There are bad things going on for U.S. stocks in China, and even if you’ve been paying attention, you probably don’t realize how bad things are. I’m not talking about the economy or corruption, I’m talking about how the Chinese government can do anything it wants. If you are invested in any U.S. stocks that do business in China, you must read this article.
I chatted with a veteran businessperson who has seen how things work over there first-hand, especially for U.S. stocks.
The first concept is that the Chinese government must keep a billion people in line, and make sure they have basic necessities.
If the people get angry, revolution is possible. So the government cracks down on corrupt rich folks to show the population that they are “on top of corruption.” That’s why Macau casinos have been hurting.
The second concept is that, for U.S. stocks doing business there, the system is totally opaque. Literally anything can be done to U.S. stocks by the government or its proxies, and there may or may not be an explanation for it, and that explanation may or may not even be the truth. Or a business may not be told anything at all. There may be multiple reasons for something, which shareholders of U.S. stocks will never hear about.
The business veteran gave me two examples. Suppose there’s a World Tennis Championship in Beijing. A mid-level bureaucrat, who doesn’t want to lose his job or car or house, wants to make sure that tennis appears to be a big thing in China. So badminton supply houses are all put out of business.
Obviously, that’s a fictional example.
He pointed me to a more chilling real-life story. Shanghai Husi Food Co. is a supplier of beef and chicken to fast food chains like Yum! Brands, Inc. (YUM) and McDonald’s Corporation (MCD). It’s a subsidiary of privately-held OSI group, based in Aurora, Illinois. Dragon TV employees (state-owned media) lied about who they were, going “undercover” at Husi. One deliberately dropped food on the floor and introduced it into the supply chain, and BINGO! They air a false story about Husi using tainted product.
The result: six employees were arrested, held without charges for 17 months, and China fined the company and sent 10 people to prison.
U.S. Stocks Have to Get Comfortable With Risk
In America, we laugh off conspiracy theories. In China, one laughs off anything that isn’t a conspiracy. Who knows what Husi did to earn this, if anything at all? As this businessperson told me, “For all Husi knows, one of their mid-level managers insulted a high-level exec at Dragon, and this was a vendetta. Or a high-level government official got sick of KFC and irrationally decided to go after Husi. Nobody knows.”
Instead, 10 innocent people are in a Chinese prison. It’s a travesty. They should all be released immediately, and given recompense for their suffering.
The lesson for investors is that one would think 25 years of experience in China would insulate any business. Guess again. Nor is this problem limited to food companies. Microsoft Corporation (MSFT) saw Windows 8 get banned because the government claimed it had tons of spyware on it. Its offices were raided in an “anti-monopoly probe.” Qualcomm (QCOM) lost almost a billion dollars settling with the government over royalty charges. GlaxoSmithKline (GSK) was slammed for almost half a billion dollars over alleged bribery schemes.
If you own any stocks that do business in China, you are exposed. A frightening 8% of 2013 revenues for the S&P 500 comes from Asia-Pacific. Apple Inc. (AAPL) reported $16.1 billion in revenue from China in Q4 — 24% of its revenue. Full-year income from China for General Motors Company (GM) was $2.1 billion in 2015. Yum Brands generates about a billion dollars in operating profit annually from China. Here’s a longer list of at-risk companies.
The bottom line is that if you want to be in big multinational companies, you are going to take risks with operations that occur in foreign countries. Sometimes, these risks may be minimal. As we’ve seen with others, they may be huge. You either have to accept that risk, or bail.
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance. As of this writing, he did not hold a position in any of the aforementioned securities. He has 20 years’ experience in the stock market, and has written more than 1,200 articles on investing. He also is the Manager of the forthcoming Liberty Portfolio. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.