The selloff in Chinese stocks in the U.S. in recent days — the worst downturn since 2008 — could be a signal that the boom in U.S. listings of Chinese companies is coming to an end, according to Muddy Waters Capital CEO and founder Carson Block.
The rout seems to have been driven by the latest in a series of crackdowns by the Chinese government on companies whose shares trade publicly in the U.S. Block, a short seller who became famous for exposing Chinese frauds, believes the communist government is sending a message to its corporations.
That message: “Don’t think of raising money in the U.S. capital markets.” For companies already in the U.S., Block thinks China is sending a warning. “You’ve got to work on your plan to basically get the f**k out of the U.S. before you get kicked out,” Block told Institutional Investor in a phone interview.
The short seller suspects that Chinese authorities are responding to a law passed by Congress last year that would eventually require the delisting of Chinese companies whose auditors have not been allowed to be inspected by the Public Company Accounting Oversight Board, a U.S. regulator.
“China is not going to allow the PCAOB inspections,” he said.
But Block is quick to note that his view is only an “interpretation” of the events. “When it comes to trying to understand what’s going on behind the curtain in China, I mean, nobody can do it,” he admitted.
At the least, he said, “foreign investors have learned that China does not feel that it needs to keep them happy anymore. They are lambs that can be sacrificed.”
The sell off, which had wiped out $769 billion in Chinese shares by the end of trading Monday, followed China’s crackdown on its for-profit educational companies, like Tal Education and Gaotu Techedu, formerly known as GSX. Block has previously called Tal a “real business with fake financials” and GSX-cum-Gaoutu a “fake business with fake financials.” Both firms have denied his claims.
As of Tuesday, Gaotu’s stock had sunk from a high of $149 at its January peak to under $3 per share, after China’s Ministry of Education announced on Saturday it would ban education firms from making profits, raising capital, or going public.
But the attack on education companies is just the latest blow. A number of other U.S.-listed Chinese stocks have been under pressure in recent weeks, following the IPO of ride-hailing company Didi Global, which Chinese authorities opposed on cybersecurity grounds. Didi’s app was then removed from the country’s app stores. That action was followed by reports that China is reviewing the corporate structure known as VIE, for variable interest entities, that allows many Chinese companies to circumvent rules against foreign ownership and list in the U.S.
“I don’t think that you can look at anything that’s happened here with the education companies or with Didi right after its IPO in isolation,” said Block. “I think that this really all relates to the auditor inspection issue and the trajectory of the relationship between China and the U.S., which is probably in a downward direction overall, but it’s certainly no better than sideways.”
Block thinks the moves are a face-saving effort by China. “It’s really just Xi Jinping [the leader of the Chinese Communist Party] wanting to make it look like the Chinese companies are exiting the U.S. out of China’s strength and the robustness of the capital markets alternatives available in Hong Kong and in mainland China, as opposed to the U.S. saying, ‘We’ve had enough... you’re gone,’” he argued.
The biggest impact on Chinese companies, according to Block, could be the review of the VIE structure, which runs across sectors. He noted that almost all Chinese companies listed in the U.S. use that structure.
“A lot of lawyers and investors are genuinely shocked right now that the VIE is up for review, but that’s just because they thought that China really wants foreign capital — it would never burn U.S. investors,” suggested Block, who previously worked as a lawyer in China.
That might have been the case years ago, but not now, he said. “I mean this is 2021,” he added. “China’s relationship with the U.S. is not good.”
While the Biden administration hasn’t softened the nation’s stance toward China, the U.S.-China relationship began to sour during the Trump administration. A big change came last December when Congress voted unanimously in favor of legislation that would force the delisting of Chinese companies whose auditors have not been allowed to be inspected by the PCAOB.
Because they are based in China, these companies until now have been able to avoid the U.S. requirement that companies be audited by PCAOB-inspected accounting firms in order to sell shares in the U.S.
Short sellers have argued that rather than open up their books to U.S. auditors, Chinese companies would simply move their listings to Hong Kong. Now they have another reason to do so.
Block pointed out that his views are not part of a China short campaign. “I’m not putting money behind this,” he insisted. “I’m not betting my business on this. I’m just telling you as somebody who’s been a player in this for a little north of a decade, this is what I believe is going on.”