Is Jack Ma's Retirement Bad News?

It is bad news. It deepens the slide in confidence in China's private economy.

There is no longer any doubt that Jack Ma will retire. The only question is how long the handover takes.

On the evening of September 8, Ma told the South China Morning Post, the newspaper Alibaba owns, that he would announce Alibaba's "succession plan" the following Monday. While the plan is being carried out, Ma will stay on as chairman of the board.

Ma said the plan had been ten years in the making: "Ten years ago, my senior executives and I sat down and asked what Alibaba would do without me. I am proud that Alibaba's governance system, corporate culture and steady supply of talent now let me walk away without causing damage."

Next Monday is Ma's 54th birthday. That is early to retire, and not just by the standards of Chinese business.

Two days earlier, in an interview with Bloomberg, Ma took Bill Gates as his example: "I will never be as rich as he is, but I can retire earlier than he did."

Gates formally retired in 2008, when Microsoft was already 33 years old. He did not give up the chairmanship until 2014. Today it is hard to picture life without Taobao or Alipay, yet Alibaba is only 19 years old, and Taobao has just turned 15.

By the goal Ma repeats so often — a company that lasts 102 years — Alibaba is not yet a fifth of the way there.

So what kind of news is Ma's retirement?

For Alibaba the company, it changes little.

Alibaba is now China's largest internet company. Its e-commerce rivals, JD.com and Pinduoduo, have each run into serious trouble lately, and Tencent — which backs both of them and competes with Alibaba on every front — has been hit by a sudden crisis in its gaming business.

Ma pulled away from Alibaba's day-to-day management years ago. He turns up instead at international conferences and charity events, or writes shareholder letters saying Alibaba will build an "internet economy" that creates 100 million jobs worldwide, serves 2 billion consumers and makes 10 million small and medium-sized businesses profitable.

Running Alibaba is already Daniel Zhang's job.

In March 2013, Alibaba said Lu Zhaoxi (Jonathan Lu) would take over as CEO from Ma. In 2015 the successor changed to Daniel Zhang.

In its most recently reported quarter, Alibaba took in 62 billion yuan in revenue, its fastest growth in three years. Revenue has now grown more than 50% for two years running. For the new fiscal year, Alibaba has raised the target again, to 60%.

At the media center after Singles' Day in 2017, only Zhang gave the closing speech on stage. Ma appeared briefly, sat in the audience through Zhang's remarks and said nothing in public. For years before that, Ma had been the closing act of the Singles' Day show.

Judging by the handover so far, Alibaba's transfer of power from founder to professional manager has been fairly smooth. That alone is rare among big Chinese companies.

Alibaba's key milestones

1999

Alibaba is founded. In October of the same year it raises its first round of investment, $5 million, led by Goldman Sachs with Fidelity Growth Partners Asia taking part.

2000

Alibaba receives a $20 million investment from SoftBank

2003

Ma sends an independent team to start Taobao outside Alibaba

2004

Alipay is split off from Taobao to run as a third-party payment service

2005

Yahoo takes a 40% stake in Alibaba and becomes its largest shareholder

2007

Alibaba's B2B business lists in Hong Kong; its market value tops HK$200 billion on the first day of trading. In February 2012, Alibaba says it will buy back the B2B shares and delist from the Hong Kong Stock Exchange.

2008

The forerunner of Tmall is set up; in early 2012, Alibaba renames Taobao Mall as Tmall

2011

Taobao is broken up and Alibaba begins several rounds of restructuring. The same year, Alibaba holds its first Singles' Day.

2013

In May, Ma becomes chairman of Alibaba's board and Lu Zhaoxi takes over as CEO. The same year, Cainiao is set up and Alibaba moves into logistics.

September 2014

Alibaba lists in the United States.

October 2014

Ant Group is formally established.

May 2015

Daniel Zhang takes over as Alibaba's CEO.

November 2016

Alibaba Group sets up its digital media and entertainment arm.

January 2017

Alibaba says it will take Intime Retail Group private.

September 2018

Ma is to announce Alibaba's succession plan.

Even so, Ma's retirement is being read as bad news, or at least as a bad sign. Duncan Clark, author of Alibaba: The House That Jack Ma Built, put it this way after the news broke: "Whether he likes it or not, he is a symbol of the health and prospects of China's private economy. Whether he likes it or not, his retirement will be read as a sign of dissatisfaction or worry."

Private business is the driving force of China's economy.

China's Ministry of Finance once published excerpts of a 2016 report by the American think tank PIIE, which said that in the first 11 months of that year private firms earned 2.1 trillion yuan in profit against just 1.1 trillion yuan for state-owned firms. And because of how the statistics are drawn up — private firms exclude privately held limited liability companies — their real profits should be about three times those of state-owned firms.

A report from the International Monetary Fund makes the same point. Even after 2015, when state firms' investment rose from about 30% of GDP to 38%, their return on assets kept falling, as it had since 2006, reaching just 1.9% in 2017 — far below the 9.5% private firms earned.

That is enough to show that private firms are still more energetic than state ones and provide more jobs. State firms hold 38% of industrial assets but account for only 14.9% of employment.

Alibaba is China's largest private company and its largest listed company. For years, Ma's own speeches — on success, on starting a business — have played on the screens of airport bookshops.

The story of Ma and Alibaba is the story of the most energetic part of China's economy over the past twenty years.

And China has now reached the most awkward moment for its private economy.

Traditional industries are losing companies

Figures released by China's State Administration for Industry and Commerce at the end of September last year show the number of private companies and their share of registered capital up 10.8% and 23.1% respectively on the same period in 2012. But the gap between industries has grown severe.

Data compiled by Ding Anhua, chief economist at CMB International, shows that under the supply-side reforms about 11,000 companies vanished between the start of 2016 and the middle of 2018 across 11 reform-hit industries such as coal mining, ferrous metal mining and non-ferrous metal mining — nearly one in ten, through bankruptcy or acquisition. The number of steel and coal companies shrank by more than 50% and 30% respectively.

Over the same period the number of companies in other industries rose by about 1,500, an increase of roughly 0.5%.

The loss of more than 10,000 companies fed straight into the total profits of large industrial firms nationwide from January to July this year. Going by the cumulative figures the National Bureau of Statistics publishes each year, industrial profits over those months fell by about 344 billion yuan from a year earlier, with private firms' cumulative profits down 394.65 billion yuan. Profits at comparable state-owned firms rose 28.5% in the same period, offsetting part of the industry-wide fall.

Deleveraging and a sluggish A-share market make money harder to raise

Deleveraging came alongside the supply-side reforms. The debt ratio of China's non-financial companies has risen fast since 2009, when it stood at around 150%; by 2015 it had passed the American ratio and reached 255%.

Peng Wensheng, chief economist at Everbright Securities, has said that although countries differ in their stage of development and their institutions, so debt ratios cannot be compared on absolute numbers alone, "the rapid rise in China's debt-to-income (GDP) ratio in recent years tells us the risk is growing."

Figures from CMB International show that private firms have taken the brunt of the past three years of deleveraging. Since the most direct way to cut leverage is for banks to tighten credit, tighter money has forced companies to stretch out payment terms, and transaction risk has climbed sharply. Since 2016 the average time state-owned firms take to collect their receivables has fallen from seven days to close to zero, while for private firms it has risen from one day to 10.9 days.

Private firms are also paying more interest: interest costs rose 11.8% year on year from January to July this year, while their core revenue grew an average of only 9.5% over the same months.

Raising money on the stock market has also been harder this year. By QDaily's incomplete count, as of September 9 this year 152 companies had filed to list on the A-share market, 80 had been cleared by the China Securities Regulatory Commission, and the money raised came to about 103.3 billion yuan. For the whole of 2017 the figures were 479 filings, 380 approvals and 230.1 billion yuan raised.

Three months of the year remain, but with filings, approval rate and money raised all this far behind, the full-year figures will almost certainly fall short of last year's on every count. A sluggish A-share market could squeeze the regulator's approval rate further, because when the capital market is short of information and short of money, adding listed companies risks spreading the money in it still thinner.

On August 22 this year, daily turnover on the Shanghai Stock Exchange fell below 100 billion yuan — 98.3 billion — for the first time since January 2016. On August 23, U.S. time, turnover in Alibaba's American-listed shares alone came to $14.05 billion, or 95.3 billion yuan, close to the whole Shanghai exchange.

At the same time, companies are paying more tax

Figures from the iFinD terminal run by Hithink Flush show that China's non-financial listed companies earned a combined net profit of 2 trillion yuan in 2017, about 55% of all listed companies' profits, their best showing in recent years.

But that same year they paid 2.28 trillion yuan directly in taxes and fees, about 1.15 times their net profit, and paid out 2.56 trillion yuan in cash to employees, about 1.29 times their net profit.

Go back two more years and the pattern holds: in 2016 and 2015, non-financial listed companies' taxes and fees came to 1.36 and 1.66 times their profits, and cash paid to employees to 1.47 and 1.64 times profits.

From January 1 next year, the tax authorities take over collection of social-insurance contributions, and companies will in effect have to pay social insurance on employees' actual wages, pushing costs up again.

Another set of figures, compiled by the economist Zhou Qiren, dean of Peking University's National School of Development, shows corporate tax burdens, social insurance included, growing far faster than GDP:

"1995 to 2012 was China's fastest-growing stretch. Nominal GDP grew 8.6-fold, the national wage bill 8.8-fold, tax revenue 16.7-fold, and government revenue outside taxes 18.8-fold. The compulsory 'five insurances and one fund' social contributions grew 28.7-fold, and land-transfer fees grew 64-fold."

Land and labor cost more

Shenzhen, one of China's biggest manufacturing bases, has watched a wave of companies move out in recent years, Huawei and ZTE among them. In May 2016 Xu Qin, then the city's mayor, said that "more than 15,000 companies have left Shenzhen recently."

That is one small picture of companies rearranging themselves around the cost of land.

The Land Market Report for 40 Cities, First Half of 2018 (《2018 上半年 40 城土地市场报告》) puts land-transfer revenue in those 40 cities at 1.0453 trillion yuan, up 14.4%, 53.3% and 127.8% on the same periods of 2017, 2016 and 2015 — an all-time high.

The 2017 National Survey and Assessment Report on Corporate Burdens (《2017年全国企业负担调查评价报告》), published by China's Ministry of Commerce, asked about seven specific costs. The burdens Chinese companies named most often were labor (61%), financing (50%), logistics (49%) and resource inputs such as water, electricity, gas and land (48%).

Research by Peng Wensheng and others into demographics, labor costs and the demographic dividend found that the ratio of producers (aged 19 to 64) to consumers in China peaked in 2015 and has fallen since; the demographic dividend is fading. Fewer and fewer people produce while more and more consume. Rising labor costs follow inevitably.

The future looks less cheerful still. Figures from the 2016 national census show that, with the birth rate falling year after year, China's population aged 10 to 19 is 36% smaller than it was in 2005 — meaning that over the next decade the number of young people entering work will be more than a third lower than a decade ago.

Consumption is slowing, and the market has less room to grow

In the macroeconomic figures for May that the National Bureau of Statistics released this year, retail sales of consumer goods for the month came to 3.03 trillion yuan, a nominal rise of 8.5% year on year, before adjusting for prices — the slowest growth in almost 15 years.

That figure mainly counts what individuals and companies spend on physical goods, online and off, plus catering revenue. By category, daily chemical goods, furniture, communications equipment, petroleum and catering all grew faster than the average.

The steep drop in consumption may partly be spending shifting online, where e-commerce promotions easily push purchases later, and partly the hot property market. Most homebuyers spend the next ten or even thirty years of their cash flow to buy a flat, take on debts in the millions of yuan, and let the monthly mortgage crowd out any appetite for spending.

Even people who do not buy cannot escape sharply rising rents in some places.

Consumption data published regularly by the Beijing Municipal Bureau of Statistics show that from the first half of 2013 to the first half of 2018, residents' housing spending grew far faster than any other category, rising 23.5% year on year in the first half of this year. Over the same period, per capita consumer spending by Beijing's urban residents grew about 7%, spending on food fell 1.4%, and spending on transport and communications fell 12.5%.

Companies face more limits on investing abroad

Consumption, investment and exports are the three indicators macroeconomists use to judge how an economy is running over a given period; together they are called the three horses pulling aggregate demand.

As consumer demand slows, companies are also running into more restrictions on investing abroad.

A report from the consultancy Acuris shows Chinese companies spent $137.1 billion on overseas acquisitions in 2017, down 32.8% year on year. Chinese investment in the United States was hit hard too, falling from $46.23 billion in 2016 to $29.4 billion, down 57.2%.

That is a sharp reversal of the image of Chinese money buying up the world.

The bigger constraint came on February 11 this year, when the National Development and Reform Commission published a list of sensitive industries for overseas investment: property, hotels, cinemas, entertainment and sports clubs. Companies investing in these fields, directly or through equity funds, now need approval from regulators first.

Like Wanda, the other former stars of overseas dealmaking — Fosun, HNA — have largely stopped as well. Those still able to get foreign exchange to invest are either state-owned firms or private firms investing in specific approved sectors.

Internet companies were the biggest dark horses, but starting one costs more now

In 2003 Taobao went live. A platform where anyone could buy and sell online, it made Alibaba what it is today.

Regulation of e-commerce has always lagged behind. On counterfeit goods, consumer bodies, the industry and commerce authorities and product trade associations all get a say, but the rules they apply are usually a patchwork of administrative measures or laws written for brick-and-mortar shops.

China's first law written specifically for e-commerce, the E-Commerce Law (《电子商务法》), does not take effect until January 1 next year, almost 16 years after Taobao was founded.

That regulatory environment incubated some of China's largest private companies. In 2003, the year Taobao was founded, NetEase was the only private company among the ten most valuable Chinese companies listed overseas. Today Alibaba and Tencent are worth more than China's largest state-owned firms — China Mobile, PetroChina, CNOOC.

But the cost and the risk of starting a company have genuinely gone up.

Around 2015 the state was encouraging "mass entrepreneurship and innovation" and the growth of private equity and venture funds; the stock market had just crashed, and local governments needed companies to come and build their economies. To grow those economies and pull in outside money, some places — Beijing, Shanghai, Shenzhen and Chongqing among them — taxed the partners of venture firms at a preferential personal income tax rate of 20%.

Since last week, reports have kept coming that the national tax authority would set a single 35% rate for the partners of investment firms, and collect retroactively on past profits. The State Council's executive meeting later said the taxes would not be applied retroactively and that a line would be drawn between the old rules and the new.

Regulation has tightened, and together with a national financial strategy of controlling risk, deleveraging from the top down and draining market liquidity, raising money for equity investment is no longer as easy as it was. Deloitte's figures show that completed fundraising in 2017 fell 148.2% against 2015.

After the asset management rules of April this year, the requirements on investment scope, leverage and disclosure grew stricter. Zero2IPO's figures show that in the first half of this year equity investment funds in China raised around 380 billion yuan, down 55.8% year on year. Tighter regulation is one reason.

The bar for entering any industry is rising

In May 2016 the National Radio and Television Administration issued the Notice on the Administration of Mobile Game Publishing Services (《关于移动游戏出版服务管理的通知》), which requires a publishing license to operate a game. Only a licensed game may charge players; without one it can only run free open betas forever.

From studios of a dozen people to listed companies like NetEase and Tencent, the industry had grown used to license approvals. Across 2017, about 9,000 mobile games in China received one.

Then, in March this year, license approvals stopped dead. Tencent was not spared.

Not long after Tencent president Martin Lau told analysts there was a fast-track approval channel and that he expected approvals to resume in September, the rules moved again. On August 30 the National Press and Publication Administration said it would impose total-quantity controls on online games, capping the number of new titles allowed to launch.

That day the market value of A-share gaming companies shrank by nearly 10 billion yuan at one point; add NetEase, Tencent Holdings and Kingsoft, listed in the United States and Hong Kong, and the industry lost about 180 billion yuan overnight.

The gaming clampdown has taken nearly HK$1.3 trillion off Tencent's market value, more than the entire listed value of Bank of China.

Gaming is only one small picture of how China regulates its industries now. To run an internet company here you need licenses at nearly every step of the business you can think of, starting with putting a website online: an ICP filing, an ICP business license, an online culture business license, and more.

Harder still, holding a license may not be enough, because the room to interpret what a license covers keeps widening.

In April 2014, for instance, the broadcasting regulator told video sites to stop streaming four American series — The Big Bang Theory, The Good Wife, NCIS and The Practice — without giving a reason.

Later, licensed video sites playing by the rules were told to stop releasing episodes weekly in step with overseas broadcasts. Whole seasons had to be translated, submitted for review, and posted only once approved.

Even after Didi got its ride-hailing license, it still had to pull non-compliant cars and drivers offline and suspend them, following new requirements issued afterwards by one province and city after another.

Doing business means worrying about more than commerce and the law

In May this year Liu Chuanzhi, the founder of Lenovo Group, who had left the company years earlier and holds no operating role, sent an internal letter titled "Take Action, Fight to the Death to Defend Lenovo's Honor" (《行动起来，誓死打赢联想荣誉保卫战》), setting out the facts and the findings of an inquiry into the "5G vote" affair. He said he had spoken with Ren Zhengfei, Huawei's principal founder and president, and that Ren had vouched that there was nothing wrong with Lenovo's vote.

It was a vote on a technical standard, led by companies rather than governments. Lenovo backed its partner Qualcomm instead of its direct competitor Huawei, and was denounced for "selling out the country."

There are more and more cases of companies landing in serious trouble for "doing the wrong thing" or "saying the wrong thing." Live-streamed trivia shows, hailed as the industry's next big thing at the start of the year, vanished overnight for the same sort of reason.

The entrepreneurs' accounts that were once busy on Weibo and WeChat say less and less. There is not much left that can be said in public.

And the uncertainty keeps growing

After the venture-tax news broke at the end of August, Wang Ran, CEO of China eCapital, wrote on Weibo: "The sense of uncertainty about policy and regulation grows stronger and stronger => more and more entrepreneurs and investors will find ways to move their assets overseas."

The venture tax and the sudden halt to game approvals are one example. Back in 2014, when Weibo listed, its prospectus disclosed the risk of content moderation. It also ran straight into the "Cleaning the Web" campaign, which shut down assorted accounts for violations and fined the company as well.

By the time iQiyi prepared to list this year, its prospectus ran to more than 100 lines explaining uncertainties, among them:

Because of limits on disclosure, iQiyi may only find out it has broken a rule after breaking it, because "China's legal system gives retroactive effect to certain provisions of government policies and internal rules that were not published in a timely manner, or not published at all."

When an environment is this uncertain, people as a group think short term.

Ma announcing his retirement plan now, however carefully it is worded as "succession," will only deepen the slide in confidence.

Cover image from The National and financeblvd