Waiting for the final audit

In September 2014 Facebook hosted a conference at its headquarters to discuss how the tech sectors in China and the US could work more closely together. One of the attendees was Zhang Yiming, the founder of the then two year-old Chinese start-up Bytedance.

Zhang, who was 30 at the time, noticed that a lot of Silicon Valley engineers were already using devices and apps from Chinese companies. After returning home, he wrote an article titled “The Golden Era of Chinese tech firms”, expressing confidence in Bytedance’s prospects in the US.

Facebook boss Mark Zuckerberg visited Beijing a few months later as a newly-appointed member of the advisory board for the Tsinghua University School of Economics and Management, an institution that has played a prominent role in shaping Sino-US relations over the years. He made optimistic noises about improving the dialogue between the two nations. “We also want to help the rest of the world connect to China,” he promised in a speech he delivered in Mandarin. 

A few years later, Bytedance was making a splash across the US with its addictively popular video app TikTok. Zuckerberg’s tone was different. “I think it’s well documented that the Chinese government steals technology from American companies,” he told a congressional hearing in Washington in 2020. His blunt assessment angered netizens in China, some of whom had warmed to the Facebook founder as “China’s son-in-law” because of his marriage to an ethnically Chinese woman.

However, when news broke last week that Zuckerberg had hired a top consultancy firm in America’s capital city to lead a smear campaign against TikTok and deflect political scrutiny away from Facebook, no one seemed too surprised. Talk of how the two country’s tech firms might work closer together no longer gets much traction either. Instead, commentators are focusing more on how companies with significant commercial interests or shareholdings on both sides of the Pacific need to draw up separation plans, because of the changing dynamics of China-US relations.

Why no news might be good news for Didi…

Probably the most high-profile casualty so far of the separating tech worlds of the two superpowers is Didi, the ride-hailing giant. Soon after raising $4 billion in an initial public offering in New York last June, it was dramatically slapped down by the Chinese government for failing to respond to concerns about data security. Its share price crashed immediately. Faced by the threat of a shutdown of much of its operation in its massive domestic market, Didi had little choice but to announce that it would be dumping its New York listing.

Commentators in China described Didi’s decision to call it quits as “a declaration of political allegiance” to Beijing that raises bigger questions of how increasing sections of the world’s two largest economies would start to decouple (see WiC567).

Among many other disagreements, Beijing has also been locking horns with Washington over the push from US regulators to get more oversight of Chinese firms that have sold shares on American bourses, especially in terms of fuller access to audit information. The Chinese government has long refused, arguing that its national security could be compromised if companies such as Didi give access to sensitive data.

The two-pronged attack has seen Didi face pressure from both sides to delist from the NYSE. On March 11 its share price plunged 44% in a single day after Bloomberg reported that its plan to switch to the Hong Kong bourse had also been shot down, because Chinese regulators weren’t happy with its revised proposals to prevent data leaks.

The news came amid a brutal sell-off across Chinese tech stocks in general – a ‘techmageddon’ of panic selling among hedge fund managers, the Wall Street Journal reported. The fear was not only about what was going to happen to Didi, but that hundreds of Chinese stocks were heading for forced departures from the New York market.

Then in an apparent reversal of policy on March 16, Beijing came up with a strong statement to stem the panic. Fund managers took heart from assurances that the Chinese government “will continue to support various enterprises to seek listings in the overseas market” and the promise that officials from both sides were “working on a concrete cooperation plan” (see WiC577).

A truce in the audit war was soon being trailed by media sources and the China Securities Regulatory Commission published new draft rules last weekend that signalled that Beijing is looking for a compromise in the row, preferring that to a wave of confidence-eroding delistings at a time of growing economic and geopolitical fragility after Russia’s invasion of Ukraine.

China Daily – the newspaper tasked with feeding Beijing’s official line to the international community – published a front page story on Monday, laying out what the new deal meant: a scrapping of requirements that on-site inspections in China of overseas-listed Chinese firms should be “mainly” conducted by Chinese regulators or rely on their inspection results.

“Experts said the changes will help remove hurdles to China-US cooperation on audit oversight that may prevent some US-listed Chinese companies from being delisted over the next two years,” the newspaper added.

Didi’s share price in New York has rebounded strongly since the announcement, although there’s no further news on the ride-hailing giant’s hopes to sell shares in Hong Kong instead.

But perhaps no news is good news for shareholders, in this respect. Why hurry the process, some counsel: after all, the more emollient spirit of compromise exhibited by Beijing last weekend could mean that Chinese firms may not need to depart the NYSE after all?

In the same lane as Didi: step forward TuSimple

Didi is based in Beijing but hosts much of its AI research and development effort in California. It also counts Uber and Softbank as major shareholders. That cross-border identity makes it harder to choose between political masters. But it is not the only company in the fast-growing ‘mobility sector’ to feel the heat from rival regulators. Companies with significant business interests in both the US and China are under similar pressure.

One example is TuSimple, a developer of self-driving trucks. It went public in New York just a few months ahead of Didi’s disastrous IPO. But according to news portal Jiemian, it is now in talks to make its China operation into a completely separate entity in a bid to stave off regulatory risks.

TuSimple was founded in 2015 by a group of young entrepreneurs and programmers, including Chen Mo. Chen was born in China in 1984 but emigrated to Canada with his family when he was a boy, Jiemian reported last year. He returned to the country of his birth in his twenties and tried his luck at start-ups. It didn’t take him long to focus on the autonomous driving sector, which was attracting huge interest from investors.

Chen partnered with Hou Xiaodi, also born in the 1980s, to found TuSimple. A talented computer scientist, Hou was educated at Shanghai Jiaotong University before earning a PhD in computing and neural systems from Caltech (the California Institute of Technology, a private research university based in Pasadena).

The autonomous driving market has drawn a crowd of major tech players in both China and the US – with much of the investment directed at the biggest and highest profile segment of driverless cars. TuSimple picked a less competitive but still lucrative path into the $4 trillion global freight market. After raising $1 billion last year, it already has more than 70 driverless trucks in operation, with about 50 of them (manned by ‘safety drivers’) actually hauling freight in southwestern US states such as Arizona.

In China TuSimple has focused more on developing its logistics operations in container ports, including Shanghai’s. But Jiemian reported last month that the company was also in talks to sell the China unit for about $1 billion. At least two suitors, including the state-backed financial conglomerate Citic, have submitted takeover bids. If the sale goes through, Citic is planning for a subsequent management buyout led by Chen.

The sale is TuSimple’s plan to remedy its ‘identity crisis’?

TuSimple has been categorised by Chinese media outlets as a ‘mixed race company’, a term employed by local journalists to describe firms with interlocking shareholdings or business interests between China and foreign markets.

The company’s name is a combination of the English word ‘simple’ and the Chinese pinyin of ‘road’ (or tu). But it’s hardly straightforward to describe TuSimple as either a ‘Chinese’ or a ‘US’ firm. It set up headquarters in both Beijing and San Diego. It has operations in both markets, with plans for growth in both. Its major investors include Charles Cao, founder of Chinese portal Sina (which was delisted from New York in 2020; see WiC504), the American logistics behemoth UPS, and the California-based chip designer Nvidia.

Indeed, one of the main draws for investors was TuSimple’s promise to bring together the best of both markets’ scale and tech talent to create a globally competitive proposition. But the reality today is that there is growing pressure on companies like TuSimple to pick a side.

In TuSimple’s case, the Nasdaq-listed firm seems to be making preparations to distance itself from its Chinese background. Just a month prior to the company’s launch on Nasdaq, the Committee on Foreign Investment in the US (CFIUS) began a security probe into the ownership stake held by Cao, a director who is also linked to the microblogging platform Sina Weibo. As part of an agreement to bring the investigation to a close, TuSimple announced in February that Cao (who owns 13% of its shares) wouldn’t be reappointed as a board director. It also agreed to limit access to its operational data and “adopt a technology control plan”, while also making regular reports to CFIUS officials.

In another move last month, TuSimple said chief technology officer Hou will replace Chen as chairman. Hou will also take over the chief executive role currently occupied by Lu Zheng, a former executive of Citic Capital and CIC (China Investment Corporation).

The appointment could then pave the way for a sale of TuSimple’s China operations, which might be subject to a management buyout led by Chen and Lu. This (presumably involuntary) separation mirrors the challenges being presented to other ‘mixed race companies’, Jiemian comments, as they grapple with more piercing regulatory oversight from both the Chinese and US governments. Splitting a company into two as a response to rival regulatory demands might be the simplest way forward.

Arm plans to spin off its China unit as well?

Nvidia, as a shareholder of TuSimple, probably has some advice for Chen and Hou on navigating political and regulatory challenges. Last year it had asked Chinese decisionmakers to approve its $40 billion takeover of British chip designer Arm, although that deal collapsed (blocked by America’s Federal Trade Commission) before Beijing was required to reveal a formal position on the takeover.

Arm’s controlling shareholder Softbank has since opted to float the chip designer in New York. The IPO plan, however, has been hampered by concerns that Arm is not going to be able to audit the financials of its China joint venture (called Arm China, see WiC501).

According to the Financial Times, the Cambridge-headquartered tech firm is now pushing to spin off shares in Arm China to a special-purpose vehicle under Softbank, in order to clear the way towards a New York flotation.

If successful, the restructuring will tie Arm China to its ‘parent firm’ through a licencing deal, instead of the 47% equity stake it currently holds. Arm would get licencing fees from Arm China (instead of a dividend) and would no longer need to demand access to the joint venture’s financial information.  It’s still not clear if this kind of spin-off will be approved by the Chinese government, though the Financial Times reported that Softbank has been talking with representatives from Beijing about it for months.

Could Bytedance still need to sell TikTok?

TikTok is also a Chinese-owned company carrying “American genes”. It started out as a company known as Music.ly in 2014. Based in Shanghai, its outlook was global from its inception: it became the most downloaded US short video app on Apple’s App Store within a year. According to Jiemian, Zuckerberg was considering whether to acquire Music.ly but Bytedance moved more decisively with an $800 million takeover in 2017. That deal was subjected to an investigation by the CFIUS in 2019 (there have been no details whether the probe has concluded).

Bytedance was on the verge of a forced sale of the TikTok app in 2020 after Donald Trump issued an executive order banning new downloads of the app, citing national security concerns. Trump’s successor Joe Biden revoked that order and the plan for a rapid divestment of TikTok to American investors was shelved.

Right now TikTok needs to fend off a new challenge: a smear campaign. According to the Washington Post, Facebook owner Meta is paying Targeted Victory, one of the biggest consulting firms in the American capital, to allegedly promote stories in the media that TikTok is a danger to American children.

Of course, for Zuckerberg all these alleged activities may be born of frustration and his sense of an unlevel playing field. Facebook, of course, has not been permitted to operate in the world’s most populous country. A decade ago that probably irritated Zuckerberg but he could console himself that at least his social media empire in the US had little to worry about from Chinese rivals. That changed with TikTok. Its compelling algorithms drove addictive content for younger audiences. Its expansive American ambitions were supported by fast-growing revenues from its sister companies in China.

The latest attack on TikTok’s business – and the attempt to portray the platform as a danger to America – are a reminder that Bytedance can’t be wholly confident over its prospects of maintaining full control of TikTok if the political mood worsens between Washington and Beijing. In this respect Bytedance’s management will be particularly concerned about what might occur if Trump gets re-elected in 2024.

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