The Communist Dotcom Bubble Is a Dead Giveaway

Call it the Communist dotcom bubble. Pinduoduo Inc. shares surged 22% in the U.S. on Tuesday after it became the latest Chinese technology giant to pledge a big donation to social aid, as the country’s corporate leaders respond to President Xi Jinping’s drive for “common prosperity.” These days, it seems, the more Chinese internet companies give away, the more they’re worth. 

Pinduoduo’s bounce followed a revival in shares of Hong Kong-listed Tencent Holdings Ltd., China’s most valuable tech company, which said Aug. 19 that it would donate another 50 billion yuan ($7.7 billion) to aid the government’s wealth redistribution efforts, doubling the amount it’s setting aside for social responsibility programs. Tencent added $67 billion in market capitalization since then, climbing more than 12% after four straight days of gains (as of Wednesday’s close).

It’s a distorted echo of the U.S. internet frenzy in the late 1990s, when companies’ market value soared in tandem with the losses they racked up. As chronicled entertainingly in Michael Wolff’s Burn Rate: How I Survived the Gold Rush Years on the Internet, the young breed of first-generation dotcoms weren’t really losing money, they were “investing to build market share.” Two decades on, and on the other side of the Pacific, investors might consider that Chinese tech companies aren’t giving money away, but “investing to build political capital.”

The through-the-looking-glass logic of bigger losses (or reduced profits) leading to greater stock market rewards is an irresistible parallel to the first internet boom. The circumstances, though, are notably different. The mania of two decades ago was a market phenomenon driven by the animal spirits of private investors and a tide of cheap money. This time around, China’s internet companies are responding to the mortal threat of draconian government regulation.

In that light, the actions of these companies, and of the investors who are marking up their valuations in response, is entirely rational — unlike the day traders who piled in to make a symbol of excess back in the dotcom day. Tencent lost about $430 billion of market value between its Jan. 25 peak and the trough on Aug. 19, as regulators told the company’s music arm to relinquish exclusive licensing deals with record labels, torpedoed a Tencent-led merger of two game-streaming platforms, and banned tutoring companies — an industry in which the internet giant has invested — from making profits when teaching the school curriculum. 

China’s Communist Party has become wary of the growing wealth and power of the technology industry, as well as flamboyant entrepreneurs such as Alibaba Group Holding Ltd.’s Jack Ma. At the same time, Xi has shown a determination to reassert political control of the economy and reverse the trend of soaring inequality in China. In this environment, earmarking resources to placate regulators and signal alignment with the government’s socioeconomic priorities is money well spent — even if it reduces profits in the short term.

To be sure, the donations aren’t the only factor driving tech shares. Arguably, they were due to rebound after becoming oversold. Tencent is trading on a mere 20 times trailing earnings — making it look more like a value stock than a dotcom by today’s U.S. standards. Profits have proved resilient and the company has resumed share repurchases, which presaged recoveries in the stock in 2018 and 2019. These and other factors “are leading to improved sentiment,” said Bloomberg Intelligence analyst Matthew Kanterman. 

Nevertheless, it’s clear that regulatory action has become the overriding risk for China’s technology corporations. How much should be set aside, then, and what will be left over for shareholders? These are the difficult questions that investors have to weigh.

Pinduouo, an e-commerce platform, pledged to donate the equivalent of $1.5 billion to address critical needs in agriculture after posting its first-ever quarterly net profit — of $374 million. Promising to give away more than 100% of profits to good causes may earn the company a place in the pantheon of Communist heroes, but doesn’t appear a sustainable path to long-term success in the stock market. For Tencent, a far larger and more profitable enterprise, the $15 billion pledge is a more manageable 53% of its $28 billion net income in the 12 months through June.

It’s safe to say, though, that stock investors bidding up the shares aren’t betting on Tencent giving away half its earnings or Pinduoduo giving away 100% forever. The calculation must be that these donations will be sufficient to persuade the government to back off and let them return to something resembling normal business. Whether that wager proves correct remains to be seen.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Matthew Brooker is a columnist and editor with Bloomberg Opinion. He previously was a columnist, editor and bureau chief for Bloomberg News. Before joining Bloomberg, he worked for the South China Morning Post. He is a CFA charterholder.

©2021 Bloomberg L.P.

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