Ant Group and China’s Fitful Convergence

Plus! The Startup Cycle; Buybacks; Return-on-Kickback; Legalization; Housing; Big Tech, Monopolies, and Attack Surface; TikTok

In this issue:


Ant Group and China’s Fitful Convergence

Ant Group, China’s largest digital payments company, is preparing an IPO, and has filed an extremely comprehensive draft prospectus detailing their business. Ant is rumored to be worth $200bn ($, WSJ),  and plans to sell roughly 10% of its shares to the public, which would  make Ant the second largest IPO in history after its partial parent  company, Alibaba.

Ant is a revealing look at China’s economic strengths and weaknesses.  On the strengths side, China’s consumer Internet companies are  absolutely world-class, with faster growth and a far faster shipping  cadence than US companies can manage. Ten years ago, this was mostly due  to catch-up growth: if you named a major American consumer web  category, and bet that a Chinese company would implement roughly the  same model and dominate its market, you’d be right.

(A friend of mine once worked for a US-based company that wanted to  do a deal with a competitor in China. He met with the CTO of the Chinese  competitor, who bragged that his company had copied the US company’s  product pixel-for-pixel.)

That is definitely no longer the case. Today, Chinese consumer  Internet companies ship so many products, so fast, that every American  Internet company can be described as implementing a subset of any given  Chinese Internet company’s offering.[1] A brief case study in this is  Ant’s app:

It’s a payments app, so naturally it gives users the option to (in the order in which they appear in the app):

Clearly, Ant’s business is focused on the narrow, well-defined market  of a) money, and b) goods and services that can be purchased for money.

Ant’s main business, in terms of gross volume, is payments. In the  last year, Ant handled RMB118tr of payments ($17tr USD). This is a bit  under 3x the total spending handled by Visa and Mastercard.  It’s an astoundingly large number, not just because it exceeds China’s  $14tr GDP. (Peer-to-peer transfers, loan borrowings and payments, or  transfers from a savings account to a money-market fund would not be  accretive to GDP but would show up in Ant’s total payment value number.)

But the payments business is not as exciting as it looks. In 2019,  Ant reported total payment value of RMB111tr, and total payments revenue  of RMB52bn, for a take rate of 0.05%. As Marc Rubinstein points out,  even that exaggerates the economics, since Ant pays most of its payment  revenue back to financial partners. After those fees, Ant’s share of  payment volume is a bit over 0.01%.

Ant makes its real money from other financial services. In the last  six months, payments were 36% of revenue, while expediting small  business and consumer loans was 39%, investment products were 16%, and  insurance was 8%.

In these businesses, as in payments, Ant mostly operates as an  intermediary, connecting borrowers or investors to companies that can  work with them. Ant’s ubiquitous payment product gives them a low cost  of customer acquisition, and growth in China’s consumer spending is a  tailwind.

Ant as a bet on consumer finance. In the US, it’s very easy to borrow  money for consumption, but fairly hard to borrow to start a business.  China’s financial system is geared towards financing things like steel  mills and property developments, not providing consumers with revolving  credit.

And this means that the upside case for Ant is that China’s economy  gets more normal and balanced over time. China has had a heavily  investment-driven model for decades: when growth is strong, companies  invest their profits in more manufacturing capacity, and when growth is  weak, the government builds more roads, ports, and power plants to keep  GDP growth elevated. This model was effective when China was  significantly underinvested—at the start of their industrialization, not  only did China have few factories, but the factories they did have were  often located in deliberately hard-to-reach places, to make the country  harder to invade. This made last-mile transportation painfully  expensive, so China’s industrialization in effect started from zero.

A small, poor country can afford to be dependent on exports, because  their cost advantage means they’re somewhat insulated from drops in  global demand. As a country gets richer, it runs into a problem: its own  GDP is dependent on policy decisions made elsewhere. Refocusing on  internal demand can give a country more policy flexibility, which is  especially important as China’s exports get more politically risky.  There are signs that this is already happening. Ant customers'  outstanding credit balances compounded at 76% from 2017 to 2019. And debt collectors are growing, too.

If the upside case for Ant is that China gets more normal, the  downside case is that things don’t change. One risk factor in Ant’s  prospectus is the solvency of the banks and financial institutions they  deal with. Assuming banks are solvent (or will get bailed out) is  generally the default in rich countries, but it’s a meaningful risk  factor in China because their banks' solvency is unknown, and banks have  the implicit liability of needing to direct funds to projects that  fulfill policy goals even if they’re not creditworthy.

Ant’s own background showcases the sometimes rickety regulatory  framework in which Chinese companies operate. Ant’s predecessor, Alipay,  was created as part of Alibaba, but in 2011 Alibaba quietly announced  that it had sold Alipay to its CEO. At the time, some analysts  speculated that Alipay was worth $1bn, but it sold for $51m, in two  transactions in 2009 and 2010. This is not exactly stellar corporate  governance (imagine Apple releasing an annual report where a footnote  reveals that they sold the App Store to Tim Cook).

Alibaba’s explanation was that the Chinese government had created new  rules around payments, which precluded payments companies from having  outside investors. Those regulations do, in fact, make sense; China  always runs the risk of money fleeing the country, and when money does  so, it uses whatever the simplest channel is. The sale, at a low price  and without disclosure until a year after the fact, was deeply  concerning to outside investors, who demanded their money back. After  extensive negotiations, Alibaba ended up entitled to 37.5% of Ant’s pretax profit, since converted into a 33% equity stake ($, FT).

This kind of deal has gotten rarer, but the risk doesn’t go to zero,  and outside investors don’t really have recourse. In finance, there’s  sometimes a phase change where a transaction goes from an iterated game  to a one-shot game. For example, VCs tend to back founders because they  don’t want to risk dealflow, but when one company is a large enough  share of their fund (as Uber was for Benchmark), it makes economic sense  for them to optimize for that one situation rather than future  transactions. (An even easier call if you’re planning to retire after). In Ant’s case, investors have to hope that behavior improves  when the game switches from iterated to one-shot. The optimal choice  for Alibaba would have been to treat investors nicely when Ant was worth  $1bn, and then exploit them more at a $200bn valuation.

Financial markets work well when property rights are certain, and  easy to analyze. A complex financial system often involves borrowing  against financial assets which are themselves secured by real assets or  future incomes; that pyramiding of debt quickly falls apart if  uncertainty about collecting it compounds through a complicated  financial structure. Ant is a bet on this kind of certainty, in the face  of a much stronger incentive to exploit uncertainty for the benefit of  insiders.

[1] One reason for this is the pure volume of work. Chinese Internet  companies often adhere to a “9-9-6” schedule—9am to 9pm, six days a  week. A while ago, an anonymous whistleblower shamed some companies for this schedule and praised others for demanding less ($, NYT),  but the companies on the praiseworthy list include Amazon, Google, and  Microsoft, which have had difficulty making inroads into the Chinese  market. Meanwhile, the worst offenders are Alibaba,, Huawei, and  Bytedance. That list doubles as a short list of the most successful  technology companies in China.


The Startup Cycle

Silicon Valley famously benefits from a cycle where successful  founders decide they don’t want to run a company any more, but still  want to be involved in the business, so they start cutting checks and  offering advice to new startups. Something similar is happening in  electronics assembly in China: Lens Technology and Luxshare, two  acquisitive contract manufacturers, were founded by former factory workers, one of whom got her start at Foxconn. In this case, there’s a commoditization angle, too:

Media reports from Taiwan and Japan saw Apple’s hand in  the takeover too, claiming that the Californian giant is trying to groom  Luxshare as a rival assembler of iPhones to Foxconn.


In the last few years, one theory of US equity outperformance was  that it was driven by buybacks. American companies tended to return over  100% of their cash flow to investors, mostly in the form of buybacks,  and all those share purchases would tend to bias stocks upwards. Spring  2020 was not exactly a test of this proposition, except in a limited  sense: unprecedented monetary interventions from central banks with  effectively unlimited buying power can, indeed, be a substitute for  equity demand on the part of CFOs. In the coming months we’ll see a  return to normal, as more companies resume their buybacks. Since banks have record deposits, often from corporate customers ($, WSJ),  and are understandably nervous about reinvesting in their businesses,  buybacks may quickly return to being the default option.


A new study ($, The Economist)  shows that bribery has high expected returns: $6-$9 in market value per  dollar paid, ignoring the risk of getting caught. The US has had a  number of bribery scandals, in part because the US has a large economy  with many multinationals and in part because America is relatively  aggressive about enforcement (for comparison, Germany got rid of their  tax deduction for bribe costs in 1998). As American regulators  increasingly use the dollar system as a tool for enforcing rules,  American bribery standards could become more universal.


2020 is an interesting year for cannabis legalization. Congress is currently considering a bill, which may pass in the House but which likely won’t make it through the Senate. But there are two other reasons to expect it:


After the financial crisis, Blackstone permanently changed the  housing market by turning single-family homes into an investable asset  class. This, I’ve argued before,  permanently reduced swings in housing prices by creating a source of  demand for homes that wasn’t fueled by selling other homes. They’re back in the market, with a new investment in a single-family rental company.

Meanwhile, one category of housing that’s doing especially well: vacation homes.

Big Tech, Monopolies, and Attack Surface

Software businesses lead to natural monopolies across a thin-but-wide  slice of the value chain: dominating search, but not controlling the  content; dominating social, but not owning news; selling game engines,  but having a low market share in games themselves. This tendency means  that an economy more driven by software will have more monopolies, but  also that they will be more fragile. Three case studies:


One dog that didn’t bark with respect to TikTok: if the technology is  so dangerous to the US, why isn’t China worried that an American  company will control it? Now, they are. China has added some AI technologies to its export control list ($, Nikkei),  giving them the potential ability to block a TikTok sale. The TikTok  deal continues to get more complicated: there’s the US-TikTok  negotiation, the TikTok-acquirers one, and now an acquirer-US-China one.  Microsoft’s increasingly sophisticated lobbying efforts ($, NYT) mean they’re likely still the top prospect.

(Disclosure: Long MSFT, but not because of any TikTok speculation.)