In the past three months, I did a number of stock purchases in a bid to grow my existing portfolio.  Arranged chronologically, my stock purchases from July to the present are as follows:

28 July: Alibaba @HKD181

29 July: Tencent @HKD488.40

31 August: SGX @SGD9.972

2 September: Alibaba @HKD169.7

16 September: Alibaba @HKD153.6

4 October: Keppel DC @SGD2.42

11 October: Lion-OCBC HS Tech @SGD1.079

A significant portion of my money went into Chinese stocks. I went into Chinese stocks in spite of the China market meltdown. A lot of the fear, though very justified, has been dramatised and played up to bring about the market meltdown, in my opinion.  I entered the China market to enlarge the China portion of my portfolio when many are fleeing or have fled.

Since almost a year ago, Alibaba stock has been on a sharp downtrend.  At today’s price HKD168.40 (Oct 11), the stock has fallen some 45% from its 52 week peak (52 week high: HKD309.40; 52 week low: HKD132) and it is definitely undervalued.  I estimated Alibaba’s intrinsic value to fall in a range between HKD280 to HKD350.  

Alibaba had been under fire since Ant Financial’s IPO was canceled by the Chinese authority last year.  Several months from that failed IPO launch, sometime in April, Alibaba was issued a USD2.80 billion fine in a landmark antitrust cases.  Alibaba stock also got cut down further in recent months with the rest of the tech sector under the Big Tech crackdown.

While some has given up on Alibaba, I still think that all hope is not lost on Alibaba.  Sure, it is not the shiny star it once was, but its business is still doing just fine.  Even Charlie Munger seemed to think so, having doubled his stake in Alibaba in the third quarter this year.

It still makes sense to invest in Alibaba:

1. The group owns multiple ecommerce sites and controls over 50% of China’s e-commerce market.  It is undoubtably still the “Amazon of China”.  While Alibaba’s main income comes from its e-commerce business, it also has considerable influence in other segments such as cloud computing, digital media and entertainment, and innovation initiative and venture investments.

2. Alibaba boasts of having some 1.18 billion active consumers on its entire ecosystem, 912 million consumers in China and 265 million consumers overseas served by Lazada, AliExpress, Trendyol and Daraz.  

3. In fiscal year ending March 31, 2021, gross market value transacted on Alibaba’s e-commerce market places in China alone reached approximately 7.49 trillion yuan (an increase of 13.74% from 6.59 trillion yuan a year ago).

4. Alibaba still owns roughly 33% stake in Ant Group, which owns China’s largest digital payment platform Alipay (processes more than half of China’s third-party payments).  Ant group is undergoing government-mandated restructuring.  China’s central bank governor Yi Gang raised the possibility on Tuesday that Ant Group could be allowed to pursue an IPO once it fully satisfies China’s new fin-tech regulations.

5. Alibaba’s financials still remain stellar.  In its 2Q report, Alibaba’s posted USD32 billion of revenue, a 34% increase from 2020. It still sits on a huge pile of cash, some USD73 billion in cash, equivalent and short-term investments on its balance sheet as of June 30, 2021.  And this signifies Alibaba is financial sound and has the wherewithal to expand its business or acquire any emerging competitors. 

6. The share price of Alibaba has literally fallen into an abyss in recent months from its 52-week peak at HKD309.40. As the share price fell, so did the PE.  Its current PE is about 20, a far cry from its elevated PE of 42.85 about a year ago.  Given its dominance in China’s e-commerce space, and its potential for future growth, Alibaba at its current price is literally a steal.  I only wish I have bought Alibaba at HKD135++ just a week ago.

Buying Alibaba, or any of the Chinese tech stocks for the matter, comes with one huge risk … regulatory risk.  This time round the Party’s hand has come down very hard on these big tech companies, wiping off billions of market value.  

It looks like the regulatory storm has kind of abated as these giant tech firms obediently subject themselves to the new regulations.  The questions, though, are: (1) when will the current legislative onslaught end? (2) will there be more rounds of crackdown at some point in the future?  One thing for sure about regulatory risks from China is that they are highly unpredictable.

As of now, regulatory uncertainty still remains, but I think it is okay to nibble a little here and there to take advantage of price weakness.  China’s top-down governance model has always been interventionist, and does not suffer the rise and dominance of any monopolistic company within its borders.  Even so, Alibaba’s strong business and financial fundamentals, coupled with its growth potential and relatively inexpensive valuation makes it an attractive investment.

As of January 1, 2020, Alibaba was the largest China company by market cap.  After the regulatory blitz, Alibaba slipped to number 2 position.  Tencent is now the largest company in China by market cap.

Tencent has been losing its shine since February this year.  Tencent suffered the same fate as Alibaba when the country’s top market watchdog began a probe into its alleged anti-competition practices in its music-streaming business.  Tencent was also investigated and duly fined for not properly reporting past acquisitions and investment for antitrust reviews.

In early August, a mainland newspaper published a report calling online gaming “spiritual opium,” and singled out Tencent for harming China’s teenagers by making them addicted to the games offered by Tencent.  In a matter of two weeks from the newspaper report, Tencent share price dropped to its lowest in 15 months, to a new low of HKD421.20.  

I began to take notice of Tencent when its share price go south slowly beginning in February.  I didn’t take action until late July.  On hindsight, I might have acted too early, missing out on lower stock prices for Tencent in August.  

The crackdown has made Tencent an attractive investment to me:

1. Tencent is a huge tech titan and makes money from its core businesses in value added services (games and social networks), online advertising, and FinTech and business services (cloud-computing).  Tencent’s market cap is USD602.1 billion, making it the 7th largest company by market cap in the world.

2. Tencent owns 51% of the market share in online gaming in China.  NetEase, the second largest online game provider in China only has 18 percent of the market share.  To help curb teen addiction to their games, Tencent has a set-up that locks out teens after 1 hour of playing on school nights and 2 hours during holidays.  Tencent said that 2.6 per cent of its revenue originates from players under the age of 16 and 0.3 per cent from under 12s. So this cracking down on teens’ activity on mobile game platforms hardly puts a dent in Tencent’s total gaming revenue.  In Q2 2021, mobile games accounted for 30% of Tencent’s overall revenues of $6.3 billion, a rise of 13 per cent yoy.  

3. Tencent’s advertising and FinTech+business services segments are also firing on all cylinders.  Its advertising business revenue (ads on WeChat and QQ, for example) rose 23% yoy; its Fin-tech+business services revenue grew 40% yoy.  Tencent offers several of its software tools for free: Tencent Meeting, WeCom, Tencent Docs etc.  These software tools have great commercial value and the FinTech+business services will get a further boost should these tools be monetised.

4. Tencent is the “Berkshire Hathaway of China”.  It has taken significant minority stakes in winning companies such as Tesla (4%), Spotify (4%), Snap (12%), and SEA (25%).  Just its stakes in SEA, Snap and Tesla alone make up 17% of Tencent’s total market cap.  Tencent invests to expand its empire and grow its wealth.  Tencent’s net debt position totalled RMB21 billion.  This is a small sum compared to the fair value of Tencent’s stakes in these investee companies which totalled RMB1446 billion.

5. The share price of Tencent is pretty fair-valued now, having fallen about 36% from its 52-week high of HKD775.20.  As long as Tencent stays below HKD500, I think it is a fair bargain, especially given its dominant business and prospect for growth.

6. Since announcing its Q2 results in August, Tencent has been buying back its own shares, about 2.2 million shares, at an average price of HKD464 per share.  This share repurchase program indicates Tencent’s confidence in its business outlook and long-term strategy, government regulatory measures notwithstanding.

Just like Alibaba, Tencent faces regulatory risks as well. 

Regulatory clampdowns, be it an antitrust crackdown, data security overhaul, or just a check on capitalist excesses, are nothing new in China.  The Chinese government does not intend to damage these tech giants.  It only wants to regulate them, and truly there is a world of difference between regulating and destroying.

Back in 2018, for instance, the Chinese authorities took steps to limit the number of online games and reduce screen time.  Why?  Mr Xi thought that too much game playing was damaging children’s eyesight.  In a day, Tencent shares came tumbling on the Hong Kong Exchange.  Damage was only temporary, and in no time Tencent’s share price rose again.  

The tougher regulatory environment is here to stay (I might even say, it has always been here all along) and investors will have to look beyond this and refocus on the business potential of Tencent.

Conclusion

Because of the way China is and operates, there will always be uncertainty for investors.  Hence, Chinese stocks will not form a large portion of my portfolio … maybe subject a 20-30% allocation limit.  

The Chinese stock market has been on sale for a while now and the opportunity to pick up some good buys are here.  Alibaba and Tencent stocks present themselves as excellent long-term opportunity today.

I believe these two bellwethers will survive the regulatory storm.

Everyone has the brainpower to make money in stocks. Not everyone has the stomach.

Peter Lynch

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Disclaimer: I am only an amateur investor and nothing you read here on my blog constitutes financial advice.  I write here to detail my investments, strategies, and analyses.  Feel free to read at your own risk.  Should you need financial advice, consult a licensed financial advisor.