While the board cautioned that it could immediately reassess the decision if it faces obstructions or access issues, we think it marks a crucial step for US and Chinese authorities to settle the years-long auditing dispute that has threatened the delistings of Chinese ADRs. We expect to see a continued positive rerating in China’s internet sector if more progress is made.
The breakthrough provides reassurance that the US and China are keeping a meaningful line of dialogue open. The PCAOB’s full access to inspect and investigate Chinese firms for the first time ever in history is a clear breakthrough after the two countries agreed to settle the dispute in August. While it’s just the beginning of an inspection process that involves much work, with over 170 China-affiliated US-listed companies, it shows that the two countries could find some common ground on this issue.
Investor focus could return to fundamentals with the regulatory overhang gradually removed. China’s internet sector has declined by over 60% since the US House of Representatives passed the bill targeting Chinese ADRs in December 2020. Investors have been concerned by the lack of visibility on the future of US-listed Chinese companies and the risk of wider delistings, which would hamper the sector’s access to US capital markets. Despite ongoing geopolitical tensions, the latest development puts the worst of the ADR delisting risk behind us, in our view. We also believe this removes the last of the regulatory overhang after Chinese authorities moved to ease domestic regulations from the past two to three years.
China’s shift toward reopening is a boost to the internet sector. China’s internet platform names are key beneficiaries of the country’s move toward an eventual reopening, in our view. With valuations remaining attractive compared to historical levels, we see further upside for the sector. We expect China’s consumer confidence to gradually recover in the coming months as a bumpy removal of COVID-related controls eventually leads to a full reopening in early 3Q23. As this process unfolds, we like second-tier internet players that seem poised to gain market share and those that stand to benefit from an expansion in advertising spending.
Overall, after having optimized their operational efficiency amid tough conditions in the past few years, we think that Chinese internet platforms are able to operate with better margins. A recovery in discretionary consumption spending and an expansion of advertising budgets should support their revenue growth in 2023. While we remain neutral on Chinese equities within our Asia portfolio, internet, alongside pharmaceutical and medical equipment, consumer, transportation, capital goods and materials are all sectors we think will directly benefit from China’s gradual exit from its zero-COVID policy.
Main contributors - Alejo Czerwonko, Eva Lee, Yifan Hu, Yifan Hu, Daisy Tseng, Christopher Swann
Content is a product of the Chief Investment Office (CIO).
Original report - China’s internet sector has upside potential as ADR delisting risk eases, 19 December 2022.