The article below is from our BRIEFINGS newsletter of 05 May 2022
China’s digital champions have been buffeted by uncertainty on three fronts: COVID-19 measures, regulatory tightening and the risk of delisting from US stock markets. We sat down with Ronald Keung, the head of Goldman Sachs Research’s Asia internet team to discuss the recovery of China’s internet sector following a period of weaker earnings. Looking beyond the near-term COVID impact, Keung says that the outlook remains promising for investors.
Strict containment measures have been imposed in China’s tech hubs, including Shanghai. How have these restrictions impacted the internet sector? Do you expect an increase in online spending?
When containment measures were first rolled out in Wuhan in 2020, we saw a significant shift online across multiple verticals in China. The temporary closure of physical stores was positive for many players and China’s online population surged. This time around, while we think that restrictions are likely to increase time spent on games and online videos, consumption started on a weaker note this year, and people are spending more on staples rather than on clothes and other discretionary items. Local governments in China are issuing coupons to boost consumer confidence and ramp up spending in the second quarter. The upcoming “6.18” shopping festival in China, that spans from June 1st-18th, will be a key event to gauge the impact of consumption stimulus across big-ticket items.
Another factor is that the containment measures have caused disruption to supply chains, but e-commerce companies are working closely with the government to restart their operations. To put this into perspective, in the first week of April, when containment measures were introduced in Shanghai, one of the biggest e-commerce companies operated at 20% of their average daily handling capacity. In the fourth week of April, their handling capacity bounced back to around 80%.
Looking beyond the near-term COVID impact, what are the future growth drivers in this sector?
The medium-to-long-term outlook remains promising for investors, and we’ve forecast China's e-commerce market to reach US$2.7 trillion by 2025 from US$1.7 trillion in 2021. Firstly, we expect solid growth from China's internet verticals with lower online penetration. Some of the major platforms have already tapped most of China’s internet users. For instance, online penetration for China’s advertising and games industries is already at nearly 80%. That’s why we think the key growth opportunities ahead are in the underpenetrated categories, like fresh food, pharmaceutical services and to-Business opportunities, including enterprise I.T. spending on cloud and logistics supply chain services. Secondly, we see internationalization as a key growth driver. Various platforms are tapping into the opportunities outside of China, with expansion into South East Asia and Latin America.
China's internet share prices have underperformed their U.S. peers over the past year. Do you expect this to change?
Weaker earnings momentum and concerns over macro weakness and regulations were the main reasons that China’s internet sector underperformed their U.S. peers over the past year. But we expect to see a recovery of earnings towards the second half of this year. There are long-term winners in this space that have built high enough moats around their businesses and have multiple growth drivers beyond their core business. Those with strong balance sheets and cash positions could drive further buybacks or even start to pay dividends.
Last year the Chinese government tightened regulations on tech companies. How is the internet sector faring?
2021 was a year of new regulations focused on driving long-term health and fairer competition in China's internet industry. This year, many of those regulations will go into effect. We’ll gain more clarity as this progresses, but recent signals have been positive. Last month, the Politburo, China’s top decision-making body, stated its plans to complete targeted inspections of the country’s internet platforms and launch measures that aim to support regulated healthy development of the sector.
There are a few key regulatory developments that we’re watching this year. Firstly, we’re expecting continued oversight and guidance from Chinese authorities on platform business take rates. There are plans to set a cap on the percentage that ride-hailing platforms can take from drivers’ fees, as well as guidance to lower online food delivery platforms' delivery service fees during COVID periods.
Secondly, in July last year, the Cyberspace Administration of China launched a probe into a few U.S. listed firms as part of its focus on data security and we’re awaiting the conclusion. Finally, we’ll be looking for any progress on US-China audit inspection. Currently, Chinese companies traded in the U.S. aren’t audited by the Public Company Accounting Oversight Board (PCAOB), a U.S. audit regulator. Chinese regulatory authorities are hopeful that an agreement can be reached with the PCAOB and we’ll be watching out for progress.