Solid earnings outlooks put spotlight on lesser-known mainland companies

Investors are driving up valuations on Chinese Internet companies as an almost threefold surge in Alibaba Group Holding Ltd's profits buoyed the earnings outlook for the industry.

Online companies including Vipshop Holdings Ltd, a fashion retailer, and YY Inc, a social entertainment website, have led gains this year on the Bloomberg China-US Equity Index. The gauge, with half of its members focused on Web business, trades at 18 times forward earnings, near a four-year high reached July 28 and up from a multiple of 11 in February.

Investor confidence is growing in companies that provide online services to the world's largest pool of Internet users－some 632 million people－after Alibaba said in June that net income rose to about 23.1 billion yuan ($3.7 billion) in the 12 months through March from 8.4 billion yuan a year earlier. Alibaba, China's largest e-commerce operator, is preparing its US listing in a deal that analysts estimate may value the company at $198 billion, three times what it was in May last year.

"The surge in Alibaba's valuation along with its booming sales and profit help bring people's attention to the quick growth in China's Internet sector and its potential," Tan Chiheng, an analyst at Granite Point Capital Inc, which invests in Chinese equities, said by phone from Boston. "The giant has made quite a few acquisitions that have lifted the targets' valuations. More mobile-focused Web companies can become buying targets."

Guangzhou-based Vipshop has soared 148 percent this year while YY jumped 71 percent, helping fuel a 6.8 percent advance in the Bloomberg gauge of the most-actively traded Chinese companies in the United States. The Dow Jones Internet Composite Index, whose members include Twitter Inc and Groupon Inc, has lost 0.5 percent in 2014. The valuation gap between the two benchmarks narrowed to the smallest since December 2012 last month.

Alibaba's profit soared as sales jumped with shopping promotions and new acquisitions bolstering mobile services. The Hangzhou-based company said in a filing for its initial public offering that it will make investments and acquisitions in areas of mobile, digital media and logistics after announcing 26 deals worth $16 billion since the start of 2012, for companies ranging from online mapping and video to Web browsers.

Companies in the KraneShares CSI China Internet Fund, an exchange-traded fund that tracks Web companies with listings abroad, boosted sales by 41 percent and earnings by 30 percent on average in the first quarter, compared with sales growth of 19 percent and 24 percent profit increase for US Web-focused companies, said Brendan Ahern, managing director at New York-based Krane Fund Advisors LLC. The ETF has rallied 16 percent in 2014.

Guangzhou-based Vipshop's net income surged fourfold in the first quarter this year as sales jumped 126 percent to $701.9 million. YY, also based in Guangzhou, said profit rose 139 percent in the April-June period while revenue doubled to $135.6 million.

"The Internet is picking up momentum in China, the population is vast, and the language, regulation and cultural barriers have made it good for local companies," said Gustavo Galindo, senior emerging markets portfolio manager at Russell Investments.

While Chinese Internet company shares have done "tremendously well," the prices may not reflect the risk that more and more mergers and acquisitions make differentiation more difficult, according to Devan Kaloo, head of global emerging markets at Aberdeen Asset Management Plc.

"The boundary between Internet companies is blurred," Kaloo said in an interview. "They are going to fight each other out. That means there is potentially a big risk to margin compression because of that."

Alibaba bought AutoNavi Holdings Ltd, an online mapping service provider, for $1.5 billion with a 27 percent premium over its market value before the offer was first disclosed in February. The e-commerce company also offered in April to acquire about 16.5 percent in online video operator Youku Tudou Inc at $30.50 per American depositary receipt, 26 percent higher than its closing price before the announcement.

Internet penetration in China is still "much lower" than developed markets and the country just entered a stage when companies can see stable and sustainable earnings growth as their sizes expand, Joohee An, a senior portfolio manager at Mirae Asset Global Investments (HK) Ltd, wrote in an e-mail Aug 6.

"If you consider how big its population is, the leading companies in China deserve a similar level of valuations to US peers," An said.

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