Where the Next Front Might Be -- Barron's

Dow Jones2023-04-01

TikTok won't be the last Chinese company to get caught in the crosshairs Reshma Kapadia

The road to a U.S. ban on TikTok, the popular app owned by Chinese company ByteDance, is long and twisted, even as support builds for bipartisan legislation that would give the White House authority to ban not just TikTok but other Chinese information and communications technology companies. Expect more volatility for Chinese and U.S. companies along the way.

But the direction of travel is clear: The U.S. and China are in a slow-motion decoupling in critical areas like technology. TikTok, the short-video app used by 150 million Americans, is the highest-profile company targeted by the U.S., as policy makers increasingly view the relationship with China through the lens of national security. But it's not the first or most important Chinese company to get caught in the crosshairs, nor will it probably be the last.

Companies have been bracing for retaliation from China for measures the U.S. has taken. But nothing significant has happened, even after the U.S. in 2019 blacklisted China's Huawei Technologies, the world's largest maker of telecom equipment, curtailing its access to advanced chips. China also hasn't retaliated after the Biden administration last fall restricted China's access to advanced chips technology, hampering Beijing's efforts to build up its domestic chip industry.

"Banning TikTok, or forcing a sale, would not inflict significant pain on China and is certainly far less of an issue than other recent decisions by Washington," says Andy Rothman, investment strategist at Matthews Asia. While a decision to ban or restrict TikTok would further strain the relationship, Rothman doesn't expect Beijing to take retaliatory actions against U.S. companies.

Part of the reason: Options are limited. "Beijing has been wanting to do something to push back, but it didn't have leverage in the tech ecosystem to counter U.S. efforts," says Xiaomeng Lu, director of geotechnology at Eurasia Group, who thinks that Beijing's retaliation will focus on prohibiting the divestiture of TikTok or the transfer of its algorithm in any sale.

That would force the U.S. to pursue a ban, possibly in an election year when both sides are courting younger voters who view TikTok as a daily necessity rather than a national security risk.

Though China has limited immediate options to retaliate much further, Lu says it is positioning for the long run by reshuffling government agencies and retooling its chip strategy to bolster its defenses, and in ways that could potentially disadvantage U.S. companies.

Others see China making subtle decisions like sitting on mergers before Chinese regulators or rewarding European or Asian rivals of U.S. companies. For example, Gavekal's head of research, Arthur Kroeber, says that U.S. carriers didn't get a single flight slot at Beijing's second-largest airport when it recently opened.

But a consumer-oriented boycott or move against companies with significant operations in China, such as Apple (ticker: AAPL), is unlikely. "Retaliation against Apple or any firm like that would be counterproductive. They want to preserve the ecosystem and capability and relationships that having Apple operating in China and Foxconn assembling phones create," says Thomas Gatley, senior analyst at Gavekal, noting that's especially true as companies like Apple look to diversify their supply chains.

The takeaway for investors: While most of the companies ending up on U.S. blacklists aren't publicly owned, a handful of big Chinese technology and internet companies, including Alibaba Group Holding $(BABA)$ and Baidu $(BIDU)$, have cloud businesses or data that could eventually put them in the crossfire.

For those drawn lately by China's economic recovery prospects, focusing on companies catering to Chinese consumers may be a less volatile way to participate, through exchange-traded funds like Global X MSCI China Consumer Discretionary $(CHIQ)$ or active funds from veteran emerging markets managers who tend to favor companies focused on domestic consumers, like Matthews China fund (MCHFX) or William Blair Emerging Markets Growth (WBEIX).

For those focused on the U.S., the investment impact will be felt over the course of some years, as companies reassess new investments in China following three harsh years of Covid restrictions that pummeled the economy. China's crackdowns on the property and technology sectors, and President Xi Jinping's interventionist policy approach, also are considerations.

Another variable: The U.S. has increased scrutiny of investments in China and restricted access to core technologies, while China is beefing up efforts to rely less on the U.S. and others.

"It is becoming increasingly treacherous for multinational corporations to navigate through barriers to private enterprise that are being constructed by the U.S. and Chinese governments -- and some are finding themselves forced to choose which of the world's two largest economies is more important to them," says Kurt Tong, a managing partner at consultancy the Asia Group and former U.S. consul general in Hong Kong.

These shifts will be like ice melting -- a very slow but significant reshaping of relationship and corporate strategy that will create spillovers in different parts of the global economy and markets -- and that will force a rethink by investors and companies.

"This is a multidecade regime change, one in which national security has replaced economic interests," says Mohamed El-Erian, chair of Gramercy Funds Management and former deputy director of the International Monetary Fund. Increased nationalism in China could push U.S. companies to follow in the footsteps of Yum! Brands $(YUM)$, which spun off its China operations years ago into Yum China Holdings $(YUMC)$. "Today, Yum China is viewed as a Chinese company, but Yum! Brands receives dividends, " El-Erian says.

The bigger question may be the outlook for Chinese companies operating in the U.S., especially if the Restrict Act passes in its current form. Such legislation could create an existential risk for Chinese technology companies in the U.S. -- and, if nothing else, make it difficult for these companies to expand in critical sectors that fall under a broad national-security umbrella.

Even if the U.S. and China maintain a "managed decline" in their relationship, Chinese telecom, aerospace, defense, and technology companies -- especially semiconductors and quantum-computing companies -- could be targets of additional restrictions and sanctions, says Clayton Allen, a director at Eurasia Group focusing on politics and policy.

The battle could also expand to new fronts, including inputs for electric vehicles, an area where China has more leverage, given its dominance in parts of the clean-energy ecosystem.

"The two complementary economies attract each other like magnets, but a thicket of economic and national-security concerns -- and a backdrop of deep distrust -- are pulling deals apart," says Asia Group's Tong.

Write to Reshma Kapadia at reshma.kapadia@barrons.com

 

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March 31, 2023 21:30 ET (01:30 GMT)

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