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What’s Next For Baidu, Alibaba and Tencent?
Our call on China’s three internet giants has been right. Here’s our guide to which stock to buy now.
By ISABELLA ZHONG
November 11, 2016
Jack Ma - founder and executive chairman of Alibaba
Barron’s Asia predicted in January that a three horse race between China’s largest internet companies this year would see Tencent take gold, Alibaba silver and Baidu bronze – and so far we are on the money.
Online gaming and social media giant Tencent (700.HK) has added 33% to its share price since the beginning of the year. Tencent’s competitive edge in online-to-offline (O2O) commerce – one of the key battlegrounds for new growth among China’s three internet giants – and its cash cow online gaming business made it a stand-out favorite for us. CEO Pony Ma also jockeyed the Shenzhen-based company to two major milestones this year: a 10 billion dollars acquisition of Supercell and the title of Asia’s largest company. Following behind is Alibaba (BABA), which has notched up a 16% gain in its share price. The e-commerce giant has reaccelerated earnings growth this year by improving conversion of eyeballs into cash. However, it’s been a tough year for Baidu (BIDU). China’s number one search engine is down 14% this year after authorities clamped down on its search advertising business. The company also trailed its two larger rivals in capturing new sources of growth.
So what now for China’s internet behemoths? Here’s our guide to what investors need to be watching over coming months.
Tencent
Tencent is one of the most–loved stocks in Asia - but it’s also priced for perfection. At HKD202 a share, Tencent trades at a pricey 31 times forward earnings. Such a ritzy multiple leaves no room for disappointment on growth expectations. The next major hurdle for Tencent is September quarter earnings due on November 16. Analysts surveyed by FactSet have penciled in year-on-year growth of 40% for revenues and 41% for earnings per share. The numbers are similar to what Tencent posted in the June quarter: 46% on the top line and 39% on the bottom line. HSBC ’s Chi Tsang is one analyst who is upbeat on Tencent delivering a strong performance in the September quarter. Tsang expects speedy growth in smartphone games and advertising, combined with steady margins, to underwrite a 48% increase in earnings. The analyst has a buy rating on Tencent with a HKD256 a share target price. In the unlikely event of an earnings miss, any dip in the shares could present a buying opportunity as Tencent’s rising dominance in many new growth areas such as online media and payments – backed by its massive WeChat user base – is poised to power strong earnings over coming years.
Alibaba
Alibaba has been working hard to boost revenues from its e-commerce platform this year. A higher monetization rate – or the amount of revenue generated for each yuan of goods sold on Alibaba’s platform through commissions and advertising – has helped the company to trump earnings expectations this year. The big question now is how much further Alibaba can bolster its monetization rate. Morgan Stanley analyst Julia Zhu expects the monetization rate to rise to 3.5% in 2020 from 2.8%, but argues it could be as high as 4.7% as online marketing spending by retailers grows and Alibaba snares a larger share of the pie. Zhu has an overweight rating on Alibaba with a 132 dollars a share target price. At 94 dollars a share, Alibaba trades at 24 times forward earnings, making it the cheapest of the three Chinese internet giants. Another area to keep an eye on is Alibaba’s nascent cloud computing arm – a new source of growth the company has invested heavily in over the past year. AliCloud recently announced price cuts of up to 50%, but Deutsche Bank analyst Alan Hellawell expects the boost to demand from the lower fees to neutralize the impact on revenues. AliCloud’s revenues surged 130% year-on-year in the September quarter to lift Alibaba’s top line above analyst expectations.
Baidu
Baidu is looking to reinvent itself after a rough year. The search engine is expected to generate only 4% revenue growth this year after authorities tightened rules for online advertising, which accounts for 90% of the top line. Baidu suffered its first ever quarterly revenue decline in the September quarter as the number of advertisers plunged. The company’s core search business is also being buffeted by the shift of Chinese internet users to mobile from PC, while it’s been dialing down investments in new growth areas that it has previously invested heavily in such as O2O. Baidu now is betting on A.I. – or artificial intelligence – to power future growth. It recently launched venture capital firm Baidu Venture to invest in A.I., as well as augmented reality and virtual reality. JPMorgan ’s Alex Yao argues that while A.I. could become a long-term growth driver in three to five years and is a better fit with Baidu’s core search business, it’s likely to have only a negligible effect on earnings in the next year or two. A possible disposal of O2O assets could bolster Baidu’s earnings in coming quarters, but visible sources of growth are lacking for the next few years, notes Yao. The analyst has an underweight rating on the stock with a 164 dollars a share target price. At 163 dollars a share, Baidu trades at 28 times forward earnings.
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