Military Designation for Tencent, Tesla Supplier Show Perils of Investing in China

We get a strong reminder of the perils for China stock pickers today, with Tencent Holdings TCEHY (HK:0700) leading the losses in Hong Kong.

That’s because Tencent and battery maker CATL SZ:300750 are both newly identified as “Chinese military companies,” and included on a U.S. Department of Defense list to that effect.

It is a surprise to see Tencent included. The company is best-known for making videogames, streaming music, and operating the messaging superapp WeChat, which is omnipresent in China.

Tencent says in response that it believes its inclusion on the Chinese military companies list is a “mistake.” The company is not directly a Chinese military company, nor is it a military-civil fusion contributor, it insists.

But it is very clearly identified as one of 56 parent companies, some with multiple subsidiaries, that have links with the Chinese military. You can find the full list here.

Tencent, the largest Chinese company by market capitalization, led the losses for the Hong Kong benchmark, the Hang Seng index, today, down 7.3% at the close, just off its 8.0% low for the day.

Other noteworthy new inclusions include COSCO Shipping Holdings CICOY (HK:1919). The company operates a fleet of 1,417 cargo vessels, including oil tankers, with a total capacity that as of a count at the end of 2023 made it the largest shipping company in the world.

COSCO Shipping shares ended the day down 3.3% today in Hong Kong.

CATL (full name Contemporary Amperex Technology Co. Ltd.) fell 2.8% on the Shenzhen exchange. The shares recovered from a 6.1% fall at the open.

CATL, too, says its inclusion on the Defense Department list “is a mistake.” With market share of around 38%, the company is the world’s largest maker of batteries for electric vehicles, counting Tesla TSLA among its customers.

We can see with CATL that the listings on the mainland markets in Shenzhen and Shanghai are insulated from the worst of any selloff. They fluctuate less than their counterparts in Hong Kong, where international investors typically do their buying and selling for China stocks.

Tencent has borne the brunt of the selling, even if the damage is more reputational than direct to its business.

The U.S. Department of Defense is required to publish the roster, known as the Section 1260H list for the clause that created it, annually since 2021.

There are currently no legal ramifications to inclusion. The main upshot is that the U.S. Department of Defense will be barred from buying goods or services from such companies as of June 30, 2026. As of 2027, the Pentagon would have to cut out all products and services from anywhere in its supply chains.

Companies can request for a review of their inclusion, and it’s possible to get taken back off. CATL says it will “engage with DoD to address the false designation, including legal action if necessary, to protect the interests of our company and shareholders as a whole.”

Likewise, Tencent says inclusion does not affect the group’s business, but it will “initiate a Reconsideration Process to correct this mistake.” It intends to “resolve any misunderstanding” but also hints at legal proceedings should discussions not prove successful.

Those efforts are not without hope.

The major civil-engineering and construction contractor China Railway Construction Corp. (CRCC) (HK:1186) has successfully been removed from the list as of today, alongside China State Construction Group and four other companies. The two construction companies are among the largest infrastructure and civil-engineering operations in the world.

CRCC shares closed essentially flat, down 0.2% today in Hong Kong, outperforming the benchmark Hang Seng index, which dropped 1.2%.

The smartphone maker Xiaomi XIACY (HK:1810) was the first such company to pursue legal action to get itself taken off the defense-department list. Those efforts succeeded in May 2021, after its addition that January.

But the drone maker DJI and the sensing-technology company Hesai Technology have both sued for removal after inclusion last year, so far without success.

China’s foreign ministry lambasted the U.S. government move, urging Washington to “immediately correct its wrong practices” and stop “long-arm jurisdiction” of Chinese companies.

Mainland stocks shook off any U.S. government action, with the CSI 300 index of the largest listings in Shanghai and Shenzhen up 0.7% on the day.

The facial-recognition software maker SenseTime Group HK:0200 is another new inclusion. The company issued a statement expressing “strong opposition” to its addition to the list, a move it says is “baseless.”

But SenseTime is already included on a separate sanctions list maintained by the U.S. Department of Treasury that declares it part of the Chinese military-industrial complex.

Inclusion on that list, maintained by the Office of Foreign Assets Control, is far more serious in that it carries sanctions implications. It bars U.S. investors and entities from owning the securities of such companies.

The stipulations caused SenseTime to pull the plug on a planned initial public offering in Hong Kong. It did eventually list, but with the stipulation that U.S. investors could not buy the shares.

For SenseTime, then, the new inclusion should have “no substantial influence on the company’s business,” it says. Its shares closed flat today.

Likewise, the largest Chinese aircraft maker, COMAC (full name the Commercial Aircraft Corp. of China) already found itself on the military-industrial complex list, and as of today is also included on the Department of Defense list.

It’s interesting to see today that the biggest gainer in Hong Kong is the Chinese chipmaker SMIC HK:0981. Its shares are up 5.1% on the day.

SMIC (full name Semiconductor Manufacturing International Corp.) is already included on both the defense department and treasury department lists. The company is set to be the chief beneficiary of China’s efforts to domesticate semiconductor production.

SMIC makes chips that are used in electronics with both civilian, police and military capabilities. So its inclusion as a military-linked company is no surprise.

But its history does reveal the difficulty that Chinese companies face in attracting global investors. The company voluntarily delisted from the New York Stock Exchange in 2019, and then removed its ADRs from Nasdaq in 2021.

The fact that the U.S. Treasury Department list prevents U.S. investors from owning the securities of the associated Chinese companies is likely to muddy the waters for companies included on the U.S. Defense Department list. The sanctions make it extremely tricky for index trackers and exchange-traded funds to mimic Chinese markets without violating the restrictions.

Watch this space, to see if the efforts of Tencent and CATL to remove their names are met with success.

At the time of publication, Alex Frew McMillan had no position in any security mentioned.