Financial Times recently had an opinion piece revealing the true reason Western companies flock to China despite its opaque business environment.

The opinion piece was authored by Jay Newman, a senior portfolio manager at Elliott Management; Alexander Campbell, a senior commodities investor at Bridgewater Associates; and John-David Seelig, a senior data scientist at Rose Technology – a data platform.

According to the piece, hundreds of Western public companies have invested in China. China’s revenues make up a significant portion of its overall sales. For example, last year, Apple recorded $69 billion or 19 percent of its sales in China. The largest automaker Tesla reported $13 billion or 25 percent. Volkswagen reported $54 billion or 22 percent. And Disney recorded $6 billion or 8 percent. 

This might not be a surprise, as people assumed a consumer market of 1.4 billion people would be too much of a lure for any global brand to ignore. However, China is a closed, opaque, and centrally controlled bureaucracy. So sales made there are markedly different from sales in other countries where property rights are more stable.

Auditing is one thing. The U.S. Securities and Exchange Commission has recently delisted 200 Chinese companies from the stock exchange. 

Big state-run companies like oil giant Petro China, and insurance giant China Life, will be delisted. Some of China’s largest tech companies including Alibaba, JD.com, and Baidu are facing the risk. Why?

Because in China, rules, accounting standards, tax policy, and legal protections are all closed systems directly controlled by the Chinese Communist Party. Rules are malleable and have a political nature. Everything is a potential weapon when needed. 

You can put money in, but you don’t know when, how much, or at what value you can reap the rewards. The yuan – the Chinese currency – is not freely exchangeable. The CCP controls the price of the currency and, by extension, the value of investments.

More importantly, investors cannot easily reap the profits and dividends. 

By law, you can not transfer more than $50,000 out of China without permission. If the CCP is worried about its hard currency reserves, foreign investors will find it very hard to get back their deserving dividends. 

In case of a hotter Cold War, Western investments in China could be held hostage. And sending large amounts of money home would not be possible without coerced transfer of technology under a then geopolitical quagmire.

That’s not counting many other risks, including unfair competition, industrial espionage, forced sharing of intellectual property, and explicit or implicit expropriation. 

Still many companies still accept the big risk to chase sales in China. And there must be a reason.

In fact, it reflects right on the stock price. In this graph, we can see that the price to sales ratio, or the market value of the company over its revenue of Western companies are about 50% more than their Chinese counterparts.

Through arbitrage, international capital markets can turn Chinese income from indistinct income statement entries into real money. This reflects on its market value markup on American and European stock exchanges. Western executives and shareholders can sell shares to reap the profit. In essence, share prices of Western companies have gone up because of sales money that got stuck in China. The elusive Chinese yuan has now become real dollars and euros, all thanks to market sentiment. 

But things are seldom what they seem, skim milk might masquerade as cream. Things that seem too good to be true don’t last forever, but until the cream sours, the masquerade goes on.

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