Beijing municipal Cybersecurity Administration summons officials from the website, sometimes called the ‘Quora of China,’ for hosting ‘illegal’ content

Key takeaways:

  • Officials from the Quora-like Zhihu were summoned to a meeting with internet regulators for hosting ‘illegal’ content on the company’s site
  • Infraction appears to be relatively minor, despite selloff that saw company’s shares initially tumble as much as 16% the day of the announcement

By Doug Young

Today we depart from our usual review of official announcements to look at something that most companies would probably prefer not to talk about: getting in trouble with one of China’s many regulators. In this case we’re zooming in on the latest news that Q&A site Zhihu Inc. (ZH.US) has tangled with one of China’s regulators for allowing “illegal” content on its site.

This kind of run-in has become all the rage among China’s many regulators this year. Those regulators include everyone from the Education Ministry, which led a massive crackdown on China’s private education sector; to the State Administration for Market Regulation, which is leading anti-monopoly probes that have led to massive fines for some of China’s top internet firms; to the Cyberspace Administration of China, whose data security probes have led, among other things, to the recent decision by DiDi Global (DIDI.US) to abandon its U.S. listing for a re-listing in Hong Kong.

Since many of the companies netted in the various campaigns are publicly traded, it’s become increasingly important for investors to understand the differences between various regulatory actions. That means knowing whether something is a regulatory rap on the knuckles, or whether it’s something more serious that could potentially cost a company millions of dollars in lost revenue or even put it out of business.

We’ll look at that part of the equation in more detail in the second half of this discussion. More broadly speaking, investors seem to be treating all these actions roughly the same in the current climate, when perhaps they should be taking some more seriously than others. Thus, big selloffs on regulatory actions that look relatively minor could present good buying opportunities for people who can understand the difference.

All that said, let’s take a closer look at the latest development for Zhihu, the popular knowledge-sharing website that listed earlier this year and is slowly moving towards profitability, as we discussed in our look at the company’s third-quarter results issued late last month.

According to a statement dated Monday by the Beijing branch of the Cyberspace Administration, Zhihu officials were summoned to the regulator’s office to discuss the company’s repeated allowance of unspecified “illegal” material on its site. The officials called on Zhihu to rectify the situation immediately and punish the people responsible. 

“The Beijing Municipal Internet Information Office opened an administrative penalty case against Zhihu’s illegal activities,” the statement said. “The Zhihu representative said the company has learned a deep lesson, and will strictly take various measures to rectify the situation, and suspend certain functions during the rectification period.”

The statement caused the usual panic among Zhihu investors the day it came out, with the stock tanking as much as 16% before rebounding to close down about 10% on roughly triple its typical trading volume. The stock continued to rebound with a 3.5% gain on Tuesday, though it’s still down 6.4% from where it was at the end of last week.

Cause for concern?

The stock’s big drop, followed by the partial rebound, is probably a good indicator of how investors should look at this news in terms of its true significance. The bottom line is that this really looks like a rap on the knuckles rather than a major cause for concern.

One of the biggest clues lies in the entity that issued the statement. In this case it was the Beijing municipal branch of the Cybersecurity Administration, rather than the administration’s central headquarters, whose similar statements carry much more weight.

That’s probably a good lesson in general for investors in this day of hyper-regulation: when in doubt, check to see who exactly is doing the regulating. When it comes to relatively minor matters, such as posting of unauthorized, but not necessarily sensitive, content, or providing customer service that’s deemed insufficient, it’s often the local chapter of a national regulator that will issue the statement and a relatively minor punishment.

In fact, this kind of action goes on all the time in China, even before the latest wave of major regulation. When it occurs, a local regulator will often cite many companies in a single announcement for a particular kind of infringement, for example, for improperly using customer data.

A second clue that this is a relatively minor infraction is its use of quite boilerplate language, in this case things like “rectification measures” and “deep lesson,” that are probably issued in dozens of similar announcements each year. That’s not to say that serious infractions might also include similar boilerplate language. But such language is likely to be much stronger in such instances.

Then there’s the question of what wasn’t included in the announcement. Nowhere is there wording related to any of the latest major campaigns, such as “double reduction” that is often tied to the education crackdown, or “anti-monopoly” or “data security,” that would also raise red flags if they appeared in an announcement.

Equally important, nowhere is there any mention that any action has been taken beyond an administrative penalty. In the most extreme cases, a company can be forced to suspend its business pending the outcome of an investigation that can last days, weeks or even months. Similarly grave, but slightly less-severe, would be the removal of the company’s app from Chinese app stores, or a ban on signing up new customers pending the outcome of an investigation.

A final clue is that Zhihu itself didn’t make any official announcement, indicating the company probably didn’t consider the action substantial enough to merit notifying investors.

We should also point out that Zhihu’s stock has been under pressure for at least the last month, with its shares down more than 40% since mid-November amid broader weakness for U.S.-listed Chinese shares.

So, it’s understandable that battle-weary investors may have become spooked at the latest punitive announcement. But at the end of the day, the big selloff that followed really does look overblown, providing a potential buying opportunity for anyone who believes in Zhihu and also thinks the recent broader selloff for U.S.-listed Chinese shares may be near a bottom.

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