China Tech: From Cubs to Pandas
China’s technology sector, once a discretionary purchase within a regional portfolio, now deserves scrutiny. China is a place where Google, Facebook and Twitter simply do not exist. Their analogues do. In their place stand Baidu and Tencent. Alibaba is a much more significant concern than Amazon.
The digital economy is thriving. E-commerce penetration has overtaken the US, as has mobile payments, led by Alibaba (AliPay) and Tencent (WeChat Pay), where the value of transactions dwarfs the US by nearly 50 times. The army of Chinese netizens pay for almost everything from goods and services to bills and insurance via one of the two payment systems available on a smartphone.
The internet is one area where foreign brands do not possess any competitive advantage over indigenous brands. China’s netizens have never become accustomed to Google, Facebook, and Twitter. This is in part due to regulation: popular social media sites are often blocked by the “Great Firewall”, and Google left the country some years ago over censorship disputes. The latest to fold has been Uber, which decided to sell its local arm to Didi Chuxing, a Chinese competitor, after burning through billions of its investor money.
Nor is this just a matter of access, ethics or censorship: the Chinese players have proven they can innovate. All of the big players offer a twist. WhatsApp is freely available in the country but WeChat’s offering knocks it into a cocked hat. Alibaba is beating Amazon, fair and square with its inventory free model.
Alibaba is the undisputed leader in Chinese e-commerce, hosting 443 million active buyers on its online marketplace comprising four main platforms: Taobao (general retail), TMall (branded shops), Juhuasuan (group-buy), Alibaba (wholesale/export). The business attracted media attention in 2014 for being the biggest IPO in history, opening on the New York Stock Exchange. At US$529bn Gross Merchandise Value (GMV) in 2016, Alibaba is racking up more than Amazon and eBay combined (US$344bn). It has almost single-handedly shaped the structure of the retail landscape in China, transitioning shoppers from bricks-and-mortar stores to online. The famed annual shopping event – 11.11 Singles’ Day sales in 2016 – saw a staggering CNY121bn (US$17bn) in GMV in a single day, a 32% rise from the previous year.
The company has a much broader offering and deeper penetration compared to its Western peers. Aside from providing a retail platform selling physical goods, Alibaba has extended its reach to gauge in almost every aspect of peoples’ digital life. It’s entertainment portfolio spans music (Xiami – Chinese Spotify & Damai – ticketing), online video (Youku Tudou – Chinese Youtube), film (Alibaba Pictures), travel (Alitrip), selling everything from concert tickets to foreign visas. It also owns the strategically important payment system Alipay (now under the subsidiary Ant Financial), where linkage to its Taobao account facilitates the payment of bills, school fees, transfer money, investment in stocks and funds, order/pay for third party goods and services, all under one account.
This ‘all in one’ approach appeals to users as they no longer need to download multiple apps or register multiple accounts to access these services and ingrains Alipay into people’s payment habit. An estimated 58% of China’s online transactions go through Alipay. Encouraged by an increasing number of Chinese tourists travelling abroad, merchants overseas have also been incentivised to add Alipay to their payment options. The huge network effect from Alibaba’s wide offerings create a deeply entrenched customer base, and the vast amount of intel collected from their spending habits is invaluable in the era of big data analytics (e.g. target advertising & credit scoring – Zhima).
Tencent, the second largest player with a US$245bn in market cap, is best known for gaming (c.50% sales) and social media. It is the largest player in China’s US$24.4bn gaming market, having established a comfortable duopoly with its smaller rival Netease (c.70% market share between them), both investing heavily in original content to satisfy China’s demanding gamers. Whilst not the largest revenue generator, the company’s instant messaging apps QQ and WeChat are two of the largest globally by monthly active users (864mn in 2016, 90% domestic users) the latter, in particular, has exploded in popularity and overtaken the legacy QQ platform. Whilst the idea of WeChat originated from WhatsApp, it has quickly evolved into a full scale social media suite offering a range of in-app services, on top of the usual messaging features. Functions including Moments (Twitter-like postings among friend circles), gaming, and media outlet ‘Official Accounts’ (individuals/companies) for people to follow, where original articles are written and read every day. Advertising from these accounts is increasingly significant to Tencent, accounting for 18% revenues, and represents the highest growth segment for the company at a 5 year CAGR of +37%. WeChat is also the number two player in mobile payments behind Alipay (38% market share), where its own payment system, WeChat Pay, also allows users to access an array of financial services within the app itself, all managed through a smartphone. In contrast, Facebook Messenger and WhatsApp still offer only the basic messaging services to date.
The smallest of the B-A-Ts is Baidu. It became the largest search engine in China post Google’s high profile departure from China in 2010. It now has over 80% market share in China, and offers a wide range of online services including search, maps, multimedia, encyclopaedia (similar nature to Wikipedia), forums, and cloud-based storage. It also operates a video streaming site iQiyi and owns 24% stake in the popular travel site Ctrip. The main revenue generator for Baidu is online advertising, although compared to the other two, it has the least intimate connection to its users due to the generic nature of its business, although the enormous amount of data generated by its portfolio of web services will boost user targetability if exploited intelligently. The fake advertising scandal in 2016 damaged its reputation, resulting in a slide in market share and slowing of its core advertising business. In recognition, Baidu sought to become one the largest spenders in R&D with a US$3bn investment fund researching Artificial Intelligence, with initiatives including heavy investment into language processing, speech and image recognition, smart homes, and even electric vehicles (just this week, it has made a new investment into China’s electric carmaker NextEV) to diversify its offerings and counter this slowdown. It appears that perhaps the peripheral ventures are the most interesting for the company.
While the core offerings for the three B-A-T companies are very different: Alibaba focuses on e-commerce, Tencent on social media and gaming, and Baidu on search, they are increasingly engaged in fierce competition both in their core as well as peripheral trades. Tencent has added e-commerce features onto its most popular chat app WeChat, it also owns 21% of the second largest online retailer JD.com. Alibaba has also forayed into social media via its 30% stake in China’s most popular microblogging site Sina Weibo and the dating-app Momo (monetising both). Before the merger of Didi and Kuaidi, the two ride-hailing apps backed by the two giants respectively went head to head in a price war, heavily subsiding the rides in attempt to grab market share from the other. Another example sees Alibaba backed group-deals platform Meituan merge with Tencent backed lifestyle site Dianping to create the third largest lifestyle e-commerce platform, while Baidu launched its Nuomi equivalent. In Baidu’s home turf – search – both Alibaba and Tencent have eaten into Baidu’s traffic with the former acquiring UC Browser in 2014 (est.50% market share in mobile search), and the latter acquiring a 36% stake in China’s number three search engine Sougou. Furthermore, both companies have forayed into mapping, challenging Baidu Map’s dominant position, while Baidu obtained a banking licence to create its own Baidu Wallet to combat Alipay and WeChat Pay. Its video streaming site iQiyi also competes directly with Alibaba’s YoukuTudou, though neither have yet achieved dominance. Cloud computing, still a relatively nascent market, is sure to be the next battleground for the three, each armed with their own offering.
Competition at home has not hindered their ambition for international expansion. With China’s economic growth rate beginning to slow, the internet giants are no longer satisfied with being domestic leaders and have begun to look for growth opportunities abroad. Alibaba acquired Lazada, an e-commerce platform in Southeast Asia, tapping a young and highly populous market. It has also invested into India’s mobile payment system PayTM (50% stake), gaining entry into a market with immense growth potential. Investments are not limited to core competencies either, demonstrated by their US$200mn funding in Snapchat back in 2015.
Tencent has also been busy: it invested in Garena, a Singapore based e-commerce business. It has also poured funding into the gaming front; investments include an 84% stake in Finnish mobile games developer Supercell and partnerships with Activision Blizzard amongst others across the US, Korea and Japan.
Baidu has also identified several target markets including Brazil, Indonesia and Thailand to launch a selected replica of it internet services, and made investments into several overseas fintech start-ups using its US$3bn investment fund. A recent Economist article also pointed to this trend, and that it is not limited to larger players, citing ‘micro-multinationals’ that aim for the global market from the outset, something unheard of a decade ago.
China’s technology sector has been hitherto a specialist interest. We now hold the view that it is an essential study for global investors and have re-geared our research activities in response. Whilst there are reasons for and against investing in the individual stocks that are listed today, the greatest consequences will be felt when the door to the secret garden opens and Chinese info-tech companies begin to seek wider domination.