Two Chinese Stocks Retain Instituitional Interest Despite Overall Selloffs
Full context for commentary made during Friday's Hankyung TV broadcast
This past Friday, my colleague Bora Kim appeared on Hankyung TV, a 24-hour business news channel in the Republic of Korea, to discuss my recently analysis of two Chinese companies — Alibaba Group Holding Ltd and Baidu, Inc — that encapsulate why non-Chinese “instituitionals” continue to hold some conviction in these stocks despite an overall risk-off from the Chinese market . See the Korean-language segment here on YouTube. For the English-language version of the analysis, read on!
In 2019, Jack Ma, the "chief founder" of Alibaba Group Holding Limited (U.S. ticker: BABA), stepped down as chairman and gave way to co-founder Daniel Zhang Yong who rapidly went on to enter the roster of Time Magazine's 100 most influential people in 2020. Alibaba’s sprawling business empire was long considered to be driven by those in the chairman’s seat. This, however, changed in April 2023 when the company announced that it would split into 6 units — each of which will be managed by its own CEO and board of directors. These units will be free to pursue independent fundraising and a public listing.
Taiwanese-Canadian lawyer and long-time Hong Kong resident Joseph Chung-Hsin Tsai — who left a $700,000-a-year job with Sweden's Wallenberg family wherein he handled their Asian private equity investments to join Alibaba in 1999 after meeting Mr. Ma — took over as Chairman six months later. At the same time, Eddie Yongming Wu — another 1999 alumnus who started out as technology director for the group — became the group's CEO. Reporting segments changed to reflect the “6-unit” change as well, starting from the full-year results for the company’s Fiscal Year (FY) 2024, which ended on the last day of March this calendar year.
The recent earnings release thus effectively constitutes the first quarter (Q1) for their Fiscal Year (FY) 2025. Trends derived would be early but somewhat interesting: while total revenue is currently trending to run slightly above par for FY 2025, Earnings Per Share (EPS) is trending to close out FY 2025 at a solid 24% higher than the previous year. However, it bears noting that despite two full FYs of solid Year-on-Year (YoY) growth, the deep losses sustained in FY 2022 haven't been fully recovered yet.
On the other hand, segment-wise metrics provide additional depth:
In terms of revenue, “Taobao and Tmall” (China-focused commerce business), Cainiao (global logistics), and Cloud Intelligence remain fairly consistent in Q1 2025 relative to FY 2024. However, international e-commerce is beginning to contribute increasingly while trending to close FY 2025 12% higher than the previous FY. In a similar vein is “Local Services”.
Trends in earnings before interest, taxes, and amortization (EBITA), however, is a much more interesting story. While “Taobao and Tmall” show stable trends with a modest trend in revenues and EBITA at par, three businesses — cloud, international commerce, and logistics — show an explosive improvement in EBITA over the past FY.
Local services and content businesses, at first glance, might seem to be underperformers. But, since local services are currently showing a substantial improvement in terms of losses in the most recent quarter, it's quite likely that it will break into positive earnings in Q2 2025, i.e., the next earnings release.
The content business has long been an overall underperformer in terms of earnings contribution. While the most recent quarter shows substantially lower losses relative to the past FY, it could be expected that a breakout into positive earnings might be possible, albeit a few quarters down the road.
If “Taobao and Tmall” is the anchor of the group, then the progressive improvement in metrics will be the signal for the other five units’ respective IPOs. Going by the metrics, the most promising candidates for a spin-off and IPO would be Cloud Intelligence and Cainiao Smart Logistics. Given that it’s deeply enmeshed in “Big Tech” with its own AI platform, a “Cloud Intelligence” IPO would be keenly anticipated and likely well received by the investing public, both retail and institutional.
“Cainiao” is a much more prosaic story. The group has expended considerable resources to build out the infrastructure over the past couple of years in a bid to attain its goal. Infrastructure is a costly business: the fact that relative EBITA contribution turned positive in the previous FY and remains so in the current year might be grounds for the business to secure additional financing via an IPO.
While the “International Commerce” business has shown a strong uptick in revenues, the fact that it has to burn capital to contend with the Amazons and Shopifys of the world indicate that it has some ways to go. Nonetheless, in the order of precedence, an IPO will likely be a keenly-anticipated development in the course of a year.
“Local Services” is an interesting business. FY 2025 might be a transformative year in that it might eventually prevail against its myriad competitors in China by producing a positive EBITA by the end. The fact that it offers a “Google Maps” equivalent as a service will likely make it one to watch in the future.
Content is a tough business to sell to investors. There’s a glut in the market and there is likely an upper limit on market penetration that is highly dependent on subscription price. Of all of the group’s businesses, this one will have the longest and hardest road to an IPO.
For a stock of this vintage, hype narratives tend to be dated for Chinese investors. However, traded volumes and price trajectories indicate that Chinese investors seem to be in unison with their American counterparts in terms of anticipation of strong possibilities ahead. In the event of an IPO and spin-off wherein a business ostensibly pays the group for its freedom, the cashflows would likely be used by the group to further strengthen "Taobao and Tmall" in its long and cut-throat running battle with the likes of JD.com, Inc. (U.S. ticker: JD), PDD Holdings Inc. (U.S. ticker: PDD) and Meituan (among others) for dominance in China.
While global investors have been divesting from the breadth of investments made in Chinese companies given economic headwinds, the group's vintage does give it a certain amount of brand equity among sellers, buyers, clients, and investors. While the breadth of China investments might be narrowing for global investors, this group likely stands out as an exception. Any prospective IPO timeline would only be a boost for the stock’s valuation. But, until then, it's going to be a bumpy ride with lots of tactical opportunities both on the upside and the downside.
Next up is China’s search giant Baidu, Inc (U.S. ticker: BIDU). Over the course of Q2 of the calendar year, a number of institutional investors — with Scion Asset Management run by Michael Burry of "The Big Short" fame finding particular mention in the media — loaded up on Baidu as it floundered. The stock has notably not been doing well over the course of the Year Till Date (YTD), and its Q2 earnings were decidedly mixed: while revenue did drop on a quarter-on-quarter basis by 0.4%, it delivered ¥33.93 billion ($4.67 billion) rather than analysts' average estimate of ¥33.55 billion. However, in terms of net income, trends indicate that the company's bottom-line net income will close out the year with a net 4% and 6% increase in net income and earnings per American Depository Share (“ADS”, which equals eight shares), respectively.
The company's expenditures in infrastructure are cyclical and interesting. For instance, while net revenues were up by a whopping 19% in 2021 relative to the previous, both net income and earnings per ADS were down by over 50% as the company spent and expanded infrastructure and capabilities. When said capabilities mature, the effect on the bottom line is electric: a mere 6% increase in revenue in FY 2023 translated to a massive triple-digit percentage increase in net income and earnings per ADS.
To many investors in the West, Baidu is perhaps best known/described as China's "Google" in that its mainstay is ostensibly its search engine. Unlike in the Western Hemisphere, where Google reigns supreme with a 90%-plus market share, China's search space seems a little more fragmented:
Among China's homegrown search engine options outside of Baidu, Tencent’s Haosou — which is optimized to crawl through Chinese social media, particularly the near-ubiquitous WeChat (also by Tencent) — has been the only domestic competitor that is estimated to have occasionally shown signs of sustained periodic uptrends. The mobile-only search engine Sogou — developed by Alibaba — is steadily flattening away from consequence.
While Baidu is estimated to have come close to breaking through to the 90%-plus market share towards the end of 2021, this is estimated to have declined in favor of a Western competitor: Microsoft’s Bing.
Within the Great Firewall of China, citizens' curiosity is a matter of intense scrutiny that search engines must necessarily tread lightly through. In other words, a proactive and "censorious" paradigm works out best in terms of managing regulatory risk. Microsoft has long worked on building out where the likes of Google have largely abandoned efforts to make inroads by building out a censorship framework that U.S. lawmakers have contended is more rigorous than domestic engines. Microsoft, however, maintains that the Chinese version of Bing is "the least censored search engine" in the country.
However, there are numerous workarounds when curiosity isn't in certain matters and is instead (for example) of a more commercial nature. Herein, the company has traditionally shone. In its “Core” segment, the company's online marketing division is the workhorse of the company. This is primarily via the Baidu App while cloud services — much like Google Cloud or Amazon's AWS — have been a division that has been nurtured cyclically and led to progressively stronger payoffs. Within this division also lies its driverless taxi venture "Apollo Go," which (as of Q2 2024) offers 100% fully driverless ride-hailing services in practically the entirety of Wuhan, a Chinese city of some renown even among those not entirely proficient in China's geography. A relatively recent entrant to the company's ranks has been ERNIE, a chatbot in the vein of ChatGPT, which is being made available to a wide swathe of corporate clients at increasingly higher cost-effective pricing bands. Like many tech giants, the company also operates the “iQIYI” segment, which handles a long-from video platform in the vein of Amazon Prime, Apple TV, and so many others.
Segment-wise, Baidu’s “Core” and “iQIYI” are trending below par in terms of revenue as of H1 2024, “Core” shows a positive uptrend in net income as the company optimizes utilization of infrastructure and capabilities. Content production and distribution is often a gruesome business with high capital usage and uncertain payoffs. From FY 2020 till 2022, iQIYI was no different and delivered net losses on the company's bottom line. This changed in FY 2023 when net income went positive with $275 million. In fact, throughout FY 2020 till then, net losses steadily declined. As of now, iQIYI's net income trend — predominantly driven by subscriptions — remains positive but is trending towards a little under 75% of that recorded in the previous FY.
While it is indeed true that online marketing driven by the search engine is flagging due to economic headwinds cooling the average Chinese consumer's appetite for consumption, sophisticated investors are likely sensing one critical feature: the company's consumer mix is increasingly “corporate”.
The launch of ERNIE 4.0 Turbo in June 2024 is designed to run faster, at a lower cost and offering superior capabilities for typical use cases as compared to ERNIE 4.0 as well as a “native” AI Cloud developer community numbering at 14.7 million has fostered a stack of applications across the spectrum of corporate interfaces within Baidu's ecosystem. In Q2 2024, 51% of online marketing revenue was derived from “Managed Page”, wherein clients can build an account and use Baidu ecosystem apps and tools to engage with users without maintaining their own website and paying for software, server, and bandwidth costs.
Simultaneously, the company also reports that it’s working on renovating its search algorithms, which it concedes will be a substantial cost in the short term but believes will lead to greater long-term success. Given the complexity of the task the likes of Baidu are into, this belief is an interesting proposition for some investors. While the short-term top-line trends (i.e., in revenue) won't endear the stock to many retail investors, its ongoing consumer mix transformation has been piquing the interest of long-term institutional investors, creating conditions ideal for “buying the dip” as part of a mid- to long-term strategy.
Notes:
The analysis of Alibaba’s earnings was also published in the English language via articles on SeekingAlpha, the Tiger Brokers Community platform as well as on the Leverage Shares website. On the Community platform, it was one of the most-read articles for that week. HankyungTV also published the article in the Korean language here.
The analysis of Baidu’s earnings was also published in the English language via articles on SeekingAlpha, the Tiger Brokers Community platform as well as on the Leverage Shares website.
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