A different approach to play: China’s software & IT services sector is quite
discrete and has a unique logic of growth. Rather than a general
macroeconomic top-down view, we prefer a different approach which places
emphasis on industry dynamics across different sub-sectors. We analyse
government’s micro policy, IT demand from key industries, and influence of
cloud computing, which are the dominant factors behind the statistics and
news headlines.
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Micro policy, key industries & cloud services: The software industry in
China is divided into numerous sub-sectors, each subject to specific
customers. It is more important to focus on micro policy (which determines
the industry’s internal structure and the sub-sector growth strategy) than
macro policy, and on key industries’ demand than overall demand. Ideal
investment target would be an IT leader in a key industry with huge demand
potential and at the same time benefiting from certain micro policies. On the
other hand, we are negative on the development of cloud services in China
for the next few years, but positive in the long run. SaaS (software as a
service) will likely be a hot sub-sector after 5-10 years.
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Four to pick and one to avoid: According to the logic above, we initiate
coverage of Aisino (monopoly in local value-added tax software) and Glodon
(a leading application software vendor for the architecture industry) at
OUTPERFORM. Aisino and Glodon are our top picks in this sector. We
maintain our OUTPERFORM rating on YGSoft and Mesnac. Retain our
UNDERPERFORM rating on Ufida.
Watch micro policy, key industries’
software and cloud service
China software sector: a different approach to play
Software & IT service is an emerging industry in China, the revenue of which will grow by
20-30% CAGR in five years, in our view. However, the sector is quite discrete and has a
different logic from other TMT sectors. Instead of a macroeconomic top-down view, we
prefer an alternative approach, which places emphasis on industry dynamics across
different sub-sectors, in which we analyse micro government policy, IT demand from key
industries, as well as the influence of cloud computing. We believe that investors must go
deep into details and specifics in order to understand this industry.
Micro policy: what the government really supports
Government policy is certainly a crucial factor for every industry in China. When it comes
to software industry, we believe it is micro policy which holds the key. Unlike macro policy
which determines the growth potential for a whole sector, micro policy is more about the
industry’s internal structure and growth strategy of sub-sectors. We suggest investors to
watch the following micro policies: support for local base software, support for BPO
(business process outsourcing); preference for onshore ITO rather than offshore; and
higher standards for the IT efficiency level of central SOEs.
Key industries: prefer specialists to generalists
China’s software & IT services sector is quite discrete, and most vendors are only good at
providing solution to certain industries. Relationship, experience, technology and channel
are the entry barriers to a specific industry. Our investment approach is to find industries
with high IT demand growth and reasonable entry barriers, and then to find leading or
emerging IT vendors for that industry. We estimate that the following industries meet the
standard: banking, electricity, healthcare, architecture, and high-end manufacturing.
Cloud service: will it save the world sooner or later?
Most major software companies in China are talking about cloud computing, but few of
them have practical business plans. They are generally short of technology indispensible
for cloud computing systems. Meanwhile, lack of legal protection, concerns about security
and doubts on technology reliability keep many Chinese enterprises from using cloud
services. However, we expect things will change gradually in the next 5-10 years, and we
expect SaaS (software as a service) to become an important software sub-sector.
OVERWEIGHT the sector, five stocks in coverage
We are OVERWEIGHT in our coverage of the A-share software sector. We like companies
subject to the support of micro policy as well as the demand from key industries. Our
OUTPERFORM picks include: Aisino, the monopoly in value-added tax control system;
YGSoft, management software provider for the electricity industry; Glodon, a leading
application software provider for the architecture industry; and Mesnac, equipment and
software vendor for tyre and chemical industries. We maintain our UNDERPERFORM
rating on Ufida, since it is facing hardships in transformation. Aisino and Glodon are our
top picks in the sector currently.