August 7, 2020
Image: Dadya / Protocol
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!
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.
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."
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.
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.
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.'"
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."
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