In WILTWs August 19 and September 19, 2019, we summarized the major forces driving China’s indigenous software/IT industry. These can be summarized, as follows: 1) the organic growth of software/IT industry is much higher than China’s overall GDP growth and this is likely to continue in the foreseeable future; 2) the Chinese government has stepped-up its IP-protection efforts to encourage more innovation and R&D; 3) the growth of labor productivity in the Information and Communications Technology (ICT) sector has significant upside to reach the levels of most OECD countries; and 4) a five-year corporate tax holiday from Beijing is bolstering the domestic IT sector’s fortunes, as Beijing increasingly views the business as a strategically-important sector for national-security purposes.
These driving forces remain largely intact, and in many cases, have gotten stronger. Furthermore, the coronavirus outbreak has brought to light another major driving force: the rising demand for services that facilitate telecommuting, as widespread quarantines have triggered an increase in demand for videoconferencing and other IT services, such as cloud-computing services and software-as-a-service (SaaS). Importantly, most of the customers attracted by these short-term factors are likely to continue with these services long after the virus outbreak has passed.
Telecommuting is rapidly becoming a new trend in China and the rest of Asia. People now avoid offices and group meetings due to the fear of being infected. Major Chinese tech giants, from Alibaba to Tencent, have introduced digital solutions that enable office workers to work from home. For example, in recent weeks, Tencent began a free real-time audio and video service that allows a maximum of 300 users to attend an online conference at the same time.
Domestic software/IT market leaders are likely to be the biggest beneficiaries of this trend, because they are at the forefront of offering integrated solutions for small businesses. A large percentage of their new clients incurred minimal costs for these services during the virus outbreak, and therefore, they are likely to continue using them once the panic has passed.
Many business functions—ranging from online office software to online receipts generation and reimbursement systems—are now more integrated than ever before. Once users are trained to use these systems, it will be hard to switch back. The overall organization’s costs associated with migration to other platforms would be prohibitive for most small companies.
This so-called “stickiness of services” will enable the indigenous IT leaders to strengthen their market positions even more, as small competitors are constrained by both financing resources and labor availability.
Even before the virus outbreak, the cloud services business was a rapidly-growing subsector in China. According to the IT consultancy IDC, the nationwide cloud services market grew 27.5% year-over-year in the first half of 2019, reaching 5.58 billion yuan ($789 million). IDC estimates that China’s cloud market will grow at a compound annual growth rate (CAGR) of 27.3% through 2023, reaching 30.6 billion yuan ($4.4 billion). The aftermath of the virus is likely to push this growth rate even higher, based on the telecommuting trends.
On Wednesday, the CSI Information Technology (IT) Index, consisting of 103 IT-related stocks listed on the mainland exchanges, reached a 55-month of 5,797—breaking-out above its pre-virus high of 5,422. We reiterate our buy recommendation on our favorite software/IT names covered in WILTW September 19, 2019, some of which could become the Chinese equivalent of the U.S.’s Salesforce.com (CRM US, $192.87):
Yonyou Network Technology (600588 CH, CNY 43.56) is the largest provider of enterprise management software in China. Yonyou has identified cloud-computing as its core driver going forward. At an online business partnership conference held on February 15th, 2020, Yonyou launched the “SaaS Accelerator Program” to empower its partners and to speed-up the development of the SaaS industry. The program will provide support in development, marketing and funds for independent software vendors (ISVs), businesses, and individual developers for cloud services on Yonyou’s platform. Yonyou announced that it will help train 100 ISVs and 1,000 individual developers for free and offer free expert support during the development process in 2020. Yonyou has returned 28% since last September’s recommendation.
Inspur Electronic Information Industry (000977 CH, CNY 46.90) is a leading provider of data centers, servers, and cloud computing solutions. Inspur has also dominated the Chinese AI server business for two consecutive years, controlling over half of the market. On February 15th, Inspur unveiled a plan to provide free cloud and video conference services for small and medium-sized businesses through April 30th. Inspur has returned 85% since last September’s recommendation.
Kingdee International Software (268 HK, HKD 10.54), which is the largest domestic enterprise SaaS provider, has returned 24% since last September’s recommendation.
Glodon (002410 CH, CNY 42.01) is the largest domestic AEC (architecture, engineering and construction) IT company by market share, and the first such company listed on the mainland. Glodon has returned 14% since last September’s recommendation.
Overseas investors looking for additional exposure to this theme should also consider the Global X MSCI China Information Technology ETF (CHIK US, $ 22.67), which is designed to track the performance of the MSCI China Information Technology 10/50 Index. The “10/50” is derived from the fund’s concentration constraint, which stipulates that each stock’s weight in the index is capped at 10%, while the cumulative weight of all the stocks having weights above 5% does not exceed 50% of the index.
The index’s top-10 holdings include many of the IT names that have appeared in this publication, such as SMIC, ZTE Corp., Kingdee Software, and Kingsoft Corp., among others. This ETF has generated a 30% return since our September 19th recommendation.