China Internet:US marketing feedback

Event.

We had two weeks’ marketing in the US. Investors have turned more positiveon China internet on seeing the industry consolidation, margins bottoming andmacro recovery. Big internet companies such as Alibaba and Baidu areviewed as China investment proxies and beneficiaries of MSCI indexinclusion. Among smaller names, investors showed particular interest onvertical and media names. Our top picks are Tencent, Ctrip and JD.

Impact.

China’s e-commerce industry is going through a structural downturn.

1) With China’s e-commerce GMV reaching Rmb3.9trn in 2015 and itspenetration of total retail sales exceeding 13%, it has started showing highercorrelation with China’s economy and exhibiting cyclicality. 2) Cross-bordere-commerce transactions bring inventory risk for Chinese e-commerceplatforms. 3) Cash flow is not as good as before as platforms shorten payabledays and provide financing to suppliers. JD is our e-commerce favourite for itshigh GMV growth, high entry barriers and potential for margin expansion anduser growth. That said, we estimate China’s e-commerce revenue growth todecelerate from 39% in 2015 to 25% in 2016.

Consensus bullish on travel in the LT but concerned about NT. Investorsagree that no other internet subsector is as consolidated as travel, and thetravel industry in China is booming. However, investors are concerned aboutCtrip’s near-term top line due to integration hiccups and airline policychanges. Notably, China’s travel market was Rmb4trn in 2015 by revenue,with 11% online penetration. Yet in this subsector, the largest company, withover 90% online market share, is trading at US$25bn EV (enterprisevaluation). Riding China’s leisure travel headwinds, we believe Ctrip’s EVcould reach US$31bn in 12 months’ time and US$50bn in the long term.

Media names attract more interest. Compared to 12 months ago, there isclearly increasing interest in traditional media stocks like SINA/Weibo as theysee revenue growth recovery and start showing operating leverage with costunder control. Investors are also turning positive on online video platformmonetisation, although they expect content bidding to intensify.

Internet finance. While lack of transparency and data, investors are keen tounderstand supplier financing, consumer financing and the online paymentbusiness of Alibaba, JD and Tencent. We believe internet finance is still atearly stage in China. With booming demand and greater regulatory oversight,internet companies need to differentiate their internet finance models andbuild around their core businesses.

Outlook.

By June 2016, the Chinese internet sector should account for 29% of MSCIChina or 8% of the MSCI EM Index. While the hyper growth of internetindustry behind us, most internet companies have started to get headcountand marketing cost under control, with the industry getting more consolidatedand competition becoming rational. For the stocks in our coverage universe,we estimate revenue growth to decelerate from 43% in 2015 to 34% 2016,while earnings growth should accelerate from 18% to 27%.