Source: CITIC Securities Research
Author: Liao Yuan, Xu Yingbo, Chen Junyun
Since 2023, China's Internet sector market has been mainly affected by domestic consumption recovery expectations and overseas liquidity tightening expectations. Currently, the factors affecting the interpretation of the sector's market have all shown marginal improvements. Since March, government working meetings have supported statements on the development of the platform economy, the gradual implementation of macroeconomic data on domestic consumption, and a slowdown in the tightening of overseas liquidity. We believe that the sector's performance and valuation showed a certain degree of cost performance advantage.
There is still a high degree of certainty that domestic Internet companies will improve their performance in 2023; according to Bloomberg's unanimous expectations, the total revenue of major Internet companies will grow by about 14% year on year in 2023; net profit (non-GAAP) will increase by about 22% year on year. The valuation is still relatively low. The 12-month Hang Seng Technology Index's 12-month Forward PE is 24x in the historical quartile of 30% since listing, which is about 1 standard deviation below the historical average. The leading Internet company's PEG was around 0.7-1.0x, and the average value of the US MAAMG PEG was 3.7x and the median 1.5x during the same period.
In the long run, in the global technology competition environment, leading Internet companies will still be important participants in domestic technological innovation, and their layout in the fields of AI, cloud computing, and intelligent driving is also expected to bring potential valuation increases to the company. We recommend focusing on leading internet companies with undervalued values, stable competitive advantage, clear performance improvement trends, and steady cash flow.
The valuation of the Internet industry is expected to improve due to marginal improvements in the external environment, such as policy support, recovery in consumption, and mobility.
Since 2023, the Chinese Internet market has mainly fluctuated around the pace of domestic economic recovery and the tightening of overseas liquidity. Currently, the main influencing factors are showing marginal improvement.
On the domestic macro side, the government work report sets the GDP growth target at around 5% this year. Among them, expanding domestic demand is the primary arrangement for doing a good job in the economy, while industries related to strong economic cycles, such as e-commerce, advertising, and online recruitment, are expected to benefit from the overall macroeconomic recovery. From January to February 2023, China's total net sales volume increased 3.5% year on year, and total online retail sales of physical goods increased 5.3% year on year. It is also gradually fulfilling expectations of a recovery in consumption.
In terms of overseas liquidity, the US CPI rose 6.0% year on year in February, falling for the eighth month in a row, a new low since September 2021; the US core CPI, which was not seasonally adjusted in February, rose 5.5% year on year, falling for the sixth month in a row, to a new low since December 2021. The downward trend in US inflation, compounded by liquidity pressure on the US banking industry, especially small and medium-sized banks, is expected to adjust the pace and peak of the Federal Reserve's interest rate hikes. According to CME, the probability that the Federal Reserve will raise interest rates by 25 bps to 4.75%-5.00% in March is 62%, and subsequent rate hikes will be suspended.
At the regulatory level, the 2023 government work report proposed “vigorously developing the digital economy, raising the level of normalized supervision, and supporting the development of the platform economy”, and proposed relevant stimulus policies in areas such as recovering consumption, cloud computing, and stabilizing employment. The policy side is shifting from standardizing development to supporting development, which is expected to bring about improvements in the business environment and valuation preferences of Internet companies.
Currently, Internet companies have a cost performance advantage, and performance recovery has brought upward catalysts to meet expectations.
As of March 17, the Hang Seng Technology Index's Forward PE for the next 12 months is 24x, at the historical fraction of 30% since listing, which is about 1 standard deviation below the historical average. In terms of valuation, leading US Internet companies have an average value of 3.7 x a median of 1.5x of US MAAMG PEG in 2023, while the PEG of major Chinese internet companies is about 1x or even slightly lower. Among them, e-commerce companies are significantly underestimated (Ali/JDong/Pinduoduo PEG is about 0.8x/0.9x/0.7x, respectively). At the same time, we noticed that companies such as JD/ Baidu/ Ali account for 53%/53%/36% of their cash/market capitalization, respectively, and their current market capitalization has a certain margin of safety.
We believe that with macroeconomic improvements and a recovery in consumption, there is still a high degree of certainty about improving the performance of Internet companies, which is expected to drive upward stock prices. According to Bloomberg's unanimous expectations, the total revenue of major Internet companies will grow by about 14% year on year in 2023; net profit (non-GAAP) will increase by about 22% year on year, and net interest rate (non-GAAP) will increase by about 12% (yoy+1pct).
Internet companies are still leaders in scientific and technological innovation in China, and new technologies and new markets are expected to contribute to increasing valuations. We believe that, based on the deep accumulation of Internet companies in infrastructure, R&D investment, business models, etc., leading Internet companies such as Baidu, Ali, and Tencent will still be important participants in domestic scientific and technological innovation, and the layout of new businesses such as AI, cloud computing, and cross-border e-commerce is also expected to bring potential valuation increases to the company.
AI: Global AI industrialization is progressing at an accelerated pace, focusing on the technological competitiveness of Internet giants. The rapid rise of ChatGPT sparked a new wave of AI industry boom. The launch of OpenAI GPT-4 and Microsoft 365 Copilot in March, and Baidu's official release of Wenxin, the language model, once again pushed AI's interactivity, efficiency empowerment, application scenarios, and industrialization implementation process to a new level. We believe that as important participants in the Sino-US technology race, the active entry of Internet companies is expected to drive the overall development of the domestic AI industry. Based on the deep advantages accumulated in infrastructure, technical architecture, self-developed chips, model algorithms, etc., Internet companies themselves will also benefit from the efficiency improvements and business opportunities brought about by AI development.
Cloud computing: AI development is rapidly increasing the demand for computing power, and cloud vendors will benefit from higher certainty. Massive parameters, databases, and rapid growth in the number of user calls in the AI model training process have all brought about a surge in computing power demand. Taking the GPT model as an example, the number of parameters in the GPT-1/2/3 model reached 150 million/1.5 billion/ 175 billion, respectively, and the complexity of the model has increased exponentially; on the user side, ChatGPT's daily activity has exceeded 10 million, and its website has also been down several times due to a surge in traffic. Considering resource advantages and economy, cloud vendors are expected to become the main carriers of AI computing power requirements. For example, Microsoft is OpenAI's exclusive cloud service provider, and Anthropic uses Google Cloud as the preferred cloud provider. Domestic Internet cloud vendors have accumulated deep advantages in databases, elastic computing, etc., and are also expected to benefit from the incremental computing power demand for training and application processes brought about by the booming development of the domestic AI industry.
Cross-border e-commerce: Supply chain advantages combined with policy support. E-commerce going overseas will be an important second growth curve for domestic e-commerce platforms. As the endogenous growth of the domestic e-commerce industry slows down, combined with policy support to “encourage platform companies to make a big difference in international competition” proposed by the Central Economic Conference, going overseas has become an important second growth curve for domestic e-commerce platforms. In the context of the continuation of the trend of online global consumption and overseas inflation, cost-effective products and high-quality supply chains are still the core advantages of China's cross-border e-commerce exports. With strong support from superimposed policies and a complete supporting service system, China's cross-border e-commerce market share is expected to continue to grow, and the share of the global e-commerce market (excluding China) is expected to increase to 13.1% from 8.6% in 2021. Based on the successful practice of mature e-commerce models in China, we are optimistic about the ability output of leading domestic platforms based on their own advantages.
Risk Factors:
Exceeding expectations of policy regulations led to a further decline in sector valuations; macroeconomic growth slowed, leading to growth in e-commerce, gaming, advertising and other industries falling short of expectations; rising interest rates or tightening liquidity led to a downward shift in the market valuation center; performance recovery fell short of expectations due to Internet companies' cost reduction and efficiency falling short of expectations; new business and new market expansion fell short of expectations, or investment losses exceeded expectations; the impact of new personal privacy and data security regulations on advertising revenue fell short of expectations; the risk of US stock delisting due to US stock PCAOB regulations exceeding expectations; risk of US stock delisting due to US stock PCAOB regulations exceeding expectations; risk of US stock delisting due to US stock PCAOB regulations exceeding expectations; risk of reducing holdings by core shareholders, etc.
Investment Strategy:
We believe that the current external environment facing the Internet industry has clearly improved marginally. Under the trend of rising valuation preferences and improved liquidity expectations, the implementation of performance fixes and valuation increases brought about by new businesses are expected to provide further upward catalysts. We recommend focusing on leading internet companies with undervalued values, stable competitive advantage, clear performance improvement trends, and steady cash flow.
Editor/jayden