China's ongoing crackdown on its top tech companies has rattled investors and crushed the sector's bellwether stocks, including Alibaba, Tencent (OTC:TCEHY), and Baidu.
It's tempting to avoid all Chinese stocks until this regulatory storm ends, but investors should keep an eye on two companies that aren't as exposed to the government's wrath: NetEase (NASDAQ:NTES) and Bilibili (NASDAQ:BILI). Let's see why these companies could actually benefit from the government's recent moves, and why they're generally safer investments than their larger competitors.
NetEase is China's second-largest mobile game publisher after Tencent. It also owns NetEase Cloud Music, the country's second-largest streaming music platform after Tencent Music (NYSE:TME), and Youdao (NYSE:DAO), an online search engine and education platform.
Youdao, which NetEase spun off in an IPO in late 2019, was recently hit by China's crackdown on for-profit education companies. However, NetEase only generated 4% of its revenue from its stake in Youdao last year -- so a complete shutdown of Youdao wouldn't derail its long-term growth.
Meanwhile, China's State Administration of Market Regulation (SAMR) recently ordered Tencent Music to give up its exclusive music licensing rights. That blow could give NetEase Cloud Music, which controls nearly a fifth of China's streaming music market, a chance to catch up to Tencent Music, which still dominates roughly two-thirds of the market.
China's regulators haven't gone after Tencent's core gaming business yet, but they've already blocked its proposed merger of Huya and DouYu, the country's two largest game streaming platforms, and forced it to suspend new user registrations for its monolithic "super app" WeChat. If they also start probing Tencent's mobile gaming unit, NetEase stands to profit from its top competitor's headaches.
NetEase's revenue rose 24% to 73.67 billion yuan ($11.29 billion) last year, led by the growth of its mobile gaming business, but its adjusted earnings dipped 9% as it boosted its marketing expenses (especially for its mobile games and Youdao) and ramped up its R&D investments.
Analysts expect NetEase's revenue and adjusted earnings to rise 21% and 25%, respectively, this year as its core gaming business continues to lock in gamers with popular titles like Fantasy Westward Journey. Those are robust growth rates for a stock that trades at just 21 times forward earnings -- and it could clearly benefit from Tencent's challenges. Its stake in Youdao should remain a sore spot, but it could easily offset those losses with the expansion of its gaming business.
Bilibili, a Gen Z-oriented platform for mobile games and digital content, is one of China's fastest-growing tech companies. It primary focuses on ACG (anime, comics, and gaming) content, and prides itself on hosting a "geek" community for hardcore fans.
Bilibili only lets its visitors become "official" members -- who gain access to exclusive content and perks -- if they pass a 100-question test on ACG content.
Its number of official members, who can be more easily converted to paid users, rose 38% year-over-year to 112 million last quarter. Its monthly paying users grew 53% to 20.5 million, and its average monthly active users climbed 30% to 223.3 million.
Bilibili generates its revenue from mobile games, value-added services (such as virtual gifts for live broadcasters), ads across its gaming and streaming ecosystems, and an Alibaba-backed e-commerce marketplace for tie-in ACG products.
All four businesses generated double or triple-digit sales growth in 2020, which boosted its total revenue 77% to 12 billion yuan ($1.8 billion). Analysts expect its revenue to rise another 63% this year, and none of its core businesses face any significant regulatory threats. In fact, the government's decision to block Huya's merger with DouYu could actually help Bilibili, since it also streams live video games.
Bilibili isn't profitable yet, but it trades at 11 times this year's sales, making it cheaper than many other companies with comparable sales growth. If China eases its tech crackdown, I expect Bilibili's stock -- which tumbled about 30% over the past six months -- to recover faster than those of many of its larger peers.