China investment themes: the internet

16.03.2017

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In the second instalment in a series of articles on key Chinese investment themes, Charlie Awdry and May Ling Wee, China equity portfolio managers, discuss how the rapid adoption rate of the internet, supportive demographics and embracing of social media are leading to attractive investment opportunities in internet stocks, particularly in social media advertising and mobile gaming. 

Rising internet penetration

China's internet sector is a key beneficiary of consumers' changing appetites. According to the China Internet Network Information Center (CINIC), in 2016 China's internet users grew at its fastest pace in three years, expanding by 43 million internet users. China boasted a staggering 731 million internet users; putting this into context, the entire population of the US is just under 320 million.

The emergence of affordable, locally-branded smartphones is improving rural access to the internet. Over 90% of China’s internet users access the web via mobile devices. This is set to grow even further as China's national broadband strategy aims to achieve 70% fixed broadband penetration and 85% mobile broadband penetration by 2020.

Supportive demographics

China's millennials and their consumption habits are playing a major role in shaping the country's internet landscape. Like their western counterparts, Chinese millennials have cultivated a desire to explore and share their experiences with anyone who might be willing to listen. Companies looking to sell to this increasingly important segment must effectively tap into that desire in order to succeed.

The number of young Chinese that can be classified as digital natives* is rising. This group of Chinese consumers is the first generation to effectively digitise their leisure time, employing a range of mobile applications and mobile devices to participate in various online activities.

*Digital native: a term coined by US author Mark Prensky in 2001. Broadly refers to the generation which has had exposure to technology in the early years, giving them a greater familiarity and understanding of technology than people who were born before tech was widely adopted.

Strong potential for advertising on social media

The Chinese have taken to social networking in a big way. According to statistics portal, Statista, there were 514 million social network users in China in 2016, with millennials currently comprising almost half of this figure. Not surprisingly, the numbers have not gone unnoticed and the huge online population has been identified as a lucrative market for advertising. Marketing research firm, eMarketer, predicts that digital ad spending will reach $50.5 billion in China this year, up from $31 billion just two years ago.

Sina Corporation is a leading Chinese social media site. The company’s Weibo microblog website has been reinventing itself from a news and social information platform to a key opinion leader (KOL) social outlet. Through KOLs, expert spokespersons can actively promote a product, brand or service to Weibo users. Weibo earns advertising revenue when the KOL promotes their posts or when brands advertise with the KOL.

According to digital consulting company, China Internet Watch, Weibo's monthly active users grew by 33% year-on-year to 313 million in December 2016. Of these, 90% were mobile users.

Buoyed by online advertising revenue, Sina Corporation reported net income attributable to Weibo had increased 122% year-on-year to $32.1 million in the third quarter of 2016.

Today, Sina's Weibo microblog is reaching and engaging more than 300 million users who follow and discuss, among other things, celebrities, social hotspots, sports and business topics. We believe Weibo will capture an increasing share of television as well as online search budgets as the company continues to improve user engagement and delivery of more targeted advertisements rather than broadcast ads.

Game on for mobile gaming

China's mobile gaming sector is another segment being buoyed by millennials' appetites for entertainment on-the-go. According to China Internet Watch, the sector is expected to reach an estimated worth of US$8.3 billion in 2017.

China's second largest mobile game provider, NetEase is capitalising on this trend. The company's Fantasy Westward Journey (FWJ), a highly successful multiplayer online role-playing game (MMORPG), has topped mainland mobile game rankings following its launch in March 2015. In 2016 the company launched Onmyoji, which surpassed FWJ to clinch the top spot on the iOS game rankings.

NetEase is also active in China's PC game segment where it has a partnership with US games company Activision Blizzard to distribute games such as the highly successful World of Warcraft series.

We believe growth in the Chinese mobile gaming market can be sustained with the launch of new game titles, increasing user adoption as well as pricing gains. NetEase is a key holding in our portfolios as it continues to launch successful new games; the gaming business remains highly cash generative and, furthermore, the company's valuation remains attractive.

Summary

Our strategy remains invested in the long-term structural growth story of China's internet sector, which looks set to continue growing on the back of millennials' expanding spending power, increased online engagement, and rising mobile and PC penetration across China. We maintain that a strategy focusing on well managed, cash generative companies in the consumer space is well suited to prospering in China's new economy.


Note: References to any specific company or stocks are for illustrative purposes only and should not constitute or form part of any offer or solicitation to issue, sell, subscribe or purchase the security.

 

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