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China tech – from followers to innovators

By Wietse Nijenhuis, Head of Global Equity Strategy, Citi Private Bank

April 4, 2018

Facebook’s and Amazon’s recent respective data privacy and tax concerns add to wider worries over US and European regulation in the information technology (IT) sector. The sector has already come under pressure this year from increasing global trade tensions and rising interest rates.

 

Compared to their US counterparts, Chinese tech companies operate in a much more sanguine regulatory environment. In this context, the larger drawdown (-12%) in the Chinese tech sector over the past several weeks compared with the US (-10%) appears overdone.

 

In terms of tariffs, while we recognize trade disruption as the largest single risk to global economic growth, we do not expect a full-blown trade war between these two superpowers. By targeting the Chinese tech industry, US policymakers acknowledge the incredible rise and influence of companies such as Tencent and Alibaba.

 

Chinese companies have long been accused of infringing on the copyrights of foreign firms. While this may have been the case in sectors like automobiles, it is largely untrue in the tech sector. In fact, the likes of Tencent and Alibaba have moved on from merely being apps or marketplaces, to developing vast ecosystems differing from any in Western markets.

 

Facilitating this is market-friendly regulation, reforms and barriers to entry, such as language and culture. Protectionism has played a role too, but in many cases US tech giants were unable to understand or adapt to Chinese consumer tastes and habits. For similar reasons – including regulatory – Chinese companies have struggled in Western markets.

 

Overall, it would be reasonable to assume that the FAANGs (Facebook, Amazon, Apple, Netflix and Google) will continue to dominate in the US and Europe, while the BATs (Baidu, Alibaba and Tencent) will remain firmly in control in China. The key battleground, therefore, will be in markets such as South East Asia and India where structural drivers such as population growth, urbanization, financial inclusion and smartphone penetration are underpinning the long-term prospects for the tech sector.

 

Heavy investment in areas such as artificial intelligence, virtual reality, autonomous driving and biotech is likely to create future industry leaders in China. The price for these long-term growth prospects? Perhaps not as expensive as one would think. Emerging Asian tech companies have higher earnings growth and stronger earnings momentum but trade on cheaper multiples than their US counterparts.

 

We advocate investing in technology’s lasting industry disruptors. The longer-term prospects for EM Asian technology appear even stronger than in other regions.

 

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