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Unpacking the Chinese tech boom


The growth of its technology sector has been a big part of China’s industrialisation.

 

The growth of its technology sector has been a big part of China’s industrialisation. There’s a substantial amount happening investors need to know and here we look at emerging developments in its technology sector.

One of the most important trends is the increasing use of industrial robots, machines that can be controlled to manipulate and move objects. Industrial robots are an enabler of the industrial internet. This is a term that describes industrial engineering combined with sensors, software and big data analytics to create more efficient machines.

While there has been a substantial rise in the number of automation-related companies in China, further growth is expected as the government encourages domestic players to capture market share from foreign brands like ABB, Kuka, Fanuc and Yaskawa. China has been the largest buyer of robots for the past two years and accounts for 25 per cent of the market. This demand from China is likely to continue as factories are modernised and wage inflation rises.

However, foreign brands currently dominate more than 90 per cent of the high-end industrial robot market in China and are unlikely to lose substantial ground to their Chinese peers over the next five to 10 years.

The implication for investors is that China is developing a significant core competence in one of the great upcoming themes of our time – the industrial internet – which will enable it to maintain a competitive cost advantage in manufacturing. Investors could consider monitoring the industrial internet as it evolves and potentially build opportunistic positions that provide exposure to its growth.

Technological disruption

A handful of themes are driving outperformance in publically listed companies in a narrow range of sectors. Companies such as Alibaba, Tencent, JD.com and Baidu have dominated the contribution of earnings growth to the index.

Given the rapid growth of technology and globalisation, the place of listing is now less relevant, although currency risks remain. Investors should be less concerned with the question: “Do I invest in the US or China?” Rather, the more important question is: “Do I invest in tech disruption through Chinese stocks or US stocks?”

It’s useful to observe developments in China and the US within e-commerce, search and advertising, and content.

E-commerce

Almost US$400 billion worth of shopping transactions were conducted on e-commerce giant Alibaba in 20141. This represents double the merchandise volume of Amazon.com and eBay combined.

Alibaba also has a much larger customer base: there are about 1.4 billion people living in China, compared to 319 million in the US. It has a goal of generating 40 per cent to 50 per cent of revenue from outside China in the next ten years, and is expanding its online shopping malls into Singapore, Malaysia, Brazil and Russia.

While Alibaba delivers more packages than Amazon, Amazon is the larger company by revenue. In 2013, e-commerce represented 15 per cent of total retail sales in China. E-commerce sales could increase to 27 per cent in 2018, and could represent 50 per cent of China’s total retail sales in ten years’ time.

Search and advertising

While Google maintains its stronghold in the global internet search arena, Baidu has the upper hand in China, taking 82 per cent2 of the nation’s online search queries.

According to eMarketer, China accounted for US$14.90 billion, or 32.8 per cent of global search-related advertising spend in 2015. The US, by comparison, accounted for US$25.66 billion in advertising spend last year. With the rapid growth in online search, search-related advertising spend in the US could be eclipsed by China. According to Internet Live Stats, the US has internet penetration of more than 86 per cent of the population, while in China just 46 per cent has internet access.

Content

China’s largest online content firm iQIYI reported it has more than five million regular subscribers for its premium video on demand (VoD) system. Regular subscribers represent just one per cent of its 500 million-plus active users, so the potential to convert users to subscribers is tremendous. Subscriber growth has been rapid, with the company reporting a surge of 765 per cent year–on-year growth in VoD subscribers3.

A key point of difference between Netflix and Chinese content peers is that Chinese firms are all playing a much bigger game, known as ‘Internet Plus’, which uses integrated technologies to sell to consumers. iQIYI is part of and technically well-integrated into Baidu. Tencent Video is part of the social media leader Tencent, with its WeChat and QQ products driving traffic and simultaneously benefitting from online video consumption to drive offline consumerism. The Chinese content providers are backed by the dominant payment gateways AliPay and WeChat Pay, also owned by their respective parent companies.

The relative lack of concern over privacy, and China’s huge population, allows these firms to make significant advances in big data, artificial intelligence and algorithm research. By comparison Netflix has yet to dip its toe into big data.

There are numerous implications for investors from the tech disruption theme. The online battlefield for control of search, e-commerce and content is heating up and there is evidence disrupters have taken market share from incumbents. We expect this trend will continue. Second order thinking is: at what point do disrupters start disrupting themselves?

The technology leaders of today can and will be challenged. We believe investors who do not focus on China may be underestimating Chinese firms’ potential. SMSF investors should keep this in mind as they assess their investment options.

1Alibaba Group Annual Report, 2015
2Internet Live Stats
3CNNIC, Morgan Stanley Research

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