Famous Chinese Proverb: 山雨欲来风满楼 – Coming events cast their shadows before them
The Chinese internet sector’s performance has been more tame in 2014 relative to 2013. Stocks within the sector have shown very divergent performance, with winners like BIDU, which we highlighted in yesterday’s NTT post, outpacing the competition in developing new platforms and attracting users and advertisers.
Last summer, I laid out the long-term bull case for the Chinese internet sector in a Macro Wrap post, with the following takeaway:
However, there will be winners as well. The Chinese internet sector will be one of the largest single sources of consumption demand in the world over the next decade. Relative to developed markets, it is still in its infancy. The stocks are signaling that investors are willing to provide the sector with capital, despite China’s systemic troubles.
The macro trend of increasing online usage and spending in China is certainly in tact. What’s crucial for investors, though, is to be adept at picking those stocks that are executing well on the strategic vision, particularly since the barriers to entry in the internet space are so low. For example, BIDU ran into some trouble in 2012 and 2013 as QIHU rapidly gained share in the search market, but BIDU management has re-focused and found its footing as it diversified its product offerings and made a strong push in mobile.
While QIHU has stalled in the past 6 months, the stock remains a leader on both a performance basis as well as on its fundamental metrics. Sales growth has been around 100% per annum for the last couple of years, and while it is expected to slow down to around 30-50% per year over the next 2 years, growth is still blazing. EPS growth is expected at 40-60% per year over the next couple of years as well. The weekly chart shows its leadership position:
Aside from BIDU and QIHU, Tencent has been a major winner in the Chinese internet space. TCEHY is the ADR for the internet behemoth, which now sports a market cap of over $150 billion. Tencent is another company that has consistently grown sales (average of 45% per year growth over the past 3 years), and EPS (20-25% annual growth). The stock has more than doubled in the past year:
However, there have been a couple of bad apples in the Chinese internet sector, major laggards since 2011. While both SOHU and SINA have registered double digit annual sales growth in the past 3 years, both companies have also seen EPS contract in that period as they have not been able to keep up with the competition.
Of course, both SINA and SOHU are only worth a few billion dollars in market cap terms, vs. QIHU at around $13 billion, BIDU at around $75 billion, and Tencent around $160 billion. Alibaba will soon be added to the list with its September IPO (more details in Wednesday’s Bloomberg article).
The elite group that is moving to the top of the market cap list is likely going to dominate the Chinese internet business for some time to come. As we’ve seen in the U.S., the largest internet properties have major economies of scale and network effects that are long-lasting.
With that in mind, QIHU, BIDU and TCEHY are situations where I’ll be on the lookout to add long positions on pullbacks, while I plan to stay away from the lagging losers of the group, SINA and SOHU. As for Alibaba, that’s in the “not enough information” camp for me, especially given the opaque financial structure and corporate structure concerns surrounding Jack Ma’s various companies.