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Emerging Markets

Chinese Equities Unicorns

Trip notes: Chasing Chinese Unicorns

August 2018

James Kenney, Senior Investment Manager

The Chinese investible universe continues to grow and evolve, offering an exciting dynamic for fundamental investors in the region.

Only 5 years ago, Chinese corporate unicorns were as rare as… magical horses with single horns. But by the second quarter this year, there were over 160 of these Chinese Unicorns – as private companies worth more than USD1 billion have come to be known – with total value at over USD700 billion. By number of companies, that’s more than there are in the US. So we recently took a trip to China to have a closer look at this exotic corner of the market. We will delve deeper into the details in a later post, but here are a couple of things that really stood out. 
CHinese unicorns - on par with the US

By number of companies, Chinese unicorns have outgrown US counterparts

USChinaUnicorns.png
Morgan Stanley, Pictet Asset Management, August 2018

Chinese companies becoming more global

I’ve been on many investment trips to China, but this was the first where I haven’t needed a translator for a single meeting – and I met with the management teams of 14 unlisted companies, whose cumulative valuation was close to USD400 billion. Increasingly, senior managers have been educated at business schools in the US and Europe. If nothing else, this should help foreign investors’ perceptions of investing in Chinese companies.
Most of the companies we met consider the entire world as their ultimate market.

It is also giving corporate China an ever more global perspective. Most of the senior executives we met talked not only of expansion within China, but also considered the entire world as their ultimate market.

Unicorns are rapidly expanding the investible universe

Not only is the profusion of Chinese Unicorns eye catching, but so too is the pace at which they’re listing – a key point for us as investors. If we consider the current universe of H-shares and ADRs within the MSCI China index, only 52 percent were listed 10 years ago. For the MSCI China Small Cap index, this figure is considerably smaller, with only 21 percent being listed 10 years ago. These trends can be seen below; the charts categorize the current constituents of the mentioned indices by their respective market caps 5 and 10 years ago.
The Chinese investment landscape continues to expand
MSCI China constituents ranked by their historic market caps.
MSCIChinaSmallIndex.png
Source: Morgan Stanley, Pictet Asset Management, August 2018

With China relaxing the rules for listing companies both in Hong Kong and in the domestic A-share market, we expect ever more of these Unicorns to come to market. Indeed, in 2018 alone, Xiaomi (hardware and online services, USD50 billion market cap), CATL (battery producer, USD25 billion market cap), iQiyi (online video, USD20 billion market cap), Huya (game live broadcasting, USD6 billion market cap), and PingDuoDuo (e-commerce, USD 25 billion market cap) have all listed.

Meanwhile, Tencent Music and Meituan both recently filed for IPO. We anticipate Ant Financial will list in 2019 which, based on current market valuations, would be the largest Unicorn in the world valued well in excess of USD 100 billion.

Chinese unicorns are different

One common denominator in a lot of the internet-related Unicorns is that they are typically owned by one of the BAT (Baidu, Alibaba, Tencent). This provides a structural advantage few American based IPOs can count on – an advantage central to why we believe the returns and the cash generation of these Chinese companies can be superior to their developed-market counterparts.

The largest cost item for an internet company is the process of acquiring and engaging users. Many of these Chinese Unicorns are born into massive accessible markets. The BAT owns large gateways to the internet, through a huge collective user-base. Baidu is China’s largest search engine with 70 percent market share. Alibaba is the largest online retail company with over 550 million active consumers. Tencent owns the largest social networking mobile application in China, WeChat, with over 900 million monthly active users (MAUs). Access to any of these gateways reduces customer acquisition costs drastically through various mechanisms and increases the addressable market from day one. This is a luxury which few American based IPOs can exploit.