Best Advice for Investing in China: Play the Hits

The Chinese government's move against DiDi (DIDI 0.43%) is only the latest in a string of actions against technology companies. In this episode of MarketFoolery, Bill Mann, with host Chris Hill, discusses what he believes some investors are missing in the story and shares his straightforward approach to investing in China. Plus, he digs into the brands underneath Authentic Brands Group as well as Robinhood's S-1 filing.

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This video was recorded on July 12, 2021.

Chris Hill: It's Monday, July 12th. Welcome to MarketFoolery, I'm Chris Hill. As I mentioned late last week, I'm off this week, but I can't leave the MarketFoolery feed with no content in it just because I'm on Cape Cod. That's why the one and only Bill Mann is here. Good to see you, Bill.

Bill Mann: Because you asked everybody else.

Hill: Dude, you're my No. 1 traffic, you know that.

Mann: Nice to see you, Chris.

Hill: There are a couple of things I want to get your thoughts on. Let's start with something that Jason Moser and I had talked about last week. I know this is a story that has crossed your radar because you were tweeting about it. That is DiDi, the ride-hailing app is the "Uber of China" although it has a much bigger market. Uber would love to have the market share in the United States that DiDi has in China.

Mann: Exactly. Uber is the DiDi of the U.S.

Hill: Yeah. What went through your mind when you saw the news that the Chinese government basically said, "We're going to halt new users from downloading the app because we want to conduct a cybersecurity review." This is not the first time in recent history that the Chinese government has done this to a big tech company in its own country.

Mann: The big story here is that DiDi's now been removed from WeChat and Alipay, which are super apps in China. When President Trump threatened to ban Apple from working with Chinese companies and forced them to take Alipay off of the App Store, Apple said, "You will destroy our business in China." This is as big a deal as having something removed from the App Store. It's interesting. I don't know if a lot of people realize this, but back in 2015, people figured out, using Uber data, that some hackers in China were actually working with the government by virtue of having gotten ahold of their Uber data. So there is a lot of government sensitivity to the data that DiDi is able to collect. DiDi, I think, made a huge mistake a couple of weeks ago. They put out a survey saying, "Hey, look. This is the government ministry that works the longest on average by virtue of us having the data when people are going and leaving from the Ministry of Public Security," which seems like a bad Chinese ministry to track. They've got a big problem. It's interesting to me that the big problem came up after the company went public and took in $4.5 billion of non-Chinese money because the Chinese government knew the past of this company going public. But yeah, this is a big, big problem for DiDi.

Hill: There will absolutely be investors who look at the risk of the Chinese government acting quickly, intervening when they want to and saying, "You know what? I'm happy to take on that risk because again, this is a business that has 90% market share. I think this is [...]." There are always going to be people willing to make the bull case for DiDi. I guess my question for you is, what does this do to inform your thinking about investing in Chinese companies? Because there are plenty of investors who will just say, "Look, there are a lot of companies I can invest in. I know there are some great rewarding businesses in China, but I'm just not interested in that particular flavor of risk in my portfolio." Do you look at it as, "Look, this is the cost of business and I'm willing to take on this risk because there truly are some great rewarding businesses out there."

Mann: A little bit more of the latter. But I would say there are two types of people who are making mistakes out there: the people who are investing in China, and the people who are not investing in China. China, it's a different beast. Most of the Chinese companies that you own through the American stock exchanges are actually nominee entities that are domiciled in places like the Cayman Islands. There are a bunch of corporate issues that you need to be aware of in China. My advice to people when you're talking about Chinese company is, just play the hits. Just play the hits. Own Tencent, own JD.com, own Alibaba, own Ping An, and don't get too fancy with Chinese companies. Because those companies we know are at least as large as they are, although they do have plenty of risk from Chinese regulatory actions, they are big enough that you know that the CEOs and the management of these companies are already deeply tied in with the Chinese government. It's realpolitik. It might sound a little ooky, but it is true. If you want to invest in China, it's different from most any other economy in the world. Don't get fancy.

Hill: Recently on Motley Fool Money, we did our review of the first half of 2021, some looking ahead to the second half of the year. I want to get your thoughts on it because I am curious what you're watching in the second half of the year. But before that, I think it's fair to say that one of the big stories certainly of the last 12 months when it comes to the stock market is the number of companies that have gone public. Far more IPOs than I would've guessed we'd have during the pandemic. Certainly, the companies that went public via SPAC skyrocketed. You brought something to my attention that I'm still trying to wrap my head around. It's another company going public, and I'm not sure what the upside is here. It's a company called Authentic Brands Group.

Mann: Yeah.

Hill: It's a licensing firm, and I will say this. The brands underneath Authentic's umbrella are really well-known brands. These are brands everyone has heard of: J.C. Penney, Sports Illustrated, Marilyn Monroe. I'm not sure how the late great Marilyn Monroe is a brand onto herself nearly 60 years after her passing.

Mann: Eddie Bauer is one, Nine West is one, Brooks Brothers. It's like this set of risky businesses called and it wants its brands back. This is 1987 pulled forward to today. The thing that caught my eye was that this company has actually done something that is a tried and true way of making money, which is to do maybe the absolute opposite of David Gardner's style of investing. What they have done is essentially grave brands that had some value. They were buying brands that have absolutely run their course. But because they've run their course, they're getting them for next to nothing, they're just assuming certain liabilities, they're repackaging this and they are bringing it public as a 30-brand conglomerate. Who knows? I can tell you this, this is probably not the IPO that people are going to be super excited about. Ultimately, I think this is probably good for the insiders, and I can't think of too many situations in which brands have really gone as far down as J.C. Penney has that have revived themselves. But there are 30 of them in this basket. They don't have to be right about all of them.

Hill: No, they don't. Look, licensing is one of those things if you do it right, it becomes a nice little profit center.

Mann: Yeah.

Hill: As you said, they've got 30 of them. They don't need all 30 to be winners. But it really does seem like, as you said, this seems like something that benefits the insiders. I'm not saying I'm rooting against them, but it is one of those situations where I'll be curious to check back a year after they've gone public.

Mann: Yeah. Super important to note is that Simon Property Group is one of the investors. I haven't read through the S-1 yet, but I suspect that the reason why Simon Property Group, one of the largest mall owners in America, is an equity holder in this is because it was in lieu of contracts on leases that weren't going to be fulfilled. This may be a cash out for all of them. Maybe Barneys will turn around. Who knows? But it's common. If you missed out on losing money on J.C. Penney last time, I got some good news for you. I've got good news. It could happen again.

Hill: Before I let you go, what are you watching in the second half of the year? I've said recently, most immediately, I'm interested to see what we hear out of the big retail CEOs at the end of this month and into August, not just in terms of the quarterly earnings for Walmart, Target, Costco, etc., but also around hiring because I feel like we're going to get some clues to permanent hiring as well as seasonal hiring. But that's me. What are you curious about?

Mann: That is definitely something that I'm paying attention to. I'm really, really, and this will sound a little twisted, I am very much paying attention to all of the factors around the Robinhood IPO. If you've gone through the filing of the Robinhood IPO, they make about 81% of their money from payment for order flow, which is money that executing brokers pay them to execute trades, which is how they make money. They make about 39% of all of their money off of options trades and another 28% off of cryptocurrency trading. They have a huge level of exposure to things that may have been just hot in 2020 and coming into 2021. There's potential further regulatory action against the types of business plans that companies like Robinhood have. If Dogecoin stays flat for the next six months, what's going to happen to this business? This is a mutant business, and they have disrupted a huge industry. But I'm also interested to know just how much of that is going to stick.

Hill: Which is more surprising to you, the 28% they make off of crypto or the 39% they make off of options because the options one is the one that struck me as being absurdly high.

Mann: Yeah, it blows my mind. I mean, any options trader will tell you what you need in a good options market is volatility, which in 2020, obviously we had. What happens to Robinhood when you've got a year like 2017 where the stock market is as flat as a board for the entire year. Anyway, there's a lot to be seen there and really to me, it's not so much the company, Robinhood, so much as it is. What is the market that we're going to operate in going to be like in 2022 and beyond because Robinhood has changed things? So many brokers had to chase Robinhood into zero-commission trading, and that's billions of dollars that the other brokers said, "Just to compete with Robinhood, we need to give this high-margin revenue away." They've done some things, but it's going to be interesting to see how many of those things end up sticking going into the end of this year and into next year.

Hill: Bill Mann, great talking to you. Thanks for being here.

Mann: Thanks, Chris. Enjoy your trip.

Hill: As always, people on the program may have interest in the stocks they talk about and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. That's going to do it for this edition of MarketFoolery. This show is mixed by Dan Boyd. I'm Chris Hill. Thanks for listening. We'll see you tomorrow.