Blue Lotus

Mar 23th and Mar29th
Shawn Yang, managing director at Blue Lotus Capital Advisors, discusses Alibaba business split up and Tencent’s recent quarterly earnings with BBG on Mar 23th and Mar29th, respectively. Shawn also discussed his 2023 outlook for eCommerce, gaming, and ads sectors. We maintain a BUY rating for Alibaba and Tencent.

BBG interview on Mar 29th
https://finance.yahoo.com/video/blue-lotus-capital-advisors-alibaba-052312126.html
 
Q: This is about unlocking value, or about bowing to regulatory pressures from China, or all the above?
Yang: Probably both, but I’d like to say unlocking value is the priority. Many investors worry that BABA is too large and a lot of employees have been comfortable with the current situation. Daniel Zhang sends a very clear message that if you are capable to survive in the competition, then you can get much more reward, compared with staying in BABA. It’s going to be very positive for BABA.

Q: How much more upsides do you see for BABA and other tech stocks, bearing in mind these companies are vulnerable to headlines out of China.
Yang: If you use SOTP, even if today we already see it rallies, we think there is upside about BABA. The valuation of its 6 BU is actually at discount to its peers. So there would still be some incremental purely because of valuation. Going forward, it also depends on its fundamentals. Investors will look at whether these 6 business units can survive after independence. Can they get more outside investors and clients. That’s the key question.

Q: What does this mean for the existing shareholders?
Yang: I’m not very surprised. I’ve been following BABA for more than 3 years. In the past 2 years, BABA has been emphasizing that each of its business units has to survive by themselves. If you look at Cloud or Freshippo, they are saying that we can breakeven and make profits. So actually BABA has been pushing its business units to be more independent. If you can survive in the competition, then you can get rewards. That’s a very clear message. I would say it’s a very positive thing.

Q: Which units would be the first to list and the most promising?
Yang: There are two criteria. Frist, you have to prove you can breakeven. Second, you have to have enough external clients. So I think cloud is one of the largest and the first to list. The other two is Cainiao and Freshippo, which are very good assets. All these three have proved that they can reach breakeven point and have enough external clients.

Q: Will other big techs go on the same road? Is Tencent next?
Yang: A lot of investors ask me this question overnight. It’s a little bit different if you look at Meituan and Tencent. For BABA, a lot of its business lines are independent. But for Tencent, it’s very different, a lot of its business lines rely on Wechat traffic. In BABA, there’s 6 trees. In Tencent, there’s only one tree. If you cut one branch, it’s very difficult to give high valuation because it leaves its root. For Meituan, it’s more likely to separate some of its new initiatives businesses. Meituan’s core business, food delivery and instore, are highly connected. But other new initiatives, like supply chain and community group buying, are more independent. I would say Tencent and Meituan would follow BABA to some extent, but would not extend to a large scale.

BBG interview on Mar 23th
https://www.bloomberg.com/news/videos/2023-03-23/blue-lotus-capital-advisors-on-tencent-earnings-video
 
Q: These are more encouraging numbers for sure. What’s your take?
Yang: In our previous report, we already forecast that Tencent will get back to the way of growth. The key driver is Video Account, a short video function in Wechat. That’s why we think Tencent’s ads is stronger than we previously estimated. Game is a little bit weak, but I’m not so worried, because there will be more friendly regulatory environment and more games will receive game code approval. In general, Tencent is back to the way of rebound and growth. It's a very positive sign for China internet stocks.

Q: How strong do you expect gaming revenue to be and how well positioned is Tencent to benefit from better regulation of mobile gaming approval?
Yang: I think several of its games already got game code approval, such as Valoran, a very popular shooting game in the West. It also has several games to launch overseas. This year our estimate is between roughly 5%-6% YoY. It’s not very high, but considering that Tencent gaming has been performing relatively weak for the past whole year, I think it’s still a positive sign.

Q：Can Tencent read this as a sign of relief of regulatory concerns when it comes to gaming. Will government stay out of the way of Tencent?
Yang: For gaming, we’ve already see game codes approval resume for the past several months. It becomes normalized with around 70 games on average gets approval on monthly basis. Now people are guessing whether DNF, another hit title, could get game code approval, because if it gets approved, it will be a very large catalyst for Tencent. So far we haven’t seen a very clear sign. In general, the regulatory environment will become more friendly this year.

Q: How does Tencent monetize AI given that there’s plenty of AI now?
Yang: I think that’s very similar to last time when all China internet companies introduce recommendation feeds to their ads system. Every company develop their own technology based on AI, because every company has its own data set. For example, some companies focus on eCommerce while others on gaming. For Tencent, they can largely reduce cost of developers and artists, and help generate some simple game plays. Because a lot of its games based on large DAU, which means a lot of players have to play against each other. So adding AI will create the feeling that I am playing with humans not computers. As for ads, AI will help merchants create video and ads for Tencent, which would reduce costs. In general, it would be a long-term positive thing, but so far Tencent mentioned we’d rather do it right, not in a rush. I think that’s a right attitude.

Q: Will Tencent be hiring or cutting when it comes to employees?
Yang: They already cut some people, but their G&A is actually higher than people thought in Q4 earnings, which means that they did have some layoffs, but not that large. Tencent is a large company with a lot of divisions, so this year we would still see Tencent increase their headcounts. But for most Chinese companies, they still emphasize that they would spend money more prudently and cautiously. So Tencent would have some headcounts but not a lot.

Q: Do you see some macroeconomic risks as the potential global recession. Will that put a dent on the recovery prospects?
Yang: We publish a couple of reports recently. The recovery is a little bit slower than we previously thought. Online ads is a very good indicator. What we have seen is that eCommerce slightly recovers a little bit, but FMCG and automobile, their spending on major ads platform is still relatively weak. So if macroeconomy recovers slower than people expected, less than 50% of Tencent ads will be impacted, because it is contributed by FMCG and automobile. For other parts, like eCommerce and gaming, I think advertising spending on Tencent will continue to increase.