Digital China: Transforming To Greater Competitiveness

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Includes: ATHM, BABA, BIDU, CTRP, TCEHY
by: Kevin Carter

Summary

China has become a leader in digitalizing its economy.

China leads in the adoption of ecommerce.

Venture cap has become big in China.

China is already a major player in digital technologies at home and around the world, and it has enormous growth potential. As digital forces shake the status quo and restructures value chains, an even more globally competitive Chinese economy and dynamic firms can emerge. China continues to shrink the technology gap between itself and more developed countries and lead the world in the adoption of ecommerce and mobile payments. China has become more active in the venture cap arena, both in seeking funding for its new companies as well as investing in emerging technologies abroad.

Companies such as Baidu (NASDAQ:BIDU), Alibaba (NYSE:BABA), and Tencent (OTCPK:TCEHY), collectively known as the BATs, have been huge beneficiaries of these trends as they have build the platforms to facilitate the adoption of trends such as ecommerce and mobile payments. And they will continue to benefit as they continue to build and invest in the next generation of technology.

Investors can participate through direct investment in Chinese companies that are at the forefront of the digitalization trends in China. Alternatively, they can invest in funds like EMQQ – The Emerging Markets Ecommerce and Internet ETF - which invests in companies like the BAT companies who, among others, who are leading the digitalization charge in China.

China’s Rapid Progress

A recent study completed by McKinsey & Company noted the rapid progress that China has made in the digital transformation of its economy and the potential for further rapid progress. The study, Digital China: Powering the Economy to Global Competitiveness, was dated December 2017.

China’s progress can be illustrated by the fact that the gap between digitalization in Chinese industries compared to the U.S. has been shrinking. The study noted that U.S. industries were 4.9X more digitalized than China’s in 2013, but that gap had shrunk to 3.7X as of the end of 2016. No where is that more evident than in ecommerce. However, China is increasingly becoming more active in the venture capital area, both funding its own ventures and seeking opportunities abroad.

Growth of Ecommerce

China is leading the world in the rapid adoption of ecommerce. In e-commerce, China accounted for less than 1 percent of the value of worldwide transactions only about a decade ago; that share is now more than 40 percent. The current value of China’s e-commerce transactions is estimated to be larger than in France, Germany, Japan, the United Kingdom, and the United States combined, according to McKinsey.

While the BATs readily come to mind when thinking of the growth of ecommerce, there are many other companies that are benefiting. In addition to the big three, JD.Com (JD) is also a large ecommerce company in China. Although specializing in electronics, the company also sells a wide variety of products online.

In addition to traditional retail, other industries are also benefiting from the rise of ecommerce. Travel is one of them. Ctrip.com International (CTRP) provides online travel booking services such as airline and hotel reservations, package tours, and corporate travel management. Autohome Inc. (ATHM) is the leading online destination for automobile consumers in China.

The study also noted that penetration of mobile payments among China’s internet users grew from just 25 percent in 2013 to 68 percent in 2016. In 2016, the value of mobile payments related to individuals’ consumption was $790 billion, 11 times that of the United States. China is fast moving toward a cashless society where everyday transactions are paid for through mobile applications.

The mobile payments market is dominated by Alibaba's Alipay and Tencent's WeChat Pay.

Follow the Money

China is flexing its muscles in the technology start-up industry as well as venture cap, both commanding and supplying capital in the segment. One in three of the world’s 262 unicorns (a start-up that is worth more than $1 billion) is Chinese, commanding 43 percent of the global value of these companies. China’s venture capital industry is increasingly focused on digital. Overall, China’s venture capital sector has grown rapidly, from just $12 billion, or 6 percent of the global total, in 2011–13 to $77 billion, or 19 percent of the worldwide total, in 2014–16. The majority of venture capital investment is in digital technologies such as big data, artificial intelligence (NYSE:AI), and financial technology (fintech) companies. China is in the top three in the world for venture capital investment in key types of digital technology including virtual reality (NYSE:VR), autonomous vehicles, 3‑D printing, robotics, drones, and AI.

Alibaba's Ant Financial and Tencent are particularly active in the venture cap space, seeking attractive companies around the world.

Three Reasons for Digital Success in China

McKiney’s study cites three reasons for digitial success in China.

The first factor is that China is a large market. In 2016, China had 731 million internet users, more than the European Union (NYSEARCA:EU) and the United States combined; and 695 million mobile users (95 percent of total internet users), compared with 343 million in the EU (79 percent), and 262 million in the United States (91 percent). Nearly one in five internet users in China relies on mobile only, compared with just 5 percent in the United States. China’s mobile share of e-commerce sales is around 70 percent vs. 30 percent in the United States; its share of internet users making mobile digital payments is around 68 percent vs. 15 percent in the United States.

The second is that three of China’s internet giants—Baidu, Alibaba, and Tencent, or BAT—are building a rich digital ecosystem that is now growing beyond them. These companies have built strong market positions by taking out inefficient, fragmented, and low-quality offline markets. These companies started with an anchor offering and then diversified. Players like Alibaba’s Alipay and Tencent’s WeChat now offer “superapps,” which give consumers a one-stop shop covering education, health, information services, entertainment, e-commerce, and social interactions. These companies provided 42 percent of Chinese venture capital investment in 2016. One in five top Chinese startups was founded by BAT or BAT alumni, and an additional 30 percent receive funding from BAT firms. Additional Chinese companies are following the BAT model.

Finally, the government gave digital players space to experiment before enacting official regulation, and it is becoming an active supporter. The Chinese government moved to regulate the digital sector only after a delay. While consumer protection may sometimes have been weak, this approach gave innovators space to experiment. Today, the government is actively building world-class infrastructure to support digitization as an investor, developer, and consumer.

Segments That Are Benefiting the Most

The most digitized sectors in China include information and communications technologies (ICT), media, and finance. China’s consumer-facing industries and sectors associated with government rank higher relative to other sectors compared with their counterparts in the United States and Europe. Chinese consumers are enthusiastically embracing digital technologies, and the industries that serve them have had to respond by investing in digital assets and processes. The sectors that lag furthest behind are fragmented and localized industries such as real estate, agriculture, local services, and construction.

Summary

China has made great strides in digitalizing its economy. In areas such as ecommerce and mobile payments, it is far ahead of developed countries. China continues to invest heavily in developing and acquiring leading edge technology. Baidu, Alibaba, and Tencent, collectively known as the BATs, are leading this charge.

EMQQ – the Emerging Markets Ecommerce and Internet ETF – invests in companies such as the BATs who are poised to potentially benefit from the continued efforts of China to digitalize its economy and become a world leader in the next generation of technology.

Disclosure: I am/we are long BABA, BIDU, TCEHY, CTRP, ATHM.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.