Ashwin Alankar is Global Head of Asset Allocation and Risk Management at Janus Henderson Investors. He explains why he thinks China’s biggest tech firms look set to overtake America’s FAANGs. This article appeared first on Bloomberg on 25 August 2017.
China is no stranger to revolution, be it cultural, political or economic. But the ready adoption of a mobile-first approach* to technology, which has propelled the most populous country to the global forefront – and storefront – of the digital age, may be the most far-reaching reformation yet.
China’s online search, e-commerce and content landscape is dominated by Baidu, Alibaba Group Holding, and Tencent Holdings, collectively known as the ‘BATs’. In May, Alibaba and Tencent joined a group of 11 titans with a market value of more than US$300bn, ranking seventh and tenth on that measure. The first five names on the list are, in order: Apple, Google parent Alphabet, Microsoft, Amazon.com and Facebook.
The options market indicates the BATs can close the gap on the FAANGs, an acronym standing for Facebook, Apple, Amazon, Netflix, and Google. Options provide efficient estimates of the market’s assessment of whether asset prices are more likely to rise or fall. Using options prices to garner information about the distribution of future outcomes is similar to using crowdsourcing** to gather data. Market prices convey important information about changing risks.
According to the China Internet Network Information Center 723.6 million people in China (out of a population of about 1.36 billion) access the internet via a mobile phone; that is double the population of the US and about a third more than the number of people in the European Union (EU). Online sales reached $750bn in 2016, according to China’s National Bureau of Statistics, more than the US and UK combined, and appear set to grow by 20% annually until 2022, twice the pace of the UK and US, with mobile accounting for 74% of the total by 2020, compared with 46% in the US.
Baidu is the country’s dominant search engine, Alibaba’s Taobao and TMall marketplaces control online shopping with 529 million mobile monthly active users, while a third of WeChat’s*** 963 million monthly active users access the app for four hours or more a day. With WeChat, users can find a doctor by location, discipline and price, book an appointment, pay for treatment, and order prescriptions for delivery. In a restaurant, users bring up the menu on their phone, from where they order and pay. After eating, the app can book movie tickets and a ride to the theatre. To settle with friends, users transfer money between accounts. In return, Tencent receives all of that data.
Because everyone uses Alipay (established by Alibaba) or WePay – accounting for 54% and 40% of online payments, respectively, in the first quarter, according to China’s central bank – it is becoming difficult to pay in cash for something as simple as a bowl of noodles from a street vendor. This is an example of consumers ‘leapfrogging’ technologies by skipping credit cards and going directly to mobile payments from cash.
The ubiquity of their apps gives Alibaba and Tencent the ability to leverage data for new ventures, such as financial services. In four years, Alibaba’s Yu’e Bao has become the world’s largest money market fund with $210 billion in assets, 28% of China’s market, according to Fitch Ratings. Yu’e Bao’s parent, Tianhong Asset Management, is the first Chinese money manager with more than one trillion yuan (US$145 billion) in assets. The success of Yu’e Bao, majority-owned by Alibaba affiliate Ant Financial, led Tencent to introduce a similar offering, while Tianhong is seeking to add fixed income and equity-based options to the exchange-traded funds it introduced last year.
Such innovation is working. On 17 August, Alibaba said its fiscal first-quarter revenue grew 56% over the three months to June 2016. A day earlier, Tencent reported a 59% surge in second-quarter revenue from a year earlier. Alibaba’s stock has doubled since 22 December, a day longer than it has taken Tencent’s shares to advance 80%. Baidu has climbed 30% since 16 June.
While options prices indicate plenty of upside for Amazon, Facebook, Apple and Alphabet, the FAANGs have to overcome entrenchment in financial services, traditional retailing and in consumer attitudes. The BATs face lower hurdles, making the options market appear extremely optimistic about their potential.
The box plots below show the ratio of expected upside to downside of FAANG and BAT equities inferred from option prices. A yellow dot higher in the box signals more attractiveness to the upside.
Box plot 1: FAANGs
Box plot 2: BATs
Source: Janus Henderson Investors as at 25 August 2017. Views are the manager’s own; references made to individual underlying securities do not constitute or form part of any offer or solicitation to issue, sell, subscribe or purchase the security.
Antitrust threats may also present headwinds for the FAANGs, especially in the EU, where Google was fined €2.4bn ($2.83 billion) in June and faces further probes. In the US, President Trump has pondered visa and tax rule changes that could impact Silicon Valley companies that some conservatives view as too powerful and too liberal. By comparison, China has cleared a regulatory path for internet companies to innovate.
The options market has confidence in the Chinese companies’ abilities to develop cloud computing and to ramp up advertising revenue while remaining dominant in e-commerce, content and gaming, such as through Tencent’s hugely popular ‘Honour of Kings’ mobile game. Additionally, with most mobile users concentrated in the biggest cities, the BATs have an opportunity to expand into smaller cities and China’s rural communities, where it’s often uneconomical for retailers and financial, healthcare and educational organizations to have a presence.
When it comes to growth in mobile commerce, options prices suggest that the BATs have the FAANGs licked.
*mobile-first approach = designing an online experience for mobile (smaller screens) before designing it for the desktop web, or any other larger device.
** crowdsourcing = enlisting the services of a large number of people, either paid or unpaid, typically via the Internet
***WeChat = instant messaging, commerce and payments mobile app software developed by Tencent
The opinions expressed are those of the authors and do not necessarily reflect the views of others in Janus Henderson Investors organisation. Stock examples are intended for illustrative purposes only and are not indicative of the historical or future performance of the strategy or the chances of success of any particular strategy. References made to individual securities do not constitute or form part of any offer or solicitation to issue, sell, subscribe or purchase the security.
Foreign securities are subject to additional risks including currency fluctuations, political and economic uncertainty, increased volatility, lower liquidity and differing financial and information reporting standards, all of which are magnified in emerging markets.
Technology industries can be significantly affected by obsolescence of existing technology, short product cycles, falling prices and profits, competition from new market entrants, and general economic conditions. A concentrated investment in a single industry could be more volatile than the performance of less concentrated investments and the market as a whole.