Earlier this year, the Daily Journal (DJCO, Financial) made the first significant change to its stock portfolio since the fourth quarter of 2014.
The company, which counts the billionaire investor Charlie Munger (Trades, Portfolio) as its chairman and portfolio manager, acquired 165,320 shares in Chinese e-commerce and tech giant Alibaba Group (BABA, Financial). According to the company's latest 13F filing, this holding made up 17.6% of the equity portfolio at the end of June 2021. It was worth $37.5 million.
However, since the Daily Journal acquired this holding, shares in the company have plunged. Year-to-date, shares in Alibaba are down 13%, and over the past 12 months, the stock has dropped 22%.
Regulators crack down
The sell-off was triggered as Chinese policymakers have started to crack down on monopolistic activities in the country's technology sector. Towards the end of last year, regulators suspended the IPO of Ant Financial after the company's founder, Jack Ma, criticized the Chinese banking industry and regulatory system. Ma is also the founder of Alibaba.
In an interview with CNBC, Munger later stated that the attack on Ma was needed to control the tech entrepreneur. However, since then, regulators have continued to scrutize the Chinese tech sector more closely. At the beginning of July, Chinese ride-hailing company Didi (DIDI, Financial) became another high-profile victim when regulators took aim at its data security issues just after it was listed in New York. The stock crashed 40% after the IPO as a result.
Since then, the country's regulators have also moved on to the tutoring industry. Specifically, regulators have banned tutoring companies from using the variable interest entity (VIE) structure that all Chinese tutoring companies used to go public in New York. This has triggered speculation that other VIE structures could come under attack. In fact, Alibaba's stock is a VIE structure.
What's the deal with VIEs?
VIE structures are the easiest way for Chinese companies to raise money outside of the country, although they are not technically legal. Policymakers have tolerated them for the past two decades as they have helped companies gain access to capital. VIEs are corporate structures which are essentially holding companies, usually based out of tax havens. They give foreign investors the ability to invest in a business while limiting investors' control.
Historically, investors have always assumed that Chinese regulators would allow this situation to continue, as putting a stop to it would cut off access to capital. It now seems as if regulators are reversing their stance.
This raises a question mark over all VIEs, including Alibaba. If Chinese regulators take the ban further and extend it to All New York-listed businesses, it's unclear what, if anything, would remain for shareholders. Are regulators just making their presence known, or will they really begin to limit foreign direct listings? While access to foreign capital can help companies get off the ground, it can later come back to bite a country if foreign investors reap the majority of the benefits from their business growth, so it is currently unclear which option would be more beneficial in the eyes of Chinese regulators.
Has Munger made a mistake?
Considering the above, I think it's reasonable to ask if Munger has made a mistake with Alibaba. The company's fortunes, at least from the perspective of a shareholder in the U.S. listing, are unlikely to be affected by this disruption.
It seems likely that over the next few decades, the Chinese economy will only continue to expand. As one of the country's largest businesses, Alibaba will certainly benefit from this. Munger is also close friends with Li Lu (Trades, Portfolio), who is an experienced investor in China. And for this reason, I think he probably knows more than most when it comes to analyzing Chinese businesses and the risks of investing in these equities.
Therefore, I do not think it is unreasonable to assume that Munger wouldn't have invested if he were not entirely comfortable with the risks involved. However, I will personally be steering clear of this one, as the risk is above my appetite.
