From Alibaba and Tencent to Baidu, JD, and iQiyi, China Internet tech titans continue to enjoy global reach, business model monetization, and new improvements in sales and profits worldwide.
The original blog article is available on our AYA fintech network platform. https://ayafintech.network/blog/stock-synopsis-china-internet-companies-continue-to-enjoy-global-reach-business-model-monetization-and-new-improvements-in-sales-and-profits/
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We launch our unique coverage of top 25 China Internet stocks. In the post-pandemic period, we believe the mainstream fundamental forces reflect some steady and robust consumption recovery, although the Chinese economy now faces some rare headwinds and challenges. Specifically, China suffers from socio-economic malaise in the residential real estate sector, and the Xi administration now directs new fiscal stimulus programs toward macro recovery across the mainland financial markets (Shanghai, Shenzhen, Hong Kong, and Macao). Key tech titans benefit substantially from the macro maneuver. These tech titans include Tencent (TME), Alibaba (BABA), Baidu (BIDU), NetEase (NTES), PinDuoDuo (PDD), JD.com (JD), iQiyi (IQ), Bilibili (BILI), Kuaishou Technology, and Meituan. The Xi administration continues to focus on common prosperity and the wider Chinese dream in the dual form of high-quality economic growth and technological advancement with an increasingly supportive regulatory environment. We expect global institutional investors to partially re-engage with the strategic sector of top 25 China Internet stocks in the next few years. From BlackRock and Vanguard to State Street and PIMCO, these global institutional investors choose to revisit these China Internet stocks with unique historical distortions in their fundamental prospects and financial results over the past pandemic years. As China Internet has historically been a cyclical high-growth sector, we can expect to see mid-to-long-run sustainable compound growth rates in both sales and profits. With the latest technological advances in artificial intelligence, virtual reality, and 5G high-speed telecommunication, at least some, but not all, of the top 25 China Internet stocks enjoy favorable and impressive P/E and P/B multiples due to positive network effects, information cascades, and scale and scope economies from the massive population of 1.4 billion people in China (or more than 1 billion smartphone users in Mainland China).
As the mainstream business models for China Internet (e-commerce, online advertisement, and digital entertainment) seem to have reached their mature stages, we expect to see huge opportunities for some China Internet companies to generate mid-to-longer-term sustainable growth rates, high-single-digits to even double-digits, in both sales and profits as the broader sector pursues substantial productivity gains due to AI, VR, and 5G new technology adoption. We believe the supportive regulatory environment would be especially favorable to several Chinese tech titans across several vital niche sectors such as video games, Esports, cloud services, electric vehicles (EV), and autonomous robotaxis. These vital niche sectors seem to amount to RMB$3 trillion annual sales by 2025-2027. Also, business services and fintech platforms provide hefty long-term growth opportunities, despite economic policy uncertainty around business model monetization, antitrust scrutiny, and e-commerce regulation in China. In summary, we combine our proprietary alpha stock signals, fundamental insights, and new ESG scores to help better inform our top-of-mind China Internet stock investment themes.
Over the past 35 years, China has successfully transformed from a low-income economy to a mid-income East Asian country with a secure and robust middle class, better employment, higher-quality economic growth, and a reasonably better quality of life. Since October 2022, the most recent National Congress of the Chinese Communist Party (CCP) has formalized the next phase of China’s economic governance framework. In this broader context, China’s regulatory regime changes over the Internet incumbents can help shift the delicate balance in favor of both economic and non-economic policy goals such as fair competition, consumer protection, and online data security. In addition to other risk considerations, these regulatory changes can help boost significantly the equity risk premiums for the Internet incumbents in recent years. These tech titans have risen to the challenge with almost real-time adjustments in their business models, monetization strategies, and best practices to help further extend sustainable sales growth and operational profitability in the longer run.
These Chinese tech titans still face several business risks as the recent regulatory changes affect the medium-term sales, profits, and cash flows across the entire Internet sector. The Chinese government launches new Internet rules and regulations in support of better online consumer protection, privacy control, social surveillance, and freemium monetization. These new Internet rules and regulations seem to cause a pervasive slowdown in online sales for e-commerce, advertisement, mobile video games, and Esports etc. At the same time, these Internet rules and regulations may inadvertently reduce corporate support for new initiatives and innovations in cloud services, fintech platforms, electric vehicles (EV), and autonomous robotaxis (AR), in-game purchases, and some other online business processes. Despite the recent demographic changes and structural challenges such as post-pandemic healthcare, rural poverty, and longer longevity, and Sino-American trade rivalry, Chinese tech titans can continue to benefit substantially from the largest middle class worldwide, a potent consumer market, robust and resilient global supply chains, new online growth engines, and extensive regional manufacturing capabilities in East Asia. In time, these competitive advantages help secure favorable foreign investment returns. In combination, these economic insights shine new positive light on at least some, but not all, of the top 25 China Internet companies.
The vast majority of the top 25 China Internet companies are likely to further leverage online business models and freemium monetization capabilities through world-class cloud services and software solutions (Software-As-A-Service (SAAS)) outside the traditional consumption sector. Also, the China Internet companies can further tap into the large consumption sector with more inclusive fintech platforms, local merchant services, and food delivery robotaxis. For several Chinese tech titans such as Alibaba (BABA), Tencent (TME), and Baidu (BIDU), their foreign subsidiaries can further expand their geographical reach to the rest of the world, especially North America, Western Europe, and East Asia. All of these recent developments help accelerate the next paradigm shift in the CCP’s national strategy in favor of longer-term growth performance for the Internet incumbents. To the extent that the financial benefits can manifest in higher sales, profits, and cash flows across the China Internet sector, we believe the dominant tech titans retain rare unique business niches and competitive advantages in support of both favorable stock market valuation and operational performance. These recent economic policy developments reflect at least part of the paradigm shift toward increasingly more inclusive state capitalism with Chinese characteristics.
In practice, the conventional economic theories cannot perfectly explain the growth miracles in China over the past 35 years. The new classical theory fails to account for monetary non-neutrality, a lack of monetary policy effectiveness due to strict cross-border capital controls, and significantly less fiscal-monetary policy coordination in Mainland China. Also, the New Keynesian theory fails to explain the adverse impact of interest rate hikes on residential real estate prices in light of substantially lower residential property affordability in Mainland China in recent years. In addition, structural supply-side reforms may or may not help render global supply chains more robust and more resilient in response to hefty changes in world demand for high-tech advancements, such as semiconductor microchips, graphical processing units (GPU), 5G high-speed telecom networks, and virtual realty (VR) headsets for the metaverse. In light of these economic considerations, we believe it takes a totally new skillset and macro analytical framework for us to better understand the new China Internet sector. In essence, China Internet serves as a cyclical fair-trade sector in the current trade war between the U.S. and China. This China Internet sector seems to be less of a buy-and-hold investment theme for many global institutional investors, although the Xi government seeks to re-establish the longer-term sustainable growth outlook for the China Internet sector.
During the pandemic years from 2020 to 2023, the vast majority of the top 25 China Internet stocks experienced sharp decreases in stock market valuation by at least 25% to 45%. We can attribute this significant industry rotation to a few fundamental reasons. First, extremely strict anti-epidemic measures not only compressed domestic consumption, but also raised rampant concerns about the Xi administration’s Covid exit strategy. As a result, institutional investors withdrew their foreign capital in a new flight to higher quality. Second, key Internet incumbents were particularly vulnerable to new geopolitical tensions in light of the trade war between the U.S. and China, the Russia-Ukraine war in Eastern Europe, and the relentless regional conflict between Israel, Iran, Lebanon, Hamas, and the Palestinians. Third, at least some of the fiscal and monetary stimulus programs turned out to be weak and ineffective in response to sluggish economic growth, deflation, unemployment, and residential real estate slowdown in China. Fourth, the Xi administration chose to clamp down on the spiritual opium of online video games by restricting children from playing these video games more than one hour per day. This draconian policy measure inevitably led to significantly less monetization for several China Internet companies such as Tencent (TME), Weibo (WB), NetEase (NTES), iQiyi (IQ), Baidu (BIDU), and ByteDance (the parent company of the globally popular video-sharing app TikTok). Finally, the current series of interest rate hikes from the People’s Bank of China (PBOC) further compressed stock market valuation for many of the China Internet companies in recent years.
As we re-assess the keystone fundamental factors and forces for the recent industry rotation away from the China Internet sector, we believe most of these considerations seem to have turned from economic headwinds to at least incrementally positive economic tailwinds. Back in December 2022, the Joint Disease Prevention and Control Mechanism of the CCP’s State Council published 10 Covid exit policy measures. These measures included lifting all Covid tests and health code requirements for domestic travel and some foreign travel in the Pacific region. From early-January 2023 onwards, China’s National Health Commission announced downgrading Covid to a Level 2 epidemic disease. The CCP’s State Council further released a series of travel policy measures to better mold the post-pandemic new normal steady state. These policy measures included removing Covid tests and quarantines for inbound travelers, cancelling passenger load restrictions on international flights, and optimizing domestic travel arrangements between Mainland China and Hong Kong and Macao.
Although some other geopolitical tensions persist in the post-pandemic period, the Chinese government has chosen to effectively reset the clock for China Internet American Depositary Receipts (ADR) de-listing risks for at least 3 years. The CCP’s Public Company Accounting Oversight Board (PCAOB) announced in December 2022 a new requirement for issuer audit engagements for all Chinese companies with headquarters in Mainland China, Hong Kong, and Macao. In accordance with the Chinese SEC statement, this policy change empowered the SEC to investigate completely issuer audit engagements for China Internet companies with ADR arrangements in America. We believe this positive development would effectively remove the de-listing risks for several China Internet companies for at least 3 years. In spite of the fair-trade rivalry between the U.S. and China, these tech titans would continue to enjoy dual status in China and America for greater foreign capital diversification.
The CCP’s Central Economic Work Conference (CEWC) reiterated its central emphasis on economic development and macrofinancial stability in the 5-year time frame from early-2023 to late-2027. First, the CEWC aims to help boost substantially domestic demand with state subsidies, tax breaks, and other non-cash incentives in support of greater household income, consumption, and investment. Second, the CEWC seeks to transform the modern industrial system with AI, VR, and 5G high-speed online networks, upgrades, digital downloads, and green energy solutions. Third, the CEWC attempts to help ensure equal government support for both state and private enterprises (outside some strategic sectors such as semiconductor microchip production, high-speed cloud computation, artificial intelligence (AI), virtual reality (VR), and the metaverse etc). Fourth, the CEWC welcomes foreign direct investments (FDI), especially from North America, Western Europe, and some parts of the Asia-Pacific region. Fifth, the CEWC takes some effective policy measures to prevent macro financial risks, with a central emphasis on promoting stable and robust economic development in the residential real estate market. In this broader context, we believe many of the prior fundamental factors, forces, and considerations seem to have turned from major economic headwinds to at least incrementally positive economic tailwinds.
For the online gaming sector specifically, we believe the regulatory environment has become more benign with substantially more license approvals for video games in recent years. The National Press and Publication Administration (NPPA) approved far more than 150 domestic game titles from October 2022 to mid-2024. The vast majority of the resultant game licenses were for mobile games, and the residual game licenses were exclusively for PC and console games. One of the most popular Chinese video games turns out to be Black Myth: Wukong. Its game play follows the inspiration from the classical Chinese novel Journey to the West, and then follows an anthropomorphic monkey Sun Wukong from the novel. This action role-play video game allows each player to fight both villains and monsters through the westward journey with a unique staff in 3 different staff stances (the smash, pillar, and thrust stances). Through this rare unique gameplay and storyline, the black myth for Wukong symbolizes the current world reality that China continues to deal with domestic socio-economic policy issues under fair-trade pressures from the U.S. and its western allies.
By comparison, the NPPA approved only 54 foreign game titles within the same time frame. This clear comparison indicates a more benign regulatory environment for the online gaming sector in China, although the Xi administration characterizes online video games as modern spiritual opium for children, and as a result, imposes a strict restriction on screen time of no more than one hour per day. On balance, we believe the broader regulatory environment for Chinese video games continues to be relatively benign. However, some of the China Internet companies may find it harder to monetize on freemium mobile games, digital downloads, in-game purchases, cosmetic avatar accessories, and software upgrades due to the stringent restriction on screen time in China.
For the fintech sector specifically, Ant Financial Group’s consumer finance unit received new regulatory approval from the Banking and Insurance Regulatory Commission (BIRC) in late-2022 to raise additional capital from RMB$8 billion to RMB$18.5 billion. Ant Financial Group continues to serve as the largest shareholder with a unique 50% majority equity stake in the consumer finance company after this major capital injection. As of mid-2024, Ant Financial Group runs the world’s largest mobile fintech payment platform, Alipay, with more than 1.3 billion users and 80 million merchants in China. Through these central business operations, Ant Financial Group continues to provide inclusive and convenient mobile financial services to both retail consumers and small-to-medium enterprises (SME) in China.
More broadly, the Cyberspace Administration of China (CAC) seeks to encourage profitable and sustainable development of Internet tech titans in China. Specifically, the CAC attempts to favor open and transparent economic development with supportive regulatory norms and values in addition to social and economic benefits for many Internet companies. In the longer run, we believe many Internet companies can benefit substantially from the broader benign and supportive regulatory environment in China. In support of better technological advances, this economic reality remains rock-solid especially when the Chinese government seeks to further outcompete the U.S. and its western allies in several technologically driven markets, such as e-commerce, video games, cloud services, fintech platforms, electric vehicles (EV), autonomous robotaxis (AR), and even business services worldwide.
All these positive fundamental factors, forces, and considerations shine new light on China Internet tech titans. From BlackRock and Vanguard to State Street and PIMCO, many global institutional investors are likely to revisit our chosen top 25 China Internet stocks, some of which list their foreign equity stakes as ADRs on NYSE and NASDAQ. To the extent that we expect the China Internet companies to experience fundamental improvements in both sales and profits over the next few years, we believe some of the Chinese tech titans are likely to see greater and faster bottom-line growth acceleration in 2024-2026. In a fundamental view, our top targets include Tencent (TME), Alibaba (BABA), Baidu (BIDU), iQiyi (IQ), PinDuoDuo (PDD), NetEase (NTES), JD.com (JD), Bilibili (BILI), Kuaishou Technology, and Meituan.
In a post-pandemic fundamental view, we prefer direct consumption, e-commerce, and other local community merchant services, to online ads, search engines, and digital forms of video entertainment (mobile video games, films, movies, and live concerts), because we believe direct consumption would be the earliest to deliver tangible top-line and bottom-line benefits through more robust and more resilient global supply chains in the next few years. From an online regulation perspective, we believe online games garner the greatest growth potential for positive sales surprises due to the broader, more benign, and more inclusive regulatory environment in light of the major domestic video-game license approvals in recent years. In a normative view, we believe some of the top 25 China Internet companies, especially video game publishers, can out-compete their North American, European, and Japanese rivals in due course. Specifically, we expect to see more new video games with the unique Chinese characteristics of game progressions for fair monetization. Black Myth: Wukong serves as a good example of this gameplay design in the broader context of Historical Mandarin China. Tencent (TME) and NetEase (NTES) arise as the 2 largest mainstream Chinese video game publishers with global ambitions. In addition to these China Internet stocks, we would prefer some other China Internet stocks with cyclically lower stock market valuation but rock-solid fundamental momentum. These other China Internet stocks include Bilibili (BILI), iQiyi (IQ), and Kuaishou Technology. Billions of Chinese viewers continue to enjoy video clips, films, movies, soap opera series, manga animations, and other forms of online entertainment from Bilibili (BILI), iQiyi (IQ), and Kuaishou Technology. These China Internet operators can differ dramatically from western video-streaming platforms such as Netflix (NFLX), Amazon Prime (AMZN), Apple TV (AAPL), YouTube (GOOG), and Disney+ (DIS), because the former often tailor their online video contents to the increasingly capitalist, inclusive, but Chinese modern life with smartphones, mobile payments, almost real-time reviews, and many other high-tech software solutions.
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