Why invest in China's internet
China’s internet is essentially a “closed” ecosystem. The platforms and providers that we use and experience on a daily basis are not available in China. - Google Search, Yahoo, Facebook, YouTube, Wikipedia (Chinese), Twitter, Netflix, Reddit, Instagram, Tumblr, and WhatsApp are all banned.
Their functions are provided by numerous domestic players who have mastered and improved the underlying technology of the internet. In fact, China is the only country after the US to have built internet giants, which puts it in a good position to continue developing other digital technologies.
That said, post COVD-19, we see China’s internet sector as an important growth opportunity for investors with various services upgrades triggered by the availability of 5G network likely to drive new global trends and stimulate innovation. The launch of new 5G smartphones and services upgrades that follow could spur spending and promotions that could support economic activities and monetization upside.
In addition to 5G opportunities, we see growth opportunities and monetization upside to be supported by growth in lower tier cities and companies’ proactively leveraging cross-selling/cross- promoting efforts into bigger addressable markets as well as exploring opportunities in overseas markets. With increasingly “crowded” mini program ecosystems and a capping out of user time spend, Internet companies are seeking new growth drivers such as membership programs that not only could cultivate user engagement but could also stimulate transactions and spending, hence, the reinvestment into existing users has and will become an important growth driver for many internet platforms in the coming quarters. Providers and platforms are also moving into the industrial internet by helping traditional industries to digitize their processes.
The structure of the China Internet is vast and while anchored by the two giant platform
companies Alibaba and Tencent, there are a plethora of other players- ecommerce providers, online travel portals, vertical players (employment, autos etc), digital content providers (music, entertainment), advertising portals, live streaming platforms, gaming / software providers, media and entertainment specialists, and software services / security operators.
The China Internet: Five of the Best and why
1. Alibaba (BABA)
Alibaba Group Holding is an online and mobile e-commerce company. It provides online and mobile marketplaces in retail and wholesale trade, as well as cloud computing and other services. The company's major businesses include Taobao Marketplace (China's predominant online shopping destination), Tmall.com (a third-party platform for brands and retailers), Alibaba.com (a global wholesale platform for small businesses), Alibaba Cloud Computing (a developer of platforms for cloud computing and data management) and Alipay (an online and mobile payment solution).
Industry analysts expect Alibaba to remain the powerhouse in a unique China e-commerce market that has huge growth headroom, given still-low Internet penetration, wide dispersion of consumers, and an underdeveloped retail sector. A dominant online shopping platform, backed by payment services Alipay and cloud technology, gives Alibaba a competitive moat that will be hard to breach. Progress is being made in mobile Internet, with O2O and location-based services providing future opportunities for revenue growth. An asset-light model generates higher margins than a direct sales model, giving Alibaba the profitability to reinvest and strengthen its ecosystem for the long term, not only domestically but also overseas.
Alibaba’s cloud business is the clear leader in China’s public cloud market, supported by its cloud infrastructure scale, strong big data capability and rich cloud use cases in a large range of verticals (retail, finance, logistic etc). Analysts expect increasing enterprise cloud demand in cost-effective IT solutions (i.e. IaaS) and business model transition via digitalization of customer data/resource planning/work flow (SaaS/PaaS) to drive robust revenue growth.
2. Tencent (700 HK)
Tencent is one of the largest Internet companies in the world. Its services include social networks, web portals, e-commerce, and multiplayer online games.
Its offerings include the well-known (in China) instant messenger Tencent QQ and one of the largest web portals in China, QQ.com. Its mobile chat service WeChat (Over 1 billion users at last count) has helped bolster Tencent's continued expansion into smartphone services.
Tencent has both size and scale. The instant messaging platform QQ has over 800 million monthly active users. Weixin/WeChat has over 1 billion monthly active users. Think of WeChat as a messaging app but with many of the functions of PayPal, Yelp, Facebook, Uber, Amazon, Expedia, Slack, Spotify, Tinder, and more. It is becoming the primary means of communication for the Chinese.
Tencent is well positioned to capture the rising mobile monetisation opportunities, leveraging its dominant position in the social communication platform of WeChat and Mobile QQ with well-rounded exposure to entertainment (games, video and music); local services (fee-based income via Weixin Payment and traffic leads) and targeted social advertising (Qzone, Moments ads, news and official account ads). Tencent also holds 15% stake of JD.com, one of the largest B2C online retailers in China.
Tencent’s cloud business has been growing rapidly and has strengthened its position as the second largest public cloud company in China (after Alibaba) with a 19% market share in 2019. Tencent Cloud will continue to serve as a strategic focus for Tencent’s 2B initiatives and we see ample potential in smart industry solutions in various verticals such as retail, finance, education and municipal services
Tencent is also integrating Artificial Intelligence (A.I.) into a number of key application use cases including gaming, social and content businesses. Some of its most popular products (such as Honor of Kings, QQ and Kuaibao) have already started to integrate AI technology to enhance user experience. The use of AI technology not only applies to Tencent’s core products i.e. social, gaming and content, but is also spreading to Tencent’s new initiatives in the finance and healthcare sectors. This is a significant competitive advantage in our opinion.
3. Weibo (WB)
Weibo is a social media platform that allows people to create, discover, and distribute Chinese language content. Analysts are positive on Weibo and believe the company is well-positioned for strong growth given the dynamics of China's booming social media advertising, live video and broadcasting. Its platform's high proportion of celebrity- and entertainment- oriented content, with an emphasis on timeliness, helps maintain Weibo's position as one of the dominant leaders in China's social media. With over 90% of users accessing Weibo through mobile devices, it appears well-positioned to capture mobile internet opportunities.
A partnership with Alibaba, its biggest investor, should help Weibo draw more users and advertisers. Advertisers in China are likely to continue to shift toward social media, attracted by significant return-on-investment potential and high user engagement. As well, Weibo's sharp focus on user acquisition in third- and fourth-tier cities should be a catalyst for user growth as internet penetration climbs in China. The release of Weibo Lite, a less data-intensive variant of the main app, should help the company grow its 215 million daily active users by onboarding those living in regions with poor internet access. Partnering with domestic smartphone manufacturers to have Weibo pre-installed in devices should help, as affordable smartphones are commonly used in lower-tier cities
Weibo’s user base is growing strongly. At the end of Q4 2019, Weibo had over 515 million Mobile MAUs (monthly active users) up 12% Y/Y which represents some 94 % of MAUs. Weibo expects to enhance the user experience through better optimisation and relevance of information feeds through backend algorithms to increase content consumption efficiencies.
4. NetEase (NTES)
NetEase, Inc. is a leading online games and internet technology company in China. It operates through the following business segments: Online Game Services, Advertising Services, and E-mail, E-commerce and Others.
The Online Game Services segment offers multi-player online role-playing games and mobile games. The Advertising Services segment provides banner advertising, direct e-mail, and interactive media. The E-mail, e-commerce and others segment comprises free and fee-based premium e-mail services, e-commerce services, online payment platform, e-reading applications, matchmaking services, online music social network, personalised photo-based products, and online game-related accessories. Its basic service offerings on the NetEase websites are available without charge to its users.
NetEase has very well-developed R&D capabilities in PC and mobile games as well as music (Cloud music). It is one of the dominant market leaders in online gaming (second only to Tencent in terms of online gaming revenues). NetEase has experienced steady growth underpinned by a rich game portfolio (both client-based and mobile). It also has a deal with US game company Blizzard to license a list of their game titles. This should continue as it successfully transforms its self-developed PC game IP to mobile games. NetEase’s overseas game expansion should continue with “Diablo Immortal” potentially in 2H20 and possibly a second Marvel game soon after.
5. Momo (MOMO)
Launched in 2011, China based Momo is a location-based mobile social networking platform that enables users to establish and expand social relationships based on location and interests. In Sept. 2015, Momo launched live streaming services and offered the service to a limited number of pre-selected performers. In April 2016, Momo opened up the service to all users so everyone can become a broadcaster. Live streaming revenue took off since its launch and has become the biggest revenue contributor for Momo. Also, in 4Q 2016, Momo introduced a virtual gifting service to enhance user interaction and social networking with others. Momo is now one of China's leading mobile-based social and entertainment platforms that include a live-streaming platform and online dating platforms.
Growth drivers for Momo include:
- Momo is likely to continue to gain share in live broadcasting – its core business. Although Momo is the No.1 talent show live broadcasting platform in China, it has just a 21% market share which could be increased via further collaboration with top guilds (Momo is currently relatively moderate in guild cash incentives), a royalty system, which has proven to be an ARPU (Average Revenue Per User) accretive on peer platforms, and the development of VAS (virtual gifting) in non-live streaming social activities such as chatrooms and social games, which should continue to grow faster than core live streaming revenue.
- Tantan (China’s Tinder – an online dating app), acquired in early 2018, has only just begun to monetise its large user base. Since January 2018 its paying user base has grown to over 3.6 million users. Tantan has 114 million MAUs, over 3 times that of Tinder and 13.4 million of them bought virtual gifts or signed up for premium dating services on Momo and Tantan. Management has high hopes for Tantan due to the 300 million millennials in China and the higher mobile internet penetration rates. Tantan’s revenue per subscriber (ARPU) was merely 11% of Tinder’s in 2Q 2018 with a comparable subscriber base so there’s a lot of upside here.
Investment Summary: COVID-19 effects
To be clear, all of these companies will be affected both positively and negatively by the disruption of the coronavirus pandemic in China. Investors will receive some clarity as they report 1Q & 2Q 2020 earnings.
Fortunately, China’s economic recovery is underway as the country gradually reopens and Chinese equity markets have performed far better than other Asian markets.
It is likely that ecommerce businesses will have proven to be quite resilient during the downturn, benefiting from a structural demand shift for fresh/FMCG products and shopping festival promotions as well as the shuttering of most brick and mortar retail outlets, Alibaba is a clear beneficiary like Amazon in the U.S.. Online games will have done well supported by the release of quality titles and growing overseas revenues contributions. Tencent and NetEase are winners here. Live streaming and digital content should also do well given the strong uptake in usage and membership subs. Weibo and Momo (to a lesser degree) will have benefitted but will need to see a strong recovery in online advertising in 2H 2020. Momo will also need to see a relaxation of social distancing and a more open economy for a number of its services (especially Tantan) to recover. Momo is the clear recovery stock here followed by Weibo.
(Note: Tencent trades on the Hong Kong exchange in HKD, Alibaba trades on the NYSE as an ADR while Weibo, NetEase and Momo all trade on NASDAQ as ADRs in USD)
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