In 2009, many of my most successful trades as well as my top pick from the stock picks competition were Chinese tech stocks and after a difficult 2010 year for most of the Chinese market, I think it might be a good time to consider opening a new trade. What would that be? Quite simply betting on China’s internet leaders and going short on the US ones. The reality is that I do think US tech stocks like Google will do very well over time but I do expect Chinese competitors to do even better.
Why Chinese stocks?
As I’ve said, this is not so much about being negative about US stocks, very far from it but rather about these companies being in a very specific and favorable climate. Here are the main reasons…
While smartphone and mobile devices are still growing fast in the US and Europe, it is a few worlds apart from what will eventually happen in China when the users start to convert their usage. That will happen very gradually and certainly in different ways than what happened in the US but I still think that the Chinese companies given their ties with local telecom corps will have a huge advantage and should be able to nicely leverage the explosion in the news/blogs/mobile/games and other emerging trends in China.
It’s not easy for US or foreign companies to do business in China. Google’s now famous “exit” out of China as it got tired of playing by Chinese rules is just one of many examples. Many companies like Facebook and Twitter are blocked at times or on a permanent basis in China. There are many reasons why but it certainly is a major help for a company like Baidu to not face much competition from Google, Yahoo or Microsoft. It makes it easier to focus on other important things like innovation, new markets, etc. Over the long run, this will give Chinese companies a huge advantage in what will become the most important market. Given the uncertainty when dealing in China, it’s difficult for US companies to invest much in terms of money or resources in China knowing they could get shut down at any moment.
Desire for national leaders
As great as things have been in China in the past 10-20 years, one thing that has proven to be a challenge is building up huge multinational companies that have strong brands accross the world like Apple, Microsoft or Google. Both the government and the Chinese consumers would love to see this happen and I personally think this will result in a few huge companies that like Baidu will then try to take their success abroad. Will it work? I am convinced it will work in at least a few instances even though it could take some time.
Ability to be “inspired” by US
Another huge advantage for the Chinese companies is that they can get “inspiration” from what is done in the US without having to innovate as much since those US corps cannot bring the services to Chinese consumers. This significantly reduces the R&D costs but also helps the Chinese corps focus on other aspects such as better attacking specific markets or needs.
When I say long term…
In my opinion this is not a 1 or 2 year trade but rather a trade that would be done over 5-10 years and given the swings that will happen, I would take a position that can sustain a 20-40% loss because it will happen at some point although I do think that over time this trade will end up being wildly profitable. Being short a company like Google over 20 years will certainly make you nervous at times but I think that it is worth the risk.
So what are the match-ups?
Tencent Holdings (Chinese listing)
IAC Interactive (IACI)
Look for changes in leadership or fragmentation
Obviously as in any other trade, there are risks involved and here are the main ones that I would be very careful about:
-Changes in leadership: If at some point either Google or Baidu is no longer the “leader” in its respective market, I would switch the positions. Remember this is about China vs US not about Google vs Baidu.
-Fragmentation: Generally, there have been clear leaders in specific countries and I would want to be sure that the Chinese market will not split at some point with Baidu and other players taking their respective parts as that would kind of screw up the thinking behind the strategy.
-WTO or other international laws: While the Chinese impose tough internet laws on competitors right now, it’s difficult for others to complain set their own laws because the Chinese companies do not really operate abroad much right now. However, when that starts to happen, you can bet that the Chinese govt will start feeling the pressure to relax its rules on foreign companies.
Any thoughts on on such a trade?