China tech: Is the market pricing in too much regulatory fear?

[BEIJING] China’s technology stocks have a familiar problem: Just when investors begin to regain confidence, another regulatory announcement sends them running for the exits.

That was precisely what happened on 22 Oct, when the Hang Seng Tech Index plunged 5 per cent, its steepest single-day decline in 2026. Alibaba, JD.com and Meituan were among the biggest casualties, with Alibaba shedding 6.1 per cent in Singdollar terms.

The trigger landed when China’s State Administration for Market Regulation summoned major e-commerce platforms to a meeting on product quality and consumer protection.

For investors still scarred by Beijing’s sweeping crackdown on the technology sector in 2021 and 2022, the announcement sounded uncomfortably familiar.

Yet, unlike the 2021 to 2022 crackdown, the latest announcement introduced no new fines or sweeping restrictions. The market may have reacted more to past regulatory fears than to the announcement itself.

Could tighter regulation improve margins?

From discounted meals to aggressive shopping-festival promotions, China’s e-commerce giants have spent years sacrificing profitability to defend market share. Consumers may have enjoyed the bargains. Shareholders, less so.

But the economics of this competition has started to change. While Chinese regulators have stepped up scrutiny of product quality and consumer protection, they have also sought to curb excessive competition and destructive price wars.

Recent earnings suggest that profitability is already recovering. Meituan reported a 14.4 per cent year-on-year increase in revenue in the second quarter of 2026, returning to profitability with a net profit of 2.2 billion yuan (US$331 million).

Alibaba’s e-commerce business, meanwhile, had its adjusted earnings before interest, taxes and amortisation rise from 23.9 billion yuan in the January-to-March quarter to 39.7 billion yuan from April to June.

The benefits could extend beyond reduced promotional spending. Following about 3.6 billion yuan in collective penalties imposed on e-commerce and delivery platforms over food-safety violations in April 2026, companies have accelerated efforts to strengthen merchant verification and quality controls.

Meituan, for instance, conducted more than two million merchant inspections in May alone, removing about 75,000 non-compliant merchants.

Alibaba introduced its “3+1+AI” governance framework, combining merchant oversight, delivery-rider reporting and artificial intelligence-powered risk monitoring.

While these measures come at a cost, they can also strengthen consumer confidence, reduce disputes and encourage repeat purchases. Larger platforms with established compliance infrastructure may additionally gain a competitive advantage over smaller rivals that struggle to absorb the additional expenses.

Crucially, recent earnings suggest compliance costs have not derailed profitability. By curbing destructive competition and improving consumer trust, tighter regulation could ultimately support healthier industry margins.

This brings us to a distinction investors may overlook: Not every regulatory intervention is necessarily bad for profitability.

AI spending question

Regulation, however, is only part of the story. A lasting rerating will depend on whether Chinese tech companies’ heavy investment in AI can generate meaningful financial returns.

For much of the recent AI boom, investors have rewarded companies for announcing ambitious expansion plans, building data centres and securing advanced computing capacity.

That enthusiasm is becoming more selective. The question is no longer simply how much companies are spending on AI, but also how much they can earn from it.

The clearest winners are the chipmakers selling the picks and shovels. SMIC, the country’s leading chip foundry, reported a 36.1 per cent year-on-year increase in second-quarter revenue, while gross margin improved from 20.1 to 25.3 per cent quarter on quarter.

Similarly, Hua Hong Semiconductor recorded a year-on-year improvement of 5.6 percentage points in gross margin to 16.5 per cent. Both companies benefited from stronger semiconductor demand, improving capacity utilisation and China’s push to develop a more self-reliant chip supply chain.

For internet companies, however, the payoff is taking a different shape. Alibaba’s AI Cloud and Compute Services revenue surged 45 per cent year on year in the June quarter, while its cloud business’ adjusted operating earnings jumped 133 per cent to 5.6 billion yuan.

This suggests AI demand is beginning to translate into stronger operating profits, rather than merely higher infrastructure spending.

Kuaishou is also demonstrating that AI applications can become commercially viable businesses. Its Kling AI video-generation platform generated over 850 million yuan in second-quarter revenue, more than trebling from the year-ago period.

Yet, there is a catch. Despite Kling AI’s rapid growth, Kuaishou’s overall adjusted net profit declined.

Alibaba, meanwhile, aims to build 20 gigawatts worth of data-centre expansion by 2032 that could keep capital expenditure elevated for years.

This highlights a crucial distinction between revenue growth and investment returns of AI. A company can generate impressive new revenue streams, and still struggle to create value for shareholders if the costs of building and operating its AI infrastructure grow just as quickly.

That is why the next phase of China technology companies will be less about technological ambition and more about financial discipline. Investors will increasingly want evidence of improving profitability, shorter investment payback periods and stronger free cash flow.

The companies that deliver on these measures could be the next winners of China’s AI boom. Those that cannot, may find investor patience wearing thin.

Has pessimism gone too far?

Investor sentiment towards Chinese technology stocks remains fragile. As at 30 Oct, the Hang Seng Tech Index traded at about 18.7 times forward earnings, well below its 10-year average of 28.8 times.

Some discount is justified. Regulatory uncertainty persists, competition remains intense and substantial AI investments have yet to demonstrate consistent returns.

However, the current valuation gap suggests investors may already be pricing in considerable pessimism, leaving room for a recovery even without full-fledged earnings rebound.

What matters is whether the key risks weighing on valuations begin to ease. Sustained improvements in quick-commerce unit economics, supported by more disciplined subsidy spending and healthier margins, would strengthen confidence in the sector’s profitability.

A more targeted and predictable regulatory environment could help narrow the regulatory risk premium, while greater discipline in AI capital expenditure, alongside early signs of monetisation, could reassure investors that heavy investment will eventually translate into sustainable cash flow.

For long-term investors, the opportunity lies not in waiting for all the risks to disappear, but in recognising that even gradual improvements in fundamentals could trigger a meaningful valuation rerating.

The writer is a senior research analyst with the research & portfolio management team of FSM Global, the B2C division of iFast Financial