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U.S. Blacklisting Threatens to Derail $1 Billion Chinese Tech IPO

Lulu Yilun Chen and Gao Yuan

(Bloomberg) -- Donald Trump’s latest salvo against China threatens to derail a $1 billion coming-out party for a prominent startup backed by Alibaba Group Holding Ltd., while curtailing the country’s broader ambitions of leading artificial intelligence in the coming decade.

The U.S. placed eight Chinese technology giants on a U.S. blacklist on Monday, accusing them of being implicated in human rights violations against Muslim minorities in the country’s far-western region of Xinjiang. Among those singled out for sweeping American export restrictions were SenseTime Group Ltd., the world’s largest AI startup, and Megvii Technology Ltd. -- two giant enterprises Beijing is counting on to spearhead advances into a revolutionary technology, aided by billions of dollars in foreign backing.

The White House’s actions -- announced days before sensitive trade negotiations resume in Washington -- cast a pall over not just Megvii’s capital-raising effort but the burgeoning Chinese sector. Leading players like SenseTime and Megvii, already having trouble securing financing during an economic downturn, had considered international forays to sustain a sizzling pace of growth. The Commerce Department’s action threatens to derail that effort while spooking the business, supply and research partners needed over the longer term. Nvidia Corp., for one, is a key supplier to both AI firms.

“This will make people think twice about working with these companies even if there are no legal reasons preventing them from doing so,” said Isaac Stone Fish, a senior fellow with the Asia Society’s Center on U.S.-China Relations. “Reputational costs will be greater than financial costs.”

Read more: U.S. Blacklists China’s Hikvision, 7 More Over Human Rights

Monday’s move marks another escalation in a U.S. effort to contain China’s technological ascendancy, a campaign that began by slapping curbs on Huawei Technologies Co. and now encompasses some of the country’s most promising startups. Apart from SenseTime and Megvii, the Trump administration placed six other Chinese technology giants on its so-called Entity List. That bars them from doing business with American companies without a U.S. government license.

SenseTime and Megvii are trying to reduce their reliance on American software and circuitry by developing their own chips. Monday’s blacklisting could further decouple the two Chinese companies from the U.S. in terms of tech and funding. Megvii said in a statement that it “strongly objects” to the U.S. blacklisting and that the company complies with all regulations in the markets in which it operates.

“We believe our inclusion on the list reflects a misunderstanding of our company and our technology, and we will be engaging with the U.S. government on this basis,” the company said.

“We are deeply disappointed with this decision,” SenseTime said in a statement, emphasizing it complies with all relevant laws. “We have been actively developing our AI code of ethics to ensure our technologies are used in a responsible way.”

U.S. Just Started Targeting China’s Tech Future: Tim Culpan

A spokesman for China’s foreign ministry said on Tuesday the U.S. is interfering in its internal affairs and harming the country’s interests. Asked if China would retaliate over the blacklist, the spokesman told reporters to “stay tuned.”

Chinese AI has raised hackles in Washington like no other segment of the country’s vast corporate machine, in part because of the welter of headlines daily proclaiming how it may surpass the U.S. Broadly defined as anything from autonomous driving and robot waiters to facial recognition systems, names like Megvii and SenseTime are joined by established players including Huawei, Tencent Holdings Ltd. and Didi Chuxing in an effort that’s intended to seal China’s place at the nexus of the modern global economy.

Read more: China’s Hottest Startups Struggle for Cash Amid Trade War

Megvii’s IPO was supposed to have been the Chinese industry’s unofficial debut on the global stage. Already mothballed because of rising violence in Hong Kong, that offering now looks in question. While the startup warned in its prospectus about the unforeseen circumstances of conflict between Washington and Beijing, it never publicly addressed the prospect of getting cut off from American technology or markets.

It’s unclear how foreign investors may respond to Monday’s decision. Megvii counts Qiming Venture Partners and Chinese AI guru Lee Kai-Fu’s Sinovation Ventures as backers. SenseTime won funding from global powerhouses from Fidelity International and Silver Lake to Tiger Global and SoftBank Group Corp., en route to a valuation of $7.5 billion.

Both have enjoyed rip-roaring growth in recent years. SenseTime has expanded from facial recognition technology to financial security, robot deliveries and driverless cars. The five-year-old startup now has 3,000 people and is hiring about 100 staff every month. Revenue is still growing at triple-digit percentages, though it remains cash-flow-negative because of the need to invest in new areas such as AI chipmaking. While it still relies on Nvidia chips, it’s also developing in-house alternatives and investing in startups, SenseTime Chief Executive Officer Xu Li said in September.

Also on Commerce’s list were lesser-known Xiamen Meiya Pico Information Co. and Yixin Science and Technology, major resources for China’s police force. Meiya, whose products are used for data gathering and analysis, is controlled by China’s state capital management body. Yixin also provides big-data analysis for the Chinese authorities, according to its website.

Read more: CEO of Biggest AI Startup Says Valuation Passed $7.5 Billion

Hefei, Anhui-based iFlytek Co., another company on the list, specializes in natural language processing but also provides AI-based video and security services. Its shares slid Tuesday but the company dismissed any major impact from the blacklisting because its core technologies are homegrown.

“We have been preparing for this kind of situation and have contingency plans to keep providing high-quality products and services to our customers,” it said in a statement.

(Updates with company statements from sixth paragraph)

--With assistance from Candy Cheng.

To contact the reporters on this story: Lulu Yilun Chen in Hong Kong at ychen447@bloomberg.net;Gao Yuan in Beijing at ygao199@bloomberg.net

To contact the editors responsible for this story: Peter Elstrom at pelstrom@bloomberg.net, Edwin Chan, Vlad Savov

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