From October 1st to the 7th, the People's Republic of China enjoyed a week-long holiday break dubbed the Golden Week. Nevertheless, the news flow from the populous country in celebratory mood did not stop and was, in fact, strong and mostly positive. Stocks of Chinese companies (CQQQ)(FXI) generally staged a mild recovery from the previous week's mayhem that stemmed from a Bloomberg article that reported officials from the White House were considering limits on U.S. portfolio flows to China.
The biggest boost to the market sentiment, in my opinion, was the unexpectedly big jump in the Caixin China General Manufacturing Purchasing Managers' Index ('PMI') released on the morning of September 30, Beijing time. The PMI came in at 51.4 in September, up from 50.4 in August. The pace of improvement was the quickest seen since February 2018, 19 months ago, signaling a recovery in the manufacturing sector. While the companies surveyed often commented that the ongoing China-US trade dispute had continued to dampen foreign sales, domestic market consumption has stepped in substantially to support the growth in manufacturing demand.
"The recovery in China's manufacturing industry in September benefited mainly from the potential growth of domestic demand. The trade conflicts between China and the U.S. had a notable impact on exports, production costs and confidence of enterprises. Compared with growth in new orders, the employment situation recovered only a bit, indicating that structural issues may exist in the labor market. Central policymakers have recently been emphasizing the strong growth in the domestic market. Faster construction of infrastructure projects, better implementation of upgrading the industrial sector, and tax and fee cuts are likely to offset the influence of the subdued overseas demand and soften the downward pressure on China's economic growth."
- Dr. Zhengsheng Zhong, Director of Macroeconomic Analysis at CEBM Group, a subsidiary of Caixin Insight Group, on the drivers leading to the favorable September PMI reading.
Our bevy of Chinese internet stocks didn't disappoint, with many of them seeing a rebound in their share prices. The Chinese Internet sector representative ETF, the KraneShares CSI China Internet ETF (KWEB) jumped 3.25 percent. As if obeying the law of physics, those stocks that suffered big falls the previous week experienced a large rebound. For instance, Ctrip.com (CTRP), JD.com (JD), and Pinduoduo (PDD) which saw their share prices plunged 12.27 percent, 10.08 percent, and 8.22 percent respectively that fateful week, managed to claw back some losses. Their share prices rose 4.58 percent, 4.21 percent, and 6.62 percent respectively.
It was baffling that in spite of several positive developments from Tencent Holdings (OTCPK:TCEHY)(OTCPK:TCTZF), the gaming and social media titan experienced another week of decline. On the other hand, the share price of TAL Education Group (TAL), which is increasing its revenue share from the online delivery of classes, skyrocketed from Thursday to end the week 11.64 percent higher, more than erasing the previous week's 6.94 percent loss. I will explore further the possible drivers for the outperformance of TAL Education in the subsequent section.
As explained in a past issue of the Chinese Internet Weekly, I found the KWEB ETF holding the most representative stocks in the sector. An overview of the week's share price movements of the top few holdings of KWEB as compared with the ETF itself is provided as follows for convenient reference.
TAL Education's Big Bounce
TAL Education isn't the typical technology firm relying on internet-based revenue as the bread-and-butter. Nevertheless, the manager for the KWEB ETF felt the stock was deserving to be a top ten holding ostensibly by virtue of its savvy leveraging of technology in delivering its core mission of "advancing education through science and technology" and concretely, K-12 after-school tutoring services.
TAL Education now provides online and mobile platforms across the full age group, starting from Peiyou, a social platform targeting expecting and young parents, to the other end of the academic journey with Kaomanfen, a platform assisting in the preparation for China's postgraduate entrance examination.
Source: TAL Education
With the trade war more than a year-old, there have already been plenty of discussions on why Chinese internet stocks shouldn't really be impacted much by the additional tariffs being imposed and the ill effects in general. Joseph Tsai, the Executive Vice Chairman of Alibaba Group (BABA), even painted a very positive picture, believing that the e-commerce and cloud services giant would be able to thrive from the trade war aftermath - among other justification, his confidence stemmed from Alibaba's strength in being the "platform of choice" for global producers, products, and brands selling into China, thanks to its "over 650 million active Chinese consumers" on its platform.
Daniel Zhang, the chief executive officer of Alibaba and now also the executive chairman, stated during the 20th-anniversary party his aim of increasing the number to over a billion consumers and further develop its platforms to enable a total consumer spend reaching a staggering RMB10 trillion by the year 2024. If an e-commerce titan can make a convincing pitch like this amid the trade conflict, why should we not believe that an education service provider like TAL Education would not be affected?
After all, we have long heard about "tiger mom" in China who have no qualms spending on tuition for their children. When the time comes for belt-tightening - the economy gets stuck in the doldrums in the event of an extended trade conflict - education-related expenses would probably be the last on the list to get the chop. As such, we should not be surprised that the share price of TAL Education has been fairly resilient relatively.
The trigger for the sharp gains last week, however, seemed to be a delayed reaction to French bank BNP PARIBAS price target revision from $28 to $33, a whopping 17.9 percent jump. Despite the big increase, the analyst report released on September 30 called for a "hold" on TAL Education, unchanged from the previous rating. Investors probably latched on the idea that analysts are being slow in recognizing the potential in the company and expect more revisions to come. The closing price last week at $37.70 was just 3.2 percent away from the consensus price target.
According to the charting provided by Seeking Alpha Essentials, the number of "hold" calls on TAL Education has been on a rising trend, with the number of "buys" and "outperform" narrowly edging out the number of "holds". In contrast, in January-April 2017, the stock received 100 percent "buys" and "outperform" calls.
Source: Seeking Alpha Essentials
Tencent's Major Moves In Gaming
In the past year, game developers have been living on the edges and treading carefully so as not to evoke the wrath of the regulators. In April, it was reported that thousands of video game titles that were in the queue for government approval had to provide additional material before re-applying for approval again. Some of the titles which were already in the queue for more than a year were also not spared. The extra re-work certainly beat the long freeze in-game approvals last year though.
Tencent was forced to conduct its third company-wide reorganization since its founding to manage the winter in gaming. The company turned its attention to "industrial internet," the Internet of Things, artificial intelligence, 5G, etc. The management created the Cloud and Smart Industries Group which would lead the renewed focus on Tencent's cloud offerings. The other new division, the Platform and Content Group, was aimed at recovering lost grounds in user attention from other competing services and apps.
With the restructuring, the gaming division saw diminished attention as Tencent wanted to shift the narrative away from games. Nevertheless, as the saying goes, time heal all wounds, Tencent's gaming unit probably emerged from the dark period and is seeking to regain its prominence. What could go wrong when one works with the government? That was exactly what Tencent did, developing the patriotic city-building mobile title "Homeland Dream" in partnership with state media outlet People's Daily which was launched on September 24.
Homeland Dream reportedly topped the chart for free games on Apple's China App Store on the eve of the 70th anniversary of the founding of the People's Republic of China, surpassing the ranking of Tencent's established titles such as "Honour of Kings". However, it is not known how many of the downloads were actually legitimate. According to TechNode, many of the reviews awarding the title five stars were found to be bot-generated, with comments regarded to be irrelevant to the content of the game. Regardless, Tencent has certainly generated plenty of publicity for itself and also goodwill among the authorities for the effort.
This wasn't the first time that Tencent has tapped on the patriotism theme. After failing to get the official approval for monetizing the highly popular "PUBG Mobile: Exhilarating Battlefield", Tencent modified the game to feature the Chinese airforce and renamed it to "Game for Peace". An analyst from IHS Markit (INFO) said the game subsequently "sailed through the approvals process." Tencent was reportedly allowed to monetize the game from April 2019.
Shareholders of Tencent need not worry that the company would become complacent. The company management remains cognizant of the risk of being overly reliant on a single market - China - for their gaming business. On September 30, Oslo-listed computer games developer Funcom (OTCPK:FCMKF) announced that Tencent entered into a share purchase agreement to acquire 29 percent of its shares. According to Reuters, Tencent bought the shares from KGJ Capital AS at a 21.8 percent premium over the closing price on September 27, valuing Funcom at 1.22 billion Norwegian crowns ($134.33 million).
Funcom described itself as the independent developer and publisher of games such as Conan Exiles, The Secret World, and Mutant Year Zero: Road to Eden. When the acquisition is completed, Funcom would join many of the world's leading gaming companies such as Riot Games, Epic, Supercell, Ubisoft, Paradox, Frontier and Miniclip in having Tencent as the shareholder. Following the closure of the deal, Tencent would replace KGJ Capital as the largest shareholder of Funcom, quashing speculations that the Shenzhen-based company would move away from gaming.
Tencent is also said to be penetrating deeper into emerging markets. PUBG Mobile Lite - the lightweight version of PUBG Mobile - was released to several Android-first markets with a large presence of low-spec smartphones such as Indonesia, Thailand, Brazil, and India. The lite version garnered over 40 million downloads in August alone.
Tencent's relentless push into overseas markets has helped it maintain its leading position among mobile game publishers. According to Priori Data, Tencent achieved $256.8m in app store net revenue for July. The amount was higher than the next two competitors, Bandai Namco (OTCPK:NCBDF)(OTC:NCBDY) and NetEase (NTES), combined.
Source: Priori Data/IHS Markit
The Highly Anticipated Resumption In Trade Talks
This week, we should be reading and hearing more developments from China as the Chinese return from their long holiday re-energized and brimming with confidence about the country's prospects after witnessing a spectacular military parade that brought out the 'big guns'. Most critically, we would have the resumption in trade talks between the U.S. and China at the principal-level scheduled for October 10-11 in Washington.
With the U.S. continually sending conflicting (sometimes conciliatory, sometimes aggressive) messages often skipping the diplomatic channels, it would take much courage for the Chinese side to acquiesce to a deal, however interim or limited in scope. Nevertheless, at this point, market players are probably too jaded to have much hope of a resolution and this would be when some positive outcome could spur a substantial uptick in the share prices.
Disclosure: I am/we are long BABA, BIDU, NTES, JD, INFO, TCEHY. 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.