China technology sector stock outlook for 2023

It’s been another rough year for China’s tech stocks. Billions are out of the value of the country’s internet giants, incl Alibaba and Tencent and companies posted their slowest growth rates on record.

A Covid resurgence in China, which the government countered with its strict “zero-Covid” policy of quick and hard lockdowns in major cities, has hurt the world’s second-largest economy. Chinese Internet firms have seen a slowdown as consumer spending has been hit and advertising dollars have been reduced.

Investors are entering next year with caution regarding Chinese tech stocks and analysts generally expect regulation to be more predictable and growth to accelerate. But uncertainty about China’s economic outlook creates risks.

Still, signs that China may be thinking about reopening its economy have given investors hope for a turnaround.

“We are bullish on 2023 internet sector outlook in light of reopening story and improving consumer sentiment,” analysts at investment bank Jefferies said in a research note last month.

Since the outbreak of the pandemic in 2020, China has adopted the so-called zero-Covid policy that seeks to use strict lockdowns and mass testing to control the virus outbreak. But those policies weighed on the economy and took a toll on businesses.

Internet giants Tencent and Alibaba posted their slowest revenue growth rates on record in 2022, while electric vehicle makers such as Xpeng saw weak sales as consumer sentiment took a hit.

But there are signs that China’s Covid policy may be reversing.

This month, Chinese Vice Premier Sun Chunlan said the Omicron variant of the coronavirus was less severe than previous versions, a shift in tone from the government ahead of announcements about easing Covid controls.

On December 7, Chinese authorities formalized a raft of easing measures that include allowing some people infected with Covid to isolate at home rather than at government facilities, and removing the need for a virus test for those traveling around the country.

How the exit from zero-Covid is handled may ultimately determine the extent of the recovery for China tech.

“I would argue the prospect of a technological recovery next year depends mainly on the extent to which macroeconomics and consumption in particular can recover,” said Xin Sun, senior lecturer in Chinese and East Asian affairs at King’s College London, per told CNBC via email.

“Given the current extremely depressed level of consumption, largely due to COVID restrictions and also the lack of confidence among consumers, a technological recovery is indeed likely if China can smoothly exit from zero COVID and reopen the economy.”

Analysts generally see growth for Chinese tech names accelerating again in 2023 as the Chinese economy prepares to reopen — but growth is unlikely to be at levels seen in the past, where quarterly revenue rose 30% to 40% has.

According to analyst consensus, Alibaba will see a 2% year-over-year jump in revenue in the fourth quarter of this year, before accelerating to just over 6% in the March quarter of 2023 and 12% in the June quarter. . estimates from Refinitiv.

Tencent, meanwhile, is expected to post year-on-year revenue growth of just 0.5% in the December quarter, followed by 7% in the first quarter of 2023 and 10.5% in the second quarter, according to Refinitiv.

Jefferies said in a note that it sees “online shopping as a sweet spot to embrace the recovery story ahead of advertising and entertainment.” This could benefit companies like e-commerce giant Alibaba and rival JD.com.

Analysts at the investment bank said they expected growth in the online advertising industry to recover in 2023, but warned that growth would be “highly dependent on the macro environment”.

China’s strict Covid policy has been a major headwind for its tech sector this year, but investors have already been spooked since late 2020 when Beijing increased regulatory tightening.

The regulatory crackdown was a big factor in giants posting slower growth rates and hammering their shares.

Since the beginning of 2021 the Hang Seng Technology Index in Hong Kong, which includes most of China’s tech giants, fell by more than 50%.

Over the past two years, Beijing has introduced a range of policies, from new antitrust rules to data protection laws and an unprecedented law governing the use of algorithms by tech companies.

Firms that violated antitrust rules were hit with heavy fines, including Alibaba and food delivery company Meituanas Beijing moved to reign in the power of its Internet giants that until recently had grown largely unchallenged.

The gambling sector has been hit hard. In 2021, regulators froze approvals for the release of new video games and introduced rules limiting the amount of time children under the age of 18 can play online.

The rules spooked investors who were largely caught unawares by China’s regulatory assault on its technology sector.

However, there are signs that some of the regulatory pressure may be easing. Regulators restarted approving games this year, which Tencent and NetEase, China’s two largest online gaming companies. The government has also promised to support the technology sector on several occasions this year.

“Beijing’s top priority this year is economic growth. The repression-style governance is over because Beijing has recognized that spooking markets and undermining business confidence is a bad idea,” Trivium China analyst Linghao Bao told CNBC.

“We have already seen some recent attempts to relax Covid measures and save the property markets. That said, regulations will be here to stay. This means the focus has shifted to a more measured, predictable approach to regulation of great technology.”

From diversification to selling stakes in other businesses, the impact of regulation and a slowing economy is changing the way Chinese tech giants run their companies.

First, Chinese technology firms have cut costs and exited non-core businesses to boost profitability.

In addition to running China’s most popular messaging service WeChat, Tencent is also a prolific investor in other firms.

But the company has recently begun selling stakes in some of China’s biggest companies. As scrutiny of the technology sector has increased, Tencent has sold stakes in some investments, including JD.com and Meituan.

Tencent is also focusing on other areas, including the new cloud computing business and an international push as game sales, one of its biggest drivers of revenue, remain under pressure.

Alibaba, whose China retail business accounts for the bulk of its revenue, is trying to increase sales from areas such as cloud computing to diversify its business.

Beijing has also sought to divest some financially-linked companies linked to technology companies.

Ant Group, the fintech affiliate of Alibaba, was ordered by China’s central bank to become a financial holding company in 2021 after its initial public offering was pulled in November 2020. Earlier this year, Tencent said it was investigating whether regulations would require its WeChat Pay mobile payment service to also fall under a separate financial holding company.

“The crackdowns have fundamentally changed the business logic that these firms must follow… in the past, Chinese tech giants sought to build the so-called ‘ecosystem’, which through aggressive acquisition and integration of different businesses increased customer stickiness and engagement, ” said Sun of King’s College.

“Now they need to scale back to focus on their core business lines and seek revenue growth from optimized operation and innovation.”

While some investors have reason to be optimistic about China’s technology industry next year, they are certainly cautious.

Uncertainty over the path of China’s exit from its zero-Covid policy and the trajectory of the economy in 2023. Several investment banks have cut their China economic growth forecasts over the past few months amid a slump in exports and a downturn in the real estate sector, two important drivers of growth in the world’s second largest economy.

“In my view, the biggest challenge facing tech companies next year is probably still COVID and, as a result, the weak and uncertain economic outlook,” Sun said.

Tariq Dennison, wealth manager at Hong Kong-based GFM Asset Management, told CNBC there are also a number of geopolitical risks, including U.S. investors being blocked from buying Chinese tech stocks in companies being nationalized.

However, he explained that these risks are present but unlikely.

“I don’t think many of those scenarios are that likely,” he said, adding that geopolitical risks are the “biggest collective threat.”

A number of analysts and investors have told CNBC in recent months that the plunge in Chinese tech stocks has made some of them look “cheap” or undervalued.

That’s because stock prices have fallen faster than analysts believe the earnings potential for some of these Chinese tech companies could be.

“I’m more bullish than I was 6 months ago, simply because I think prices have fallen much further than future earnings estimates have had to be revised downward,” Dennison said.

One metric analysts look at is forward price-to-earnings, a measure of a company’s earnings relative to its stock price, expressed as a ratio. A high P/E can indicate that a stock’s price is relatively high compared to its earnings, and may be overvalued.

“The average valuation of China internet names … is 14x 2023 P/E versus 22x of global peers as of November 30,” Jefferies said. “We expect the market to look past the 2022 turmoil and revisit the sector in 2023.”

Indeed, analysts continue to see significant upside for Chinese tech stocks.

On average, analysts have a $134.40 price target on Alibaba’s US-listed shares, indicating roughly 54% upside from Monday’s close of $87.16. Analysts have an average price target of 386.91 Hong Kong dollars on Tencent’s stock, or about 20% upside from Monday’s close of HK$320.40.