Executives at Chinese ride-hailing giant Didi Chuxing had plenty to worry about last April when they filed confidentially with the U.S. Securities and Exchange Commission for permission to list shares of the company on the New York Stock Exchange.
The Chinese economy was rebounding from its bout with COVID-19, lifting Didi’s revenue with it. The U.S. stock market was soaring. Didi’s long-suffering venture investors, among them Masayoshi Son’s Softbank Group, urged seizing the moment to take the company public.
And yet China’s political landscape was fraught. In November, President Xi Jinping had personally scuttled the IPO of billionaire Jack Ma’s Ant Group, and now China’s antitrust regulator, the State Administration of Market Regulators, was grilling leading Chinese tech companies, including Didi, about unfair competitive practices. In the state-owned media, commentators clamored for government to “rectify” the nation’s influential tech sector.
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China’s cybersecurity watchdog, the Cyberspace Administration of China (CAC), hadn’t played a prominent role in the spring crackdown. But in the weeks before the IPO, according to the Wall Street Journal and Financial Times, officials from the CAC raised questions about the security of Didi’s network, expressed concern about the sensitivity of information displayed on its mapping function, and cautioned the company to delay its listing until it could conduct a thorough internal security review.
Didi says it never received an explicit warning from the agency—and that it didn’t divulge customer data to U.S. officials. And in any case, the CAC had never derailed the overseas listing of a Chinese company, and technically didn’t have the power to do so. China adopted a new cybersecurity law in June, but the measure was vaguely worded, and it remained unclear how it would be implemented.
And so Didi officials pressed ahead with plans to go public in New York, eventually settling on Wednesday, June 30—three days before U.S. investors were to decamp for the long July 4 weekend and one day before China would celebrate the 100th anniversary of the nation’s communist party.
The day was a triumph. Executives kept low profiles, declining to ring the opening bell or even celebrate the event on Didi’s Weibo social media channel. Didi Global, the name under which the stock is listed, raised $4.4 billion and debuted at $16 a share, making it one of the year’s biggest public offerings and the largest overseas listing of a Chinese company since Alibaba Group’s $25 billion debut in 2014.
Two days later, China’s cyber watchdog bared its fangs.
On Friday, before trading opened in New York, the CAC announced it had launched an investigation into Didi on suspicion the company had violated data privacy and national security laws. It ordered the company to stop registering new users. On Sunday, the CAC instructed all Chinese app stores to remove Didi’s app. On Monday, the agency said it had broadened its investigation to include two more U.S.-listed Chinese companies.
Didi’s shares dropped 5% on Friday, then a further 25% when trading reopened on Tuesday.
Didi vice president Li Min said in a Weibo post that “Didi stores all domestic user data at servers in China. It is absolutely not possible to pass data to the United States.” But by Tuesday, it was clear the agency’s regulatory blitz was part of a larger government effort to revamp procedures governing all Chinese companies seeking to raise capital on foreign exchanges.
The State Council, China’s top executive body, issued a brief but sweeping statement vowing new rules for overseas listings and stricter supervision of cross-border data transfers. On Wednesday, Bloomberg reported that the China Securities Regulatory Commission plans to let regulators block Chinese companies from listing overseas even if they sell shares through an offshore affiliate. Since 2000, hundreds of Chinese companies have used that strategy—the so-called variable interest entity model—to raise capital on foreign bourses even if they operate businesses in sensitive sectors, such as the Internet, in which Beijing forbids foreign ownership.
Details of those changes remain forthcoming. But the prospect of China creating a new layer of regulatory review for foreign IPOs and Beijing’s willingness to torpedo the value of Didi, one of its brightest homegrown tech stars, has cast a cloud of uncertainty over companies seeking to sell shares on U.S. exchanges as well as those already listed. Beijing’s crackdown on Didi, and Wall Street’s swift recoil from Chinese stocks in response to it, raises the question of whether the world’s two largest economies will remain financially integrated or ‘decouple’ in this realm too.
“The Didi experience definitely signifies that the Chinese government is starting to look closely at the various possible implications of Chinese companies listed in the U.S. market,” says Clement Chan, a managing director at professional services firm BDO. “In my view, they are preparing for further deterioration in the relationship with the U.S.”
‘Honk honk taxi’
Nearly ten years ago, Cheng Wei left a cushy executive role at Alibaba with an idea to start a ride-hailing firm. He named it Didi Dache, directly translated to ‘honk honk taxi,’ and says he thought of integrating yellow cabs with smartphones after waiting in a cab line on a frigid evening in Beijing.
Wei beat out other Uber-wannabes in China in the early years by promoting his ride-hailing app to younger, tech-savvy taxi drivers in Beijing. The platform had a breakout moment during a 2012 snowstorm in Beijing. With regular taxi-hailing nearly impossible, over 1,000 people ordered Didi cars in a single day for the first time.
Two years later, 5.2 million riders were using Didi every day, a growth rate that helped the company score $700 million in funding from major investors, including Chinese tech giant Tencent. Around the same time, Wei sold Goldman Sachs executive Jean Liu on his vision to reshape transportation in China, convincing Liu to become Didi’s chief operating officer.
In the next few years, Didi established a near-monopoly in China’s ride-hailing market by merging with rival Kuaidi, which gave Didi access to new sources of capital like Softbank and Alibaba. It also burned through hundreds of millions of dollars in cash to oust Uber as a competitor in China. In 2016, Liu and Cheng traded Uber an 18% stake in Didi (now reduced to 12.8%) for Uber’s departure from the Chinese market.
Didi’s dominance means even the worst kind of scandals haven’t derailed its growth.
In 2018, two drivers on car-pooling platform Hitch, a Didi subsidiary, murdered their passengers, prompting a social media backlash—’Boycott Didi’ trended on China’s Twitter-like Weibo platform—and increased supervision from Chinese regulators. Didi suspended the Hitch service for over a year after the murders, and Wei noted in Didi’s IPO prospectus that the incident prompted a period of “deep self-reflection” for the startup.
This year, Didi reported that it has 493 million annual users and 15 million drivers across 15 countries, though China is its chief market by a wide margin. Didi’s ride-hailing business in China accounts for 90% of all revenues, and, as of the fourth quarter of 2020, Didi was responsible for 88% of all ride-hailing trips taken in the country.
But that stranglehold on the market hasn’t guaranteed profitability.
In its IPO prospectus, Didi reported net losses of $1.6 billion in 2020, $1.5 billion in 2019, and $2.3 billion in 2018. The losses likely reflect Didi’s investment in emerging technologies, like self-driving ‘robo taxis,’ that have yet to hit the market. But earlier this year, Didi clawed itself out of the red. In the first quarter of 2021, Didi posted net income of $95 million, the only quarterly profit it’s reported since 2018.
In its prospectus, Didi cited its newfound profitability as a reason for going public, and the IPO gave stakeholders like Softbank, Uber, and Tencent a chance to cash out after funneling money to the startup for years.
Wei, Liu, and other Didi executives likely had personal incentives to follow through on the IPO too. Security filings show that “certain senior management” granted themselves $3 billion worth of stock options in the run-up to the listing. Wei and Liu also own 6.5% and 1.6%, respectively, of the company.
This week, the Wall Street Journal reported that government regulators warned Didi that it should delay its IPO amid national security concerns. Thomas Gatley, China corporate analyst at Gavekal research in Beijing, says that Didi may have ignored the warnings, in part, because of the promise of payouts.
“Didi went ahead and did it anyway, because they worried that if the IPO got delayed it would never happen,” says Gatly. “Clearly there were considerable incentives for senior executives who just got $3 billion worth of stock options.”
But the Didi crackdown suggests China’s leaders aren’t just worried that China’s tech tycoons have grown too rich and too arrogant, or that their companies control too much of China’s economy. Unlike the year’s earlier tech rectification measures, the Didi case is all about data.
Didi, with its hundreds of millions of drivers and riders, drinks in oceans of data every instant. The company tracks who goes where when, and can monitor traffic patterns across the country in real time.
After news broke of the CAC probe, Chinese social media users resurrected a report first published by the state-owned Xinhua news agency in 2015 showing how Didi data reveal patterns among bureaucrats who used the company’s service. The report showed that traffic at the Ministry of Public Security was among the busiest, while traffic at the anti-corruption office was relatively quiet.
Chinese consumers have grown increasingly conscious of data privacy in recent years. And as relations between the U.S. and China have deteriorated, Chinese authorities have grown more fearful that data collected by private companies might fall into the hands of foreign adversaries.
“The proximate cause for [the Didi crackdown] is that Chinese regulators don’t know [what data vulnerabilities exist],” says Gatley. “If they have any suspicion that Didi is using foreign equipment or foreign services for storing data…they want to make sure that they know about it before [Didi] is exposed to the SEC.”
Those fears bewilder U.S. experts, many of whom say they struggle to imagine a scenario in which U.S. financial regulators would require consumers’ personal data or any information that might jeopardize China’s national security as part of the listing process, or one in which financial regulators might be obliged to share information with U.S. intelligence agencies. Those agencies, if they wanted it, could probably get comparable data from satellites.
“Listing in the U.S. doesn’t mean that Didi has to give all the data to the U.S., it only means there is some financial disclosure,” says Bruce Pang, macro and strategy research head at China Renaissance Securities.
But U.S. leaders, similarly, have conjured the specter of Chinese-owned companies like ByteDance’s TikTok or Tencent’s WeChat hoovering up American consumer data on behalf of the Chinese government.
Warranted or not, Beijing’s new preoccupation with Chinese and U.S. disclosure requirements extends far beyond just Didi. The issue could derail U.S. listing plans for ByteDance, the world’s most valuable startup, and raise questions about the fate of already listed Chinese tech giants including Alibaba, Tencent, Baidu, and JD.com.
“There’s a lot of pressure now on Chinese companies when it comes to them sharing any kinds of data with the U.S.,” says Dev Lewis, program lead at Digital Asia Hub.
In Washington, meanwhile, U.S. lawmakers want more disclosure from Chinese companies, not less. In December, the U.S. enacted a law mandating that American exchanges de-list Chinese companies if, for three years in a row, they fail to comply with U.S. disclosure rules, including a requirement that they share audit papers with U.S. financial regulators. China’s government, citing national security concerns, has long resisted U.S. demands to see the audit papers of Chinese companies trading on American exchanges.
A new watchdog
The bilateral tug-of-war over data has bolstered the stature of the CAC, a relatively new government agency that, though often described as “powerful,” has no legal jurisdiction over overseas listings, and hasn’t previously played a significant role in Beijing’s efforts to bring wayward tech titans to heel.
“[Didi] may have underestimated the leverage the [CAC] has over them, because this is a very new area of enforcement. There have been no publicly-available precedents,” says Angela Zhang, director of the Centre for Chinese Law at Hong Kong University.
When it was created in 2014, the CAC’s primary mission was keeping foreign media and Internet companies on the outside of China’s digital firewall, and scrubbing “inappropriate” content from China’s domestic web. The agency’s founding director, Lu Wei, was a brash former Xinhua journalist who rose to become Beijing’s vice mayor for propaganda. At CAC, he was hailed as China’s “Internet czar,” feted by Mark Zuckerberg, Tim Cook, and Jeff Bezos on his first official trip to Silicon Valley, and listed by Time magazine as one of the world’s 100 most influential people. He launched the World Internet Congress to promote the idea that the Internet wasn’t a universal platform, but something that every government had the right to control within its own borders. The event drew Xi and other party heavyweights and became an obligatory annual pilgrimage for China’s tech leaders. But the agency has kept a low profile since 2016, when Lu was abruptly removed from his position. He was later jailed on charges of bribery, sexual misconduct, and disloyalty to the party.
Now the CAC seems certain to play a leading role in the proposed revision of the approval process for Chinese firms seeking overseas listing. But its mandate remains vague and ill-defined.
The end of the affair
Whatever the agency’s future role, its crackdown on Didi has opened a new dimension in the ongoing debate about the U.S.-China economic relationship. Until last week, many had assumed that, despite tensions on trade and technology, financial markets were the one area where bilateral interdependence would endure. Now investors and analysts on both sides of the Pacific warn of the possibility of “financial decoupling,” and the prospect that scores of Chinese firms will withdraw from Wall Street and relist on exchanges in Hong Kong, Shenzhen, and Shanghai.
With its moves against Didi, “Beijing seems to be preparing for a potential worsening of the Great Decoupling,” says Brock Silvers, chief investment officer of Kaiyuan Capital.
That outcome would be costly for Chinese tech tycoons and many global investors. But it may suit Chinese leaders just fine.
“[Xi] clearly intends to rein in China’s tech giants so none will think it is so big that it can ignore the Chinese Communist Party,” says Steve Tsang, director of the SOAS China Institute at the University of London. “If Didi has to pay a price for its IPO in New York, I doubt it would worry the party much.”
On Wall Street, many investors say the damage is already done. Chinese tech giants have lost over $800 billion in value since February, and some argue the days when global investors paid sky-high prices to own a piece of Chinese tech stocks are officially over.
On Tuesday, as Didi’s stock cratered, CNBC’s Jim Cramer, who prior to the IPO had given investors his “blessing” to buy as many Didi shares as they could get, declared a permanent reversal in American investor attitudes toward Chinese companies on Wall Street. “You’re a moron if you buy a Chinese deal after this. You’re a moron,” Cramer said. “I don’t care if it pops. Why do you need to put your capital at risk after this?”