What US-Listed Chinese Businesses Might Benefit Investors Long-Term?

in Public  by Anh HOANG 0 comments

Recently, US-listed Chinese companies have seen a massive slump since the 2008 financial crisis. The NASDAQ Golden Dragon China ($HXC) has dropped from 20,500 in Feb 2021 to only 10,400. In the last five months, around $770 billion have been wiped off from the market value of US-listed Chinese public companies.

Many new restrictions such as anti-monopoly policy, Alibaba’s ($BABA) $2.8 billion fine, and the requirement for Tencent to relinquish exclusive music licensing rights major record labels globally, has affected those companies stock prices negatively. The latest blow came from new Chinese regulations on private tutoring businesses. This new regulation does not allow those companies to go public for financing, and foreign capital could not invest in those institutions.

When Alibaba went public in the U.S., we’ve got many questions about whether Alibaba is a good stock to purchase. Although Alibaba is a great business, what we had always been concerned about is corporate governance. Most US-listed Chinese companies has gone public with the Variable Interest Entity (VIE) structure. With this structure, investors do not own a piece of the listed businesses. This structure works as follows: The Chinese companies create a Cayman Islands company, which has complex legal agreements with the Chinese companies on the mainland. What foreign investors buy are the Cayman companies. Although it is still a potential risk for investors, this structure has been existing for years and it seems everybody is okay with that.

Many investors have wondered if they would like to purchase US-listed Chinese stocks, what would be the best to purchase. Here is our quick summary of several big boys including Alibaba, Tencent ($TCEHY), Pinduoduo ($PDD), and JD ($JD), so we can choose the best ones.

  1. $PDD: 100% sales growth, unprofitable, negative EBITDA, trading at 5x forward EV/Sales.
  2. $BABA: 40% sales growth, 12.5% operating margin, trading at 3.5x forward sales and 26x forward EV/EBIT, ROC: 7% – 12%. (Past 5 yrs)
  3. $TCEH.Y: 28% sales growth, 26% operating margin, 6x EV/Sales & 20x EV/EBIT, ROC : 12%- 18%.
  4. $JD: 30% sales growth, 1.2% operating margins, 0.6x sales & 56x EBIT, ROC 4%.

By looking at these numbers, Tencent seems to be standing out. Although Tencent has the lowest growth among the three (but still 28% growth), it is the most profitable, highest operating margin and trading at the lowest EBIT multiples. Moreover, Tencent has the highest return on capital among those four companies. If investors prefer growth, Pinduoduo, with the highest sales growth, is the company which investors should look deeper into. In this post, we will look at Tencent.

We think that in a long run, Tencent would be the most sustainable business among those four companies for long-term investors. It has a full ecosystem covering e-commerce, cloud, music, gaming, and artificial intelligence. One of the most widely used super-app in China is WeChat, which is the platform for social media, payments, e-commerce, advertisement, etc. Chinese consumers do everything daily on Wechat, including talking/chatting with other people, reading the news, shopping, working, paying, and sending/receiving payments.

 

Moreover, the company invests in many platforms of the future, including cloud, AI, blockchain, 5G, quantum computing… to gradually build up its Metaverse.

 

Here is an interesting Tencent’s Metaverse picture:

Source: NASDAQ

 

At the beginning of last year, the company announced that there were around 800 companies in Tencent’s investment portfolio. Around 70 of these were already listed, while more than 160 are unicorns. Previously, the company’s investment activities focus on content, video games, and new technology. In the future, it would pay more attention to smart retail and its payment platform, developing its own mini-app ecosystem in its Wechat super-app.

 

Basically, we view Tencent to become one of the biggest and most successful venture capital nowadays. Furthermore, its investment activities support its own Metaverse, creating great synergies and possible collaborations among those companies.

 

Let’s do rough projections and valuation for Tencent to 2025.

If we assume that from 2021 -2025, its revenue growth would be around 25% per year, operating margin stays around 25% (lowest in the past five years). By 2025, Tencent would produce nearly 1.45 trillion RMB in revenue, 362 billion RMB in operating income. With 19x EBIT multiples (to put in the historical perspective, the lowest multiple in Tencent’s history is 19.09x in 2011), Tencent would be worth more than US$1 trillion by 2025.

If Tencent’s total outstanding share will slightly increases to 9.6 billion by 2025, its share price would be worth $104 per share, roughly 70% upside from the current share price.

In summary, Pinduoduo would fit with the high-growth investors, as it has the highest sales growth at 100%. Tencent, on the other hand, seems to be the safest bet among those four Chinese companies. With its growing metaverse, decent sales growth, high operating margin, and return on capital, Tencent would serve well in the long-term investors’ portfolios.