Alibaba Group Holding reported rip-roaring quarterly earnings in May, smashing analysts’ estimates to deliver 50% year-over-year growth in both profit and revenue. With the drums of a trade war beating, markets didn’t care. The Chinese e-commerce giant’s stock has fallen 22% since Donald Trump took a hawkish turn toward Beijing on May 4. Shares in Tencent Holdings , China’s answer to Facebook , Netflix , Spotify, and PayPal rolled into one, are off 15%.
That spells buying opportunity to some investors. “Alibaba (ticker: BABA) and Tencent (700.Hong Kong) are our two biggest positions,” says Dara White, head of emerging markets equity at Columbia Threadneedle Investments. “They are well-positioned, and attractive at these price levels.”
White’s bull case starts with the obvious: Both companies derive nearly all their income domestically. Their macro driver is Chinese economic growth, which authorities have tools to bolster, even if Washington does its worst. Export’s share of China’s gross domestic product fell from 35% in 2006 to about 20% last year. “China has slashed its export dependence almost in half,” says Colin Gillis, director of research at hedge fund adviser Chatham Road Partners. “They can likely maintain domestic consumer strength through a trade war.”
The twin internet pillars offer attractive micro stories, too. There aren’t many new users left to sign up in China, but there’s plenty of room to squeeze more cash out of existing ones. Alibaba takes an average 4% commission from online sales, versus Amazon.com ’s (AMZN) 20%, White says. Tencent sneaks just two ads a day by social media surfers; Facebook bombards them with more than 15. And there are fast-growing new market segments. Alibaba reported a 76% jump in cloud computing revenues in its latest earnings. And it’s plowing Chinese cash flows into challenging Amazon and Walmart (WMT) in the still-up-for-grabs Indian e-commerce market. “We have a longer term buy on Alibaba, based on cloud and India expansion,” says Ken Sena, CEO of artificial intelligence-based researcher Aiera.
Tencent notched 44% growth in its fintech division, which includes cloud. Meanwhile, Chinese regulators ended a moratorium on approving new videogames, which was casting a shadow over Tencent’s current cash cow.
Baidu (BIDU), a search provider that once formed a troika with Alibaba and Tencent, faces a more muddled future. It failed to develop a constellation of complementary apps on the Google model, investors say. “There’s a lack of strategic focus,” says Edmund Harriss, lead Asia manager for Guinness Atkinson. “They still control search, but that doesn’t account for much time spent online.”
Harriss does find hot prospects, though, in several smaller Chinese internet names, including car dealer Autohome (ATHM), which has crashed nearly 25% since Trump’s trade demarche; online teacher New Oriental Education and Technology Group (EDU), down 8%; and games specialist NetEase (NTES), off 11%. “Tencent or Alibaba attract so many people that you pay up on multiples,” he says. “I prefer these other companies.”
A word of warning: Investors in Chinese internet shares should be prepared for more short-term bumps and bruises, with the political background so opaque. “Alibaba may not be an attractive trade, but as an investment, I like it,” Gillis says. A rough patch for the Chinese economy could strengthen the giant incumbents, as competitors find it harder to attract capital, White adds. “Even in this environment, they are generating a tremendous amount of cash flow, and building an even bigger moat,” he observes. Unless a deluge swamps Chinese business, that should prove profitable down the road.