In its 12th five-year economic plan (2011–2015), the Chinese government indicated priority support for several strategically important industries, including the technology sector.¹ As part of the plan, China has pledged support for research and development related to advanced information technology products for mobile communication networks, data management tools for cloud computing, business-to-business (“b2b”) computing, and transportation and logistics planning. There is tremendous market potential for the technology sector due to a growing middle class based on 746 million working people. This huge workforce will support continued strong growth in demand for technology-related goods and services. The combination of increasing government investment and demographics has created many investment opportunities in the rapidly growing e-commerce and m-commerce segments. In this article, we explore two important themes relating to potential investment opportunities in the technology sector in China: the very large home market (consumers and businesses) and the Electronic Silk road that consists of online and mobile communications.

AN OVERVIEW – CHINA’S RISING MARKET CAPITALIZATION IN TECHNOLOGY

The current total market capitalization of publicly traded Chinese technology companies is relatively small compared to the U.S., indicating significant potential for growth as the industry achieves further increases in its scale of operation driven by demand from its home market.

The total market capitalization of publicly traded Chinese technology and communications companies is estimated to be about US$430 billion. This estimate is based on: (i) US$16 billion of technology stock listings in the Shanghai Composite Stock Index,² representing a 1.42% weighting of the overall index; (ii) US$375 billion in tech listings under the Hang Seng Mainland 100 index, and (iii) US$39 billion in listings on the NASDAQ, comprising Baidu and SINA Corp. Table 1 below lists the eight largest by market capitalization.

For a rough sense of the long-term market potential of the technology sector in China, we can refer to the U.S. capital market, which is the recognized global leader in technology. The market cap of U.S. technology equities in the S&P 500 index is about US$2.2 trillion, an 18% weighting. The market cap of technology issues in the tech-heavy NASDAQ Composite index is US$3.5 trillion (however, there are a number of equity issues cross-listed on the S&P 500 index).^{3, 4}

TECHNOLOGY INVESTMENT FOCUS – THE RISE OF E-COMMERCE

China’s twelfth five-year economic plan places special emphasis on supporting research and development related to technology upgrades and modernization projects. Government funding for these initiatives is expected to reach 1.85% of GDP by 2015. Several strategically important emerging industries have been identified by the Chinese Government for assistance, potentially through funding and venture capital investments. These industries include advanced IT development, digital communication products for use in manufacturing and healthcare, and transportation and logistics planning. Strong government support over the next five years for the technology sector will present promising opportunities for investors.

It is especially important to note the rapidly increasing use of e-commerce as a distribution platform and the use of social media in China, which began in the early 2000s. The strong growth in e-commerce has been facilitated by four factors: the development of secure payment systems, reliable infrastructure logistics, increasing urbanization, and steadily rising income levels. In the next sections, we review two investment themes related to investment in the technology sector (including telecommunications) in China.

THEME 1: THE LARGE AND GROWING HOME MARKET

The home market in China attained the second-highest ranking by size in the world (after the U.S.) in the survey outlined in The Global Competitiveness report 2012–2013. Building on the strengths of the country’s market size and the size of its talent pool, several Chinese tech companies have already become leaders in their sectors and markets, both within China and on a global basis. The following are snapshots of several Chinese technology companies that have public listings and have achieved substantial business scales:

• Lenovo Group is the world’s second-largest PC OEM company in the world⁴ and is considered by the Gartner research Team to be the fourth-highest ranked Asia/Pacific-based company in supply chain management, after Samsung, which is rated highest.
• Huawei Technologies Co. Ltd. is the second-largest maker of telecom equipment in the world, just behind Sweden’s Ericsson in 2011 sales.⁵ The company was also ranked the fifth-highest Asia/Pacific-based performer in supply chain management quality in the 2012 Gartner Survey.
• China Mobile Ltd. provides cellular telecommunications services in China and Hong Kong and has reported a total of 683 million subscribers as at June, 2012, of which 239 million are individuals.⁶
• Tencent Holdings Ltd., a service provider of internet, mobile, and telecommunications services in China, is a market leader for the popular instant messaging QQ platforms, with 711 million user accounts. The company is considered a major developer/operator of online games (an IBM study indicated that the global online game market size could reach US$5 billion⁷).
• ZTE is among the top five largest mobile phone vendors in the world, according to reviews conducted by iDC.⁸
• The Sina Weibo service, managed by SINA Corp., has been reported to be the leading microblogging site in China, covering 24/7 news and events.
• Baidu Inc. operates an internet search engine for the Chinese market and had a reported 300 million visitors in 2010.

THEME 2: THE NEW SILK ROAD

The legendary Silk Road, traveled by trade groups, spanned 5,000 miles, running from China to India and Egypt, and to Moscow and other European cities. Today, the Electronic Silk Road in China was developed using the strength of massive technological development and computer processing power, both globally and from creative applications in the Chinese business and consumer markets. The number of online shoppers in China reached 214 million in June 2012⁹ up from 73.9 million as recently as 2008), and total online retail sales in China were about US$119 billion¹⁰ in 2011. With the increasing mobile phone subscriber base (Chart 1) and technological upgrades to mobile devices, it is reasonable to expect that mobile commerce (m-commerce) in China will also embark on a rapidly increasing trend. (It is noteworthy that U.S. mobile commerce accounted for 13% of online retail sales in Q1, 2012.¹¹) Some of the innovative developments in e-commerce include:

• B2B and Business-to-Commerce (“B2C”) mall concepts managed by The China Construction Bank (Hong Kong listing), which provides an e-home as well as financing and e-purchase platforms for consumers and businesses.
• Two large online retail operators (currently private companies), Alibaba.com Ltd. and 360buy Jingdong Mall, accounted for 20.5% and 47.6%, respectively, of the market in China online shopping.¹²

THE FUTURE OF TECHNOLOGY IN CHINA

Future growth opportunities in the technology sector in China are substantial, and the country’s strong market potential can be seen in a few key statistics:

• China’s mobile phone subscription rate is relatively low. (It ranks 114th out of 144 economies based on subscription per 100 population, while the U.S. is ranked 72nd.) Also, China’s broadband internet subscription rate is relatively low. (It ranks 49th, while the U.S. is ranked 17th.)
• China’s mobile broadband subscription rate is low as well. (It is ranked 69th, while the U.S. is ranked 8th.)
• The domestic market size of China is second (after the U.S.) among 144 economies reviewed.

Just one example of the growth potential of the e-commerce market in China can be seen in the rates of mobile phone subscription, which grew rapidly between 2006 and 2011 as shown in Chart 1.

However, there are potential constraints to industry growth that investors should be aware of. These are:

• The two biggest barriers to doing business in China are access to financing and inflation, according to the recently released The Global Competitiveness Report 2012–2013.¹³
• With China’s science and technology upgrade initiatives, including the development of the internet and the next generation of tech products, there may be a need for greater collaboration to facilitate working across international borders. This could require further government review of legal and taxation policies.

Over the longer term, the tech sector in China may expand to neighbouring regions and integrate with the current relatively technology-heavy Taiwan and South Korea markets (Chart 2). New infrastructural development requirements and product realignments in China may be required at that time.

CHINA’S GROWING ECONOMY AND TECHNOLOGY – SOME NOTEWORTHY FACTS

• In 2011, GDP in China reached US$7.3 trillion¹⁴ and ranked second to the world’s largest economy, the United States, with US$15 trillion.
• In 2011, state expenditure in China on research and experimental development¹⁵ was about US$137 billion, or 1.83% of GDP. (By comparison, 2007 R&D expenditures in the United States amounted to US$420 billion¹⁶ or 2.9% of GDP with 64% of the R&D investments made by US businesses.)
• In 2011, China was able to complete both satellite launches and spacecraft missions.

References:

1. “2011 Draft plan for national economic and social development,” National Development and Reform Commission, www.xinhuanet.com, March 17, 2011.
2. Bloomberg data, September 7, 2012 for the Shanghai Composite index and Sept 12, 2012 for the Hang Seng Mainland 100 index data.
3. www.nasdaq.com, September 6, 2012. NASDAQ index members include foreign issuers and market cap weighting is skewed by the 8 largest issues – Apple ($628 billion); Microsoft ($255 billion); Google ($223 billion); IBM ($223  billion); Oracle ($157 billion); Intel ($122 billion); Qualcomm ($103 billion) and Cisco ($101 billion).
4. “2012 Gartner Supply Chain Top 25: Asia/Pacific,” Gartner Inc., July24, 2012 listing.
5. www.reuters.com, July 15, 2012.
6. China Mobile ltd H1, 2012 interim results, August 16, 2012 presentation.
7. “Virtual worlds, real leaders,” IBM Global innovative outlook report, 2007.
8. “Worldwide mobile phone experience,” Q3, 2011 released on oct 27, 2011 and Q2, 2012 study released on July 26, 2012. In Q2, 2012, Samsung and Apple accounted for more than half of the shipments in the world according to IDC study.
9. China Daily, www.chinadaily.com.cn, Aug 20, 2012.
10. China Daily, www.chinadaily.com.cn, May 31, 2012.
11. IBMC.com.
12. Xinhua.net, Aug 15, 2012.
13. “The Global Competitiveness report 2012-2013,” ed. Klaus Schwab, World Economic Forum, www.weforum.org.
14. International Monetary Fund, World Economic Statistics, www.imf.com.
15. National Bureau of Statistics of China, Statistical Communique on 2011 National Economics and Social Development (Feb 22, 2012). Expenditure in Yuan is translated to US$ equivalent at the Bloomberg CNY exchange rate quote.
16. National Bureau of Statistics of China, Statistical Communique on 2011 National Economics and Social Development (Feb 22, 2012). Expenditure in Yuan is translated to US$ equivalent at the Bloomberg CNY exchange rate quote.