April 11, 2014
China‘s Internet companies have witnessed a 20% average correction since early March.
“Investor sentiment and asset allocation/sector rotation likely the main triggers,” commentedJ.P. Morgan analysts Alex Yao and Yong Wang in a research note published today. But the fundamentals have not changed, which creates buying opportunities, they added.
Among these stocks, J.P. Morgan’s top picks are Tencent (0700.HK), Baidu (BIDU), Qihoo360 (QIHU), YY (YY), Soufun (SFUN) and Sina (SINA).
J.P. Morgan likes Tencent because of WeChat and its mobile game revenue potential. Here are the analysts:
We believe Tencent has largely accomplished the transition of user activity shift from PC to mobile, thanks to the ramping up of Weixin and Mobile QQ.
Mobile games delivered Rmb600MM in revenue in the first full quarter of operation in 4Q13, and we believe there is potential upside to mobile game revenue in 1Q14 and FY14.
After the pull-back, Tencent shares are trading at 22x FY15E earnings, with an FY15E-FY17E earnings CAGR of 23%, as per our estimates.
Baidu is investing heavily this year, possibly causing the negative sentiments:
Baidu is heading in the right direction to build a solid and scalable eco-system on mobile internet and such an eco-system should lead to more sustainable earnings growth in the longer term.
We expect margins to start to recover in 2015 on potential scaleback of spending and top-line leverage.
Baidu shares are trading at 18x FY15E earnings, with an FY15-FY17E earnings CAGR of 30%, as per our estimates.
Qihoo’s search revenue market share is a lot smaller than its search traffic share, giving it more opportunities to make money:
We believe Qihoo has been gradually unleashing the monetization potential of the large traffic platforms it formed across PC and mobile.
On the mobile side, we view Qihoo as one of the key beneficiaries of the fast growing mobile gaming market, given its well-established mobile platform and strong distribution power. We believe Qihoo’s search traffic as significantly under-monetized and expect monetization to pick up into 2H14, driven by improving infrastructure and expanding advertiser base.
Qihoo has been more disciplined in investment than its peers, which should help sustain its margins in 2014. Qihoo shares are trading at 24x FY15E earnings, with an FY15-FY17E earnings CAGR of 42%, as per our estimates.
YY’s new initiatives are interesting:
YY’s earnings growth in 2014 will continue to be driven by its legacy businesses, web game, and YY music (27% and 55% of total revenue in 4Q13, respectively). However, we expect it will gradually shift to relatively new initiatives in the next two to three years, such as game broadcasting, MMO/mobile game publishing, and online education.
Moreover, we do not expect the investment in new initiatives to put significant pressure on margins in 2014 as the increase investment will be in a controlled manner, according to management. YY shares are trading at 20x FY15E earnings, with an FY15E-FY17E earnings CAGR of 33%, as per our estimates.
Soufun’s shares are linked to China’s property market, but it is more acyclical:
The sell-off of Soufun also partly factored in investors’ concerns about recent weak transaction volumes of China property market, on top of the overall weakness of the China internet space, in our view. However, Soufun’s operating history has proved its business to be counter-cyclical and resilient in times of an uncertain market environment.
In an earlier blog today, Credit Suisse observes the three stocks above, Qihoo, YY and Soufun, were the only ones among the large Chinese Internet companies that have not suffered consensus earnings downgrades this year.
And Sina is just too cheap:
On top of the sector-wide pull-back, the weakness of Sina’s share price also reflected investors’ concerns about the value proposition to consumers as well as the IPO valuation of Weibo, in our view. The concerns about Weibo losing relevance for Chinese consumers due to the rising of Weixin have been a key overhang on the share price performance of Sina.
We see Sina’s share price as significantly under valued at the current level. The latest filing of Weibo indicates a valuation of US$3.5B to US$3.9B, with Sina’s holding in Weibo decreasing to 56.9% post Weibo IPO. The mid-point of Weibo’s valuation range, or US$3.7B, is 28% lower than our valuation of US$5.1B (based on 43x FY15E earnings with an FY15E-17E earnings CAGR of 61%). Even if we assume a US$3.7B valuation for Weibo and Sina’s stake at 56.9% post Weibo IPO, we derive a valuation for Sina of US$5.2B, or US$71 per share, representing 25% upside from the last closing price of US$56.85.