Xiaofan Zhang's  Instablog

China Internet stocks ended July on a high note despite enormous uncertainty over the U.S. debt-ceiling increase. After plummeting 11.6% in May and  9.3% in June, stocks in this industry rose 4.6% on average in July, snapping the two-month losing streak (Table 1). This monthly gain was a significant outperformance versus -0.62% for NASDAQ Composite, +0.61% for the BNY Mellon China ADR Index, and +0.89% for the Halter USX China Index. 

 

China Internet stocks' rebound in July was broad-based, as demonstrated by two metrics: First, the advance/decline ratio improved to 30/19 in July from 7/40 in June and 6/37 in May. Second, seven of the eight major segments had positive performance: Online security stocks gained the most in July (+25.2%), followed by social media (+16.5%), online advertising (+7.8%), online video (+7.6%), online games (+7.2%), online travel booking (+4.8%), B2B e-Commerce (+1.0%), and B2C e-Commerce (-8.6%) segments.

 

Recent IPOs were the major drivers behind the industry's monthly gain. Among the 11 China Internet stocks rising more than 15% in July, six were recent IPOs (Table 1): Taomee (TAOM) went public on June 9, NetQin Mobile (NQ) on May 5, Jiayuan.com (DATE) on May 11, Renren (RENN) on May 4, Qihoo 360 (QIHU) on March 30, and Phoenix New Media (FENG) on May 12. Their strong performance in July reflected investors' bottom-fishing sentiment after seeing these IPOs plunge to depressed price levels in recent months.

 

Despite newcomers' impressive stock performance in July, long-time incumbents Sohu (+24.7%), Baidu (+12.1%), and Sina (+3.8%) were the true newsmakers and trendsetters for the month. Sohu (SOHU) shares surged on the back of strong operating metrics of DMD, an online game developed by Sohu's gaming subsidiary Changyou.com (CYOU). The game was an instant hit, surpassing 300K Peak Concurrent Users (PCU) and 100 server groups shortly after entering open beta on July 22. DMD's success demonstrated to the whole industry that it's worthwhile to take the time to develop a high-quality game. Baidu (BIDU) reported stellar 2Q11 earnings on July 25, and introduced its "Landing Page Strategy" during the earnings call. This move indicated that Baidu is making a big push into the downstream of the search engine value chain through strategic partnerships and investments. In July, Sina (SINA) launched its social game platform and virtual currency Weibi to accelerate the monetization of its Twitter-like service Weibo.com. It also launched Tumblr-like service Qing Weibo to defend and expand Weibo's existing user base. Investors should closely monitor the progress of these two new products because they are important early indicators of Weibo's potential for monetization. In my view, Sina shares will remain very volatile until Weibo contributes significant revenues.

Table 1: China Internet Stocks' Performance in July 2011

Chinese travel-booking company Ctrip (CTRP) recently reported solid 2Q10 results and strong guidance for 3Q10. Data from the airline industry and the city of Shanghai have indicated strong growth momentum for Ctrip in July 2010. I believe Ctrip is on track to surpass its guidance of 25% Y/Y increase in air-ticketing volume in 3Q10, 25%-30% growth in hotel-booking volume, and 35%-40% Y/Y increase in overall revenue. "A rising tide lifts all boats." I forecast strong growth in China's overall travel volume will help Ctrip overcome challenges posed by less important factors such as air-ticketing commission cuts and high-speed rail's substitution effect on airlines. Detailed data and analysis are as follows:

 

Based on official data from Civil Aviation Administration of China (CAAC), total number of China's air passengers rose 21% year-over-year (17% month-over-month) to 25.47 million in July 2010. Domestic passengers increased 20% Y/Y (35% M/M) to 23.71 million. International passengers rose 44% Y/Y (13% M/M) to 1.76 million (Chart 1). Based on data from TravelSky, the leading provider of IT solutions for China's airline industry, total number of China's air passengers rose 22% Y/Y (17% M/M) to 26.73 million in July. Domestic passengers increased 20% Y/Y (17% M/M) to 23.85 million. International passengers rose 43% Y/Y (16% M/M) to 2.88 million (Chart 2). These data points have indicated strong growth momentum of travel activities in China. I believe Ctrip's air-ticketing volume in July has grown faster than the overall passenger growth of 21% because it has been gaining market share against air-ticketing industry peers. I believe Ctrip is on track to surpass its guidance of 25% Y/Y increase in air-ticketing volume in 3Q10.

 

 

Duke of Mount Deer (DMD) remains biggest driver of Changyou shares. DMD is a 2.5D MMORPG based on the popular novel "Duke of Mount Deer", and it shares the same development team and game engine with TLBB, Changyou's flagship game. Although DMD is still undergoing its closed beta testing (Nei Ce), it has been supporting Changyou's stock since the beginning of 2010. Based on my checks, Changyou's stock price has likely reflected the market's optimistic expectation that DMD will be a hit game that accounts for at least 20% of the company's total revenues. Considering the unexciting performance of Changyou's other new games such as Chinese Hero and Da Hua Shui Hu, I believe investors' optimism on DMD is the primary reason behind Changyou's second-best year-to-date performance among Chinese online game stocks (Table 1).