This is for investment professionals only and should not be relied upon by private investors

March 2014

Chinas mobile internet revolution

Chinas internet sector has reached a new stage of development,
fuelled by commoditisation of the smartphone market. As companies
continue to migrate their business from PC to mobile, monetisation of
online channels is growing rapidly. Those players that have a large user
base and clear revenue strategies are likely to win out in fact shares
in some of these companies have already soared and may be due a
correction. Recent financial reforms are also providing a tail wind for
internet finance although this may prompt increased regulation.
SMARTPHONES AND MONETISATION
Commoditisation of the smartphone market in China is being driven by lower-cost,
domestically-produced smartphones, especially within rural areas. In a country where
there is almost 100% mobile penetration monetisation of the internet is being spurred
by mobile gaming, increased e-commerce and new forms of mobile payments.
By the end of 2013, the number of mobile phone users in China exceeded 1 billion,
with more than 50% of these being smartphone users. Gartner estimates that the
penetration rate for smartphones in China will reach 90% or higher this year. However,
foreign smartphone shipments to China in 4Q 2013 fell by 4.3% Q-o-Q, the first drop
since 2Q 2011. This is because local smartphone brands, such as Lenovo, Xiaomi and
Coolpad, are pricing at around half the price or less than the latest Apple iPhone. The
average purchase price of a smartphone in China dropped to RMB 1,773 (US$286) in
2013 from RMB 2,321 in 2011, with the lowest-end smartphones a good deal cheaper.
Price trends of smartphones in China (RMB)

2500
2321

2300
2150

2100

1995

1900

1773

1700
1500
2010

2011

2012

2013

Average price of mainstream smartphone brands in China, 2013 (RMB)

5000

4361

4000
3103

2763

3000

2170 2191

2000
1000

1441

2496
1789

857

Source: Internet Consumer Research Centre, ZDC.zol.com.cn, 2014

832

AT A GLANCE
Lower-cost local smartphones are
pushing higher penetration rates for
smartphones in China
Monetisation of Chinas huge user
base is driving rapid growth
Mobile gaming to remain a sweet
spot, platform operators to benefit
Mobile Internet is a new ecommerce growth engine in China.
More vertical M&A to feature amid
physical and online integration
3rd-party payment service
providers fuelling online investing
Internet finance growth to continue,
greater regulation likely.

With the emergence of affordable, domestically-produced smartphones, many people in

rural areas will be able to access the internet for the first time via mobile phones. According
to recent research by Analysys, an IT consulting firm in China, 62% of mobile internet
users earn less than RMB 4,000 per month, with migrant workers comprising a large part
of this total. However, as part of the 12th five-year plan, China has set itself the task of
helping rural areas catch up with the more affluent cities. In line with this objective, the
government is trying to increase internet coverage to improve connectivity. The National
Broadband Strategy aims to achieve 85% fixed broadband penetration and 95% 3G/4G
user penetration by 2020.
The recent US$19 billion acquisition of messaging service WhatsApp by Facebook reflects
the potential of mobile internet monetisation. WeChat, a messaging service owned by
Tencent, is arguably ahead of WhatsApp in terms of having a clear strategy and initiatives
to monetise its large user base. Many investors have already cottoned on to this potential
and Tencents share price soared over 90% in 2013 alone. WeChat has 600 million users
in China currently (and 100 million overseas) numbers that would be extremely difficult to
replicate anywhere else. With WeChat, Tencent will likely surpass its success with PC
Internet users and benefit from the new type of consumer behaviour emerging via the
mobile internet.

Several of the most impressive

companies that Ive met in China
are in the internet area and these
are companies of a size where they
are able to make an impact on a
world scale Anthony Bolton,
President of Fidelity Investments

What is WeChat:
WeChat is Tencents mobile instant messager (IM) and platform, with various
functionalities embedded, such as: 1) mobile SNS via Moments (); 2)
mobile gaming; 3) payment/asset management services; 4) e-commerce; and 5)
O2O channels (services such as booking a Taxi, buying lottery tickets, etc. It is
often called Chinas equivalent of WhatsApp for their same functionality,
although WeChat has gradually turned into a quasi-mobile operating system,
rather than a standalone app.

MOBILE GAMING
The Asian region has the highest number of computer game players globally. Mobile
gaming revenues in Asia have grown five-fold in the last two years alone and are likely to
remain a sweet-spot for monetisation in the years to come. Given this trend, it is likely that
leading PC game developers will ramp up production of mobile games, and mobile game
platform operators will likely be big winners due to their strong distribution power and fee
revenue from developers and gamers alike.
Entertainment is a key factor for internet usage in China in particular, with online gaming
hugely popular - especially among lower income youth due to easy access and
affordability. By leveraging its large user base, Tencent has established clear revenue
streams from online games, which have contributed more than 50% to its total revenue
since 2010. With smartphone commoditisation, mobile games will likely sustain this growth
momentum as online gaming enterprises continue to migrate from PC to mobile.

There are still plenty of growth

opportunities in China as more
Chinese get online to shop and
engage in social activities. As more
people use the internet there are
spin-off industries emerging, such as
online security and cloud computing
to deal with rising traffic Teera
Chanpongsang, portfolio manager,
FF Emerging Asia Fund

According to iResearch, smartphone game revenues in China increased almost fivefold to

RMB 9.2bn in 2013 from 2012 and are expected to double this year. It also expects the
share of mobile gaming to expand from 11.6% in 2011 to 20.6% of total gaming, while PC
games will decline from 76% to 65.5%.

2011-2017 Market Structure of Internet gaming in China

100%
80%

12.4%

14.6%

11.6%

13.1%

17.8%

18.3%

18.1%

18.1%

18.1%

16.7%

20.6%

24.6%

28.2%

31.4%

61.1%

57.4%

53.7%

50.5%

2014e

2015e

2016e

2017e

60%
40%

76.0%

72.3%

65.5%

20%
0%
2011

2012

2013e

PCClient

Mobile

PCbrower

Source: iResearch, 2014

E-COMMERCE BONANZA
Thanks to the growing penetration rate of smartphones, the mobile internet is becoming a
new growth engine for e-commerce in China. Online shopping is booming because of its
convenience and cost-effectiveness. And its not only young affluent urban dwellers who
are purchasing luxury items online at cheaper prices than shopping malls - residents in
less developed regions are also buying products that are not available in their home towns.
Online transactions reached a value of Rmb1.9bn in 2013, accounting for 7.8% of total
retail sales in China, iResearch data indicates. And the total transaction value of mobile
shopping in China grew by 165% to RMB 168 billion, taking a 9% share of the total online
shopping market (versus 4.8% in 2012), and is likely to reach RMB 1 trillion by 2017,
accounting for almost a quarter of the total e-commerce space (B2C and C2C). Going
forward, the share of mobile shopping will continue to rise.
There are two main reasons behind the migration of Chinese online shoppers from PC to
mobile. Firstly, e-commerce giants such as Alibaba (the largest C2C e-commerce player in
China and a company which is part eBay, part Google and part PayPal) and JD (Jingdong
Mall, formerly called 360Buy and one of the largest B2C online retailers in China) are
encouraging users to adopt mobile shopping through heavy promotion efforts. Secondly,
more consumers are deciding to use their fragmentary time to shop online via their
smartphones and tablets as opposed to stepping down the mall.

2011-2017 Transaction value of mobile commerce in China

(RMB)

998.47

1000
800

716.25

600

495.31

400

320.34
167.64

200
11.68

63.17

0
2011

2012

Source: iResearch, 2014

2013e

2014e

2015e

2016e

2017e

2011-2017 percentage split of e-commerce between PC and mobile access in

China
(RMB bn)

100.0%

1.5%

4.8%

9.1%

13.1%

16.4%

19.9%

24.1%

90.9%

86.9%

83.6%

80.1%

75.9%

2013e

2014e

2015e

2016e

2017e

PC

Mobile

80.0%
60.0%
98.5%
40.0%

95.2%

20.0%
0.0%
2011

2012

Source: iResearch, 2014

Tencent is perhaps best positioned to tap into mobile commerce due to its large user base
and the functionalities embedded into its WeChat messenging platform. For example,
during the period leading up to Chinese New Year 2014, WeChat launched a Red Packet
feature allowing users to send virtual money to friends and designated chat groups via its
WeChat payment system. This move paves the way for future monetisation of mobile
commerce by essentially turning WeChat into mobile wallets. In future, with the likely
rollout of more virtual shops and lifestyle-related features (in addition to existing mobile topups and taxi booking capabilities), WeChat could become a one-stop online lifestyle
service platform, putting the e-commerce business in a strong position for future growth.
Other large e-commerce operators have lost no time recruiting more users by launching
similar mobile IM tools, such as Alibabas Laiwang, Neteases Yixin and Sunings Yunxin.
Theyve also made efforts to partner with telcos to lower the traffic threshold to acquire
mobile users. Even though Alibaba is the undisputed market leader in e-commerce (90%
share in C2C and 50% in the B2C space) thanks to its strong ecosystem in PCs, it still
needs to catch up in the mobile space. Last year, in collaboration with China Unicom and
China Mobile, Taobao (Alibabas online shopping website, similar to eBay) launched a
free traffic plan by subsidising users of mobile Taobao and Laiwang in some cities with
2GB of free traffic per month.
As e-commerce in China enters a more mature phase, the focus is shifting towards the
logistics front, including timely delivery of goods and low-cost storage for sellers. In
January, Tencent bought 9.9% of China South City to gain access to its warehouse and
logistics businesses. Prior to that deal, Alibaba invested RMB 2 billion in a logistics
partnership with white goods supplier Haier. The trend of Physical+Online service
integration will likely continue and more vertical integration M&A deals are expected in the
near future. In fact, both Tencent and Alibaba (which has applied to launch an IPO in New
York) have established private equity arms to invest in companies that can create
synergies with their existing business. These developments will likely bring investment and
trading opportunities for investors.

INTERNET FINANCE: A NEW DAWN

As online third-party payment services have developed in tandem with Chinas ecommerce industry there is also scope for the conversion of online shoppers into online
investors, paving the way for internet finance. This is happening just as China is reforming
its financial system.

Alibaba is the dominant market leader in the C2C space (via its subsidiary Taobao),
enjoying a 90% share. Even though about 80% of netizens in China use credit cards
online, when shopping on Taobao they tend to go through Alipay (third-party payment
service provider owned by Alibaba) instead as most goods sold on Taobao are of low
value and customers are reluctant to pay the 1% service charge if using a credit card. And
most sellers on Taobao are small businesses and not willing to absorb the 1% additional
cost either. In addition, Alipay, acting as an escrow account for online transactions, does
not transfer the money to the seller until the buyer confirms receipt of the product
purchased. This feature also makes Alipay more preferred by shoppers than credit cards.
Alipay has accumulated billions of sink funds (the money paid by shoppers which is not
transferred to sellers and shoppers idle money in Alipay accounts). Holding a huge
amount of client money in the form of sink funds became a controversial issue for Alipay.
Last year, Alipay struck a partnership with Tianhong Asset Management and launched a
MMF to manage these sink funds, namely YuE Bao. This has not only helped Alipay stay
compliant, but also serves as an effective cash management tool for its customers.
A T+0 feature enables money to easily flow between users Yu'E Bao accounts and Alipay
accounts. Over 80% of the assets of YuE Bao are invested in interbank deposits and the
return is currently around 5% per annum, beating the bank deposit rate, which is capped at
1.1 times the benchmark rate (3% last year). Since the launch in June 2013, the AUM of
1
YuE Bao has grown to RMB 500 billion to date . The instant success of YuE Bao has
spurred almost all major China internet companies, including Tencent, Sina, Soufun,
NetEase, and Shanda to offer cash management products. As such, Internet companies
have introduced MMFs to a new group of investors e-commerce (and mobile internet)
users, and built a connection between bank deposits and MMFs.
As a key element in Chinas financial reform plans, interest rate liberalisation will also likely
spur development of the Internet finance sector. At this stage, the focus of interest rate
liberalisation is on deposit rates, which will be a gradual process. In the interim stage, there
will likely continue to be a gap between the overnight interbank rate and the savings
deposit rate. Internet companies, who are lightly regulated compared to traditional financial
institutions, have moved to capture this regulatory arbitrage opportunity.

Overnight SHIBOR and saving deposit rate

The fast-developing internet finance sector has already entered the territory of traditional
financial institutions. However, the rapid growth of MMFs has raised the potential for
liquidity risks. Zhou Xiaochuan, governor of the Peoples Bank of China, said that China
will not apply a heavy hand to internet finance but will improve regulation in the area2. At
the National Peoples Congress which ended March 13, internet finance was mentioned in
the official government work report for the first time. Premier Li Keqiang noted: "We will
promote the healthy development of internet banking and improve the mechanism for
coordinating financial oversight 3.
Under Chinas patchwork regulatory system, the PBoC will spearhead regulation of internet
finance, but there will be complex coordination among other regulatory bodies overseeing
capital markets and banks. Though internet companies have been less subject to
government interference, going forward, regulatory issues could emerge as a new element
that investors need to pay more attention to.
References
1

http://finance.caixin.com/2014-02-27/100643946.html

http://www.globaltimes.cn/content/846086.shtml

http://news.xinhuanet.com/english/special/2014-03/05/c_133162141.htm.

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