China's Internet Stocks May Be Oversold
July 11, 2015 2:22 a.m. ET
Chinese Internet companies, led by search provider Baidu and wide-ranging conglomerate Tencent Holdings, held their value for nearly a month after the broader Chinese market started crumbling in late May, and with good reason. These two fast-growing giants, along with Chinese e-commerce king Alibaba Group Holding and its upstart rival JD.com, are listed on U.S. and Hong Kong exchanges. They are bought by global tech investors a world away from the mom-and-pop Chinese punters who have been borrowing money to gamble on little-known companies traded in Shanghai or Shenzhen.
None of that mattered over the past two weeks as China’s nosedive accelerated. Baidu (ticker: BIDU) and Tencent (0700.Hong Kong) have both shed 10% of their value since June 22 and June 24, respectively. But analysts expect them to regain it, and then some, once market nerves begin to calm.
“This is panic selling,” says Cynthia Meng, Hong Kong–based tech analyst for U.S. investment bank Jefferies. “Our projections and price targets for these companies remain the same.”
Most of Meng’s competitors agree. Analysts’ mean price target for Nasdaq-listed Baidu is $250, compared with a price of $189 on July 9. Tencent offers still more theoretical upside, with a consensus target of 206 Hong Kong dollars (US$26.57) against a current HK$146 for its Hong Kong–listed stock.
Alibaba (BABA), China’s most famous tech star, has a more complicated story. Like Facebook, Alibaba shares suffered from overhype following its September 2014 IPO, and have been sinking more or less steadily since last November. After pricing at $68 a share—and jumping to $92.70 on the opening—the stock was trading at $79.54 late last week. Company performance has beaten expectations, though, with sales leaping 45% year-over-year for its most recent quarterly report, in May. Gil Luria, Internet analyst for Los Angeles–based Wedbush Securities, says that makes Alibaba a Buy, now that the broader Chinese implosion has knocked it well below its first-day closing price.
China’s Big Three Internet plays qualify for an elite global club whose only other member is Facebook (FB) itself, Luria argues. “There are four companies in the world that bring together market cap, growth and margins at this level, and three of them are Chinese,” he says. All the Chinese entrants are now cheaper than Facebook on a price-to-sales basis, a key metric for young growth companies. Baidu is the value pick, at eight times revenue compared with Facebook’s 17. Baidu’s and Tencent’s price/earnings ratios are also significantly lower, though Alibaba remains pricey by that measure—with a P/E of 65 based on expected 2015 earnings, against Facebook’s 59
THE ARGUMENT FOR SELLING China tech is that the domestic market turmoil will affect consumer confidence, curbing the country’s already slowing growth rate and the e-commerce explosion with it. Analysts aren’t buying it, though. “The Shanghai market is still up from about 2,000 a year ago to 3,700 now, so most investors have made money,” Meng points out.
Jefferies’ picks for the sector are Tencent, which is dominating China’s emerging mobile Internet with seven of the country’s top 20 apps, and JD.com (JD), a smaller e-commerce play that is inexorably eating into Alibaba’s near-monopoly among retail customers. Success of the two is intertwined, as Tencent took a 15% stake in JD ahead of the company’s $1.8 billion Nasdaq initial public offering last May. And Tencent steers shoppers to JD through the ubiquitous WeChat app.
Alibaba isn’t sitting idle under this attack. Jack Ma’s empire is pouring resources into its Ant Financial unit in a bid to own the mobile payment space and compete with China’s troubled brick-and-mortar banks. Fierce battles are certain for every piece, but the prodigious growth outlook for China’s Internet pie remains intact for now. The companies will be worth a good look once the smoke clears, a process that may already be starting.
Back on the mainland, the Shanghai Stock Exchange Composite Index closed Friday at 3,878, up more than 5% for the week.