China represents a great risk reward opportunity
A year of heightened regulatory scrutiny in the Chinese internet sector and concerns around the macro environment has led to a negative short-term impact on profits. While the political calendar remains important to monitor, the impact of these regulatory constraints now seems more than priced in by historically low valuations, providing an attractive risk reward profile for the sector. Indeed, the new regulation means that internet related service providers will be able to develop themselves in a healthier environment, setting the scene for more durable growth. Pictet-Digital does not believe that the regulators intend to stifle growth in the sector, as technological innovation remains a key priority of China’s official Five-Year Plan.
Inflation: Pictet-Digital is relatively immune to cost inflation while being exposed to reopening benefiting from higher IT and discretionary spending
From a cost perspective, the internet industry is generally unaffected by traditional drivers of cost inflation like raw materials, energy or labour costs. Instead, the main source of cost inflation comes from the rising cost of customer acquisition – a consequence of slower overall internet time growth (now growing at 6-7%). Within the US Internet sector, high-margin software players with solid pricing power such as Adobe and Salesforce should weather any persistent inflationary environment. And within the Chinese Internet sector, we're optimistic about Alibaba, Tencent, Baidu, NetEase or JD.com‘s ability to improve monetisation. Chinese internet users have sticky habits by nature and we expect industry leaders to be able to pass on any customer acquisition costs. We also have limited exposure to supply chain bottlenecks.
First-party data platforms: Pictet-Digital is selectively adding the best players
Today, higher competition between platforms will favour the biggest players especially those with first-party data. Unlike third-party data that is often available to many different companies, first-party data is collected with direct consent from consumers, through interactions on apps and websites, and in response to marketing initiatives in advertising and e-commerce space. When used responsibly, first-party data helps build direct relationships with customers, create value, and boost advertising less performance. The data is more relevant and services more reliable with less fake clicks, less fake followers, more relevant ranking and understanding about user preferences and user behaviours. This creates more traffic covering customer acquisition costs and bandwidth costs, which generates better data analytics, which translates into better returns on investments.
Traffic vs conversion rate
Pictet-Digital is selective when looking at large apps/platforms’ business models as some of the growth doesn’t look sustainable long term. When looking at some social media platforms/large apps, especially those with poor messaging platforms, they end up with poor granularity on their datasets. High traffic platforms for mini videos or stories for example do not convert into meaningful conversion rates needed for long term sustainable business models. Funny posts or stories do not provide a lot of data about user purchase intentions or preferences. These data sets which you get more readily from large social media platforms with strong messaging services embedded, can produce strong monetisation while traffic alone creates weak monetisation.
An example to illustrate the 4 points above and why we are invested in Alibaba but not Pinduoduo Inc (PDD). The number of users is the same for PDD and Alibaba (about 800 million active buyers), but spending per user is 2.000 RMB/year for PDD versus 10.000 RMD/year for Alibaba. And purchase frequency is 100x per year for Alibaba versus and 30x per year for PDD. So there lies the big difference. PDD‘s variety of products offered is not as rich as Alibaba’s. PDD needs to expand the offering. They do not sell electronic products and, as a result, the purchasing frequency is too low. PDD could add more products by getting brands from wholesalers and distributors, but they would need to invest a lot to achieve this.
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