Monday, January 24

Addressing China’s Variable Interest Entity Structures


SIMON BROWN: I am now chatting with Anil Jugmohan, Senior Investment Analyst at Nedgroup Investments. Anil, I appreciate the early morning time. Speaking of China: first I want to get to the end of the story and work backwards, which are VIEs, those variable interest entities, [with] many companies such as Tencent, Alibaba; if we buy them, we actually buy them through these VIEs. It is a strange structure that is used in China. Is it something that shareholders should be extremely concerned about? The short answer? Is it a dangerous structure for us?

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ANIL JUGMOHAN: Good morning, Simon. Thank you very much for inviting me here. I am so happy to be here. That’s a very good question you ask about VIEs. I think for a long time they have [had] a lot of risk inherent in them. As you know, probably more recently, investors have become much more aware of the inherent risks, and that is what is causing a lot of stock price drops.

I think if you look only at South Africa, Naspers, as you said, we are buying Tencent through this VIE structure and it is probably worth mentioning at this point that not all VIEs have the same level of strength in terms of actual access and ownership. . to the underlying cash flow. So investors must do their job. It’s not a case where you can just take a general approach and say, look, they’re all good or they’re all bad.

But there is definitely a risk in the end and, as with any investment, you should feel comfortable and confident that you are being paid adequately to take certain risks and if there is a discrepancy between those risks, you should probably steer clear.

SIMON BROWN: I listen to what you say. So the question, I suppose, is: Is the Tencent VIE one that is better structured and perhaps lower risk, or is it perhaps one of the scariest?

ANIL JUGMOHAN: It is quite difficult to say whether it is completely good or completely bad; It’s probably not as good or bad at this point as people think. However, I think that, as I mentioned, now there is investor confidence. If you are suspicious of where they think the true intrinsic value is, in relation to the price they must pay…. And probably by now, the stock price is back a bit relative to the beginning of the year, investors are getting paid a little more to take those risks, and they have to do that kind of analysis themselves.

SIMON BROWN: I like your point there: at its core, it’s that balance of risks.
Let’s move on to “common prosperity,” a phrase that Communist Party leaders have been throwing around a lot in China. In essence, they are somewhat concerned about the extremely wealthy and even some of the sectors like education; private education was basically shut down overnight. This has scared investors a lot this year, late last year. Is it something as scary as it sounds? Common prosperity as a kind of broad idea. I look at it and I think it can’t be the worst thing in the world.

ANIL JUGMOHAN: Yes. Simon, I agree with you. In fact, I don’t think it’s the worst thing in the world. I think with China we often see the headlines [of] some of these super rich billionaires often make news and buy luxury jets etc. But we don’t really hear about the half of the population who desperately need poverty alleviation. We’ll probably one day look back at all of this and say, look, when China was a great case study for a species of the three ESG pillars (environmental, social, governance), because what they’re trying to do now is focus on type from each of those areas and really try to elevate the country from various sectors. You also mentioned education. Many of those private education companies are literally behind profit at the expense that it really costs people huge amounts of money, that they find it difficult to pay for their children, and buy houses, and just do the basic things that so many of them do. they do. We take South Africa for granted.

So we will probably look back and say that the Chinese government is doing the right thing. The Chinese often have their own way of doing things that may surprise Western investors, as you have also seen with stock price movements. I think in the long run they are probably doing the right thing and there will certainly be a period of adjustment.

But what you’re likely to find is that as the general population’s income levels rise, typical coffers say that where we’ve seen stock prices take a hit now, they will ultimately benefit from that as well. I think there will be a longer term benefit.

SIMON BROWN: So the question that a lot of people have been asking is: Should China be considered an investment destination right now? My sense of chatting with you these few minutes is that the answer is ‘yes, but’, and the ‘but’ is, as with any investment, there are risks. I guess you make sure you know what you are doing and are aware and comfortable with the associated risk.

ANIL JUGMOHAN: Simon, I think you got it right. Unfortunately, from the perspective of human behavior bias, humans often don’t do very well when it comes to investing. As you know, after a market crash, everyone’s reaction is to pull out, and after the market has done really well, they want to invest and usually that’s exactly the wrong time that people should. be doing those movements. You cannot expect to buy high and sell low, waiting for large amounts of money to invest.

But just when questioning whether China is investible, I think that, as with anything else, you should focus on companies where the value you are getting actually exceeds the price you are going to pay.

Going back to your VIE question, there are actually a lot of publicly traded companies operating according to government policy that are doing great things and offering excellent value.

So it’s not like you could consider a blanket thing that would just rule out anything China related, and it’s the same with any other region you might consider investing in, be it an ME. [emerging market]or DM [developed market]. You really have to be careful.

SIMON BROWN: Yes. Know what you are doing, know your risks, be comfortable with those risks. We leave it there. Anil Jugmohan, Senior Investment Analyst at Nedgroup Investments, thank you for early this morning.


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