Chinese military companies are surely not the type of exposure you would expect to find in just about every South African’s pension savings. Yet the US government would have us believe that Tencent (and thus Naspers and Prosus indirectly) fall into this category.
It may sound like the underpin of a swanky new Asian restaurant, but the Chinese Military-Civil Fusion is quite different. It is important to understand it from the US standpoint — which is the side of the equation that commands the deepest capital markets, whether we like it or not. Reading the supporting note for the update to the section 1260H list issued by the US Defense Department is helpful. It gives an idea of just how broadly this list of “Chinese military companies” can be applied: “The People’s Republic of China’s (PRC) Military-Civil Fusion strategy supports the modernisation goals of the People’s Liberation Army by ensuring it can acquire advanced technologies and expertise developed by PRC companies, universities and research programmes that appear to be civilian entities.”
The Competition Commission in South Africa has certainly shown a keenness to stretch its mandate in recent years, but even it might be surprised to see something this vague. Basically, the US government can wake up and simply decide that there’s a chance that a civilian company may have technology that is useful to the Chinese army. Better yet, the Pentagon goes on to point out that companies on this list that are seeking reconsideration of the decision would need to provide sufficient evidence to the government to show that the designation on the list isn’t accurate.
Innocent until proven guilty? Not in the current world of US-Chinese relations, unfortunately.
If you scan through the list, you’ll find a name or two that you might recognise (such as Huawei) and a number of companies in industries such as aerospace, construction, electronics, nuclear power, chemicals, telecoms and heavy industries. Though these are seemingly logical sectors for inclusion in a list of military collaborators, just consider for a moment how many Western companies in these types of industries do business with the public sector. In the US, there are a vast number of companies that have been built almost entirely around doing business with the government. Lockheed Martin and Palantir are two easy examples. You’ll also struggle to find many large companies that have no business dealings with government whatsoever.
So, collaboration between the private and public sectors isn’t anything new and isn’t a Chinese invention. Also, it doesn’t necessarily mean there’s a military flavour to it. The US government doesn’t care though; its concern is to avoid any strengthening of the Chinese military through the application of US-sourced investment and commercial relationships.
For those who believe that Elon Musk has captured the US government, here’s something to suggest otherwise: Contemporary Amperex Technology Co Ltd (CATL) is the world’s largest battery maker and it now finds itself on the list. CATL supplies batteries to Tesla and has a commercial relationship with Ford. In fact, it was a Republican senator and the incoming secretary of state who pushed for CATL to be added to the list, so this is coming from within the Donald Trump camp that has such close ties to Musk.
There’s an entire political hornet’s nest to consider here; because electric vehicles also aren’t a great fit for a Republican government, Musk’s positioning will be the talk of the town for years to come. In the meantime, if CATL cannot successfully show that this designation is incorrect, there might have to be a change of plans regarding the supply chain strategies of Tesla and Ford.
But what exactly does inclusion on this list mean? Is it entirely a perception issue, or are there genuine financial penalties?
First, it’s important to know that there is also a so-called NS-CMIC list, which is far more severe as it results in commercial sanctions. Notably, there is substantial overlap across both lists if you scan through the names. On the less punishing 1260H list, the main restriction is that the defence department cannot enter into any commercial arrangements with the companies. There are other potential impacts, such as exporters with a more risk-averse approach viewing the companies as “military end users” and therefore not being able to ship all items to them. Of course, there’s also the impact of an approach of extreme compliance being taken by US firms, where any company on the list is simply not an option for any kind of dealings or investment. This is the safest approach for those US citizens and the most damaging one for the companies on the list.
Innocent until proven guilty? Not in the current world of US-Chinese relations, unfortunately
With such a wide spectrum of outcomes, the risks once you get onto the list go through the roof. During Trump’s first administration, he signed an executive order banning Americans from investing in Chinese firms that the US government believed were owned or controlled by the Chinese military. That’s different from simply having a commercial supply arrangement, but it shows that these list inclusions can have serious ramifications for companies that are relying on US commercial relationships. It can be disastrous for any reliance on American capital.
That’s why Xiaomi fought as hard as possible against its inclusion on the list in 2021, with a federal judge eventually ruling that Washington lacked substantial evidence to support its claims about Xiaomi. The ban on investing in the company was therefore lifted. That created helpful precedence in court from a Chinese perspective, with CATL’s official statement already noting that the company will pursue legal action if necessary.
Being on the list is therefore most problematic for companies that have operational exposure to the US market or which have major US investors. Being off the list is also no guarantee that the US government won’t attempt to shut a Chinese business down, as TikTok owner ByteDance can attest to. At the time of writing, the US Supreme Court is mulling upholding the law that bans TikTok in the US unless ByteDance sells the platform before January 19.
Geopolitical risks are red-hot right now and there are many ways for that to play out.
Much like CATL, Tencent quickly issued a statement in response to its inclusion on the list. Aside from making it clear that a reconsideration process will be initiated and legal action taken if necessary, Tencent also reminds the market that the inclusion on this list doesn’t stop any parties from having business dealings with the company.
It’s also worth highlighting that unlike many other companies on the list, Tencent’s value is derived from its activities in the Chinese domestic market. Exposure to the US is incidental rather than core to the strategy.
Still, Tencent’s share price is down almost 11% in the past week despite an acceleration in share repurchases by the company in response to the drop, which was a clever strategic move. On the local market, Naspers and Prosus are down 11.4% and 9.2% in the past week respectively.
This drop cannot be explained by financial exposure to the US. It can therefore only be attributed to sentiment and a risk-off approach in response to the news, particularly in a jittery environment where the incoming Trump administration has put renewed focus on issues such as tariffs and trade wars. Markets hate uncertainty and they especially hate a catalyst for their fears. It’s very early in 2025 for these things to already be happening, hence the sharp response in the market.
Is this a buying opportunity? Given the strong recent performance of Naspers and Prosus under new CEO Fabricio Bloisi, it just might be. Even after the drop, Naspers is up 22% over 12 months and Prosus is up 20%. The e-commerce businesses are showing a vast increase in profitability and the entire focus at the group has switched from chasing market share and revenue growth to prioritising profits. Plus, the Despegar deal in South America looks like a solid strategy at a reasonable valuation for a platform business. There’s a lot more to like at the group these days than what we’ve seen in recent years.
Exposure to China requires a strong stomach. Volatility is assured and the gains are not. Still, when the market reacts like this, there is often money to be made. Reasonable position sizing is key, along with keeping a very close eye on proceedings.
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