Invest Like the Best with Patrick O'Shaughnessy
· Patrick O'Shaughnessy
[00:00:00] S0: I'd love to ask some investing questions. This is an investing audience. If I were to shrink down the investing debate about China to a single common debate, it would be around ByteDance, because it’s a company that produces crazy amounts of free cash flow. Its equity trades at a tiny fraction of that free cash flow in terms of a multiple than it would if you took the exact same financials and put them in America—it might be, I don’t know, ten times more valuable or something like that. So people use this as an example of: what do you think about ByteDance, when they’re really asking, what do you think about the opportunity to invest in China? Maybe this is the right time to talk about the sort of kneecapping that happened several years ago around some of the Chinese internet giants—what happened, why it happened, and what that tells us about the Party and beyond. But I’d love just your general framing on how to think about these companies—which sound really interesting and fantastic, which have produced lots of free cash flow in some cases—as investment opportunities, or not. Or maybe they just belong in the “too hard” pile for American investors.
· Dan Wang
[00:00:00] S1: As a former technology analyst at Gavekal Dragonomics, this question was on our minds every day. Our clients were endowments, pensions, hedge funds, and asset allocators of all sorts—from a strictly macro perspective. So I never said anything about buying or selling particular stocks, but we thought deeply about these broad trends in China. There are several paradoxes. The first paradox is that Chinese companies are really capable, and China’s economy has grown by an average of something like 9% over the past 20 years. And what has been happening to China’s stock market? It’s been essentially flat. The Shanghai and Shenzhen exchanges have not risen very much—nothing commensurate with 9% growth. There are a variety of structural factors that make it really difficult for China’s stock markets to grow at large. That’s one component of the valuation puzzle with a big company like ByteDance or Alibaba. Alibaba is listed and still relatively cheap. I think another paradox here is that, yes, a company like Alibaba or ByteDance could be throwing off so much cash, but the nature of their businesses sometimes entangles them with the Communist Party. The Party, as I think about it, resembles something like the God of the Old Testament—very generous sometimes, but it can also randomly smite you because it’s trying to pursue some sort of values-driven belief system. In 2018, when I was living in Beijing, ByteDance was humiliated by the government after officials said that one of its suite of apps had violated “core socialist values” because it contained a lot of jokes the Party didn’t like. The founder of ByteDance, Zhang Yiming, wrote a totally self-flagellating letter saying, “We are so sorry that we did not uphold core socialist values, and I am at fault.” It’s just impossible to imagine any tech CEO in America writing something like that. Alibaba, most famously, was founded by a loudmouth named Jack Ma, who shot off his mouth one too many times in 2020 when he launched a blistering broadside against financial regulators, saying that they were behind the times. Shortly after that, the Communist Party smashed Ant Financial and prevented it from going public—which is still the case today. Ant Financial is still not public.
· Dan Wang
Soon after, the Party started taking the scalps of companies beyond Alibaba, including online education and e-commerce firms, with antitrust actions across the entire sector. That part is real as well. Then there’s a third component of these risks that investors have a hard time putting to bed: the suite of geopolitical issues particular to China. American investors aren’t even buying Alibaba directly—they’re buying from a Cayman Islands entity that has contractual relationships with ByteDance. Are we really sure we’re getting something real here? It’s hard to lay that fear to rest. China has capital controls, and that has deterred a lot of investment, including portfolio flows from many investors. Probably the biggest geopolitical puzzle for most people is that Beijing is very clear it intends to seize the island nation of Taiwan one day. If it does so, it’s likely to face very hard sanctions from the U.S. government and probably all Western governments. We saw what happened in 2021 when Russia decided to move on Ukraine: a lot of central bank reserves in Russia were frozen, American portfolio managers could no longer invest in Russia, and even McDonald’s Corporation had to leave Russia because of sanctions. Can anyone really be sure that a few years from now—or even a few months from now—Beijing won’t initiate some sort of action against Taiwan? This is not really my expectation that they will do something. But none of us can be sure that they won't do something. And so long as that fear is present, I think that goes some length to explaining why it becomes pretty unappetizing.
· Patrick O'Shaughnessy, Dan Wang
[00:00:00] S0: ByteDance trades for 10 times. Recast. Three times— [00:00:00] S1: Yeah, whatever. A pension or you're a university endowment. Do you really want to hold this? No thanks. And then the U.S. government Treasury comes asking, “What are you doing?” [00:00:00] S0: Thinking about potential future equilibrium states between the two superpowers—let's just assume these are the two big important powers. One of the things that’s always caught my attention in the U.S., maybe the reason it’s become less interested in global affairs, is how self-sufficient it is. There’s actually not a huge percent of the economy that’s reliant on the outside. Pretty self-sufficient in lots of ways in terms of major goods. Understanding that, is one of the future scenarios that these two just sort of exist as separate universes from each other? Is that one? What are the other equilibrium states that you could imagine 20 or 30 years from now between the two countries?
· Dan Wang
[00:00:00] S1: Equilibrium is a really important concept here because it implies that no state really feels the need to shift in a big way. I think the scary thing might be that something upsets the equilibrium—where one country feels under threat in some way. First, I think I only partially agree with you that the U.S. feels very self-sufficient at the moment. You're right: by a lot of simple conventional measures, imports are something like 12% of U.S. GDP, and that's not a huge amount. But in a crisis, it turns out that the U.S. actually really needs that 12%. I think a lot about the early days of COVID, which speaks to another difference between China and America. In the early days of COVID, the U.S. struggled to produce anything as simple as masks and cotton swabs. I was living in China, and one of the most instructive little moments I remember was going up to a factory manager around Shanghai. This factory manager marveled to me that American manufacturers didn’t get their act together to produce really important goods. In this Chinese guy’s formulation, too many American companies asked themselves whether making masks and cotton swabs was part of their core competence. And for very few companies, that’s their core competence—so they didn’t make it. Chinese companies say that making money is their core competence; therefore, they go make what the market demands, which then was masks and cotton swabs. So I was grabbing masks made by Foxconn, which normally makes iPhones, and by JD.com, one of China’s biggest e-commerce retailers. They just decided to retool a lot of their factory lines to produce what the market needed. Then there was some complacency and lack of hustle among American manufacturers to actually produce these things. In the early days of the pandemic, a lot of consumer goods were in shortage. Furniture was in shortage. Random fruits ran out depending on which part of Mexico had a COVID outbreak at that time. And generally speaking, the American manufacturing base has not covered itself in glory over the last 20 years. It’s not just Boeing, Intel, Tesla, Detroit—broadly, there’s all sorts of rust and inability to move. If we take a look at China’s energy imports, they’re importing less and less, in part because they’ve scaled up so much solar capacity within China.
· Dan Wang, Patrick O'Shaughnessy
By the end of this year, China is expected to add 500 gigawatts of solar capacity. The U.S. is expected to add about 50 gigawatts—just one order of magnitude less. There are 33 nuclear plants under construction in China right now, and zero under construction in the U.S. The Chinese have been much more successful in shifting their consumers toward buying electric vehicles. By the end of this year, one out of every two cars sold in China will be electric. They’ve been able to blunt this dependence on foreign energy. It’s not growing so much, and perhaps it will decline soon enough. There are all sorts of ways in which they’re also very serious about food self-sufficiency. They’re also very serious about semiconductor self-sufficiency. And so this is again where I see, if the U.S. and China are in competition, China’s been much better at patching up its own problems than the U.S. has. [00:00:00] S0: The factory story—the retooling to make masks and cotton swabs—sounds like a very high-agency thing. Which society do you think is higher agency?