China’s diverse listed universe remains the primary vehicle for investors looking to access China’s long-term growth story, there is an increasingly significant opportunity set among its vibrant and diverse unlisted companies.
With companies generally coming to market later, there’s a huge amount of activity in the pre-initial public offering (IPO) stage in China.
The unlisted sector is less well-known, and therefore more mis-priced, offering greater potential upside for investments. Over the years, the unlisted space in China has deepened, and while still not as developed as in Western markets, it does offer plenty of interesting opportunities for the patient, long-term investor.
The Fidelity China Special Situations investment trust has been investing in China’s unlisted companies since it was launched in 2010 and has the ability to invest up to 10% in this space. For example, we were early investors in online e-commerce company Alibaba, which we had held as an unlisted holding for nearly three years before its record-breaking US$25 billion IPO in 2014.
When we analyse any company, we look at three main areas: its ability to generate consistent and high returns over time, the potential for future growth and the strength of its management team. To help us find the best ideas, we have research teams on the ground in Shanghai and Hong Kong. This extensive research capability helps us to identify ideas which haven’t been discovered or are not so well understood by the market.
Investing in the future of China
Our analysts focus on companies that are most likely to benefit from China’s growth and changing economy. For example, China is home to the largest online community in the world, and its internet population is expected to grow to 1.14 billion by 2025 from around 883 million in 2019.1
A key holding in the portfolio is ByteDance, an internet technology company with core domestic Chinese products being its content platform Toutiao and its video-sharing social networking service Douyin. It also currently owns the more globally popular social media app TikTok, although their domestic business remains the key driver of earnings growth. From a market capitalisation perspective, the company has the potential to become one of our biggest holdings. When it does come to the market, we expect ByteDance to be valued north of US$100 billion.
The company has been able to successfully monetise its business with significant online advertising revenues in China. The management has also done a remarkable job of growing the business and the brand globally.
With regard to news about Bytedance’s sale of TikTok, Oracle has become the latest company to enter the race to acquire the social media app’s business after US President Trump ordered ByteDance to divest TikTok’s US operations. Before reports about Oracle, Microsoft had been the lead contender to buy TikTok.
Other holdings include Didi, the ride hailing app, which after its takeover of Uber in China, has over 90% market share. While the company is benefitting from its market dominance, it is also profitable. Of course, there has been a significant drop in traffic due to the coronavirus pandemic, but business is coming back quite strongly as economic activity normalises. Indeed, across China, we continue to observe a slow and steady pick-up in overall activity which suggests that the world’s second largest economy is benefiting from being “first in and fist out” of the pandemic.
We also have a holding in DJI, the leading consumer drone manufacturer which accounts for over 70% of the world’s drone market. With commercial use expected to rise significantly, the company is expected to see strong growth in areas such as agriculture, construction and even movie production.
Pony.ai, the autonomous vehicle start-up based in Silicon Valley and China is another investment. Earlier this year, Pony.ai and Toyota announced a pilot program to test self-driving cars on public roads in two Chinese cities - Beijing and Shanghai. While Toyota has invested US$400 million into the company, the company also has a strategic relationship with Hyundai. Pony.ai has a stellar management team and is a technology leader. To put its business into perspective, there are five leading players globally in this nascent industry, with limited opportunity for newcomers given high capital requirements and advanced technological progress already achieved by the incumbents. Having taken test rides in its cars several times, I can say they compare quite favourably versus human drivers.
Opportunities beyond tech
Besides the technology space, we see opportunities in the consumer space and healthcare where there is a huge amount of entrepreneurial activity, as well as significant research and development that has the potential to reap rewards in the future.
More generally, we remain firm believers in China’s long-term structural growth story and are focused on identifying companies - across both public and private markets - that are best placed to benefit from a growing middle class and the shift towards a more consumption driven economy.
With our in-depth bottom up fundamental analysis, we are uniquely placed to identify - very early on - the many opportunities available among mis-priced companies that offer direct exposure to China’s long-term growth story - in effect: tomorrow’s winners.
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