The US and Chinese governments, while increasingly competitive with each other, by and large hold civilized attitudes on most issues (though the difference in human rights record notwithstanding). As long as the baseline attitude is civilized, no matter how adversarial the bilateral dynamic becomes, at least some issues can be resolved reasonably.
The “Reasonableness” Margin of Safety
If you were an investor who had enough confidence, intuition, and belief in the level of reasonableness that the US and China would apply to handling this delisting issue, you would have had a large margin of safety to buy Chinese firms’ shares, added more as the delisting fear escalated, and made a handsome profit in the end.
In hindsight, not even the best of the best investors were able to pull this off perfectly.
Munger began buying Alibaba shares in Q1 2021, under his Daily Journal portfolio, and added more during that calendar year to as many as 602,060 shares. But as the delisting fear persisted during 2022, he reduced his $BABA holding to now 300,000 shares. Some people suspected that he transferred some of the ADR shares to the HKEX and maintained the size of his Alibaba holding. I have no way to verify if he did this or not. But it’s clear he did not add to his holding while Alibaba, along with most Chinese firms, was on a steady decline for much of 2022.
Seth Klarman of Baupost Group, a famed value investor often mentioned in the same breath as Munger and Warren Buffett, did a bit better. He made an investment in New Oriental Education (ticker: EDU) in Q2 2022, to the tune of 8 million shares, after the stock fell off a tall cliff in 2021 and early 2022. Instead of adding to his holding as $EDU’s price continued to stay depressed, Klarman took some profit in Q3 2022 instead, as the share price showed modest recovery.
I, a much much much less capable investor than both Klarman and Munger, bought and sold shares of various Chinese companies throughout 2021 and 2022, but was not confident enough to hold onto any of them for long. Throughout the “delisting saga”, I personally placed the probability of a mass, wholesale delisting at no more than 10%, because cutting off the flow of global capital just to avoid a perfectly reasonable auditing requirement seems utterly unreasonable. However, I did not have enough chutzpah of my own to increase and hold on to my holdings. Of course, the delisting threat was just one of several reasons why Chinese stocks have been falling during the last three-plus years – Zero Covid, antitrust enforcement, policy changes on tech, education, property, and other major sectors, to name a few.
As Munger once said: “If investing wasn't hard, everyone would be rich.”
Capital Markets Are More Than Just Capital
Many Chinese firms hedged against the delisting risk with costly Plan B’s to duel list on the HKEX.
Big Tech’s like Alibaba and Baidu did secondary listings. Newcomers like XPeng and Li Auto did dual-primary listings on both the NYSE and the HKEX. Pinduoduo and Full Truck Alliance had plans to do the same, but waited just long enough to receive the good news from the PCAOB and scrapped their plans.
These hedges gave the false impression that the HKEX, and the Stock Connect program that gives Mainland Chinese investors a conduit to the HKEX, is a good enough alternative to Wall Street that Chinese firms can stay within the comfort of their own border and still do fine.
That could not be further from reality.
Of course, if you are a Chinese firm whose market and ambition rest solely within China (or a straight up state-owned enterprise), then listing on the HKEX or Shanghai or Shenzhen is perfectly fine. Being publicly traded in New York is more trouble than it's worth in this day and age. And logistically, sophisticated foreign institutional investors can figure out ways to invest in these purely domestic companies if they really want to. There is no capital access issue, just higher transaction cost.
However, there is a large crop of Chinese firms with global ambitions – either because the Chinese domestic market is not big enough for them to scale, or their products indeed have international appeal, or they simply sold their early investors on the dream with a high valuation and must deliver sooner or later. Examples would be firms in electric vehicles, enterprise software, cloud infrastructure, and maybe a subset of the semiconductor industry.
For these types of companies, listing on the NYSE or NASDAQ is still the most preferred path by far. This is partially because the SEC’s disclosure-oriented regime is more friendly to high-growth companies than Hong Kong’s compliance-oriented regulatory regime. But more importantly, the reputational halo effect of being listed on either the NYSE or NASDAQ is not something the HKEX can replicate. A newly-listed company in New York, at least within the sectors I spelled out above, simply has a better chance of becoming a global brand while attracting enough capital to deliver on its ambition. An HKEX listing currently cannot and may be increasingly unlikely to deliver that reputation bump, as Hong Kong continues to evolve inward.
So from the Chinese government’s perspective, it is worth cooperating with the PCAOB if only to not thwart the global prospect of its most promising and ambitious companies, whose success will eventually accrue back to China, either financially or reputationally.
When there are enough incentives to be reasonable, reasonableness tends to prevail, even between the increasingly adversarial governments of two superpowers. I may sound too optimistic here (as it is my nature), but as the end of the “delisting saga” has shown, there could be other issues of conflict between the US and China that can still be resolved reasonably.
And it pays (literally) to know what the next of those issues may be.
这让我想起了查理·芒格（Charlie Munger）在2022年初说的一段话，当时他在每日日报（Daily Journal）股东大会上被问及买阿里巴巴的ADR会不会有风险时说道：
Seth Klarman，Baupost Group的著名价值投资人，也经常与芒格和沃伦·巴菲特（Warren Buffett）相提并论，表现得稍微好一点。他在2022年第二季度投了新东方教育，买了800万股，这是在2021年和2022年初股票暴跌之后的举动。然而在东方的股价持续低迷时，Klarman没有继续买，而在2022年第三季度股价回升是，卖出了一些兑现。
然而，很多中国公司有出海的野心 — 要么是因为国内市场规模不够大，支撑不了长期发展，要么是因为自身的产品确实具有国际吸引力，要么是因为他们向早期投资人画了个大饼，估值过高，必须出海发展才能兑现。电动汽车、企业软件、云基础设施以及部分半导体行业的公司都有这些特点。