Thoughts on China’s Regulatory Landscape

Below is the market commentary excerpt from our recent 2021 Q2 letter.

The Rise of Mr. Government

Modern finance, as a school, was developed by western civilization. Investing, as a derivative of finance, can be said the same. Among all the value investing books published, there are very few mentions of evaluating government as a stakeholder or risk associated. This is unsurprising because the whole western economy system is built upon free market economy theory which believes government should intervene as little as possible. When capitalism grows more mature, we started to see a reversal shift from such premise, most recently in Big Tech regulation, but that is nowhere close to the role Chinese government plays in its economy. This is why I stressed heavily on value creation for all stakeholders, including the government, in my framework.

In the past quarter, we have seen humbling evidence of how important Mr. Government is to Chinese businesses, as waves of looming regulations on Chinese businesses materialized. E.g. the new law curbing private education was released in May. It explicitly stresses the non-for-profit nature of K9 schools and strictly prohibits related party transaction to move the profits out and M&A of schools. In July, the Cyberspace Administration of China launched data-security investigation on a few newly IPO’d Chinese tech firms, most prominently Didi, the ride hailing dominator in China. As I’m writing this letter, government delivered another heavy blow to after-school tutoring industry by releasing the Opinions on “Double Reduction” for Students in the Compulsory Education Stage, which essentially ruled all subject-related tutoring should be non-profit. Against such backdrop, some Chinese stocks suffered panic selling in similar scale only seen in 2008 financial crisis.

Implications on Investors’ Trust

Many called such interventions “unconstitutional”, “confiscation” or “authoritarian”, and starts to claim that Chinese stocks are not investable at all. I don’t fully agree with such view. For private education, I was supportive for certain tighten-up by stating “Without a sound regulatory framework, such a market is destined to be flooded by greedy and predatory players” in my last letter. Chinese government & economy, in my opinion, is a very complex hybrid system with its own merits. It seems to me that most western observers do not understand it and tend to use century-old ideology to over-simplify it. Taking one recent example, Charlie Munger in his interview with CNBC on June 29th, 2021, touched on Chinese regulation, crediting China by saying “…a wise regulator stops this stuff [Archegos’ meltdown] before it starts…what interests me in this is that the communist Chinese behave the way I am talking in favor of”. Such response disturbed even many value investors who are known for following Buffett & Munger as a cult. It seems to me that such misunderstanding is widespread and now exacerbated by the political tension between US & China. Without a deep understanding of how China works, foreign shareholders won’t be able to hold through turmoil like this one.

Widely in western investing frameworks, there are generally two pillars: fundamentals (related to the company) & valuation (related to Mr. Market). For a sound framework for future investing, I believe a third pillar of same significance on regulation (related to Mr. Government) should be added. Before this point is fully ingested by global investors, Chinese companies listed overseas may lose confidence in general and may carry lower valuation than global peers.

Our Understanding of the China Model

Helped by a hybrid model of socialism & capitalism, China, with over 1 billion population, grew its GPD per capita from $195 in 1980 to $10,262 in 2019. (i.e., a 52 folds jump or 11% annualized growth over a 39 years period!) Yet, critiques claim that this model is not based on a plural political system and that it is authoritarian. It is fair to say that the top priority of Chinese Communist Party (CCP) has always been maintain its power, which is true for any political party. What’s unique about the China model, however, is that CCP desperately tries to justify the legality of its power in a practical way – that it must be earned by improved welfare of the whole society.

Without the Separation of Powers, Chinese public administrative system serves legislative & executive roles at the same time. A typical process runs like this: 1) Central government drafts, solicits feedbacks & finalizes guidance documents. Such documents are conceptual and brief in nature; then 2) Individual agencies or Local governments use discretion to interpret the guidance, to design detailed policies & to enforce the implementation.

Such unified power, while with good intention, can utilize the best parts from socialism & capitalism and can be very effective and flexible. Take one example from not far ago, China started promoting Electric Vehicle (EV) around 2010. The market was initially swamped by players who built “cars” that better to be described as toys, only to cheat for subsidies. Over time, the government iterate through few versions of regulation, e.g. using technical specs like range to scale subsidy. Nowadays, China has multiple EV brands that can compete locally at the same level with market leading Tesla. Some of the EV technology developed by local EV companies like BYD are also recognized by global auto manufactures like Toyota in form of partnership.

After observing generations of such policies, I think the China model typically overshoots at the initial stage with little fear of making mistake (e.g. over-promoting if it intends to promote; & over-curbing if it intends to curb), but is generally fast in iterating and finetuning towards the conceptual goal identified by the central government.

China Internet Report 2019

I want to share a great overview study of China tech industry landscape of 2019 by South China Morning Post & Abacus. I think the advanced AI usage by Chinese tech companies are highly under-appreciated by the outside world.

This study has many live evidences of what Kai-Fu Lee wrote/predicted in his latest book “AI Superpowers: China, Silicon Valley, and the New World Order” which I recently just finished. Highly recommended and will try to do a review later.

Another interesting trend particularly interests me is the integration of live streaming and shopping. I think this model (temporarily dubbed it as “QVC on steroid” for the sake of western world readers’ familiarity) has huge potential and I plan to study it more.

Great Oriental Investors – Shoucheng Zhang, a Quantum Polymath (Award Winning Physicist and VC Investor at once)

As I mentioned in my first investor letter, my investing philosophy had deep roots in oriental philosophies. For this reason, I always find those investors who are able to master both eastern and western mental models extremely intriguing. On surface, lots of eastern mental models & philosophies resonate with well-known western principles already, but I also believe they have more unrecognized value to investing practices. I am planning to start a series to document all investors that fits this category, to document my lessons learned from them and to share with my readers their insights (many of which aren’t available in English media).


The first one is Shoucheng Zhang (Wikipedia Link). Zhang is an ingenious physicist, to say the least. He got admitted by one of the top universities in China purely by self-study after the Culture Revolution ended in 1978 when he was only 15, then went abroad and finished his PhD by 24. His best known finding is probably topological insulators, for which he was awarded a Dirac Medal in 2012. His work was estimated by Thompson Reuters to be able to win Nobel Prize in 2014 (Link). Zhang is also a tech VC investor. He is said to be one of the early investors of VMWare (as he’s a neighbor of the co-founder Mendel Rosenblum who is also a Stanford professor) and made hundred bagger on it. He officially started his profession investing career in 2013 by founding Danhua Capital (website link), an early/growth stage VC focusing on disruptive technologies.


Like Charlie Munger, Zhang also see Benjamin Franklin as an archetype. Zhang mentioned that he struggled at a young age on whether he should aspire to be a scientist or an entrepreneur, until he realized he really could be both after reading about Franklin, one of the greatest polymaths in history. Not surprisingly, he is also a fan of multi-disciplinary mental models. As a theoretical physicist, his application of quantum physics principles to investing (and life) is the most interesting insights among other thing. Additionally, contradicting to stereotype of physicists, he seems to have strong interests in Aesthetics.


Zhang’s key philosophy can be summarized by a quote he constantly mentioned in multiple interviews: “Complexity out of Simplicity” or “First Principle”. Before moving on, I think it would be beneficial to expand on the “First Principle” (Wikipedia link) as it initially appeared foreign to me. My understanding is that first principle is a thing/principle/notion which is in its most fundamental form and is self-evident without proof or deduction.  That is where you want to start your learning/thinking process.


Some of my favorite thoughts of Zhang (paraphrased) are below:

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Chinese ADR “Go-Private” Deals Overview-  A Changyou Buyout Inspired Study

On 5/22/2017, Changyou [CYOU] received a preliminary non-binding offer from its chairman Dr. Charles Zhang, who is also the CEO and Chairman of Changyou’s parent company Sohu, to take the company private with and offer of $42.10 per ADS. The offer letter can be seen here: It is interesting that it is Charles Zhang, the person, not the parent company Sohu, to make the acquisition.

As a current CYOU shareholder, I think it’s a OK deal despite I had higher expectation of the turnaround execution which just started to show some positive signs. As of 5/31/2017, there is still about 8% spread between the close price of $38.9 and offer price $42.1. If the deal could be closed timely, it would be a good risk arbitrage opportunity.

Inspired by this event, below I did a general study of all the Chinese ADR “go-private” deals in past few years. I’m keen to get answers to these 3 questions (which could help me evaluate upcoming similar deals’ risk/reward):

  1. How much percent of these deals fell through?
  2. What are the characteristics of the failed deals? (does CYOU have any of these traits?)
  3. How long do they usually take to close?


History of Chinese ADR Privatization Deals

Let’s begin with a rough understanding of a typical ADR privatization process. Credit to a Credit Suisse’s study [link here], here is a great chart showing the 6 milestones of such a process.


It is also important to understand the main incentive of such privatization deals, specifically for these US listed Chinese companies. Like most of the PE backed LBO deals, Chinese ADR privatization deals also target for a relist for higher valuation. However the difference is that, rather than streamlining and growing the businesses for a few year in private arms (in LBO cases), the Chinese ADR companies could seek a faster re-valuation by relisting the firm to its home market (which offered richer valuation, especially back in 2015 before the crash). This also explained why there were so many proposed deals announced in 2015.

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Texwinca (0321.HK) – a Cigar Butt or Anything More?

Disclosure: I do not hold position in mentioned stock. Also, the price has increased slightly since I initially wrote it up (from HK$5.11 to HK$5.30), however all points in this write up are still valid with a price level of HK$5.30.

Company Overview and Recent History

Texwinca is a Hong Kong-listed textile & apparel company, with two main business segments: 1) Textile business, which produces, dyes & sells knitted fabric and yarn, & 2) Retail and distribution business, which sells casual apparel and accessories. Each segment contributes about the half of the revenue to the firm. The vertically integrated cost-efficient model used to work well, however both segments have been hit hard by some adversity recently.

Texwinca’s textile business is one of the largest fabric producers in the world, serving many global fashion brands like A&F, Ralph Loren and Gap. However, it is facing cyclical headwind driven by the soft global (especially US, which is the main textile revenue source) economy and the increasing production cost in mainland China.

The retail business sells its apparel majorly through brand Baleno. However, Baleno (along with many other local mainstreet fashion brands like Esprit, Giordano & Meters/bonwe) has been squeezed very hard in its mainland China market (its main retail revenue source) by new-entering international fast fashion brands like Zara, H&M and Uniqlo. Baleno, once a high end fashion brand, lost its value significantly in the past few years, and is now considered merely as an “immigration worker (lowest income city worker from rural area) brand”. To cope with the competition, the business tried to streamline by disposing all the non-core brands and focus solely on Baleno.

Driven by weak performance on both sides, the stock has lost more than 40% of its value since the recent peak at HKD 9.38 in July 2015. At the current stock price (5.11), the stock looks attractive from first glance with following traits:

Continue reading (CYOU) – A value buy with potential near term earning catalyst

So here is how I came across this name. As I mentioned in my old post “A Part Time Investor’s Investment Process”, I didn’t have a systematic way of sourcing idea, thus usually leaving the portfolio under-invested. More recently, I started playing around with some quantitative funds’ strategy selection criteria, and found LSV’s fit my style pretty well. It goes by two parts: 1) identify value opportunities, by looking at some traditional ratios including EPS, current P/B, current P/CF and current P/S, if any of the ratios is lower than industry median, keep them for step 2; and 2) eliminate “value traps” by examining the recent momentum (e.g. Relative Price Strength over past 26 weeks >=0 & Relative Price Strength over past 13 week is larger than that of past 26 weeks. What is does is basically to look for cheap stocks in a turnaround story, the idea being if the market recently recognize a name, it usually is not a value trap. For further information about LSV, you could visit for further research done by them.

CYOU came out from these filters and happened to be a Chinese ADR, which I thought I may be able to gain some informational edge by researching in its local language. First, still need to give credits to following posts provided me some directions. By the way, their timings are much better as the stock price already went up 40% from the price level they posted their ideas. However, without the recent price surge, it possibly won’t go through the step 2 of momentum checking, meaning I wouldn’t be able to see it until the name started to rebound anyway.

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What do you need to know about Internet Finance in China

You’ve heard “Internet Finance” is booming in China, but what exactly is it? It all began from the inception of Alibaba’s Yu’E Bao (literally means balance treasure) in 2013. Metaphorically speaking, it’s like your Paypal account balance which is as liquid as your checking account, but EBay is paying you 5% interest yearly. Wait, what?! I know what you are thinking, no, I did NOT miss a decimal point. Since I was away from the country for years, I haven’t really paid close attention to this business model until recently.

It was about two months ago, one family friend from China asked me about investing in real estate in US. A REIT name – Inland Real Estate Corporation [NYSE: IRC] looked very attractive to me then and I recommended it to him (see my older post here). The company then hit the 52 week low at around $8 with yield of 6~% and FFO multiple of 8, and seems to be oversold compared to its still solid property portfolio and operation. As we are speaking now, it was announced to be bought private by DRA Advisor in a $2.3 million deal, paying $10.6 per share. However, my friend decided to pass on this would-be 20+% in two months opportunity because he wasn’t interested in investing in a non-principal-guaranteed asset for 6% yield. “I’d better off put my money in my XX Bao, which gives me up to 10%.” he said. Well, that is very impressive, especially they “guarantee” principal, so basically making it a “risk free” investment. I then asked two question: who are they, and what type of asset they have to invest in to give you that return? “I don’t know, why do I care when they guarantee my principal?” replied my friend.

After some research, I think I find some clue.

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