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China Internet Sector China / Hong Kong Industry Focus China Internet Sector Refer to important disclosures at the end of this report DBS Group Research . Equity 3 December 2014 The makings of an empire HSI: 23,654 • Leading internet players are actively positioning on NASDAQ: 4,756 mobile internet to enhance growth prospects Riding on its vast user base, Tencent could • cooperate with strategic partners including JD.com ANALYST to strengthen its presence especially in the e- Mark LI, CFA +852 2971 1935 commerce value chain [email protected] Initiate coverage on Tencent with BUY, HK$148 TP • Recommendation & valuation (on 0.9x PEG, or 32x 12-month rolling core PE); initiate coverage on JD.com with BUY, US$30.8 TP Target 15F 15F (on 1.5x 12-month rolling P/Sales ratio) Company Price Price Upside Recom PE P/Sales Local$ Local$ % x x China’s internet Mobile transformation underway. Tencent*^ sector has benefited from rising penetration of mobile HKD 119.6 148 23 Buy 26.0 9.0 devices, and robust mobile revenue contribution has (700 HK) JD.Com*^ become the main growth driver. As such, leading players USD 23.91 30.8 29 Buy n.a. 1.2 especially the BAT (Baidu, Alibaba Group and Tencent) (J D US) Alibaba# are striving to enhance their mobile presence via both USD 109.9 n.a. n.a. NR 36.2 15.7 organic growth and strategic cooperation. (BABA US) Baidu USD 234.7 n.a. n.a. NR 27.5 5.8 In (BIDU US) “Tencent Family” rides on its platform value. particular, Tencent has been actively cooperating with strategic partners such as JD.com, Dianping.com, Didi # 2015: FY3/16 Taxi and LY.com. Building on Tencent’s large user base ^ Core PE especially for Weixin and Mobile QQ, its integration with partners’ e-commerce, search, travel and O2O services Note: We expect JD.com to turn profitable in 2016F. could help to establish ecosystems around Tencent’s key Source: Thomson Reuters, *DBS Vickers platforms. Buy the winners. Within the internet sector, we believe e-commerce has the best monetization potential, thanks to its transaction-based business model. The strategic cooperation between Tencent and JD.com could enhance their control on the e-commerce value chain, and improve user experience especially in product quality, payment methods and delivery speeds. Besides, more synergies could emerge in other key segments such as online games and online ads. We initiate coverage on Tencent with BUY rating and TP of HK$148 (based on 0.9x PEG, or 32x 12-month rolling core PE). We also initiate coverage on JD.com with BUY call and TP of US$30.8 (based on 1.5x 12-month P/Sales ratio). www.dbsvickers.com ed-JS & TH / sa- MH Industry Focus China Internet Sector Table of Contents Investment summary 3 Going mobile 4 Consolidations taking place 6 (A) Horizontal expansion – Synergies emerging 10 (B) Vertical integration – Riding on e-commerce value chain 13 Valuations & recommendations 16 Stock Profiles 20 Tencent 20 JD.com 38 Appendix 58 Page 2 Industry Focus China Internet Sector Investment summary Horizontal expansion creates synergies. Cooperating closely with its partners, Tencent has incorporated functions like e- The internet sector is embracing the mobile age. Thanks to commerce, online taxi bookings, restaurant rating and travel rising penetration of smart devices, the number of mobile services into its Weixin and Mobile QQ apps (applications). We netizens has grown rapidly and exceeded 40% of total expect such cooperation to generate good user traffic and population in China. Mobile internet users are likely to stay consumption for Tencent’s partners, and increase users’ time online for >10 hours per day, which we believe is 5-10x the spent on Weixin and Mobile QQ. Thanks to synergies that arise amount of time users spend on PCs. According to iResearch, from such cooperation, Weixin and Mobile QQ could become mobile revenue contributed 22% of China’s internet sector the “Super Apps” that users would go to whenever they surf revenue in 2Q14, and could trend up further. In addition, the mobile internet. mobile internet could breed new customer demand such as Vertical expansion along e-commerce value chain. Thanks to its online taxi bookings. Hence, there is immense potential for the transaction-based model, we believe e-commerce is best- winners in mobile internet, in our view. positioned to achieve monetization (i.e. generating revenues Leaders strive to strengthen mobile presence. Seeing solid and profits). As such, Tencent has formed strategic cooperation growth and bright prospects in mobile internet, leading with JD.com, with the aim of enhancing their control on the e- internet players including the BAT (Baidu, Alibaba Group and commerce value chain. In the partnership, JD.com would ride Tencent) have invested heavily in mobile transformation, on its expertise in supplier management, online platform especially in their core businesses such as mobile search, online development and in-house fulfilment operations, and Tencent maps, mobile e-commerce and mobile games. As a result, BAT would provide support on user traffic and key processes such has recorded robust mobile revenue growth, and their mobile as payment channels. In this way, Tencent and JD.com could revenue contributions have outperformed the market. In strengthen their e-commerce presence, and compete head-to- addition to organic growth, we believe these leaders are willing head with leaders such as Alibaba Group. to acquire quality players, to enhance their ecosystems in mobile internet. Valuations and recommendations. We like Tencent’s leadership in online games, emerging presence in online ads, and large The “Tencent Family” stands out on its platforms with user active user base riding on its QQ and Weixin platforms. We traffic advantage. In our view, social network operators have also think highly of JD.com’s self-operated model that ensures advantages in the mobile era, given keen user demand for easy product quality as well as delivery speeds. More synergies could communication. Tencent has leveraged on its large user base emerge from their strategic cooperation, to enhance their of >550m MAU (monthly active users) for its Mobile QQ and competitiveness especially in e-commerce. We initiate coverage Weixin platforms, to cooperate with strategic partners on Tencent with BUY rating and TP of HK$148 (based on 0.9x including JD.com, Dianping.com, Didi Taxi and LY.com. PEG, or 32x 12-month rolling core PE). We also initiate Together with these players, the “Tencent Family” is well- coverage on JD.com with a BUY and TP of US$30.8 (pegged to poised to establish ecosystems spanning multiple segments, 1.5x 12-month rolling P/Sales ratio). such as online gaming, online ads, e-commerce, search, travel, Risks and concerns. Key risks to Tencent could include O2O and logistics services. slowdown in mobile game revenue, unsuccessful monetization efforts on Weixin and Mobile QQ, and rising content costs in videos and online games. Key risks related to JD.com could include intensifying competition with e-commerce leaders especially Alibaba Group. Page 3 Industry Focus China Internet Sector Going mobile Revenue breakdown for China internet sector (2013) Decent growth in the internet sector. More and more people in China are embracing the internet, to enjoy its various advantages such as convenience, transparency and cost savings. Online ads Online As of June 2014, the netizen population in China stood at 21% payment 632m (14m higher than Dec 2013), and internet penetration Online games 3% rate reached 47% (source: CNNIC). Driven by rising netizen 15% numbers and higher online spending, internet operators have registered decent revenue growth. According to market research firm iResearch, total revenue for the China internet Others 6% sector could record 47% CAGR for 2011-2014F to reach RMB826bn, and is projected to grow at 28% CAGR for 2014F- E-commerce 55% 2017F to RMB1,723bn. The pie is large and growing, and all players are striving to get a share. China internet sector – Total revenue size Source: iResearch RMB bn CAGR= 28% % 2,000 60% Mobile contribution trending up. The promotion of mobile 52% 51% 1,723 1,800 devices (e.g. smart phones and tablets) and development of 1,600 50% mobile internet in China have offered huge opportunities for 38% internet operators. Thanks to the convenience of mobile 1,400 40% 1,200 devices, users could access mobile internet for >10 hours per 1,000 826 30% day, which could be 5-10x the time users spent on internet in the PC era (according to Mr. Huateng Ma, founder and 800 600 20% Chairman of Tencent). 600 398 400 262 10% According to iResearch, mobile revenue contributions have 200 increased steadily, and accounted for 22% of total revenue in 0 0% 2011 2012 2013 2014F 2017F 2Q14. This ratio could trend up further, in our view. In the initial phase, we believe growth could mainly come from users’ Market size (LHS) Growth y-o-y (RHS) experimental consumption on the apps (applications). As the apps become more user-friendly, and user habits on mobile Source: iResearch internet are established, we believe mobile revenue could achieve explosive growth, and make significant revenue E-commerce, ads and games are major contributors. Breaking contributions for internet operators. down the internet revenue for 2013, e-commerce accounted for 55% of total revenue, and online ads (21%) as well as online games (15%) were the other major contributors. Online payment’s share was 3%, with good potential to grow. Aided by its transaction-based model, we believe e-commerce is best- positioned to achieve monetization (i.e. generate revenues and profits).
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