Image: Dadya / Protocol
August 7, 2020
Hello! This week: Some investors think China will be fine without the U.S., why Alphabet issued $10 billion of bonds, and the precarious position of SaaS stocks. Want Index in your inbox each week? Subscribe here.
Also, some housekeeping: I'm on vacation next week, so Index is taking a week off. I'll see you on the 21st!
- "Tencent's share price had already gone up significantly in the last month … After this announcement from Donald Trump it was the perfect time for profit taking." — Kingston Securities' Dickie Wong explained Tencent's plunging stock price after Trump's proposed WeChat ban.
- "This is a turning point for Chinese investment in India tech." — Anand Prasanna, managing partner at Iron Pillar, said recent events could shake up the Indian funding market.
- "We're in this market where the winners are going to win — and they're going to win big." — Bokeh Capital Partners' Kim Forrest said Apple's increased dominance over the S&P 500 makes sense.
- "There's no room for error in this market for SaaS companies. As crazy as it sounds, a 9% beat wasn't enough to justify current multiples." — Redpoint's Jamin Ball explained why Twilio's earnings weren't enough for investors. (Relatedly: I spoke to Wix's CEO about how some investors don't understand the financials of SaaS companies.)
The Big Story
China might not need the US
It's been an … interesting week for U.S.-China relations, culminating in today's Tencent stock plunge after an executive order from President Trump targeted WeChat. It's easy to see why investors are now freaking out: It increasingly looks like we're in a new Cold War, and that's scary! But while some investors back off, others are forging ahead with Chinese deals, arguing that now's the perfect time to dive in.
DCM recently closed $880 million for new funds, with China receiving the largest allocation. Speaking to me a couple of weeks ago, DCM partner Kyle Lui said the firm isn't too bothered by the U.S.-China tensions.
- "When others are not actively looking at opportunities, that's where you can generate real alpha," he said.
It's all a matter of untapped domestic opportunity, according to the bulls — and geopolitics needn't come into it all that much, they argue. "You can build very meaningful, large, tens of billions of dollars companies just focused on China," Lui said. "You don't necessarily need to have this cross-border angle."
- Though China's tech market is already big, it has scope to get much, much bigger. "You're still seeing this urbanization of China," Lui said, highlighting the opportunities to target people who live in tier three or four cities.
Lui isn't the only one who's hopeful. "Markets see the opportunity of the domestic market," Mizuho Bank strategist Ken Cheung told The Financial Times. And in a letter to investors yesterday, Third Point CEO Dan Loeb said the fund had taken large positions in Alibaba and JD.com, highlighting the potential for them to grow their Chinese business.
What in particular looks compelling for investors? Enterprise software is a big draw for DCM: Lui thinks China lags the U.S. in the sector by about 10 to 15 years. "Historically labor costs have been relatively low in China," Lui said, so there wasn't much need for automation. "Labor is becoming increasingly more expensive, [so] software is being adopted at a very high pace."
But the strongest evidence to support a bull position on China being a smart one right now is probably the changing rhetoric of the Chinese government. In recent months, the administration has started talking about "dual circulation" — a policy where domestic consumption will be supplemented by exports, rather than the other way round. That looks set to be a pillar of the government's next five-year plan, and it could give domestic Chinese tech companies a huge boost. If they face reduced competition from American companies banned from doing business there, all the better for them.
Up to Speed
- Monday: Google invested $450M in ADT. Farmers Business Network raised $250M at a reported $1.75B valuation. Ant was reported to be targeting a $30B IPO. Grab was reported to raise $200M. Oyo restructured its Japanese business. Google partnered with six U.S. banks to offer digital bank accounts. Trump asked for a cut of the TikTok sale.
- Tuesday: Sony forecast a big slide in earnings. Square's very good earnings were leaked. Activision Blizzard earnings beat expectations. Match earnings beat expectations. Rippling raised $145M at a $1.35B valuation. The U.K. approved Amazon's Deliveroo investment. Intuit bought TradeGecko for a reported $80M+.
- Wednesday: Teladoc bought Livongo for $18.5B. Blackstone bought Ancestry for $4.7B. Zynga bought Rollic for $168M. Byju bought WhiteHat Jr. for $300M. Roku earnings beat estimates. Tencent was reported to be planning a Huya-DouYu merger. TSMC and Foxconn were reportedly interested in an Arm stake. BigCommerce shares almost tripled on debut. Rackspace shares plunged on debut.
- Thursday: Intercontinental Exchange bought Ellie Mae for $11B. Uber bought Autocab. Nintendo earnings beat estimates. Epic Games raised $1.78B at a $17.3B valuation. Uber earnings were grim. Dropbox earnings were good, but its CFO is leaving, which investors thought was bad. Executive orders targeted WeChat and TikTok.
Tech bonds: 'Get while the getting's good'
On Monday, Alphabet set a new record: It issued $1 billion worth of five-year bonds at a yield of 0.45%, the lowest-ever corporate yield at that maturity. That was part of a total of $10 billion of new bonds, which reportedly received more than $38 billion in demand — showing just how much appetite there is for tech bonds at the moment.
Needless to say, Alphabet really doesn't need the cash. As of the end of April, it had $121 billion of cash on its balance sheet. And yet the yields on offer in the current economy made the opportunity "too good to pass up," Brown Advisory's head of fixed income Tom Graff told me.
- "You never know what's coming late down the road," Graff said. Interest rates might be higher and markets might be more turbulent than they are now — so while you can grab cheap money, you may as well. In essence, Graff explained, Google is saying "let's get while the getting's good."
The deal was also a good way for Alphabet to tout its social responsibility commitments: $5.5 billion of the bonds are reserved for environmental, social and governance uses, the largest ESG issue on record. "ESG bonds have extra demand," Academy Securities' Peter Tchir told me via email, thanks to the growing market of ESG funds. Graff wasn't sure that made much of a difference to the overall pricing, though: "I would bet that the overwhelming majority [of demand] was from people who just felt 'I want to buy at this spread.'"
- Unusually for ESG deals, Alphabet's specifically highlighted a commitment to using some of the money for racial justice initiatives, such as supporting Black entrepreneurs and building affordable housing. That "could be something we see more of," Tchir said. "There's a big, big, big increase in the focus … on racial justice issues," Graff explained.
Alphabet could perhaps have gotten even lower yields, if not for the weird way bonds are sold. "Sometimes squeezing every last basis point on a current deal can cost a company when they come to market again," Tchir said. Graff agreed, noting that Alphabet's final spread was already much tighter than originally proposed (the five-year ended up being Treasuries + 25 basis points, versus the 40 basis points spread it first offered). And anyway, it's not like it's paying out the nose.
In fact, the success of the offering could encourage other tech companies to issue bonds, Graff said: "There's a small set that just really have an unbelievable yield opportunity, and I think it'd be too much to pass."
- That said, Apple and Amazon sold bonds at the start of the pandemic, so they may not be looking for more. "I think the bulk of tech issuance is over," Tchir predicted, "but if rates stay low we could see another wave into year end."
- Earnings aren't over yet. SoftBank and Rakuten report Tuesday, followed by Cisco, Tencent, Foxconn and Lyft on Wednesday and Applied Materials on Thursday.
- We'll also get inflation data on Wednesday and retail sales Friday, which should show if ecommerce sales have held up amid reopenings.
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