Regulatory repression of the education sector and stocks related to China
As you know, I am a big fan of the Polen team as I have invested in the Australian creation of the Polen Capital Global Growth Fund. When the Chinese government articulated its love-hate relationship with the computer game industry and announced a crackdown on children’s play, it was a relief to hear that the Polen Capital team had made portfolio changes. It follows Polen’s update and provides valuable information about the team’s processes and philosophy.
The Chinese government issued several new regulations for its school tutoring industry after the $ 100 billion school industry on July 24, 2021. The new regulations effectively eliminate most of the sector. Although new regulation was envisaged, the measures taken are much more extreme than expected. These dictates are essentially a complete closure of the for-profit industry without any compensation for existing companies or stakeholders. The dramatic stock price volatility seen, first on rumors and then on the actual launch of new regulations, demonstrates the unexpected and dramatic impact of regulatory changes.
Undoubtedly, there is reason to believe that regulatory actions in the for-profit education sector cannot be extended to other sectors in China. However, the demonstration of willingness to make such dramatic regulatory changes increases this risk according to Polen. In the opinion of the Polen investment team, there is now a significantly greater risk in any area of the Chinese economy that could be considered “sensitive” as they are areas such as real estate services, healthcare and internet with capital letters.
While Polen Global Growth’s strategy has no exposure to the extracurricular tutoring market, Alibaba i Tencent they have long remained in the Global Growth portfolio. These charges have already been dropped.
It can be argued that both companies represent two of the most dominant businesses currently on offer. Polen has considered these businesses as variable interest entities, as it is the only foreign capital channel that has shares in each company. This posed a risk because it meant China had capacity to usurp these foreign shareholder businesses, resulting in a permanent loss of capital. The team felt comfortable with this risk with the following criteria:
- China values foreign investment in these companies because they are both consistent with the party’s stated goals of managing the rivalry of the great powers with the United States and also moving its economy from an export-driven economy to a more prosperous one. oriented to domestic consumption.
- The shares of both companies are so widely owned on a global scale that appropriating them could cause major political turmoil for China, which would not be consistent with the party’s goals. Finally, the risk of appropriation was considered to be so low, that Polen considered that, given the dominance and possible returns on investment, both Alibaba and Tencent were likely to produce, they belonged to the Global Growth portfolio. Risk was also managed through the size of the positions.
Although the government has always had one capacity to appropriate business of foreign owners, until recently had not demonstrated the will to do it. This changed recently when the Chinese government demonstrated its willingness to effectively turn its for-profit education businesses into public services, requiring them to re-register as non-profit entities. This abrupt and unexpected regulatory change decimated the $ 100 billion for-profit education industry and left material and permanent capital losses to foreign shareholders.
While it could logically be argued that such extreme actions will not enter China’s technology sector, increased regulation and the government-led capital allocation potential of these companies could lead to lower profit growth. to what was expected.
Simply put, Polen believes that the possible negative results of the investment case for each company have expanded, while the positive results have probably decreased.
To be clear, Polen’s team is not “calling” China and, in fact, believes that the risk of such draconian regulation of the Chinese technology sector is unlikely. That said, given the opportunity set within the Global Growth portfolio, it is prudent to reallocate client capital to companies likely to produce similar profit growth over the next five years with a greater degree of certainty.
As such, Polen liquidated the positions and reallocated the funds. At the time of the sale, holding sizes were around 2.5 percent.
Alibaba and Tencent are big companies and no doubt one or both could appear in the portfolio in the future. Polen Capital does not believe that China is irreversible. They simply recognize that right now the risks have risen and take advantage of the global opportunity offered to achieve the goal of growing the growth of the underlying profits of the Global Growth portfolio at an average adolescent rate, while taking fewer risks.
Polen has used the revenue to add a new position to ICON plc, a global provider of outsourced development and marketing services to the pharmaceutical, biotechnology and medical device industries.
The Polen Capital Global Growth Fund has shares in ICON plc. This article was prepared on August 10, 2021 with the information we have today and our vision may change. It does not constitute formal advice or professional advice on investments. If you want to operate ICON plc you should seek financial advice.
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