BMO Family Office
The latest chapter in the unfolding U.S.-China trade war has moved to the Internet, focused on the potential national security threat posed by Chinese companies operating in the U.S.
On August 6, President Trump issued two executive orders that would limit the ability of Chinese social media apps TikTok and WeChat to operate in the U.S. beginning 45 days from the date of the orders. The orders are quite broad but subject to interpretation. They bar anyone in the U.S. from transacting with the China-based owners of the apps. TikTok is the incredibly popular short video app which is owned by Beijing-based ByteDance. The app is especially popular among teenagers and has been downloaded over 2 billion times globally and 165 million times in the U.S. (see Exhibit 1). WeChat is the ubiquitous Chinese messaging app (and much more) which is owned by Tencent.
National security concerns are legitimate
Until now, Chinese-based Internet companies haven’t had a large presence in the U.S., so government controls haven’t been a big concern. Last year, The Guardian obtained documents1 revealing that TikTok’s content is subject to “moderation guidelines” that advance Chinese foreign policy (e.g. banning material that refers to the “Tiananmen Square incidents”). The same goes for Tencent’s WeChat which is used by Chinese students and immigrants living in the U.S. The Trump Administration may be concerned that TikTok’s algorithms could somehow influence the 2020 elections. Seems like a stretch, but not impossible to imagine. A big part of TikTok’s secret sauce is in the algorithms designed by engineers in China that determine which videos appear in the user’s feed.
Why is Microsoft pursuing a deal with TikTok?
Following President Trump’s executive order, TikTok’s parent ByteDance is left with few options besides selling its U.S. operations to a U.S. company. Microsoft (MSFT) is the logical buyer given its deep pockets and limited exposure to the social media market which should help with regulatory approval. Others (including Oracle) have also expressed an interest in buying TikTok but MSFT seems most likely. Microsoft’s management apparently sees the benefit of acquiring a unique asset at what could be a fire sale price (rumored to be in the range of $10 - $30 billion) given TikTok’s tremendous growth potential.
While TikTok is a consumer-oriented company that would seem to be outside of MSFT’s core competency, the hope is that MSFT’s recent success with acquisitions such as LinkedIn could be replicated with TikTok. TikTok is in the early stages of building out its advertising stack and Microsoft has some experience with that from the Bing search engine. Finally, there would be cost synergies from moving TikTok’s cloud database onto Microsoft Azure.
What if the Microsoft / TikTok deal falls through?
If the deal with Microsoft falls through other buyers would likely step in. In the event that TikTok is forced to shut down in the U.S., Facebook (FB),Google (GOOGL/GOOG) and other ad-driven internet players would be the main beneficiaries as the long-term competitive threat from TikTok would be removed. To capitalize on the TikTok controversy, Facebook has already rolled out a competing service called Instagram Reels and it has reportedly been poaching talent from TikTok’s roster of content creators.
How will China respond?
TikTok’s owners and the Chinese government are obviously not pleased about being forced to sell the business or shut down in the U.S. While there are number of ways the Chinese government could retaliate – e.g., restrict rare earth mineral sales or take action against specific U.S. companies in China – we believe that China is likely to bide time and “lie low” until after the U.S. presidential election. The long-term relationship between the U.S. and China will continue to be contentious but the specific nature of U.S. policy, and by extension China’s strategy, will differ depending on whether Trump or Biden occupy the White House. Biden, should he be elected, is likely to form a coalition with our European allies to confront China. In this case, China’s response is fairly predictable – string everyone along and attempt to exploit self-interest and lack of priority alignment between the U.S. and Europe – put simply, try to divide and conquer.
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