China’s leading AI start-ups hit by U.S. blacklisting

A U.S. move to blacklist four of China’s leading artificial intelligence start-ups has thrown a blockbuster Hong Kong listing into doubt and left billions of dollars of foreign investment caught in the cross fire.

On Monday, the U.S. Commerce Department put eight companies on its “entity list,” accusing three of China’s leading facial recognition companies, SenseTime, Megvii and Yitu, as well as the voice recognition company iFlytek, of aiding the “repression, mass arbitrary detention and high-technology surveillance” in the western Chinese region of Xinjiang.

Companies on the entity list, which include the Chinese telecom supplier Huawei, are not allowed to buy products from U.S. companies.

The move shocked Megvii, which has already filed its IPO prospectus, and SenseTime, which is considering a public listing. “We are all taken aback,” said one of Megvii’s bankers. “No change to plans now but we will have to see what happens over coming days.”

In June, Human Rights Watch withdrew an allegation that a smartphone app used to track ethnic Uighurs in Xinjiang used technology from Megvii, which gave the company confidence that it had resolved questions over its alleged activities in the region. Megvii said the U.S. decision was made “without any factual basis” and that it made no revenues at all from projects in Xinjiang in the first half of 2019, and that the region accounted for only 1% of its sales in 2018.

Meanwhile, a person close to SenseTime said the company had been surprised at the blacklisting after a “positive” meeting with two U.S. senators in Beijing last month. SenseTime said it was “deeply disappointed” and that it was “actively developing AI code of ethics.”

The company had recently sold its majority stake in a police surveillance company in Xinjiang following an international outcry.

Both companies have foreign investors, with Macquarie and the Abu Dhabi Investment Authority taking part in Megvii’s last fund-raise and SoftBank, Fidelity, Qualcommm, Silver Lake and Temasek all backing SenseTime. Macquarie, Abu Dhabi Investment Authority, Softbank, Silver Lake and Fidelity all declined to comment.

IFlytek, the voice AI company, said the decision would have little impact on its business. “We have planned for this situation,” said a spokesperson. The company’s fund manager, who was seeking to raise about $300 million for iFlytek to invest in start-ups, said earlier this year that the U.S. was imposing “an iron curtain on technology from China.”

Yitu declined to comment on the decision.

In 2016, iFlytek won a bid to supply police in southern Xinjiang’s Kashgar city with 25 sets of voice pattern collecting equipment, as part of a government initiative to gather biometric data including DNA, fingerprints and “three-dimensional portraits” from residents, according to government procurement documents.

Collectively the four companies are the brightest prospects in China’s burgeoning AI sector, and they have all won a swath of contracts from Chinese companies and cities.

Megvii and SenseTime are among the world’s most valuable AI start-ups, and are unusual in each claiming to have developed a “full stack” of AI software themselves — right down to the deep learning frameworks underpinning their applications. That means they do not rely on other companies’ popular frameworks, such as Google’s Tensorflow or Facebook’s PyTorch.

Security camera companies Hikvision and Dahua were also put on the list, and Dahua said it expressed its “strong protest to such a decision, which lacks factual basis.”

Both Dahua and Hikvision suspended the trading of their stocks on the Shenzhen exchange, saying trading would resume Thursday at the latest. IFlytek’s shares fell 2.67% from the previous day’s close in Shenzhen.

All of the sanctioned companies run and train their AI algorithms on computers which are likely to use chips made by Intel as well as Nvidia, which makes AI-specialized graphics processing unit (GPU) chips.

But they can continue to use existing computers to run their algorithms, eventually moving away from U.S. suppliers, according to investment bank Jefferies.

The impact to Hikvision would probably be “modest” said Ruiyi Xu, a research associate for Bernstein, adding that Hikvision was among the best prepared of the eight companies to be added to the entity list.

Bernstein estimated that even after Hikvision’s key components inventory runs up, the revenue impact would only be about 10%, and the profit impact even less.

“We think this is manageable although short term there will be some weighing on investor sentiment,” Xu said. “Hikvision won’t have cross-selling problems because it can rely on partners such as Lenovo and other server makers in China.”

Wu said judging from the stock reaction of U.S. chipmakers Nvidia and Intel, investors were not expecting a significant hit. Shares in U.S. chipmaker Ambarella, a key Hikvision supplier, plunged as much as 12% after news of the blacklisting.

Additional reporting by Christian Shepherd and Nian Liu in Beijing

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