What is driving the rally in Chinese internet stocks?
Two forces are pushing money into Chinese tech. First, a global rotation. This year the only winners from the AI build-out were chip makers. Now money is moving out of the chip makers and into the software companies that use those chips. In China that means the internet giants held in the KWEB software ETF: Alibaba, Baidu, and Kuaishou. These are China's hyperscalers, the ones spending the capex, buying the chips, and investing for the future. I see extreme growth potential in them. This rotation has been building for a while, and it looks like it is finally happening. Whether it starts now or a bit later, it is only a matter of time.
Inside China the split has been stark. On one side sits the hardware, the AI "picks and shovels." On the other side sit the software companies that spend on AI and deliver it to end users. The gap shows up in the numbers: the KWEB software ETF is down 20% on the year, while KSTAR is up 70%.
The Alibaba case
The story is more than a rotation. Real tailwinds are stacking up. Multiple analysts spoke out yesterday morning US time, late night at the Hong Kong market close, saying Alibaba's cloud growth will beat the 45% year-over-year growth the company projected. They also expect margins to finally improve. E-commerce in China has been very competitive, which squeezed margins and hurt investor sentiment. Add heavy AI spending, and margins and earnings per share have been very tight. Margin improvement would help Alibaba and the whole China internet space a lot. That will not show up until these companies report, possibly Q2, which is a couple of months away. Still, the outlook for the KWEB names is more upbeat.
Other supports for Alibaba: a JP Morgan shout-out to Tencent over its WeChat AI agent; a report that Alibaba holds 40% of China's full-stack AI cloud market; reports that its Q1 e-commerce profits may have resumed growth; and a report from The Information that it might launch a 2.7 trillion parameter model. After many quarters of work that recently came at a cost, these companies may finally be getting praise from investors. Two sessions are not proof of a wider trend, but it points that way.
Why IPO spin-offs matter
Fresh listings are helping too. Baidu, held in the portfolio, is spinning out its chip-making arm, Kunlun. Kuaishou is spinning out its video generation company, Kling. These spin-offs force the market to value the parent companies on a sum-of-the-parts basis, which is winning them more recognition. It is early days, but the spin-offs are helping and will keep helping.
The Chinese memory chip story: CXMT
Mainland A-shares have been outperforming Hong Kong. The STAR Market and the ChiNext, a Nasdaq-style tech-heavy board, are ripping compared to Hong Kong. The KSTR ETF, which holds the top 50 STAR Market names and is mostly chip makers right now, is up 70% year-to-date.
CXMT is an exciting listing coming to the STAR Market, and I will try to add it to the portfolio for clients. Apple is working to use CXMT as a key partner for memory chips. This targets a real problem: a global shortage of memory chips that has pushed prices up. That shortage has already pushed Apple toward raising prices on simple products like iMacs and iPhones, which it does not want to do heavily. Chinese memory chip makers like CXMT make quality products cheaply, cheaper than rivals in the US, Korea, and elsewhere. Apple's logic: it needs huge volumes, the chips do not have to be the world's most advanced, they just have to build iPhones and iMacs, so it will buy from CXMT if it can. The big "if" is tricky regulatory and geopolitical roadblocks, but the move makes the most economic sense for Apple.
CXMT has set its fundraising goal. Book building starts next week ahead of its Shanghai IPO, with subscriptions later this month. It aims to raise just over $4 billion at a valuation of $40 to $45 billion. Apple is reportedly testing CXMT memory for its made-in-China goods. For comparison, SK Hynix is listing its ADR on the Nasdaq tomorrow.
Another memory name, Yangtze Memory, could also list later this year. This is a big moment for a Chinese memory chip sector that flew under the radar. It mirrors what happened with SanDisk earlier this year: old, stodgy corporations now see strong demand for relatively stable products. Advanced chips are so supply-constrained, and demand so high, that companies are hunting for alternatives. The Chinese government is also encouraging these firms to tap capital on the stock market.
