For sure, the market has been very turbulent about Chinese regulation in the past two months, especially on Meituan, which we have been monitoring. However, we believe the recent crackdown is more sentimental rather than fundamental. And with Meituan trading at around 200HK per share. So we believe now is a bargain to bottom fishing.
I've been busy moving to Shanghai from overseas in the past two months due to personal reasons. Therefore, I haven't had enough time to review the market. Now that I have settled in Shanghai, I could finally get back to work. Here is the review：
Review on Facts that happened:
1. All-China Federation of Trade Unions released a guideline recently that called for better protection of food delivery drivers' rights by online food delivery platforms. This guideline specifies that "platforms and third-party partners shall provide social insurance to food delivery drivers who have established employment relationships and encourage other food delivery drivers to get social insurance."
2. The antitrust investigation of Meituan's "choose one out of two" practice (dubbed "Er Xuan Yi") is still underway. As of August 19, 115 days have passed since the antitrust investigation started. The investigation is still ongoing.
3. China's clampdown on private education firms wiped out a ¥500 billion ($77 billion (USD)) market.
After the assault on the private education sector, all the foreign investors are dumping Chinese ADR and HK stocks. Tencent's valuation even dropped below 20x forward PE. The entire market was in a panic, and everyone was concerned that their sector would be the next private education sector. Economic Information Daily (a Chinese state-run newspaper) published the article titled "Online games: 'spiritual opium' surprisingly became hundreds of billion worth industry." With such a blast on the gaming sector, the gaming companies' shared plunged, wiping about ¥400 billion ($62 billion (USD)) from its market capitalization. We think the market overreacted. This is a good opportunity to buy at the bottom of Chinese internet stocks from the long-term holding perspective.
After the clampdown, the most significant impact is the government wiped out the private education sector. Although the government is proposing to reduce private tutoring, lessen the strain on children, and the cost burden on parents, no regulatory moves were made in the past few years. In the past, with the development of tutoring and the private education sector, new licenses were issued, and administrative regulations were published in the past decade. Those government actions acknowledged the legitimacy of this sector. This clampdown has indeed wreaked havoc on the market economy and confidence in China's policy stability. We believe a large number of foreign investors have little knowledge about China's reality and politics. They trade Chinese companies' stocks and allocate Chinese assets with the direction of the moment. With such great uncertainty, foreign investors were in a panic. The elimination of a sector turned into a systemic risk. All the foreign investors were dumping stocks without considering the cost. An example is ARK Innovation ETF in the US, which held many China concepts stocks and has recently sold almost all its Chinese assets. The percentage of Chinese assets held by ARK dropped from 8% to 0.32%.
ARK doesn't have a deep understanding of China with no analyst with a Chinese background, let alone interpreting Chinese policy. Interestingly, Baillie Gifford Investment (BG) has been upping the exposure during this sell-off. BG loaded up 9.4 million shares of Meituan with a market value of $2 billion (HKD) ($257 million (USD)). BG did in-depth research on China with its Shanghai team, all having Chinese backgrounds. BG invested in a great number of Chinese companies. This can be regarded as smart money in this crisis.
The indices are reflecting this phenomenon. The blue line is China's A-shares with little impact compared to the slump of the US stock market China ADR (white line). Hang Seng China Enterprise Index is in between the two indices mentioned above. The plunge of the three indices also reflects that foreign investors are gradually cutting China-related exposure. After part of the capital exits, it is much more difficult or impossible to rebound to the peak level in the near term. Set Archegos blow up as an example. The stocks could never go back to the peak level (even the fundamentals remain the same with a much lower price). The foreign investment that was scared off by the policy would be regarded as a permanent loss for some time.
Back to Meiturn listed on HK Stock Exchange, let's take a closer look at what Meituan's social insurance means.nThe first thing to recognize is that social insurance shall be provided for Meituan's full-time delivery drivers, not part-time ones. Let's calculate what the actual cost is:
Meituan has 4.7 million delivery drivers nationwide, most of which are part-time delivery drivers. They would only do this job for a short time during the day. Actually, for most delivery drivers, this is a temporary solution, not a long-term career option. Many drivers would rather be crowdsourced delivery drivers (part-time or work with multiple platforms) than Meituan drivers simply because crowdsourced delivery drivers enjoy more freedom and flexibility. If providing social insurance leads to reduced income, we would see Meituan drivers choose to be crowdsourced delivery drivers to avoid social insurance. After all, they are just "outsiders" in the big cities, they will not deliver food all their lives, and they won't stay in big cities forever.
Back to Meituan's unit economy, a ￥0.9 increase in cost would have a long-term impact on UE. Meituan's average sales amount per order already reaches 50, and the increase in average price is not much, which will not result in a significant blow to the demand side. Between, Meituan the platform, and 5.4 million drivers, there is another layer of outsourcing companies. Those outsourcing companies are the real & legal employees of most delivery drivers. Those outsourcing companies would also cover part of the cost. Meituan's long-term profitability would be affected, leading to a 10-15% drop in the 2025 profit level. But the stock has down more than 50% from the peak in February. As the company with the largest number of employees in China, Meituan shall provide certain protection for its employees. For sure, the calculation of the cost is not that relevant. We believe most funds trading Meituan stocks would not drastically adjust the valuation due to a 10% drop in 2025 profit.
The most significant impact on tech stocks is the multiple or market sentiment towards the stock. Meituan reached 400+ at some point due to market sentiment. At the time, the valuation of the community marketplace exceeds $100 (HKD) ($13 (USD)) per share. In such a market environment with so much policy-related uncertainty, the foreign investments scared of by policy would not come back soon. When a large amount of capital flees this sector, Chinese tech companies' valuation will not recover to its original level in the short term. ARK's 8% assets sold off in recent weeks would not come back in the short run. Looking forward, we will not see rapid growth in China's internet sector in the short term.
To some extent, the government clampdown turned a growth stock into a value stock. We shall review the fundamentals. So is the current market price of Meituan the bottom?
Review of Meituan's STOP valuation:
1As for the food delivery business, the management expectation is 100 million orders per day with ¥1 (CNY) per order. The profit for the food delivery business would be ¥36.5 billion (CNY)). The valuation would be ¥730 billion (CNY) (112.6 billion (USD)) based on 20xPE. The corresponding valuation per share is about $140 (HKD) per share, with a 10% discount rate. 2022 discounted value is $106 (HKD) per share. It is very sensible for growth in average profit per order which is volatile as well. ¥2 (CNY) per order can translate into a market sentiment multiple over $200 (HKD) ($25.7 (USD)) per share. Considering that Meituan management generally gives conservative guidance, the overall market valuation of the food delivery business is around $140 (HKD).
The in-store business is the real source of profit for Meituan. There is a large room for growth of in-store advertising. The total offline GMV market far exceeds the online GMV. The total number of Meituan in-store paying merchants is 2.3 million today. The total number of restaurants in China is about 10 million, excluding many stores in the newly-emerged entertainment industry (such as LARP games and escape rooms). The clampdown on the private education sector would stimulate consumption, leading to a huge increase in overall in-store consumption and growth in the service industry. The market expectation for in-store business is 4.5 million merchants in 2025, with ASP of ¥12,000 (CNY) ($1,850 (USD)) for each merchant and extremely high profitability (net profit margin about 50%). The profit for in-store merchants would be about ¥31 billion (CNY) ($4.78 billion (USD)). The valuation would be ¥600 billion (CNY) ($92.5 billion (USD)) based on 20xPE. That of the hotel business would be ¥100 billion (CNY) ($15.4 billion (USD)).
Travel business and other new business: The market valuation towards the Meituan travel business is about $15 billion (USD) (about ¥100 billion (CNY)). On top of that, the valuation towards the community marketplace is ¥100 billion (CNY) ($15.4 billion (USD)), and valuation towards other small businesses is ¥40 billion (CNY) ($6.2 billion (USD)).
In general, the most core and stable business of Meituan -- food delivery + in-store+ hotel + travel values about $1.84 trillion (HKD) ($236 billion (USD)) with a corresponding stock price of $294 (HKD) per share in 2025, discounted stock price of $224 (HKD) ($28.8 (USD)) per share in 2022 with 10% discount rate. However, this STOP doesn't even consider the Community group purchase business, which has a lot of arguments on its valuation. We believe it is also a 10Billion dollar business in the long run, but for the sake of conservative. We don't include the CGP's valuation for Meituan at the current level.
China is on its way to becoming a prosperous country with all people living a better life. The three primary sources of pressure for the middle-class are education, health care, and real estate. The Chinese government is actively looking for solutions to these problems. The parents can save thousands of dollars of tutoring fees after the private education sector clampdown, which can be spent on food and entertainment. The takedown of the education sector would benefit the development of the consumption and internet sector in China. Although the short-term regulation seems horrifying, it also paves the way for long-term, high-quality growth.
There are various investors in the market. Some investment follows the thematic investing strategy that focuses on the long-term trend of capital flow; some investment follows quantitative investing strategy. In contrast, some investment focuses on trends and patterns of charts. From the perspective of cash flow and profit, the current market price of Meituan is cheap indeed. It is believed that the price would recover after the market sentiment stabilizes. For a large cap company like Meituan bottom fishing is the best way to generate huge return. Therefore, we shall buy in the stock at the moment with a noticeably cheap valuation. An opportunity like this is rare.