- The autocratic moves by CCP have cast a pall on Chinese internet sector
- Chinese internet companies remain the most innovative in the world
- The only way to get prudent exposure to the trade is via long term call spreads in #KWEB
Everyone knows that the Chinese word for crisis is made up of two characters that mean danger and opportunity. Nowhere is this combination more evident than in the Chinese internet stock sectors which has taken a severe beating this year due to new government regulation that has put the whole industry on notice.
Chinese internet stocks which include such giants as Alibaba (NYSE:), Tencent (OTC:) and JD (NASDAQ:) are off more than 40% off their highs and the key question for investors is whether the current markdown is an opportunity or simply a sign of more danger ahead.
It is absolutely clear that the series of decrees by the Chinese Communist Party over the summer has permanently changed the way Chinese internet companies will do business going forward. The sector which perhaps was the most market driven in the Chinese economy will now have to be subject to serious oversight and the government will likely exercise far greater control over the sector’s valuable reams of consumer data. Perhaps most damaging of all is that Chinese technology companies will no longer be allowed to raise capital on foreign markets with Hong Kong (whose freedoms have been greatly curtailed by the Mainland authorities) serving as the only semi-external source of funds for Chinese multinationals.
The irony of the events of the past summer is that the Chinese internet sector is perhaps the most vibrant and advanced in the world. Chinese consumers live in an essentially purely digital economy with instant payment settlements and a vast array of on demand services from apps like WeChat that are completely unavailable to western consumers. The size and scope of the sectors is also unique as the user base just in China dwarfs that of many US multinational giants. The Chinese internet sector is also far more innovative than its western counterparts and does not rely solely on subscription and advertising revenue to monetize its business. It is for these reasons that many investors believe that the sector is now a bargain with companies like Alibaba for example trading at one third the valuation of Western counterparts.
There is no doubt that the autocratic directives of the CCP have permanently damaged the valuation prospects of the sector. It is very likely that the whole sector will now trade at a lower multiple than similar companies in the rest of the world. The sector will also likely face further regulation. But while the CCP has clearly communicated that it will exert more control over the day to day affairs it is unlikely that the Chinese leadership will seek to take ownership of these assets and as long as Chinese internet companies are allowed to operate their cashflow rich franchises in social, media, fintech and e-commerce will continue to grow even with restrictions on foreign capital raises. The Chinese internet companies have already proven themselves to be great innovators in the space and as long as they face no further curbs to their business they will likely continue to reward investors with above average growth.
Still the political uncertainties in China and the opaque nature of CCP decision making process are too risky for long term investing. That is why the best way to play the rebound in Chinese internet stocks is through the KWEB ETF which allows investors to participate in the trade with a single click. Furthermore the most intelligent way to buy this dip is through a long term option call spread. For example with KWEB now trading at $49 the June 22 48/54 bull spread costs $3 to make $6. That’s a possible double on the trade with a reasonable investment target on the underlying, limited risk and ample time to let the market revalue the sector.
Fusion Media or anyone involved with Fusion Media will not accept any liability for loss or damage as a result of reliance on the information including data, quotes, charts and buy/sell signals contained within this website. Please be fully informed regarding the risks and costs associated with trading the financial markets, it is one of the riskiest investment forms possible.