Article / 30 October 2012 at 9:00 GMT

China Finance: A stock play on increased Internet censorship

Fredrik Oqvist Fredrik Oqvist
Founder / ChinaRAI
China

Executive summary

  • China's leadership change likely to spark increased Internet censorship
  • Censorship will temporarily push up costs for Chinese Internet companies
  • Sina a possible short play: strong correlation btw. censorship, share price
  • Censorship may drive down Youku shares temporarily: trade the bounce?

 

Censorship Article

As the Chinese leadership handover approaches, there are a few tell-tale signs that everyone knows are coming: Banners about the greatness of the party, clean air and blue skies in Beijing for TV appearances, lots of speculation about what is going to happen, and increased Internet censorship. The last point suggests an opportunity for a speculative short position on Chinese stocks heavily influenced by censorship.

The Chinese government controls the Internet, and it’s often helpful to imagine it having a dial with Internet censorship written on it that it can use to adjust the levels. Internet censorship in China is not a stoic monolith; instead it’s a dynamic and multifaceted system that changes with the times.

One of the most important mechanisms for regulating the Internet is the self-regulation engaged in by the companies themselves. This is not only quicker, as the companies know their own users better than the government; it also switches the costs onto the companies. Complying with Internet censorship isn’t free, and when the dial gets turned up moderation costs increase.

Costs increase, user engagement goes down

Apart from driving up costs, the censorship also somewhat limits user engagement on the sites, as certain key words cannot be used or searched for, or at times certain locations are banned from posting anything on Weibo (see the protests in Ningbo for example). This is all bad news for the Chinese Internet companies that are dependent on user engagement to drive their business.

The most obvious play here is a speculative short on Sina (NASDAQ: SINA), whose stock price has previously proved very susceptible to government censorship moves. The last time the government suspended the comments section on the company’s Weibo service, for instance, the stock dived 10%, only to later rebound back when the restrictions were lifted.

Weibo chart

The reason I use a dial to illustrate how Chinese Internet censorship works is that it’s almost always turned back to a relative default mid-setting after key events have passed. There is a case here to say the market in general tends to panic and exaggerate the impact of temporary changes in censorship policy.

Effect on shares probably temporary

While the changes will almost definitely have a noticeable impact on the results of the companies in question - for instance I expect to see increased costs for Sina Q4 - they are also temporary and not reflective of a normal quarter.

There are two potential plays here that look promising. The first is the short play on increased Internet censorship for the leadership change and an exaggerated market reaction. The second is trading the bounce by using a temporary dip in share price to get in and ride the possible price correction the following days.

While Sina is the most obvious choice for this type of play on policy, there are also other companies to keep an eye on. Online video site Youku (NASDAQ: YOKU), could see increased censorship, as would the other Weibo-style services for Tencent (HKSE: 0700), and Sohu (NASDAQ: SOHU), but the connection between stock price and microblogging service isn’t as strong for them as it is for Sina.

As the move is already speculative and depends both on increased Internet censorship and market reaction, I think Sina would be most likely to create a sitution where there is enough volatility for a short to make sense. The others could be worth keeping an eye on to get in on a correction play.  Of course, every trade is a risk, and results can never be guaranteed. 

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