Top 5 US Listed Chinese Tech Stocks

Regulatory crackdowns are making times tough, but the potential for growth is on the horizon.

• Prospects for investing in Alibaba have significantly deteriorated in recent weeks. In a multi-bagger stock, you typically want to see a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. This shows us that it‘s able to continually reinvest its earnings back into the business and generate higher returns. Alibaba Group Holding and its ROCE trend did not match this profile with a ROCE of 6.8%. This is a low return and under-performs the Online Retail industry average of 14%. Around five years ago the returns on capital were 13%, but since then they‘ve fallen to 6.8%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance. Despite the promising trends, the stock has fallen 49% over the last five years, so there might be an opportunity here for astute investors given the trends look encouraging.
• Historically, Alibaba held importance to the government’s economic and technological development which made it more convenient for the government to cooperate with Alibaba, although this appeared to change in mid-2021 with the Chinese government introducing stricter regulations that enhanced the government‘s influence over tech companies and their privacy policies. Alibaba has specifically been questioned about the quality of the company‘s audit standards by American regulators because of the limited access they have to financial data from Chinese companies. In order for them to remain listed on U.S exchanges, Chinese companies such as Alibaba must comply or face being delisted. Meanwhile, analysts continue to vigorously fine tune their estimates for this giant and continue to set price targets with upwards potential during this apparent recession.
• After four consecutive quarters of missing price estimates, it is clear that Alibaba has felt the pinch from China’s economic slowdown. Consumer spending has trended downwards along with other important economic metrics reflecting warning signs of a recession. Additionally, the company was forced to donate $15.5 billion US to the Common Prosperity Initiative to support technological and small business initiatives. Their donation was an addition to a fine imposed on the tech giant by the government for anti-monopoly infringements. The company‘s hand has been forced into tightening spending and controlling costs by letting go of staff and implementing other cost saving initiatives. “In the coming quarters and the remainder of this fiscal year, we will continue to pursue the strategy of cost optimization and cost control,” Toby Xu, chief financial officer at Alibaba, said during the company’s earnings call this month. Recent under performance hasn’t scared away the likes of Goldman Sachs, Fidelity International and JPMorgan Chase who seemingly have plenty of confidence in the Chinese tech giant’s investments in growth coming to fruition.

Tough economic and regulatory conditions have slowed growth, but new acquisitions hint at underlying strength.

• The Chinese government and Tencent hit a road bump in 2021 as the tech company was advised by the government to start enforcing limits to how long children can play online games. An unfortunate hit for a tech conglomerate that is heavily invested in the gaming industry. The government restrictions limit children to just three hours of online game playing a week and are still enforced today. The enforcement of this restriction saw the company’s stock price drop in what was a challenging year for the tech gant, and it appears these hardships continued into 2022. Further regulations from the government to promote fair competition and enforce better user protection and data security has impacted Tencent in recent months. The tech giant has also been hit with a sizable anti-monopoly fine from the Chinese government. These structural and industry changes have affected Tencent’s financial performance, leading to their slowest quarter of revenue growth in July 2022.
• Although it’s hard to exactly why Tencent hasn’t been performing well lately, there are multiple macroeconomic factors contributing to the recent changes in the stock performance. Rising inflation, geopolitical instability and the reopening of global economies have played a role in reducing consumer confidence which has meant that advertising spend across multiple sectors has taken a hit. As Tencent is a Chinese company, they are also very exposed to the weakening Chinese economy and the influence this has on the market. Due to a combination of factors, their financial performance has been disappointing with their growth rate declining significantly in their most recent earnings report. Additionally, the overall market capitalisation for business to consumer tech companies appears to have shrunk.
• China’s anti-monopoly laws have changed the playing field for tech giants such as Tencent. Until now, tech giants have held a position of importance to the government, perhaps at the cost of small business and the development of new technology within China. Not only has Tencent been hit with anti-monopoly fines by regulators but strategic business moves have been blocked. Namely, the merger of the two streaming sites Huya and Douyu have been blocked. Tencent was a facilitator of the deal and holds more than 40 percent market share in upstream online-game operation services. Huya and Douyu have a market share of over 40 percent and 30 percent respectively in downstream live games, ranking first and second, and their total market share is over 70 percent. If the merger went ahead, Tencent would have sole control of the new unit, further strengthening Tencent‘s dominance in the live-game market which may have the effect of excluding and restricting competition, hurting fair competition in the market.
• Looking further abroad, Tencent’s recent moves to acquire a large stake in Ubisoft’s founder’s holding company shows their continued push to diversify across a global gaming market and can be seen as an indication of future growth being Tencent’s primary goal as the cost of short term performance.

Future bets on driverless taxi services could be fruitful.

• There are quite a few similarities between Baidu and Alphabet. Both began their operations as a search engine and have since diversified their revenue streams, dipping their toes into mapping, AI and cloud services. However unlike its American counterpart, the company has struggled with a share price that has been edging south over the last few years. Baidu Core - the operating wing of Baidu that encompasses its cloud services, AI, mobile ecosystem and intelligent driving initiatives - has struggled to maintain the growth that was necessary to keep the share price buoyant. While the impacts of the recent COVID lockdowns in China are now being felt in the financial statements. China’s State Administration of Market Regulation hasn’t helped Baidu either, having launched anti-monopoly, data security and other crackdowns on tech companies since late 2020. Baidu joins the list of tech giants who’ve been slapped with penalties for monopolistic business practices over fears these companies have too much control over their industries. Thankfully it hasn’t been all doom and gloom for Baidu as major asset managers PRIMECAP Management, Alkeon Capital, Wellington Management, Arrowstreet Capital, Morgan Stanley have all seen value in Baidu, adding to their already sizable holdings in their portfolios. While some will be betting on a share price recovery as China emerges from its economic slowdowns, some could be taking early bets on the success of Baidu’s driverless robo-taxi service, Apollo GO, which plans to operate in 65 Chinese cities by 2025.

Value to be found as consumer sentiment improves after economic slowdown.

• Pinduoduo is an online e-commerce platform that styles itself as a ‘virtual bazaar’. The mobile shopping platform is like the Amazon of China, offering a range of products, including apparel, childcare products, electronic appliances, furniture and auto accessories. Pinduoduo’s recent venture into fresh produce, Duo Duo Grocery, has been instrumental in helping alleviate recent concerns over food security by introducing a supply and demand model that can match local shoppers with local produce suppliers in under 24 hours. However, their motto that is centered on providing more savings may have been taken too literally, seeing as they’ve come under fire from market regulators for engaging in improper pricing practices that threaten to undercut small businesses.
• The company is pioneering what it calls a feed-based shopping experience where users are presented with a social media-like feed where they can discover products they may not have known they wanted. However, this should be approached with some caution. As the impacts of the economic slowdown are felt among China’s population, consumer spending won’t be as frivolous. Consumers will no longer be looking for what they may want, as their primary concern will be only what they need. While COVID-19 lockdowns and tougher economic conditions lead to a shaky start to 2022, the company saw a recovery in consumer sentiment in the second quarter, notably during the 618 shopping festival, a sign that consumer spending can be somewhat resilient even in trying times. This is optimistic for the time being, but investors should be wary of consumer sentiment deteriorating if the macro-economic impacts linger for the near future.
• The company is still a way off from its 12 month highs, but a recent uptick in the share price over the last month will have come as a bonus to recent institutional investors who saw value in Pinduoduo at current valuations. Big players like Vanguard, State Street, Morgan Stanley, Goldman Sachs and Susquehanna International all put their money where their mouth is and added to their holdings over the recent months.

Building longevity and recognition in the fastest growing entertainment industry.

• Online gaming has surged in popularity over the recent years and has grown to eclipse both the movie and music industries in terms of global revenues. Mobile platform games have emerged as a great source of revenue generation owing to the prevalence of smartphones and simplistic approach to monetization. NetEase is one of China’s tech majors who’s dominating the online gaming services landscape. While they also dabble in music streaming and other tech services, online gaming accounts for 93% in revenues for the tech conglomerate, 66% of which comes directly from its mobile gaming services alone.
• NetEase has established itself as a distribution channel for key Western franchises popular in the Chinese market, partnering with Blizzard to operate Chinese versions of their games like World of Warcraft, StarCraft II, and Overwatch. Even though the end goal of NetEase is to gain longevity and recognition among its first-party franchise titles, regulatory restrictions are once again coming into play. In what seems to be a common theme among these tech giants, NetEase too has faced scrutiny from the Chinese regulatory board, having halted licensing on new game titles in August last year, which only resumed again in April of 2022.
• While shareholders may still be feeling the pinch from the decline in share price from the 12 month highs, the good news is that gross profit margin among NetEases services has remained strong coming in at 64.9% for Q2 2022, compared with 62.2% and 63.2% for the preceding quarter and the second quarter of 2021, respectively. Gross profit margin for games and related value-added services is generally stable and so if NetEase can expand its presence in overseas markets, continued growth will be a hopeful, but not a guaranteed prospect.