/China Calling

China Calling

A guide to the breathtaking rise of mobile and internet companies in China and the investment opportunities they offer.

 

Accelerating growth, evolving technology and huge end user demand make telecoms and the internet key growth areas of the Chinese economy … and present interesting investment opportunities.

In fact, many aspects of the technological innovation in China is leading the world. Welcome to the cutting edge.

 

Impressive (mobile) numbers

China boasts the largest mobile market in the world. There are currently over one billion mobile phone subscribers and this is growing at a jaw-dropping rate. A world class,

A world class, high quality mobile network has provided the foundation for profit boosting data services that network providers have been able to cash-in on. And users are rapidly adopting the latest services based on 4G technology. This has also sparked the creation of a host of new apps and social media platforms have blossomed – as have some of the tech companies that have developed them China’s wireless market is dominated by just three home-grown operators, including China Mobile – the largest provider in the world by subscribers. With an astonishing US$70 billion of cash on its balance sheet – and cash flows strengthening – China Mobile has the resources to ensure high network quality, invest in latest technologies and the flexibility to engage in merger and acquisition activity – or return cash to shareholders via dividends. With figures like

And users are rapidly adopting the latest services based on 4G technology. This has also sparked the creation of a host of new apps and social media platforms have blossomed – as have some of the tech companies that have developed them China’s wireless market is dominated by just three home-grown operators, including China Mobile – the largest provider in the world by subscribers. With an astonishing US$70 billion of cash on its balance sheet – and cash flows strengthening – China Mobile has the resources to ensure high network quality, invest in latest technologies and the flexibility to engage in merger and acquisition activity – or return cash to shareholders via dividends. With figures like

This has also sparked the creation of a host of new apps and social media platforms have blossomed – as have some of the tech companies that have developed them.

China’s wireless market is dominated by just three home-grown operators, including China Mobile – the largest provider in the world by subscribers.

With an astonishing US$70 billion of cash on its balance sheet – and cash flows strengthening – China Mobile has the resources to ensure high network quality, invest in latest technologies and the flexibility to engage in merger and acquisition activity – or return cash to shareholders via dividends. With figures like

With figures like these, and a bright future ahead, we believe that these markets offer the potential for further growth.

 

Calling the numbers:

Five mind blowing facts about China’s digital ecosystem

  1. China boasts the largest mobile market in the world
  2. The top 3 mobile companies are adding 30 million users (net) every month
  3. China Mobile has a 72% market share of the 4G mobile market and has cash reserves of US$70 billion
  4. WeChat messaging service has 800 million monthly users – equivalent to 14 times the UK population
  5. 5G is on the horizon

 

4G – for growth

It could be said that the provision of cheap 4G-enabled smartphones sparked a mobile revolution in China.

Smartphones offered access to the internet which for many Chines users remains the only access point to the web.

And with more and more users able to surf the net and use web enabled apps, it led to surge in demand for mobile data.

This has all been good news for the mobile providers. At China Mobile, income from data use charges has overtaken voice and SMS (text message) as the largest contributor to revenue.

But unlike some other markets, the UK for example, China does not typically offer unlimited data plans.

This means that companies are able to properly monetise the huge growth in demand for data.

Even though data is getting slightly cheaper, strong price elasticity means that surging data volume growth (more than 120% per year) should more than compensate and drive revenue growth.

 

Positive signals

“Uh-oh, no reception”.

It’s likely that we have all been in this situation, wandering about, waving the mobile phone in the air looking for a signal from the network.

To provide a signal, mobile companies have to build towers which requires significant capital expenditure and investment, both to build and maintain.

In China, the government made the bold move of requiring the network operators to sell their towers into a newly-created national tower company, China Tower Company, which the operators jointly own. The operators now lease the tower from China Tower.

This arrangement eliminates the duplication of assets, lowers the capital outlays and related maintenance expenses.

It also increases operating efficiency because of the co-location of operators’ base stations on the towers.

The creation of China Tower helps the Government to achieve its objective of levelling the playing field between the behemoth that China Mobile has become, and the challengers China Unicom and China Mobile.

The latter two should be able to increase their network coverage and capacity more quickly (and cheaply) by installing their transmission equipment on China Tower’s towers.

 

 

Another avenue for investment inthe sector

China Tower is expected to go float (IPO) in late 2017.

At June 2016, China Tower owned 1.59 million towers, making it one of the largest tower companies in the world.

Currently, only a few of the towers host trasmission equipment from more than one provider (the sharing ratio stands at 1.34 tenants per tower). But efficiency will increase as both the number of towers and the tower sharing ratio are expected to rise.

The IPO of China Tower will be large and it will be closely watched by investors. The IPO should also have knock-on positive impact on the valuation of the operators given their equity stakes.

China Unicom has a large stake relative to its size, so could be in a position to benefit the most when the shares go public.

 

A $70 billion embarrassment of riches

Wireless markets are about scale

China Mobile’s market dominance and scale means that it has amassed around US$70billion of cash on it balance sheet, with a further US$8bn due before the end of 2017 from the sale of towers to China Tower.

And, since capital expenditure programmes (like building a 4G network) have peaked for now, this free cash flow may result in higher dividend to shareholders.

However, China Mobile may also have other uses for the cash, including merger and acquisition activity, looking to bolt-on bolting-on internet companies, data analytics expertsise or cybersecurity specialists.

Inevitably, some of this war chest will be retained to foster future growth, like investing in next generation technologies, with 5G expected at the turn of the decade.

 

Digital ecosystems: the next step for the internet

 

WeChat is ubiquitous across China.

It currently has around 800 million active users every month.

With WeChat, you can message, video call, hail a cab, buy film tickets, check-in for flights, pay bills, split bills, find a parking space, make a doctor’s appointment or a donation to charity, locate your friends … and the list goes on.

It’s like having Facebook, Uber, Amazon, Spotify and a dozen other apps all in one.

 

Apps drive the consumption of mobile data

In a virtuous circle, the rise of 4G has facilitated the growth of social media platforms and apps that subscribers use.

This drives the consumption of mobile data – and the profits of the service providers.

The availability of reliable and high speed mobile data networks has, in turn, driven the emergence and growth of social media platforms and some very exciting internet-based companies.

And it’s all about ‘mobile’.

Users are conducting the bulk of their personal internet activity on the go, not on PCs.

 

Social media platforms

Social media platforms like Tencent’s WeChat have attracted very loyal customer bases.

Services like Tencent’s WeChat messaging service, Weibo(described as a cross between Facebook and Twitter) and Alibaba’s Taoboa (a customer-to-customer e-commerce company) are now ubiquitous in China.

WeChat started life as a messaging app (like Whatsapp) but has evolved into a large – and growing ‘ecosystem’ that has become integral to everyday life for many Chinese.

You can message, video call, hail a cab, buy film tickets, check-in for flights, pay bills, split bills, find a parking space, make a doctor’s appointment or a donation to charity, locate your friends … and the list goes on.

It’s like having Facebook, Uber, Amazon, Spotify and a dozen other apps all in one.

It currently has around 800 million active monthly users.

To put this into perspective, that’s over 12 times the size of the UK population and two and a half times the entire population of the United States.

 

All about the money, money, money.
It’s not uncommon to hear about a huge online company or world famous internet brand that is making huge losses and is finding it hard to monetise the user base they have.

But companies like Tencent and others like it, are building ‘ecosystems’ around their original services that provide an exciting range of opportunities for customers which the companies are beginning to monetise.

And the monetisation opportunities abound. Digital advertising, mobile games, subscription streaming services (for music, video and TV), e-commerce and payment services – to name just a few.

These can be highly cash generative, profitable activities that boost balance sheets. They also create barriers to entry. Tencent has used its highly profitable mobile and PC gaming platform to fund the development of its social network platform.

 

Internet search and ‘verticals’

As an investment team, we believe that this growth has been at the expense of search portals and verticals – internet businesses that offer everything from real estate sales, to car sales and package holidays – although we are always mindful of changing valuations.

Why? The search engines are mature businesses that need to work harder to find growth in other areas – such as so called O2O (online to offline). These are services like food delivery, or localised services that are ordered over the internet but require physical fulfilment.

Many of the O2O services have proved low return, or unprofitable so far. The cost of acquiring new users is high – as are the cost of fulfilment and logistics.

Search companies have also struggled with ad monetisation in the switch from PC to mobile search.

There is also leakage of advertising budgets to the social network platforms, e-commerce and vertical sites.

Verticals are internet businesses that offer everything from real estate sales, to car sale and package holidays.

Here too, many have had to spend heavily to win new customers and high spend on adverting and promotion has impacted bottom lines.

 

In conclusion

Imagine a world without Facebook, Uber, Apple, Vodafone, Skype… these are just some of the companies or products that we interact with on a daily basis; they have become part of the very fabric of our lives.

Leading Chinese companies have joined the ranks of big-name American, Korean and Japanese firms at the cutting edge of digital technology and enterprise.

Taking on board local needs and taste, and applying creativity and innovation, they have developed solutions that meet the needs of a tech-hungry by demanding customers.

And the firms that have cracked it have become essential features of daily modern urban living.

And the drive to innovate – and monetise – continues unabated. Just imagine where we will be in 5 or 10 years…

 

 

Martin Currie Asia Unconstrained Trust – aiming to capture Asian growth.

We believe that the investment approach of Martin Currie Asia Unconstrained Trust provides an opportunity for investors to benefit from Asia’s extraordinary growth.

Our investment research is underpinned by analysis of companies’ long-term fundamentals. Therefore, the importance of obtaining first-hand proprietary information on research trips like these cannot be underestimated.

They play an essential role in building our conviction in companies in which we are already invested, and developing valuable insight into emerging themes and opportunities.

  1. Over the long term, we aim to deliver returns in line with, or ahead of, Asian GDP growth.
  2. We adopt a ‘buy and hold’ investment approach, focusing on long-term cash flow potential.
  3. We employ forensic accounting techniques to gain an in-depth understanding of company fundamentals and place a heavy emphasis on corporate governance. This helps to increase conviction and manage risk.
  4. Our return expectations are realistic and we believe that the strategy’s long-term performance record speaks for itself.
  5. The outcome for our clients is a portfolio that efficiently captures the Asian growth story.

We don’t claim that anything we are trying to do is proprietary in nature. Much of our approach is simply ‘first principles’ investing.

Our competitive advantage is the simplicity and long-term focus of our approach, along with our disciplined and rigorous stock-selection process.

In an industry typified by its focus on short-term returns, we think that these attributes are increasingly rare.

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