Investing in China
In many Chinese ADRs you do not own the business. You own a contract with a company that has a contract with the business.
Understand the structure you are buying, before you have an opinion on the growth.
How Investing in China works, in one picture
The same argument as the text, as a chain. Each step is what makes the next one possible.
Why the debt is the engine
Put in 30, borrow 70, secure the loan against the company you are buying. A 30% rise in the business doubles your money. The same arithmetic works in reverse, which is why buyouts fail loudly.
- 1
Know which share class you are buying
A shares trade in Shanghai and Shenzhen and were historically restricted to domestic investors. H shares trade in Hong Kong. ADRs trade in New York. The same company can exist in several of these at different prices, for reasons that have nothing to do with the business.
- 2
Understand the VIE
Foreign ownership is restricted in sensitive sectors, so many Chinese technology companies are sold to foreigners through a variable interest entity: a shell in the Cayman Islands with contractual claims on the profits of the Chinese operating company.
You own the shell. The contracts have never been meaningfully tested in a Chinese court, and Beijing has never been keen to say what would happen if they were.
This is not a technicality. It is the difference between owning a company and owning a promise about one.
- 3
Policy is a fundamental, not a risk factor
A regulatory announcement has wiped tens of billions off Chinese education and technology companies in an afternoon. In most markets policy is background. Here it is one of the largest inputs, and it is not forecastable from the filings.
- 4
The growth is real, and so is the discount
Chinese companies frequently trade at a fraction of the multiples of their Western equivalents. That gap is not stupidity. It is the market pricing structure and policy risk. The question is whether it is pricing them correctly, and reasonable people differ.
Ordinary. The market expects steady, unremarkable growth.
You can say, for any Chinese holding, what legal entity you actually own.
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In many Chinese ADRs you do not own the business. You own a contract with a company that has a contract with the business.
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