Insights & Analyses

OWI Labs op-ed: China’s tech titans spread wings as regulators bare teeth

In OWI’s analyst op-ed series, the OWI Labs team breaks down the latest news with an inside look at the identity industry dynamics we’re following most closely. 

China this week saw big earnings in its tech sector, but it also came alongside some concerning cyber regulations — a trend that could see the two opposing sides on an inevitable collision course.

In good news for China’s tech world, quarterly earnings for the nation’s titanic twosome – Tencent and Alibaba – were released, and they were big.

In the quarter ending June 30, Tencent posted a net profit of $2.3 billion USD, up 26 percent from the previous quarter and 70 percent over this time last year. Driven by huge increases from online gaming and social network revenue, Tencent continues to reign as the country’s largest internet company. WeChat, Tencent’s messaging and mobile payment platform, now accounts for around a third of all screen time in China and has 963 million active monthly users.

Alibaba’s earnings report, released on Thursday, similarly exceeded expectations. The company saw 56 percent revenue growth over the same quarter, and its stock is up 81 percent from this time last year. Alibaba still rules e-commerce in China, though the number of paying customers for its cloud services also nearly doubled this quarter, breaking the 1 million mark.

It wasn’t all good news in China, however. Just last Friday, the Cybersecurity Administration of China (CAC), architect of the sweeping and controversial Cybersecurity Law that took effect on June 1, issued a terse statement announcing that WeChat is under investigation for violating the new cybersecurity regime.

Along with Sina Weibo, the Chinese Twitter analog in which Alibaba owns a 30 percent stake, and Baidu’s Reddit-like Tieba platform, WeChat is accused of “endangering national security, public safety, and social order” by allowing the spread of “terrorism, false rumors, and pornography” by its users.

In a number of clauses open to worryingly broad interpretations, the Cybersecurity Law singles out social media and news providers for extra scrutiny. Anonymous posting is prohibited, users must register with real identities, and platforms are responsible for managing content to ensure that it obeys “social mores,” promotes “dissemination of socialist values” and doesn’t subvert “national honor.”

Tencent’s stock fell as much as 5 percent while Alibaba’s sunk about 1 percent on the news that they were among the first major players to run afoul of the CAC, though both have since recovered from the dip. There has been no indication of what particular events or posts sparked the investigation.

So why, in the face of unprecedented success from its home-grown tech darlings, has the CAC picked these same companies as the targets of its first major enforcement efforts?

A few factors are likely in play here. First, pursuing the biggest players so soon after the law took effect is an efficient way to show that the CAC means business.

“It’s meaningless to go after the little companies,” one CAC adviser told The Wall Street Journal.

Tech companies have already been doing their best to stay ahead of the compliance learning curve and avoid prosecution. Last year, executives from both Tencent and Alibaba praised the Cybersecurity Law’s ratification, hailing it as a step forward for public-private cooperation in the digital world. Catching up with its peer platforms, Tieba started mandating real-name registration in June. Apple recently opened a Shenzhen-based data center to comply with the law’s data localization statute. Airbnb relocated its servers storing Chinese customer data. This CAC investigation will likely accelerate an across-the-board scramble to fall in line with the most extensive reading of the new regulations.

Second, targeting prominent domestic players serves a public relations purpose as well. The international community has decried the law as protectionist and unfair to international corporations looking to do business in China. For its part, the CAC has staunchly maintained that the Cybersecurity Law is not intended to single out foreign players and that its moves to protect China’s digital sovereignty are both necessary and appropriate. Investigating WeChat and Weibo at the outset seems to bolster this argument, sending the message that Chinese firms are not exempt. International firms whose business models are threatened by onerous new compliance burdens are unlikely to be placated, however.

Third, this investigation is being initiated within a much broader political context. President Xi Jinping’s administration is preparing for the 19th Communist Party Conference this fall, at which Xi will begin his second term. Enforcing tighter control of the largest social media platforms, and tracking the identities of those posted there, has become one of the Communist Party’s most effective tools for guiding the nationwide political narrative. Launching this investigation puts Tencent, Alibaba, and their peer companies on public alert, communicating the CAC’s expectation that they will proactively police user content during this especially sensitive period.

But it’s clear that even the threat of prosecution under the Cybersecurity Law is doing little to dampen Tencent and Alibaba’s momentum, which had been building long before the investigation was announced.

Both companies have released ambitious new growth strategies in recent weeks, and will be further buoyed by this week’s earnings reports. Tencent is playing the long game on AI development, and Alibaba is looking to reshape retail.

More importantly, though, clipping the wings of its tech pioneers is clearly not in the best interest of the Chinese government itself. In a recent illustration of their importance to the overall economy, Tencent, Alibaba, and Baidu were all among the group of investors that injected nearly $12 billion USD into state-owned China Unicom this week, amid hopes that capital and guidance from the companies will breathe new life into the stagnating telecom. The Xi administration has pushed this type of “mixed ownership reform” as a means of increasing innovation and competitiveness in historically state-run corporations, and the health of Tencent, Alibaba, and other tech leaders will be central to that plan.

The Chinese government is banking on Tencent, Alibaba, and Baidu’s success even more than any western investment analyst, so it would be far-fetched to imagine any serious financial or structural consequences arising from this investigation.

Strengthening compliance with the Cybersecurity Law while simultaneously encouraging its biggest domestic internet companies thrive are core goals of the CAC. It appears to be able to satisfy both at once, at least in the short term, with its current strategy.

Kaelyn Lowmaster is a principal analyst with OWI Labs, with a particular focus on Asian markets.