® OCBC Investment Research absorber awn Sector updates China Internet - Incremental Research Team positives China | Technology China's transformation Digitalisction and disruption Investment summary Since our last 2 reports on 9 July (China Intemet - Headwinds not letting up) and 28 July [China Internet ~ Can't seem to catch a break), the CSI Overseas China Intemet Index has retumed -19% and +3%, testament to the significant volatility in the space on the back of regulatory concerns. There still remains a fair bit of uncertainty on the horizon and the situation remains dynamic. However, we believe that we are starting fo see indications that we are entering into the later half of the regulatory reset within the China Internet space. First, there appears to be a greater desire by the govemnment to engage in more regular and deliberate communication with the market, potentially moving past the initial stages of regulatory campaigns which have caused notable investor confusion and anxiety. Furthermore, we view the recent posture adopted by the authorities when addressing regulations and private enterprises to be net constructive for tisk sentiment in the sector. For instance, comments from the Central Reform Commission meeting strike us as being balanced between regulation and development - terms which have not been mentioned together since late 2020. Second, the nature of developments appear to suggest that we are moving from a phase of fresh (and major) regulatory announcements into a phase of implementation and execution by companies. Self- inspections, investigations and fines could arise over the next few quarters, but the conclusion of these could help fo improve investor sentiment. In our view, such a transition could reflect the possibilty that issues being regarded by the government as being the most pressing have been addressed, Third, the latest earnings season, coupled with the recent post-eamings investor meetings conducted by management teams have given companies the chance to comment on the latest pieces of regulation, thus giving investors some sense of potential impact to fundamentals, if at all. At c high level, a number of major intemet firms have acknowledged impact from regulations, but these are largely manageable (details in the report). Nonetheless, it would be remiss of us not to acknowledge potential tail risks. In our view, these include regulations that effectively nationalize or cause intemet companies to become non-profit, or the unveiling of new/unexpected regulations, such as the extension of gaming regulations beyond minors to include adults. To be clear, these are not part of our base case for now. The road to recovery is likely to be a long and bumpy one, given time needed for (a] companies to complete intemal adjustments based on the applicable regulations across the 4 pillars of our framework, as well as for (b) global investors to regain confidence in the sector again. However, based on the above, for investors with a multi-year horizon, we believe that current levels do present attractive opportunities to gradually begin re-engaging with the sector. Our preferred picks in the sector are JD.com (JD US/9618 HK), Meituan (3490 HK) nd Baidu (BIDU US/9888 HK) at this juncture.@) OCBC Investment Research ee Exhibit 1: YTD performance of CSI Overseas China Internet Index vs. MSCI China 145 138 —CSI Overseas China Internet Index 12 = - -MSCI China 0 Mar 21 Agra Jun2 Aug21 Source: Bloomberg. Intemal estimates Greater engagement with the investment community In Aug'21, the State Council launched regular press briefings on tech regulation. First, on 18 Aug, the council Clafified implementation details on welfare protection for flexible employees in delivery service and ride- hailing platforms. in our view, the details appear to suggest some flexibility as it relates to social pension and insurance contribution for “flexible employees’, Second, on 24 Aug, the Vice Minister of the Cyberspace Administration of China {CAC} highlighted that the recent Regulation on Key Information Infrastructure Protection does not specifically target foreign capital on offshore listings. As we understand, said regulation actually applies to al fims regardless of their nature and planned listing locations, and companies are able to choose their listing options so long as there is adherence to data laws and regulations, and adequate cybersecurity oversight. In our view, these State Council briefings are part of wider attempts by the government to improve its communication with the investment community, even though full clarity desired by investors is sill unavailable at this juncture. We believe this is an important development given that the initial stages of regulatory campaigns appeared (to many investors at least) to be lacking in co-ordination across different agencies and with policy surprises at various junctures. This transition to a stage of greater and more deliberate communication would conceivably be welcomed by the market. Support for the private sector; balancing growth and regulation The Central Reform Commission meeting (30 Aug) declared that the ‘prevention of unbridled expansion of capital has achieved results’, while ‘market order for fair competition has improved’. Overail, comments from. the meeting do strike us as being balanced between regulation and development - terms which have not been mentioned together since late 2020. While there has been notable investor concern over the aims of the recent regulatory reset, the meeting clarified that Beijing's ultimate goals in this respect are centered® OCBC Investment Research absorber awn around (a) growth and security, (b} efficiency and social equality and (c) private sector vitality and social order. In fact, corporate giants wil be supported in 4 key areas, namely (a) technology innovation, (b) enriching market prosperity (c) enhancing convenience in people's lives and (d} increasing intemational competitiveness. Separately. in a speech at the China Intemational Digital Economic Expo on 6 Sep. Vice Premier Liv He affirmed support to private enterprises by acknowledging their significant role in shaping China's economy. He mentioned continued market reforms, opening up and protection of physical and intellectual property rights. In our view, @ sizeable portion of Vice Premier Liv’s speech appears to be similar to the then- leadership's support towards the private sector during a late-2018 symposium, which heralded a transition from regulatory tightening towards more meaningful policy support. Exhibit Vice Premier re-emphasized private enterprises’ prominent role in China's economy Cee Lente Source: Government, intemal estimates Aso on 6 Sep, the CSRC Chairman Yi Huiman mentioned that more capital market opening measures are being discussed, such as the expansion of the Stock Connect eligible universe and global offerings of commodities and financial derivative products. Importantly, Chairman Yi reemphasized that the CSRC will carry on with collaboration on ADR regulation, cross-border audit inspections, as well as law enforcement. Separately, the Vice Chaitman of the CSRC mentioned that China will release domestic listing rules for overseas companies and continue to support Chinese companies listing in Hong Kong. All considered, we believe that policymakers are actively looking for ways to strike a balance between regulation and private sector innovation, and will continue to open up its financial markets in a controlled manner.® OCBC Investment Research Equity Research 23 September 2021 Examining latest developments through the lens of our framework Since late-2020, regulatory newsfiow has been thick and fast, as highlighted by the summary of key legislations below. Exhibit 3: Internet related regulations and news 31-Aug-21 30-Aug-21 BeAue-2 WAveD 20-Aug-21 V-Aue21 V7-Aug-2 26 wh2 yuan semi 2osulan rota anwhat Peeb2 2Now-20 0820 3BApr20 18Now-19 4Now-17 Tow 16 30-Aug-07 w08e7 Draft for comment 30-Aug2 Draft for comment Ae Now 2t Draft forcomment 15ep-21 26-l2 uaa rela © efor comment Draft for comment 1sep-21 7Feb-2 2Now-20 nat 14un-20 a4en-20 aen-a8 sent? Aue 08 vy 38 = CEFR ARATE commerce 5p ERED) ) Pp ABP WRIA MEAT mings rovensng _ (ZERERNSSROERNE (CR Entertinment 32747038" a BEO AIO Information protection (F A(R BA) Uwarconpetton «REMATEMES CINE (FE Dataprvay «(RUS RMORESRNESD - (ATARMRRNTEREORMRT RE Employee Protection gAgrenmeen Advertsing CAPPER NRO SMM (27ePmnuvenvenoRmRA Employee protection weit) (ea sac NTmATMR (TERED w)) aFEREIAAS (nBEsemD2 (STEERER) Pricing Cybersecurity Dotaprvacy (REAR RAMEE IA RaRRShenaTraanamEE Ant-monepoty ATMEMSS AALAND (oo RAMEE RPE Live-streaming Live-streami Cybersecurity (INRA) Doline audio ond videc (HIGHER REE) Unfaircompetition (2 \RRAIBIERESR OA) Cybersecurity (eR ARR SCRUTINISED Antimonopoly (FA BSMIBIEED A) Pricing (@2ARsmmne) E-commerce law of China{arat for comment) National Press and Publi ‘on Further Strictly Managing and Preventing Minors rom Addiction to Online games Requirements on Managing Internet Information See “Algor Recommendction (Draft for Comment) (CAC: tha Notice on intensifying Crackdown en Malpracices in Entertainment Fandoms Personal information Protection Low ‘ules on Banning Online infor Competition (soft for comment) Citieal information Infrastructure Securty Protection equations {Guidonce on Protection of Delivery Riders in nine Food (Order Dever Platform ‘Ministry of industry and Information Technology (MIT's ‘regulation ection gains pop-up od Guidenceon Protection of Employee (draft for comment) ton Administration: the Notice Provisions on Administrotwe Penalties for ilegalPricng (6r0feforcomment) ‘Cybersecurity Review Measures (Revised, Droftfor (Comment) ata Secury Low of China Guidance on Anti-monopoly In Platform Economics ‘The Notice to Enhance the Management of Showroom tive Streaming and E-commerce Live Streaming Law on Protection of Minors of china ‘cybersecurity Review Measures Provisions on The Administroton of Online Audio and Video Information Services ‘Anti-unfair Competition Law of China (bersecurty ew of China Antstast Law of China Pricing aw of China Source: State Administration for Market Regulation, National Press and Publication Administration, Cyberspace Administration of China, The National People’s Congress of the People’s Republic of China, Ministry of Justice of the People's Republic of China, Ministry of Indusiry and Information Technology of the People's Republic of China, Ministry of Human Resources and Social Security of the People's Republic of China, National Radio and Television Administration, Xinhua net, The State Council information Office of the People’s Republic of China, The Central People's Government of the People’s Republic of China, intemal estimates ‘As we approach some of the latest developments in the sector, we believe that itis important to view them through the regulatory framework that we have established in our previous report. In our view, the regulatory landscape over the past few months can be largely organized into the following 4 areas per the exhibit:® OCBC Investment Research abSeptonver Dot Exhibit 4: 4 key pillars on Cad Crud eo rou ee Crores Pee Dl ad Croan Anti-monopoly_ In terms of high-profile anti-trust cases, the market has seen a hefty USD2.8b fine on Alibaba in Apr'21, and is currently awaiting the final ruling of the probe by the regulators into Meituan. However, one of the key developments in focus has been the recent news reports about the Ministry of Industry and Information Technology (MIT) proposing standards on instant messaging including the need to have extemal links unlocked. Following that, we understand that an MllT spokesperson has highlighted also that (a) external links should be viewable in order to ensure good user experience and protect their interests, unless there is a reasonable explanation, and (b) intemet companies need to rectify the issues and the authorities will strengthen monitoring efforts in that regard. We note that Tencent has highlighted that it will comply with regulations and implementation will be in phases, with security being placed as the top priority. In a way, this is not news to the market and we have written on this in our previous sector report back on 28 July 2021 (China Intemet - Can't seem to catch a break]. In essence, we believe that a breaking down of 'walled gardens’ represents a slight net positive for Alibaba and a more mixed/neutral impact on Tencent. This is likely also to have slight negative externalities on other players like PDD. Data/user security As widely known by now, the Personal Information Protection Law (PIPL) will come into effect from 1 Nov 2021. In our view, the PIPL is similar to the General Data Protection Regulations (GDPR|, under which companies and data processors need to provide users with an option to refuse the use of their personal data: for big-data analysis or marketing. Users should also be given a choice whether to opt-in/out relating to the use of their personal data, Based on our understanding, we believe that as a base case, investors are already expecting firms to quickly adjust their data collection algorithms, which could potentially affect monetization ramps in the near-term. However, companies that have previously overused or illegally used data of target users could experience a more pronounced impact, while there could be limited impact for companies that have traditionally@) OCBC Investment Research ee implemented controls in place in terms of handling user data as well as those that have been careful about Using big data for ad targeting or personalization recommendations. Common Prosperity/Youth Protection There have been recent regulations that address certain social topics such as protection of minors/gig economy workers, as well as the more extreme outcomes of the fan-based economy. In our view, the key consequences from these on some of the companies under our coverage should be manageable. The near-term revenue impact on gaming companies as a result of restriction on minors should be limited, while the rise in operating costs for delivery platforms (a) can be potentially shared with other parties, and (b] has at least been initially quantified (ie. by Meituan). Specifically on games, given the level of investor concem, we highlight 2 pieces of recent news and our thoughts. First, we note that according to Xinhua, the Chinese authorities have summoned leading online game enterprises and platforms (including Tencent and NetEase) for talks. Key messages that arose from the meeting include {a) more stringent implementation of anti-adgiction regulation for minors, (b) fully impose time limits on underage gamers, (c} tighten examination of the content of games, (d) prevent unfair competition to prevent excessive market concentration or even monopolies in the industry, (e) break from the solitary focus of pursuing profit or atiracting fans and other erroneous tendencies, {f) restrain celebrity commercial ads, and (g) prevent high-amount tipping and minor tipping behaviour. In our view, this could refiect potential dissatisfaction by the regulators of the current implementation of the new minor game time restrictions thus far, which might have contributed to Tencent’s decision to delay its Lol Mobile launch. Still, we believe that this wave of regulatory tightening could actually benefit the larger publishers given their infrastructure and resources to implement the necessary changes swiftly. Also, we believe that the focus of the regulator is to have companies go beyond the pursuit of profits and look to address other issues like addiction by minors, rather than making gaming companies go non-profit. Second, the SCMP has previously reported that the Chinese regulators have suspended new game approvals, though this has since been corrected to state that regulators are slowing the approvals process instead. This update. in our view. will be welcomed by the market - there has indeed been no new games ‘approved in Aug, but most would attribute this (understandably} to the policy introduction of minor game ime restrictions. Hence, we think this is consistent with the well-held view that while there could be a short period of game approval suspension, this s unlikely to be a repeat of the 2018 episode, where the suspension was related fo restructuring of government units and the formulation of detailed guidelines on the reviewing and approval process. We continue to believe that the key focus for regulators would be on protecting minors, and to that end, we believe that the impact on recent tightening over usage by minors should be limited for major gaming companies like Tencent. A key signpost to look out for One key signpost that we have been and continue to watch out for is the resumption of Chinese offshore IPOs. Per Exhibit 5, it has been clear that such activities have slowed significantly after June. In our view. a resumption of IPO activity could signal that there are indeed measures taken by companies that can give regulators sufficient comfort over key issues such as data security.® OCBC Investment Research absorber awn Exhibit 5: Chinese IPOs in the offshore market have entered a dormant phase since the beginning of July (number of IPOs of mainland Chinese companies by venue) 5 Mainland = SHK = BUS. ous! China A 3HK 204 15 10° Source: Wind, loombert Intemal estimates (as of 13 Sep) What's next from a regulatory standpoint? To be clear, we do not think that this is the end of the regulatory cycle. In terms of next steps, we expect the authorities to work on finalizing remaining draft regulations and implementing the announced policies. More activity is ikely to occur in finalizing the selt-rectification process by companies to ensure full compliance with data security and user privacy regulations. Also, we could see greater efforts by the goverment to ensure gaming companies complete protection of minor users by closing loopholes (e.g. using patent's ID) used to work around time-spent restrictions. We also do not exclude the possibility of time restrictions for minors on short video content, and potentially tighter restrictions on the type of content short video platforms can recommend to minors. Beyond these, we acknowledge that there are bear case scenarios worth highiighting. For instance. regulations that effectively nationalize or cause internet companies to become non-profit and new/unexpected regulatory developments, such as extending gaming regulations beyond minors to include adults. To be clear, these are not part of our base case for now. Encouraging takeaways from management teams JD.com (JD US / 9618 HK) We believe that JD could be relatively well positioned in the midst of regulatory uncertainties, given that the company does not expect changes in tax policies (preferential tax rate on key software entities not applicable in its case], is a likely net beneficiary of certain anti-monopoly rules (e.g. 2-choose-1) and offers comprehensive medical and social security benefits o its 300k fulltime staff, including 250k in logistics. In fact, we understand that following the anti-monopoly regulation, JD has seen large number of brands retum to the platform over the past few months, though it generally takes 6-12 months for 3P merchant sales to ramp up.@) OCBC Investment Research ee Management has also noted that it faces lesser risks especially in data security and user information, and sees limited impact to existing user targeting and ad monetization. It has also conducted self-checks and rectification to protect user data, and has established a sizeable team to oversee data leakage. In relation to the recent consultation paper on algorithms (Guideline on Intemet Information Service Algorithm Recommendation), management opines that what regulators are looking to curb is on price discrimination based on algorithms, and that personalized recommendation is not necessarily negative. Management expects JD Retail EBIT margin expansion in 2022, and over the longer term, targets mid-to-high single digit for JD Retail’s Non-GAAP EBIT margin, Tencent Holdings (700 HK) For Tencent, we believe that impact on recent tightening over usage by minors should be limited. Revenue exposure to those aged <18 was only 6% of its online game revenue from China as of 4420. Management believes that its investment strategies in gaming remains intact, and will continue to focus on R&D and intemational expansion. The company believes its general strategy direction is in line with regulators’ goals for Chinese gaming companies to expand internationally and promote quality games. Management is also not too concerned over the potential loss of long-term appeal of games to younger users as Tencent offers a wide array of entertainment to engage youth above and under 18 years old, On the impact from the PIPL, management believes that this will be manageable, and that it could be simitar to GDPR in Europe, where Tencent is aready compliant. Management notes that they are relatively better positioned for such a change, give (a) it has secured user agreement for data collection upon registration to Tencent’s apps, (b) total ad revenve (high-teen % of total revenue) is lower than that of ad-focused peers, and (c) a lot of firewalls have already been implemented to separate intemational and onshore data repositories, which strengthens data security. On further control over algorithms used by tech companies to personalize and recommend content, as per the consultation paper mentioned above, management sees potential impact on ad network revenue, but the impact will be industry-wide. Management also notes that having diversified content and service offering is in the interest of Weixin users, and the guiding principle would be to balance offerings with user experience and whether extemal operators are wiling to abide by Tencent's rules. Meituan (3690 HK) For Meituan, as it relates to Food delivery, management believes labour cost increase for platforms should be manageable, as policy intention is likely to strike a balance between labour protection and job creation Meituan has over Im daily active riders, of which 35% are dedicated fulltime riders that the company expects to pay social secutty insurance for. The overail impact should be manageable at less than RMBO.5 on rider Cost per order, which they believe can be partially offset by improved delivery efficiency through leveraging technology (e.g. autonomous driving): if the cost were fo go beyond this level, Meituan believes that it would have to share the expense with agencies, merchants and consumers. Also, management notes that 1P full time riders who plan on returning to their hometown in the future could choose residence social security benefits, which are lower than employment social security benefits. Some might also switch to become crowd-soutced riders who do not receive social security benefits in order to maximise cash payouts. Management believes that the Food Delivery business can grow at a 25% CAGR over the next 5 years with 2.2025 operating target of RMB] per order. On PIPL, management sees limited impact as the company believes users come to its platform for the intelligent location-based recommendations and valuable deals. Users cre unlikely to have good user experiences if they choose not to share personal data as 020 services are largely location driven. Hence,@) OCBC Investment Research ee management believes that the majority of users would stil choose to opt-in for transaction/location data, and the overall impact on ad revenue should be small. On the anti-trust investigation, Meituan has yet to receive an official update from the SAMR, and expects an outcome in the next 1-2 months. However, management hos noted that it has not seen any impact on its food delivery business since it stopped the '2-choose-1' practice from Jan'21 (On the back of tightened regulations in the CGP business, players including Meituan have lowered their user subsidies, which affects volume growth but benefits margins. Management is targeting a long-term target of RMBO.2-0.3 profit per item, though it will be more prudent with its investments in this area. Baidu Inc (BIDU US / 9888 HK, For Baidu, management has shared that cloud profitability is ikely to remain under pressure in the near term given the provision of new solutions or entry into new industries. However, margins should improve over time as product lines expand and product cycles/phases mature. in addition, higher margin PaaS and Smart Transportation are likely 1o continue to outgrow laas offerings. Management also notes that the company’s R&D and Al investments are aligned with the government's focus on innovation and technology at a national level, as per the 14th Five-Year Plan issued in March. In terms of the potential impact from PIPL on advertising, management shared that feed ads make up only @ small portion of Baidu Core advertising revenue, while search ads are not based on user algorithms. Hence, management believes that the latest policies should have limited impact on the company.®ocsc Investment Research ANALYST DECLARATION: For analysts’ shareholding cisclosure on individual companies, please refer fo the latest reports of these companies. DISCLAIMER FOR RESEARCH REPORT This report is solely for information and general circulation only and may not be published, circulated, reproduced or distributed in whole or in part to any other person without the writen consent of OCEC investment Research Private Limited ("OIR" or "we". This report should not be construed as an offer or solicitation for the subscription, purchase or sale of the securities mentioned herein or fo participate in any particular tracing or investment strategy. 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