If you are to have a well-rounded portfolio in 2017, you need to be in China, whose economy is projected to be roughly 50% bigger than that of the U.S. in 2020.
As is true with the U.S., investors looking for growth need to be invested in the internet. But there are dangers. I predicted recently that an internet stock bubble could be building, because the country has too many companies with too much market cap in that sector.
The U.S. bubble of the 1990s, however, developed as valuations got out far ahead of fundamentals. This allowed companies without much revenue to claim an enormous multiplier on sales from the market, based on growth assumptions that only a few companies could hope to satisfy. Chinese valuations are not that stretched. Most companies sell for little more than their U.S. counterparts, although not all have the same growth trajectories. Remember, it’s growth that you’re buying.
Take the talk that such-and-such company is “China’s Facebook Inc (NASDAQ:FB)” with a grain of salt. Chinese companies don’t stay in their lanes that way. They seek whatever niche promises growth even if, from a U.S. perspective, it has little to do with their original business model.
Whether the bubble pops, there are some Chinese internet stocks that will get to the other side just fine. You need to consider them as investments.
Chinese Internet Stocks to Buy: Alibaba (BABA)
Start with Alibaba Group Holding Ltd (NYSE:BABA), an essential part of any well-rounded portfolio. Alibaba is not Amazon.com, Inc. (NASDAQ:AMZN). It was founded as a business-to-business marketplace, empowering small businesses first rather than consumers.
That’s a point executive chairman Jack Ma was making when he met with President-elect Trump recently, claiming 1 million U.S. jobs could be created if small town America took advantage of what Alibaba offers Chinese businesses.
Whether Ma can fulfill the pledge is less important than the meeting itself, which illustrates just how much a player Alibaba has become on the global business scene. While it now has many things in common with Amazon, like a cloud service, entertainment unit and a quirky leader, it is also much more. For instance, Alibaba has a version of Groupon Inc. (NASDAQ:GRPN) called Juhuasuan, and is reportedly interested in buying the U.S. company.
Alibaba handles logistics like United Parcel Service, Inc. (NYSE:UPS) and payments like Paypal Holdings Inc (NASDAQ:PYPL). It offers its video products over-the-air like CBS Corporation (NYSE:CBS) as well as online like Netflix, Inc. (NASDAQ:NFLX). It is going to have a bigger brick-and-mortar presence by taking Intime Retail Group Ltd., one of China’s largest mall and department store operators, private.
Alibaba is also determined to expand well beyond China. It is opening a logistics center in Bulgaria aimed at exporting that country’s products to the world, and lowering prices for local consumers. This may be the most important story here. Alibaba remains, at heart, a trading company, cutting business costs by handling marketing and logistics. That’s a global vision.
In retail, Alibaba is aiming to challenge Amazon in India and has taken a position against Amazon in Southeast Asia by buying a controlling stake in Lazada, which is a logistics as well as an e-commerce company, much like Alibaba itself. Of course, BABA is not a U.S. stock. Due to Chinese rules on foreign investment, what you’re buying is a call on earnings. But since a growing number of U.S. internet giants now have two-tier share structures that eliminate shareholder rights to control management, like Alphabet and Facebook, this should not trouble you.
Any portfolio with exposure to China should start with Alibaba … but it need not end there.
Chinese Internet Stocks to Buy: Tencent (TCEHY)
Tencent Holdings Ltd (OTCMKTS:TCEHY) stock is, if anything, more of a screaming buy than Alibaba. Because Tencent operates with less infrastructure, it can easily earn fatter margins and it’s actually bigger (by market cap) than Alibaba.
Tencent illustrates the point that you can’t really compare Chinese internet companies, or the Chinese market, with that of the U.S. At the heart of Tencent, after all, is a simple chat service, called WeChat, and mobile games. But WeChat is monetized more fully than any U.S. analog, and has 846 million domestic users. That’s nearly three times the population of the U.S.
Tencent is growing its top line at 25% per year, from a 2015 base of about $14 billion. It brings 27% of revenue to the net income line. WeChat is now introducing “mini” programs, a version of apps, that allow sharing of content and purchases and could send make those results look poor. Almost half of Tencent’s revenue comes from games. This let it buy the Swedish game producer SuperCell last year, known for Clash of Clans. You are more likely to have already used Tencent services than those of Alibaba.
The company’s Apple Inc. (NASDAQ:AAPL) like cash hoard, about $13 billion at the end of September, is regularly invested in expanding the parameters of the business. That means it has a play in self-driving cars, in making personal loans, in mobile payments and now in video production. It is also expanding, not just in terms of customers but in terms of content producers, across Southeast Asia, which is filled with young people who have big ideas.
The vibe given off by Tencent is that of a company that is soaking up talent from throughout East Asia, not just its home market, and delivering the results of that talent back to the region’s consumers. Southeast Asia has the fastest changing, youngest demographics in the world, and Tencent basically owns that market. Who wouldn’t want to be in on that opportunity?
JPMorgan Chase & Co. (NYSE:JPM) does not like many Chinese investments, but it likes Alibaba and Tencent, which it is convinced will continue to do well regardless of how U.S.-China relations go. When the bear says buy, don’t ignore it.
Chinese Internet Stocks to Buy: Weibo (WB)
Weibo is essentially a microblogging platform, and the site is filled with pictures and short video clips aimed at small audiences. Think Cheezburger.com, but more niche, more personal and easier to monetize. When someone you know posts something on Weibo you will get an SMS message on your phone, and advertisers can push such messages through the service. Weibo is tied closely to brands that can conduct market research and do promotions using its application program interface (API).
Comparing Wang to Dorsey, however, is an insult to Mr. Wang, because WB is still growing, it’s already profitable and Wang is nothing like Dorsey. He’s a computer scientist, not a social visionary. He’s also very corporate, having worked for Weibo’s parent company, Sina Corp (NASDAQ:SINA), since 2000. Yet, he’s just 35 and seems to understand his young, upwardly mobile platform intuitively.
I noted last week that Sina, which still owns half of Weibo, is the wrong company to invest in, in the same way that VMware, Inc. (NYSE:VMW) was a better investment than its parent EMC before Dell bought them both out. (Alibaba also owns a stake in Weibo.) Wang is a good corporate manager with solid cost controls, so that as the company’s revenues began exploding in 2016, he could deliver fat profits.
For all of 2015, for instance, Weibo had net income of $34.75 million on revenue of $477.89 million. During the September quarter of 2016, Weibo had net income of $32.10 million on revenue of $176.88 million. Margins, in short, have been accelerating along with revenue. Revenue and margin acceleration are why some companies are worth 20 times the trailing year’s sales, as WB is.
The Weibo service is now available on Xbox One, it has begun live-streaming NFL games and it is being used by foreign embassies to interact with Chinese consumers. Weibo is becoming, in short, the window young Chinese consumers have to the world, a place where it’s safe to talk about terrorism and smog.
The assumption that China’s government prohibits discussion and debate is a misleading one. The truth is it channels discussion. Social controls have kept Weibo from becoming like Twitter, and the knowledge that government can clamp down, that it sometimes does, benefits the company enormously.
Louis Navellier of Blue Chip Growth wrote here last December that Weibo is like Twitter except you should buy it. The relationship among Weibo, Sina and Alibaba is complementary, Navellier writes, but it’s Weibo’s growth that makes it a standout at a $9 billion market cap. That’s about right. You get growth with Weibo, you get the opportunity of a take-out at the right time and you get a CEO who understands his growing market. That’s a strong combination.
Chinese Internet Stocks to Buy: JD.com (JD)
Alibaba isn’t really the Amazon.Com of China. JD.Com Inc(ADR) (NASDAQ:JD) is. While Alibaba was founded as a B2B marketplace, JD was founded specifically to serve consumers … Chinese citizens as they are, rather than the striving entrepreneurs Alibaba hopes they will become. Thus, JD.Com has built a brick-and-mortar footprint few online companies can match.
This helps in two ways. Chinese manufacturers are not as sophisticated in managing inventory as American companies, so JD has a network of 210 warehouses around the country, comprising over four million square meters of space. Chinese customers aren’t all hanging around like Amazon customers waiting for deliveries, either, so there are 5,370 delivery and pick-up centers around the country, where the company also takes payments.
In addition to its own sourced merchandise, JD.Com offers something like Amazon’s third-party marketplace, allowing companies to sell directly to consumers, using its infrastructure. While Alibaba serves small producers, JD serves retailers. The largest such retailer is Wal-Mart Stores Inc (NYSE:WMT), which now owns roughly 9% of JD.Com, a stake worth more than $3 billion. Those shares were bought at a recent peak in the stock price, nearly $30, meaning Walmart is presently underwater on the investment. But they’re not just there for the profit. They need the market knowledge as well.
The financials of JD.Com look similar to Amazon from a few years ago, before its cloud data centers, Prime memberships and media investments started delivering big profits. There is a lot of growth — 50% between 2014 and 2015, and JD.Com nearly reached its 2015 sales total in the first three quarters of 2016 — but there is not much in the way of profit.
Truthfully, there is no profit. At least, there wasn’t during 2016. But as with Amazon, when you’re growing rapidly you need to invest ahead of top-line growth. JD took on its first long-term debt in 2015, and now has almost 15% of its assets under debt as it chases top-line growth.
Don’t let the big numbers you see reported on this company fool you. The yuan-dollar rate is now nearly 7:1, so JD.Com is still doing less than $10 billion/quarter in business. Amazon does more business in a month than JD.Com does in a quarter. JD’s total assets are worth a little over $20 billion, and its operating cash flow, 11.135 billion yuan for the most recently-reported quarter. The market cap of $38 billion comes to about 1.5 times the 2015 dollar sales of about $25 billion, high for a retailer, but low for a tech stock.
Analysts disagree on the near-term prospects of JD.com. JP Morgan analysts recently upgraded the stock to “overweight” from “neutral” and Vetr recently called it a “strong buy.” On the other hand Bernstein recently downgraded it, believing it will fall further.
It’s hard for me to see Walmart backing a loser, however, and JD’s physical infrastructure gives it real advantages against other online rivals. That’s why it is on my buy list.
Chinese Internet Stocks to Buy: Baidu (BIDU)
By the time Alibaba went public on the New York Stock Exchange in 2014, Baidu Inc (ADR) (NASDAQ:BIDU) had been on the Nasdaq for nearly a decade, having debuted there in 2005. Sometimes called “China’s Google” because its primary business is that of a search engine, it has also proven a superior investment to its U.S. counterpart, the stock up 1,355% since its debut against Alphabet’s gain of 478%.
Baidu remains a minnow next to its American counterpart, with quarterly revenues of under $2.5 billion, and half as fat a profit margin.
While Google has moved to build a network of cloud data centers, Baidu has mainly stuck to its knitting in search, only adding transaction services and a service equivalent to YouTube slowly. Baidu’s video service is called iQiyi. While Google has worked heavily on the back-end of search, finding the right data in response to a typed query, Baidu, under chief scientist Andrew Ng, who teaches at Stanford, is working on the front-end, predicting that voice and pictures will create half of all search queries by 2020.
Baidu and Google, in fact, seem engaged in an artificial intelligence arms race, televising their successes across China and showing off their voice assistants at this month’s Consumer Electronics Show. Baidu also showed off an answer to the Amazon Echo, a robot with a screen called “Little Fish” in Chinese.
Professor Ng, who also co-founded the Coursera online college system and helped create the Google Brain, an early AI effort, believes AI will displace millions of jobs over the next few years and calls AI “the new electricity.” Analysts are as divided on Baidu as they are on JD, mainly due to its lower profit margins when compared with Alphabet. Stifel recently put a “buy” rating on the stock while Bernstein recently put a “sell” rating on it. Bernstein sees Baidu losing some of its 80% domestic market search share, it worries about its video share and it especially hates its transaction strategy, believing the company could more than double its operating profits by dropping it.
Bernstein may be right or wrong, in the near term. But I take a three- to five-year time horizon. I see Baidu as easily surviving in that time frame, and see its AI strategy as a winner.
Dana Blankenhorn is a financial and technology journalist. He is the author of the sci-fi novella Into the Cloud, available at the Amazon Kindle store. Write him at firstname.lastname@example.org or follow him on Twitter at @danablankenhorn. As of this writing he owned shares in AMZN, GOOGL, AAPL, FB and BABA.