Industry Trend Analysis - Chinese Tech Stocks Blow US Counterparts Away: 3 Reasons Why - APR 2018
BMI View: Chinese technology stocks have been enjoying a better run than their US peers owing to more protectionist regulations, heavily diversified revenue streams and brighter prospects in the telecoms market. A long-term correction in prices is expected, but the short term will reward Chinese tech investors.
China technology stocks have been on an absolute tear compared to their US counterparts. The MSCI China Information Technology Index, which counts the likes of Alibaba and Tencent Holdings as constituents, returned 624.7% from end-2011 to end-2017, while its US counterpart, the MSCI US Information Technology Index, returned only 167.2%, with that index including Facebook and Alphabet as part of its make-up.
|Returns From Chinese Tech Companies Outstanding|
|MSCI China IT Index v MSCI US IT Index|
|Note: Index normalized with 31/12/2011 = 100. Normalized index values are end-year values. Source: Bloomberg, BMI|
We identify three key areas which have allowed China's technology industry to outpace Silicon Valley.
Regulations: Protectionist, Data Collection Laws Lax
Competition and Internet regulation in China, despite being rigid and prescriptive, are positive for its tech companies. While the US, through the Federal Trade Commission and the Federal Communications Commission regularly intervene in the market to promote competition, Chinese tech companies are relatively sheltered by the State Internet Information Office, which oversees Internet content in China. Through the state-administered firewall, Chinese citizens are blocked from accessing foreign mainstream social media, such as Facebook and Twitter, as well as search engines such as Google, allowing companies such as Renren and Sina Weibo to operate in China without any meaningful competition.
Chinese tech companies also collect a significant amount of user data, as laws governing data collection are relatively nascent and written in such a way that interpretation of those rules can be a broad as the state needs it to be in any particular situation. The downside is that the data collected must be shared with the Chinese government. Collection of such data has become a significant pillar in the strategies of these companies, which have expanded aggressively into other emerging markets where such laws on data are also lax. Alibaba has expanded into Russia successfully with its T-Mall and AliExpress platforms, and is in the midst of cementing its position in Southeast Asia via its acquisition of Lazada. In developed markets, where laws on data are more stringent, Chinese companies have struggled to gain traction.
|Chinese Laws Create More Regulated, Uncompetitive Environment|
|US and China Operational Risk Metrics|
|Source: BMI Operational Risk Index. 100 = Lowest risk. 0 = highest risk. Score shown is the country-specific score.|
Revenue Streams: Mobile Payments, AI
The centralised nature of the Chinese social system has also allowed tech companies to expand into other industry verticals. Within the technology space, Alibaba and Tencent dominate both the e-commerce and mobile payments space, as the relatively low financial inclusion rate in China of 78.9% (latest World Bank data) versus the US (93.6%) means that AliPay and WePay have ample room to grow. US e-commerce companies, such as Amazon, find it difficult to successfully develop their own mobile payments platforms due to the proliferation of Mastercard and Visa credit/debit cards in the country; this has enabled payment services that use host card emulator (HSE) or secure element technology, such as Android Pay and Apple Pay, to proliferate.
|Forget Other Businesses; E-Commerce Alone Is Massive|
|China and US e-commerce Spending Forecasts (USDmn)|
|e/f = BMI estimate/forecast. Source: BMI|
Combining data from their online marketplaces and real-world payment data allows Alibaba and Tencent to map out the consumption habits of their users, and the latter has the advantage of an additional layer of social media data from its WeChat app. The possession of numerous layers of data has allowed these companies to venture into disruptive technologies such as Artificial Intelligence (AI); both have highlighted AI as a key business area moving forward. While Chinese companies have branched out into many business areas, their counterparts in the US have been relatively more focused on vertical growth within their respective industries.
Telecoms: Benefits From State Support, Organic Growth Opportunities
The close relationship between the telecoms industry and the Chinese government has also created many synergies in the advancement of the Internet of Things (IoT). The government regularly provides China Telecom, China Unicom and China Mobile concessions to operate smart machines in various cities, allowing pilots and trials in real-world environments. The Ministry of Industry and Information Technology (MIIT) also regularly publishes white papers on IoT, sets connection standards and has placed IoT advancement as a key national strategy. Chinese operators also enjoy close proximity to a well-established and advanced telecoms equipment supply chain, led by the likes of ZTE and Huawei.
|IoT The Next Growth Frontier For Telcos|
|China M2M Market Estimates ('000)|
|Source: BMI, operators|
Organic growth opportunities are also strong in the Chinese mobile market, which we estimate to have had a mobile penetration rate of 97.1% and a 3G/4G penetration rate of 74.4% at end-2017. The US, however, hosts a saturated mobile market, with 116.1% mobile penetration and 3G/4G penetration of 101.2%. Room to upsell 2G to premium 3G/4G offerings present revenue opportunities for telecoms operators. With the majority of the US populace already on 3G and 4G networks, revenue opportunities for US players are limited and many operators are pursuing cash-intensive convergence strategies in order to diversify earnings.
But Chinese Stocks Command Higher Premiums
We note that price/earnings (P/E) ratios of the Chinese tech giants are significantly higher than their US peers; the US Index has a P/E ratio of 25.25, while the Chinese Index has a P/E ratio of 42.27 (as of end-2017). We believe that investors are willing to pay higher prices for seemingly guaranteed future earnings. While we expect a correction in the longer-term, there should still be enough steam in the engines of Chinese tech companies to continue their current bull-run.
|Chinese Stocks Could Be Overvalued|
|Price/Earnings Ratios of Top 3 Index Constituents|
|Source: BMI, Bloomberg|