Positive economic data has lit a fire under Chinese equities. Regardless of whether the data is legit or fabricated, accelerated price action for Chinese stocks makes now a good time for a review of the key Internet stocks operating in China.
Chinese Internet stocks combine two of the of the most popular stories for equities post-crisis:
- China's rapid economic growth and urbanization, and
- The resurgence of tech stocks as engines of entrepreneurial dynamism.
As a general rule, Chinese Internet companies are focused on mobile users as an estimated 75% of China's online population access the web via mobile device. Just as Facebook had to prove it could crack the monetization problem of its mobile business, Chinese Internet companies are being judged by their ability grow in the mobile space.
Key mobile stocks in play include Sina Corp. (SINA), Baidu Inc. (BIDU) and Youku Tudou (YOKU) - the exceptional growth stocks of the group - as well as E-Commerce China (DANG) and Rennren Inc. (RENN), which have turned out to be laggards.
The Growth Winners
Sina is currently the king of Chinese mobile. Its main Weibo business has been dubbed the "Chinese Twitter."
What sets Weibo apart from Twitter are its sheer popularity (over 500 million users) and the way in which it has monetized its business, selling adspace and incorporating games in a way more reminiscent of FB.
Quarterly revenues have been growing in a relatively stable fashion since 2010 and analysts are predicting earnings growth of over 100% for 2014.
The company's forward PE of 41 is a natural reflection of strong expectations for continued growth. Still, Sina's stock price falls 15% short of analysts' average price target, and analysts have been steadily increasing forward earnings estimates.
Sina's stock price has increased over 45% since the start of July but has spent the last several weeks consolidating that gain. The stock is currently trading near the 20-day EMA and remains relatively extended above the 50 and 100 EMA.
Baidu's closest Western comparable would be Google, and Baidu's multiple of 28x earnings is only slightly above Google's PE of 27.
China's number one search portal is expanding into mobile through its acquisition of "91 Wireless." The primary motivation behind this purchase was access to the target company's app store.
Baidu has a history of strong revenue growth, and analysts continue to expect strong earnings growth over the next few years.
Youku Tudou, suffered negative earnings in 2012 as it paid the price of acquiring video streaming competitor Tudou. The stock now looks to be in the early stages of a comeback.
Earnings are set to turn positive in Mid-2014 and the stock has performed well since April 2013, reflecting Youku's growing revenues and cost-cutting efforts.
Youku's video streaming business is well-suited to mobile applications and its deals with Chinese TV and film production companies have entrenched it as the dominant player in China's video segment.
Too Little Too Late?
E-Commerce China and Renren Inc. , currently reporting negative earnings, both have lofty goals.
DANG is taking aim at being the Chinese version of Amazon.com (AMZN), while RENN aspires to be the Chinese Facebook.
Analysts only expect earnings at DANG to turn positive in the second half of 2015 while RENN's earnings are expected to stay negative into 2016.
DANG is already the Chinese leader for selling books online and is strikingly reminiscent of AMZN in its plans for expansion from that base. A major challenge for DANG lies in the fact that China may not be ready for such a company. Considering AMZN's penetration versus B&M stores outside of books and multimedia is relatively low, China's market, no matter how large, will be a tough nut to crack for DANG until Chinese incomes rise.
RENN, for its part, is perhaps trying to emulate Facebook (FB) too closely. The company is focused intently on its mobile platform, and while Facebook has shown that monetization there is possible, the success of Sina's Weibo impedes RENN from becoming the uncontested market leader that Facebook is in the US.
The implosion of Zynga's (ZNGA) share price has also shown that mobile gaming is not producing the type of growth that investors had expected. Both stocks' weekly charts show signs of topping and neither stock appears to have merit beyond a deep value contrarian case.
Sohu.com and Netease Inc. are two of the most mature players in the Chinese Internet economy. While their closest American counterpart Yahoo! (YHOO) has struggled to evolve and cope, Sohu and Netease have discovered a successful niche in online gaming.
While the business may not be as promising as the mobile applications of Sina or Yoku, expectations are for steady earnings growth at both companies and forward PE ratios have been rising.
Sohu is in talks to divest itself of its search business to focus on online gaming which has become its core strength. Both have interesting weekly charts, with Sohu in particular showing a double bottom.
Conviction Levels and Potential Runway
Our trading involvement with these names will rest primarily on two factors:
- Continued bullish sentiment for China's economic growth.
- Technical patterns for individual equities in question.
A few of the strongest candidates have rallied sharply over the past few months, but still have potential for much higher prices.
Sina, for instance is trading at 41 times 2014 expectations, but continues to grow earnings at a torrid pace. If analysts release estimates for 50% EPS growth in 2015 (a moderated pace from the 112% expected growth next year), a forward multiple of 40 would put the stock trading just below $120. Of course a growth rate in-line with 2014 estimates could lead to much larger gains and SINA could test its 2011 high near $150.
Youku also has potential for dramatic appreciation as the company is just now turning the corner to profitability. The stock is trading at 76 times forward expectations, but those forecasts are heavily in flux. If Youku hits the high-end of analyst expectations ($0.76 for next year), and continues to grow from there, PE multiples could expand much like Sina's and the stock could trade into the high-$40′s or low-$50′s - a price level it eclipsed in mid 2011.
Prospects for Netease and Sohu.com are more muted. But given the stable base of earnings, reasonable earnings multiples and improving sentiment for China, we could see a 25% to 35% increase as analyst confidence levels increase and valuations expand.