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Alibaba’s Bold Move Could Bolster Chinese Web Power

17 June 2015 in Trading Ideas

Alibaba’s bid to become an HBO/Netflix hybrid was seen by some analysts as a much-needed catalyst for the sideways-moving stock, but another opinion holds that all large-cap Chinese internet stocks haven’t been getting the embrace they deserve.

Alibaba said earlier this week that it would launch its own version of Netflix in about two months. The new service will be called TBO, or Tmall Box Office, to emulate the American HBO service. TBO will stream content bought in China and overseas, as well as in-house productions. Ninety percent of the content will be paid, while 10% will be offered free of charge, according to a report on Barrons.com.1

While video streaming may seem like a reach for the Asian country’s king of e-commerce, HSBC analyst Chi Tsang said it fits nicely into its portfolio of assets and could “redefine home entertainment” in China.

“Alibaba is already a leading set-top box manufacturer and is now layering services onto its hardware and operating system,” Tsang wrote. Alibaba owns 60% of Alibaba Pictures, a 20% stake in Wasu Media, access to Youku Tudou’s large digital library through its 16.5% stake, and has an exclusive agreement with Lions Gate (Mad Men and Hunger Games).”

As Barrons.com pointed out, Alibaba is a stock many Wall Street analysts like but has lacked a new spark. The stock has a 12.7% weight in the China Internet motif, which has risen 7.1% in the past month, even though Alibaba has slipped 0.4% during that time. In the past month, the S&P 500 is down 1.7%.

Over the last 12 months, the motif has increased 25.1%; the S&P 500 is up 7.7%.

However, Alibaba and other large-cap Chinese internet names could begin to move higher if investors eventually close the gap between valuation and performance.

As Barron’s.com noted, analysts at Pacific Crest Securities recently suggested that high spending levels remain an issue for most China Internet names as companies spend aggressively on user acquisition, transitioning to mobile and to a transaction model, and addressing adjacent market opportunities, which has resulted in stretched valuations and investment time horizons.2

Pacific Crest said that Chinese mega-cap names continue to increase their share of industry profits, but are lagging in terms of market-cap share. The analysts see an opportunity for that gap to close, and they also see benefits to mega-caps from the industry shift to transaction models and industry consolidation.

Their buy recommendations included both Alibaba and Baidu, which has a nearly 35% weighting in the China Internet motif.

Specifically, Pacific Crest said that moving into an end-to-end transaction model will be a multi-year theme for the China internet space, which play well into the strength of mega-caps, which have the largest pool of users that have the habit of making transactions.

“It is not a coincidence that the largest transactional environments in the China Internet space are already owned or invested in by the mega-cap players,” the analysts wrote.

Future development of transactional models will likely also involve the mega-cap players in some way, resulting in shared ownership or shared economics.

The vast majority of the vertical online-to-offline market will likely need to consolidate to reach a large enough scale for effective mobile user acquisition. The mega-caps are likely the only ones generating enough cash flow to be the major consolidators in this space, according to Pacific Crest.

While small- and mid-cap names have driven much of the recent rally in Chinese internet stocks, it could be time for the giants to carry more of the load.

1Shuli Ren, “Alibaba To Start Its Own Netflix: A New Catalyst?,” barrons.com, June 15, 2015.

2Pacific Crest Securities, “Beyond Alibaba: More China Internet Picks,” barrons.com, June 10, 2015.

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