Internet penetration in China has grown steadily. Five years ago only 46% of the Chinese population had internet access, a number that's expected to jump to 56% this year. This growth rate might seem slow at first, but China's huge population means that even a small percentage jump translates into millions of additional users.
During the first half of 2017, China's internet population increased by 20 million, or 1.3%, as compared to the end of 2016. So, the steady growth in internet penetration in the coming years means that millions more people will be getting online each year in China.
China's rapid internet growth means that more people are now using smartphones. In fact, 95% of China's internet population uses a mobile device to get online. Not surprisingly, the country is now crazy about mobile gaming, and users are spending a lot on in-game purchases.
According to App Annie, mobile gaming in China has grown from a $3 billion industry in 2015 to $11 billion last year. NetEase has used this trend to its advantage, clocking terrific revenue and earnings growth over the past few years, as shown below:
The Chinese mobile gaming market should keep getting better since both smartphone and internet penetration in the country have a lot of room for growth. Newzoo estimates that China's smartphone penetration is currently just under 52%, so as more users get smartphones and go online, demand for mobile gaming will increase.
Asian market research company Niko Partners estimates that China's mobile gaming revenue will hit $23.5 billion by 2021. NetEase is in a strong position to tap into this growth -- with an impressive portfolio of mobile gaming titles -- despite a slip in the recently reported quarter. The company's newly released games are very popular, and it is on track to monetize them.
NetEase is in partnership with Microsoft and Activision Blizzard to operate highly popular franchises such as Minecraft and World of Warcraft in the Chinese market. And the company is now moving into international markets.
Mobile gaming supplies 68% of NetEase's total revenue, and it won't be surprising if the company pulls in more revenue from this space thanks to the end-market growth and its solid position there.
What's more, investors can get into NetEase on the cheap. The stock trades at just 20 times forward earnings, significantly lower than the 55 industry average, making it an attractive bet on China's mobile gaming growth.
Baidu missed the mobile revolution in China despite being the country's leading search engine provider, but it has a new way to tap China's growing internet penetration. The company has used its search leadership to get to
Baidu has been aggressively investing in AI in several areas, such as self-driving cars, cloud computing, and smart homes. Its moves in these markets are beginning to bear fruit -- revenue in fiscal 2017 increased 20% year over year. Looking ahead, Baidu can sustain its impressive growth thanks to the integration of AI in fast-growing areas such as the cloud.
The company released a hybrid cloud platform last September to help enterprise customers integrate and deploy more than 60 types of AI capabilities in their operations. Using Baidu's platform, customers can perform tasks such as image, facial and speech recognition; and video content analysis.
Baidu's customers are already using this new platform to improve their businesses, allowing Baidu to consolidate a share of the fast-growing cloud computing market in China, which is expected to be worth $103 billion by 2020.
The company is also seeking to tap into China's growing hunger for video content. Its content investments in its online video platform -- iQiyi -- increased 70% in fiscal 2017 to $2.1 billion as it tries for a bigger share of this booming market. Baidu is currently in a fight with Tencent for leadership in this space, so it has decided to file for an initial public offering to float iQiyi in the U.S.
It's being reported that Baidu plans to raise around $1 billion with this offering, which should allow it to bolster its position in China's online video streaming market, which is projected to be worth almost $18 billion by 2020.
Investors looking to take advantage of China's rapid internet growth should definitely consider Baidu, especially given its attractive valuation. The stock has a trailing price-to-earnings (P/E) ratio of 31, significantly lower than the industry average of 55.
The Foolish bottom line
NetEase and Baidu will be the beneficiaries of growing internet penetration in China. NetEase can target more mobile gaming users, while Baidu will benefit from an increase in demand for video content and cloud computing. With both stocks trading at reasonable levels, that makes them top picks among Chinese internet stocks.
Teresa Kersten is an employee of LinkedIn and is a member of The Motley Fool's board of directors. LinkedIn is owned by Microsoft. Harsh Chauhan has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Activision Blizzard, Baidu, NetEase, and Tencent Holdings. The Motley Fool has a disclosure policy.