Technology companies have caught the attention of US investors lately. Cash-heavy balance sheets have sparked a wave of mergers and acquisitions (M&A) activity, and several technology companies have started to pay dividends. Many market watchers have interpreted these developments as signs that the US technology industry has matured, and that the heady, high-growth days of the early 2000s are a thing of the past. Meanwhile, Asian technology companies are still growing at a rapid clip. Internet penetration rates remain low in many parts of the region, and rising household incomes mean that consumers have more leeway to make discretionary purchases. We recently spoke with Michael Oh, manager of Matthews Asia Science and Technology (MUTF:MATFX), about the opportunities and obstacles in this exciting space.
Describe the fund’s mandate and your investment strategy.
The fund’s mandate is to invest in Asian technology- and science-related companies in sectors such as technology, health care and telecommunications. The fund’s chief strategy is to invest in companies that can tap into the growing wealth and spending power of Asian consumers, with a focus on companies that are oriented to the domestic economy.
What differentiates Asian technology companies from their counterparts in the US?
If you compare Asian technology firms to global companies you’ll notice some real differences. Take the search industry, for example. Most of the industry in Asia is dominated by a single player. In China, Baidu.com’s (NSDQ: BIDU) search offering controls more than 80 percent of the market. NHN Corp (Seoul: 035420) holds a 70 percent share in South Korea where local companies make up more than 90 percent of total market.
Local companies dominate these markets because their strategies are tailored to meet the unique demands of Asian users. Global strategies often fail in Asia. For example, e-commerce is still relatively new to China, and many clients don’t understand the power of online search yet.
Baidu has more than 3,000 sales representatives in China who are educating small to midsize merchants about the value of e-commerce. Baidu understands that there’s a need for this kind of education, which is why its sales force outnumbers that of Google’s (NSDQ: GOOG) by 10-to-one.
Google, on the other hand, believed that its superior technology would attract clients. That strategy hasn’t worked well.
Then you have a country like South Korea, where people are very familiar with Internet-related industries and online search. The country’s No. 1 player in search was a latecomer to the game, but the firm delivered a unique set of services.
Korean Internet users love to get information online, so NHN came out with a knowledge-based search service where people can ask questions and then someone else will answer them. Through this service, NHN has accumulated an impressive database of search terms.
The Asian search industry is very different from the model that’s succeeded in the US and Europe, enabling local companies to lead the way.
Are any of these local leaders expanding into global markets?
Many Asian companies are now entering other regional markets. NHN went into Japan and became the largest children’s online game company in the country. Now they’re starting an online search service in Japan that’s tracking pretty well. Baidu.com has also chosen to enter the Japanese market.
A handful of US tech companies now pay dividends to attract investors. Is a similar trend underway in Asia?
High-growth companies in the Internet space rarely pay a dividend. However, many hardware manufacturers in Taiwan pay generous dividends. It’s not unusual for some of these companies to pay dividends of 3 percent. And the valuations have become attractive lately. Some of the large-cap tech companies are at their cheapest valuations in years.
Asian companies in general have healthy balance sheets and tech companies are no exception. We are seeing some M&A activity, especially from Japanese companies taking advantage of the strong yen. Some companies are also investing more to strengthen their competitive position.
While the penetration rate for telephone services has reached 70 to 80 percent in some Asian countries, telecom is still very much a growth industry in China and other emerging nations in the region. While many people have cellular phones, the revenue per user (RPU) lags that of Western countries. The reason is that a relatively small number of subscribers in Asian emerging markets use mobile data services. But as smartphones become increasingly popular in Asia, data use will rise and RPU will increase substantially. Based on this trend, the valuations of most telecoms are very attractive and have the added benefit of being defensive in downturns.
Protection of intellectual property remains lax in the region, particularly in China. How would you characterize the threat that this poses to technology firms operating in Asia?
We focus primarily on Internet companies that provide services that are hard to replicate. Nonetheless, intellectual property protection remains a danger, particularly in the media and software industries. You can easily buy pirated DVDs of newly released on almost any street in China.
That’s why we focus more on distributors in the IT and health care space. These companies don’t depend on one blockbuster product or drug because they distribute a number of products.
The Internet penetration rate in Asia is still very low. For example, China’s Internet penetration rate is only about 30 percent, while India’s clocks in at just 5 percent. However, although China’s Internet penetration rate may lag the US, more than 300 million people already use the Internet in the country.
Once that rate reaches 70 percent, the number of absolute users will be more than the entire population of the US and Western Europe combined. That’s a huge opportunity and makes for quite an investment case.
If you look at consumer and corporate spending on information technology (NYSE:IT), it’s still very low compared to the US or Western Europe. Overall penetration rates for all IT products, from personal computers to televisions, remains on the low side, even though Asia is now the largest market for these goods in terms of total units.
Asia is one of the world’s fastest-growing regions, and the growth in total expenditure on technology should outpace increases in gross domestic product. Asian technology companies will also benefit from higher household incomes.
If you look at US consumer spending on technology products, this segment has risen steadily since 1960. Today, the Chinese consumer’s income level is comparable to what we saw in the US back in 1960. As incomes grow in Asia, spending on technology should follow suit.
Are there any other significant risks?
Technology investors, especially those focusing on Asian markets, should have a long-term perspective. A lot of volatility will accompany this growth, but that’s pretty much the case for any tech fund you buy; the technology industry tends to be highly volatile. The region’s weak intellectual property protection remains another risk.
Can you tell us about a few of your favorite companies?
Baidu.com is our biggest holding, and we invested in the company when it went public. It’s really the best example of our strategy because it’s one of the firms in the best position to benefit from domestic growth. It will see rewards from both China’s growing Internet penetration rate and the broad growth of e-commerce as the Chinese economy continues to expand.
Synnex Technology International (Taiwan: 2347) has a presence in India and China and distributes IT products throughout Asia. The company should benefit from secular growth trends in the IT sector.
We like the domestic champions that are also globally competitive. A good example of that would be Samsung Electronics (South Korea: 005930), a long-dominant player in South Korea that has become a globally recognized brand.
It’s built a market-leading position in flash memory and dynamic random access memory (NASDAQ:DRAM) products. Flash memory technology is used in almost all smartphones and tablet computers, while DRAM is the backbone of the PC industry. Samsung is well positioned to benefit from the explosion of smart mobile devices that will hit the markets.
Disclosure: No positions.