HK Housing: Fear of Losing Out Part 2 – Money Supply

According to my high school economics teacher, the price of a product is set at where the supply and demand curves intersect. Theoretically, if some force were to act on the supply or demand curve and shift it inwards or outwards, this will result in a new equilibrium price. This is how things are supposed to work.

Source: Wikipedia


As we noted last week, Hong Kong’s housing supply has increased by 31% over the past three years. Whether this was due to higher prices causing developers to increase supply (i.e. moving up the supply curve) or a more proactive government supplying land (i.e. an outward shift in supply curve) is up to debate. What is clear is that supply has definitely increased.

Ironically, Housing Demand is Driven by Money Supply

This week, we turn to the demand side of the equation. Ironically, in order to gauge housing demand, we will be looking at “Money Supply”.

M1, M2 and M3. No, not BMW’s but Money Supply

Embed from Getty Images

Simply put, money supply is how much money there is in circulation or in existence in a country. Economist generally measures money supply using three terms – M1, M2 and M3.

  • M1 is the narrowest definition. In Hong Kong, it would include all of the physical notes and coins in the hands of the public as well as demand deposits in the bank. As of Oct 2017, Hong Kong’s M1 money supply stood at HK$2,997bn.
  • M2 includes all of M1 and adds all of the deposits with licensed banks (i.e. savings deposit, time deposit and negotiable certificate of deposit). As of Oct 2017, HK’s M2 money supply was HK$13,951bn, roughly 4.7x the size of M1.
  • M3 includes all of M1 and M2 and further adds deposits with restricted licence banks and deposit taking companies. In HK, M3 is only slightly larger than M2 at HK$14,003bn.

M3 has increased 27% over the past three years

Over the past three years, Hong Kong’s M3 money supply has increased by 27% from HK$11trn to HK$14trn. Narrow money supply, M1 (i.e. the notes and coins in circulation as well as demand deposits) increased by 71% from HK$1.75trn to HK$3trn.

chart (33)

If one were to go back to the onset of the Global Financial Crisis back in October 2008, Hong Kong’s broad money supply, M3, has more than doubled, rising 131% from HK$6trn to HK$14trn.

Incidentally, home prices have risen 27% also

Incidentally, between October 2014 to October 2017, Hong Kong’s home price index has risen by 27%. And between October 2008 to October 2017, the Rating & Valuation Department’s home price index has increased by 196%.

chart (34).png

That’s the past, what about the next three years?

Looking back, we can reason that with a larger pool of cash shifting out the demand curve, asset prices have increased. Now, the questions is what will happen to Hong Kong’s money supply in the next three years?

The way that I see it, there are three factors at play.

  1. Potential in/outflow of global liquidity
  2. Will HK banks increase their loan-to-deposit ratios?
  3. Change in reserve ratio and discount rate

Central Bank balance sheet expected to shrink sometime in 2018

Hong Kong being a small open economy has and will be subjected to change in global liquidity conditions. Over the past 10 years, a big driver of its money supply has been the expansion of the various Central banks’ balance sheets. Looking ahead, with the US Fed starting to allow its holdings to roll off and the ECB expected to taper its asset buying program, Central bank balance sheets are expected to start to shrink sometime in 2018.

Screen Shot 2017-12-04 at 3.57.31 PM
Source: JPM AM via Business Insider

Will HK banks increase their loan-to-deposit ratios?

Assuming that global liquidity flows are unchanged, another way to increase money supply would be for the banks to increase lending by raising their loan-to-deposit ratios. As of October 2017, Hong Kong banks’ loan-to-deposit ratio is only around 71%. Although this has risen by more than 10pp since 2008, one could argue that there is still scope for this figure to head higher and banks to lend more.

Screen Shot 2017-12-04 at 4.11.54 PMHowever, if one were to consider the rise in household debt, I have my doubts on how keen the banks are to further increase their lending to households.

According to the HKMA’s Half-Yearly Monetary and Financial Stability Report, Hong Kong’s household debt-to-GDP ratio has climbed to 68.3% in 1H 2017. Two things shout out at me when I look at the chart below. Firstly, 68.3% is the highest household-debt-to-GDP that Hong Kong has seen since 2000 when the data started. Secondly, look at the breakdown of this debt. Mortgage and credit cards have remained broadly stable but “Loans for other private purpose” has driven almost the entire increase in household debt.

Screen Shot 2017-12-04 at 4.12.43 PMI’m not sure what this is but judging by the commercials on prime time television, it is probably people consolidating their credit card debt or taking out high interest loans to fund their down payments to fill the gap from residential mortgage LTVs have been capped.

For now, as long as liquidity is plentiful and asset prices are rising, this number may yet rise. But my guess is that when the tide goes out, this would be one of the charts that people point to and say we should have seen it coming.

Change in reserve ratio and discount rate

Just like the first two questions, the reserve ratio question is debatable. Some would argue that although the discount rate has risen from its low of 0.50% to 1.50%, it is still very low and Central banks would surely come to the rescue and cut reserve ratios and discount rates on any sign of trouble.

This could happen but unlike 2007 when the discount window was reduced from 6.75% to 0.5% within a span of 18 months, there is a lot less ammo this time around. Furthermore, with the HKD pegged to the USD, for our base rate to be cut, it would require a synchronised downturn with the US.

chart (35)

Three key takeaways on demand

  • Hong Kong’s money supply has increased by 27% and 131% since October 2014 and October 2008. This is coincidentally close to the 27% and 196% increase in local home prices over the same period.
  • Will HK’s money supply continue to expand in the next three years? Well, we know that:
    • the G4 Central bank balance sheet is expected to start shrinking sometime around Q2/Q3 2018.
    • Although overall LDR at 71% is still low, HK’s household debt-to-GDP ratio at 68% is the highest that it’s ever been at. Furthermore, this increase has almost entirely been driven by “Loans for other private purpose”

For the die-hard property bulls, yes, it is possible that Central banks can put off shrinking their balance sheet and banks can increase their lending even more. But, with the Fed clearly spelling out their asset reduction program and household debt-to-GDP at the highest levels ever, to hope that Hong Kong’s monetary base will expand at the same pace would require one to turn a blind eye to some clear and present risks.




HK Housing: Fear of Losing Out? Part 1 – Supply Snapshot

If after ten minutes at the poker table you do not know who the patsy is—you are the patsy.      Poker Proverb

Hong Kong is one of the most expensive and most unaffordable housing markets in the world. This has been the case for years but 2017 has taken us to new heights. Year-to-date, home prices have soared another 11%. Through the first 10 months of 2017, home buyers have snapped up HK$199bn of new homes, up a staggering 36% over the same period last year.

chart (31)

The fear of missing out

One of the biggest problems with buying a home is the emotional attachment. For most people, your home is the biggest investment you ever make. If you buy and the market falls, you risk a drop in your net worth. If you don’t buy and the market keeps going up, then you worry about the decline in your purchasing power. In a rising market, there is a huge fear of missing out.

Trust the process? Have the fundamentals change

With home prices having risen 28% over the past three years, my fear of losing out is starting to get the better part of me. Do you chase the market or do you trust the process? Have the fundamentals change to make this expensive market reasonable?

Taking a fresh look at HK housing supply

As a starting point, let’s take a look at Hong Kong’s housing supply picture. Although I’ve seen some of the headlines, I haven’t spent a lot of time with the detailed supply figures  for a few years. As I updated the various data points, I was struck by how much bigger the supply figures have become.

Primary supply up 31% since 2014

In December 2014, Hong Kong’s private primary housing supply (i.e. the amount of stock on the hands of the developers) was 74,000 units. As of September 2017, this figure has now reached 97,000 units, an increase of 31%.

chart (29)

Current supply equals 64 months of sales

Although housing sales (red line above) have also increased, supply (blue line above) has clearly outpaced demand. If one were to look at supply in terms of the number of months inventory (total supply divided by average monthly sales), the current supply pipeline is equal to 64 months of sales.

chart (28)

64 months is not particularly high in the historical context. In fact, since the data began in Q3 2004, the long run average months of supply has been 70 months. And when demand was particularly weak, the effective months of supply have been more than 150 months and as high as 208 months.

Composition of supply: Is it creating a false sense of shortage?

As I reviewed the supply picture, another key aspect that struck me was the composition of this supply. The Hong Kong government splits housing supply into (1) unsold units from completed projects, (2) unsold units from project under construction and (3) unsold units from disposed sites.

Since developers are allowed to pre-sell units within 20 months of completion, (1) and (2) [or the red and blue areas below] would represent the readily available supply that potential home buyers would see. However, as construction works begin on disposed sites, over time, the yellow part of the supply picture would transition to the red part, increasing the apparent supply to the market.

chart (30)

If one were to look the breakdown of housing supply, we can see that the percentage of supply where construction has not yet started (i.e. long dated supply) is now at 32%, near the highest that it has ever been at. On the flipside, the percentage from unsold units in already completed projects (i.e. leftover units) is at 9.3%.

chart (32)

At this point, there is little incentive for developers to clear stock. However, if future demand should weaken and long-dated supply starts to turn into ready supply, the goldilocks environment that has driven price up 11% and primary sales up 36% may be difficult to replicate in 2018.

Three Key Supply Takeaways

Next week, we turn our attention to demand, specifically, how much money there is to chase after Hong Kong’s housing stock. In the meantime, our three supply takeaways are:

  • Private primary supply has increased 31% over the past three years to 97,000 units.
  • Although demand has been strong, supply has risen even faster At 97,000 units, this is equal to 64 months of supply (based on elevated demand).
  • The current supply mix has created a “false” sense of supply shortage. Of the 97,000 units, 32% are from recently disposed sites for which construction work has yet to start. As construction begins, ready-for-sale units will increase and potentially alleviate the perceived supply shortage.

How instant noodles reflect where you’re from?

When I say “Instant Noodles”, what’s the first image that comes to your mind?

Do you think of the cake of instant noodles that you cook in boiling water and add the packet of MSG? Or do you think of something more along the lines of “Cup noodles?”

Your choice of instant noodle says a lot about you

Before we go into how the type of instant noodle reflect who you are, let’s start by firstly reviewing the instant noodle market in Hong Kong and China.

Instant Noodle Market Growth is Anaemic in both HK & China

According to an industry report from Frost & Sullivan, Hong Kong’s instant noodle market was worth around HK$1.8bn. Over the past four years, growth has been anaemic with sales value only rising 0.5% p.a. while sales volumes have actually contracted by 1.3% p.a.

chart (14)

Although China’s instant noodle market is much bigger, it is also not growing much. The Rmb81bn of instant noodle sales in 2016 only represent a p.a. growth rate of 0.4% over the 2012-2016 period. Volume wise, the number of instant noodle serving has actually fallen by 3.9% p.a.

chart (15)

Who eats more instant noodles?

In absolute terms, China’s 37.2bn serving of instant noodles is 90x larger than Hong Kong’s 415mn servings. However, if you consider that China’s 1.3bn population is actually 186x larger than Hong Kong’s 7 mn population, the data actually shows that Hong Kong people actually eat more instant noodle than their mainland cousins.

HK 59.2 servings Vs. China 28.6 servings

In 2016, Hong Kong people ate 59.2 servings of instant noodles, almost twice as much as the average 28.6 servings consumed by those in China.

chart (24)

What do you eat? Cups, Bowls or Bags

When we examine the data further, we see another interesting distinction between Hong Kong and China’s instant noodle connoisseurs. In Hong Kong, bag-type instant noodles make up nearly two-thirds of the overall sales volume. In China, the mix is almost 50/50 with bags taking up 53% of sales.

chart (18)chart (19)

In this respect, if you associate instant noodle with those that come in a little plastic bag that you cook yourself, then you’re most likely from Hong Kong. Conversely, if you think about pouring water into a little cup/bowl then you’re most likely from China.

What brand do you prefer? 出前一丁 or 康師傅

If you go to a Cha Chan Teng in Hong Kong and order instant noodle for breakfast, you are usually given a choice of upgrading to 丁麵 (Demae Iccho) for a few extra bucks. But what you may not realise is that in Hong Kong, 出前一丁, 公仔麵, 福麵 and Cup Noodles are all carried by Nissin Foods.

chart (22)

The multiple brand strategy has helped Nissin Group become a clear leader in the Hong Kong market with a market share of 65.3%. Nong Shim (maker of Shim Ramyun) and Sau Tao, are a very distant second and third and only have a 5.5% and 5.4% market share respectively.

In China, the names are very different. Taiwanese noodle makers like Tingyi (康師傅) and Uni-President dominate the instant noodle market and hold market shares of 46.5% and 17.8% respectively. Nissin Foods is much smaller and only holds a market share of 2.8%.

chart (21)

So if you associate instant noodle with Cup Noodle and 出前一丁, you’re most likely from Hong Kong. On the other hand, if you think of 康師傅 or 來一客, then you are most likely from China.

These two distinction is even more stark when you consider the revenue breakdown of Nissin Foods in the two areas. In Hong Kong, the revenue split between Bag type instant noodles, cup/bowl type and frozen foods are almost even at 39/28/33. Whereas, in China, the revenue split for Nissin Foods is 85/13/2 .

chart (20)

The Premium-isation of Instant Noodles

In a way, China’s instant noodle market is very unique. Unlike the other industries that we have looked at in our Mass Consumption series (travel, beer, coffee and fried chicken, online games), the instant noodle market is NOT growing. In fact, Frost and Sullivan forecast that the number of instant noodle servings will decline from 2016’s 37.2bn to 34.5bn in 2021E.

With volume in decline, the only way to make more money is to try to raise ASP through the premium-isation of instant noodles.

As the bowls get bigger…

Noodles - 1

…and fancier…


…so does the ASP. In China, over the past four years, the average selling price of instant noodles have risen by 4.4% p.a. since 2012 (faster than Hong Kong’s 1.75% ASP growth). chart (16)

However, with the “Big Cup” noodle now weighing in 80 grams, 450 calories and 1,600mg of sodium, I suspect this premium-isation trend could be hard to sustain. Furthermore, while the past few years’ increase in ASP appear to have helped with gross profit margins, the benefits do not appear to have flowed to the bottom line.

chart (26).png

I am Satay Flavour出前一丁

As for me, I’ve been told that I make the best instant noodles with the exact right balance of soup to noodle. If I had to choose one type of noodle to eat, it would be the satay flavour 出前一丁.

Screen Shot 2017-11-24 at 2.03.12 PM

Now what does that say about me?


P.S. In the first collage, there is one picture that does not belong, can you spot it.

MiFID II – What would you pay for content?

MiFID II? I reckon that except for those that work in the broking industry, most people have never heard of MiFID. This silly acronym actually stand for “Markets in Financial Instrument Directive”.

For those that work in the broking industry, the 3 January 2018 in force date for MiFid 2 represents a big sea change as it requires the unbundling of research from sales and trading commissions.

Fine line between investment research and the business pages

This means that investment funds can no longer say that research is included in the commission costs that it pays for trades, rather, it needs to write a separate cheque for the research services that it receives. While this may sound simple, it is not. Considering that the investment banks had been giving research away for free, how much do you now charge for a research report, for a phone call or for a face-to-face meeting?

Embed from Getty Images

As a content creator, I have a vested interest. My wishful thinking is that “Content is King” but I am often reminded of an old lesson from my mentor – very little separates investment research from the business pages and considering that most newspapers sell for US$1-2, sell-side research must be a sunset industry.

To a large extent, he was right in his prediction. But I would also argue that “Content is still king”, the difference we are facing is just how we consume and how we pay for it.

So how much is content worth?

To try to address this question, we turn to the hottest IPO in 2017 – China Literature Limited.

Source: CNBC

China Literature Limited is China’s largest online publishing platform. When it IPOed earlier this year, it drew HK$520bn in investor capital. The retail portion was 691x oversubscribed and its share price has since surged 82%, giving it a market capitalisation of US$11.5bn. So what is there to learn from China Literature?

The good news – 333mn online readers and Rmb4.6bn market size

First the good news. According to the industry report from China Literature’s IPO, there were 333mn users in China’s online literature market. Value-wise, the online literature market generated Rmb4.6bn in 2016.

chart (6)

…but only 6% pay for content

The bad news is that very few actually pay for content. For China Literature, of its 192mn monthly active users (MAU), there were only 11.5mn Monthly Paying Users (MPU). In other words, the paying ratio was only 6.0%. While the paying ratio might be low, one positive is that it has risen from 3.3% in 2015 to 6.0% in 1H 2017.

chart (9)


Using China Literature’s experience as guide, we can guess that the paying ratio for MiFid 2 is going to be low as well. This is especially the case since investors have historically been used to getting content for free.

Average pay rate is only around Rmb20 per month

But what about price elasticity? Here it gets interesting. In 2015 and 2016, at the same time that the paying ratio increased from 3.3% to 4.9%, the average monthly online reading revenue per paying user also increased from Rmb17.1 to Rmb17.4. The coincidental increase of paying ratio and pay rate was even more obvious in the first half data. In 1H 2017, the paying ratio increased to 6.0% from 4.4% in 1H 2016. At the same time, the monthly average online reading revenue per paying user also increased from Rmb15.1 to Rmb20.5.

chart (8)

This suggest that content does matter. Similar to how you or I would be willing to subscribe to HBO just to watch the latest season of Curb Your Enthusiasm or Game of Thrones, online readers are willing to pay, provided that the content is good.

Content Vs Platform – What do Cost of Revenues Say?

Before we get to the cost of content, take a look at China Literature’s revenue breakdown. In 1H 2017, 85% of overall revenues was generated from online reading. The second derivation of this content, in this case, intellectual property (i.e. making the stories into movies, TV shows, games) and physical books made up 8% and 5% of overall revenues.

chart (13)

In order to acquire this “premium” content, which helps to attract paying readers, China Literature was willing to pay around 40-50% of the online reading revenues. According to the Frost & Sullivan industry report, in 2016, the average income of the Top 10 online literature writer was Rmb32.3mn.

chart (11)

Although having the right content is important, the platform is key to its monetisation. As a percentage of overall revenues, selling and marketing expense took up 24% of the top line, general and administrative costs was 17% and the actual platform and distribution costs was 6.4%.

chart (12)

Content is not dead, it’s just the banking platform that is failing

Bringing this back to the issue of MiFid 2, I don’t think investment research is dead. It’s just the medium that is changing. For me personally, in addition to forking out HK$10 everyday for my newspaper, I am also happy to pay US$299 per year for a monthly investment newsletter. But for the rest of my content consumption, it is likely to be driven by ads (whether sponsored or not).

Until the big investment banks recognise that investors actually want good content, any effort to try to collect while they simultaneous cut content costs is just an exercise in futility.

While they are at it, maybe Nokia can try to drive revenues by cutting production costs and try to sell the old 3310. Hang on, isn’t that what they are doing? Perhaps, the investment banks should talk to Nokia and find out how it’s going.

Nokia 3310
Photo from Karlis Dambrans via Flickr





Mass Consumption 8 – Cash, credit or QR code?

It used to be “Cash or credit”. Then it became “Visa or Master” and more recently “ApplePay or AndroidPay?”. In China and increasing in the West, it is becoming AliPay or WeChat Pay. In 2016, card based spending totalled US$20.6trn but compared to the total payment flow market, this is still just around 10%. Although the detailed business model may be complicated, at its essence, it is really just about capturing a sliver of the massive payment flows.

How do you consume? After coming back from China and seeing the proliferation of AliPay, I wanted to do some work on the rise of cashless payment methods. For most people, when we think of cashless payment, we think of the latest technology like ApplePay or P2P and we often forget that there is still the good old credit card.

Embed from Getty Images

US$26trn of spending was done on plastic

According to data from the Nilson Report, in 2016 there were 257.2bn transactions in the global credit and debit card market. These credit and debit cards recorded total spending of US$26trn, up 6.4% YoY. (comprising of US$20.6trn in purchases and US$5.4trn in cash).

chart (55)

Visa account for 54% but UnionPay is growing the fastest

While Visa dominates the payment scene and accounts for 54% of global purchases, Union Pay is the fastest growing payment brand. Transactions handled by Union Pay rose 32% YoY in 2016 and it now accounts for 38% of purchases by transaction volume.

Four Party, three party network, two-sided proprietary platform? What?

So far, so good. Where it starts to get confusing is trying to understand how these companies make money. You’ve got the likes of Visa and MasterCard who operate a four party network comprising of (1) cardholder, (2) merchant, (3) issuer and (4) acquirer. Then you’ve got three-party networks like Amex where they operate as both both issuer and acquirer (acquirer is essentially who pays the merchant). When we think about the 1.5% -2.5% fee that the merchant has to pay for credit card transactions or the interest on overdue amount, this is where the issuer and acquirer comes in. From this perspective, it is easier to understand Amex’s business model.

Screen Shot 2017-11-15 at 9.08.18 AM

But if Visa and Mastercard’s role is really just to process the transactions then how does it make money? And where does the likes of PayPal come in as you can also choose to pay via Visa or Mastercard on PayPal?

Revenue and net profit snapshot

We start by taking a snapshot of the financials. The first point of interest is how Amex’s top-line compares to Visa and Mastercard. By payment volume, Amex only process one-seventh the amount that Visa does and only one-fifth what Mastercard processes (Amex US$1,037bn, Visa US$7,336bn, Mastercard US$4,828bn). However, by capturing the payment discount (i.e the fee charged to the merchant) Amex’s revenue at US$26bn is much larger than Visa and also Mastercard.

chart (57)

But this is not quite the right comparison as they do operate different business model. This difference can be seen in their net profit margins. Visa and Mastercard both have net profit margins around 36%, Amex’s margin is only around 20% and PayPal is at only 13%.

chart (58)

Another aspect that sets Amex apart is its sizeable net interest income. Since Amex also takes on the role of Issuer and Acquirer, it earns interest on overdue charge amounts. In 2016, Amex generated net interest income of US$5.7bn, this account for 71% of its pretax income of US$8.1bn. For Visa, Mastercard and PayPal, net interest income were insignificant.

For Mastercard and Visa, when we consider their revenue segments, we see descriptors like “domestic assessment/service revenues”, “cross-border volume/international transaction revenues” and “transaction processing/data processing”.

It’s all about capturing the flow

Although it all sounds terribly confusing, at its core, I think it is all about capturing the overall payment flow.

Screen Shot 2017-11-08 at 2.53.33 pm
Source: Mastercard Investment Community presentation

According to Mastercard, the global personal consumption market is about US$45trn. Of this, roughly 50% is done via credit/debit cards. While US$45trn is a huge number, it is still much smaller than the US$120trn B2B market and the US$60trn in P2P/B2C market. Since both of those are largely untapped by cards, in the grand scheme of things, the US$22trn payment flow currently captured by credit and debit cards only represent 10% of the overall payment flow market.

What about the likes of PayPal?

But what about the newer payment technologies like PayPal, ApplePay, Android Pay that are linked to credit cards? Using PayPal as a guide, we see the following:

  • Total Payment Volume of US$419bn in the previous 12 months. This is roughly one-tenth the size of Mastercard but growing at twice the rate.


  • On average, each payment is around US$56-60, slightly lower than the US$65-86 average transaction size that is processed by Visa and Mastercard.

chart (2)

The interesting part is the average transaction take rate (which is basically how much is charged per transactions). For PayPal, over the past six quarters, this has trended down from 2.69% to 2.49%. This was partly attributed to the rise of P2P transfers like Venmo. On the expense side, transaction expense accounted for around 94bp-100bps while transaction and loan loss was another 30-32bps.

chart (1)

With volume based expenses making up some 40-45% of revenues, if these payment companies can increase flow and keep non-variable expenses in check, there can be much to gain from greater payment flows. Furthermore, since much of the variable expense is payment to the card companies, this is probably why many of the new operators are encouraging payments via their own wallets.

Who drinks best from the firehose?

Embed from Getty Images

chart (59)


Mass Consumption Part 7: Who’s got game?

Computer games is big business. Gaming has been the key driver behind some of the best performing stocks like Tencent and Nvidia. As an entertainment industry, games is the third largest and brought in US$101.1bn. We take a snapshot to see (i) Who’s playing, (ii) What are they playing, and (iii) What are they spending money on?

Plants Vs. Zombies 2 – Screenshot from my phone

If you ask me what is my favourite computer game, I would probably say Plants Vs. Zombies or MarioKart 8. Although I’m not a serious gamer, gaming is big business.

Gaming is big business

chart (47)

According to the prospectus that I came across today, the global gaming industry brought in US$101.1bn of revenues in 2016, making it the third biggest segment of the global entertainment industry behind TV & Video (US$314.3bn) and, surprisingly, Publishing (US$329.3bn). Going forward, the Publishing industry is expected to contract by 0.5% p.a. between 2017-2021 but the Gaming industry is expected to grow 5.1% p.a.

Who’s playing?

Among the geographies, Asia Pacific (including China) is the biggest market, contributing 46.4% of the US$101.1bn of gaming revenue in 2016. The Americas and Europe contribute 29.6% and 20.9% respectively.

chart (48)

While the Rest of the World only contribute 3.2% of games revenue, they make up 14.8% of active gamers in 2016. On a standalone country basis, China make up 25.4% of active gamers and 24.3% of games revenues.

chart (49)

What are they playing?

As expected, mobile games are the most popular. In 2016, there were 1.973bn active mobile gamers, which is like 95% of all active gamers. PC gamers (1.162bn) make up 56% of all gamers while console gamers make up around 30%. Among the three categories, mobile games is expected to remain the fastest growing segment with a CAGR of 6.2% between 2017-2021, followed by PC games at 3.6% CAGR and console games at only 1.5%.

chart (50)

Who’s watching?

Embed from Getty Images

While the number of gamers is expected to grow 5.4% p.a., there is one aspect of gaming that is expected to grow at almost 3x the speed. The global eSports audience (those watching televised computer games) is expected to increase from 322.2mn in 2016 to 665.3mn in 2021, a CAGR of 14.6%. In 2016, China had the largest eSports audience at 106.2mn people and is expected to remain the leader with 217.6mn eSports audience in 2021.

chart (51)

In terms of prize money, the richest tournament appears to be Dota 2 with a purse of  US$88.33mn, followed by League of Legends at US$36.61mn.

Screen Shot 2017-11-07 at 11.22.46 am

Source: HKEJ

Serious machines for serious gamers

Just like how professional cyclist need serious bikes, serious gamers also need serious machines. In 2016, the global gaming systems market was worth US19.3bn with revenues evenly split between Asia, the Americas and Europe.

chart (52)

In addition to getting machines with the fastest processors, the best graphics card and memory, peripherals are also an important component. If you’re trying to navigate through Doom, you need the best mouse and the best keyboards. But one thing that I did not appreciate was the importance of sound quality.

chart (53)

Among the US$2.2bn gaming peripherals sales in 2016, headsets accounted for nearly half, more than the sales of  mice (US$526.8mn) and keyboards (US$458.6mn) combined. Look closely at the picture below, everyone has a headset on and if you’ve seen the prices of some of the latest Bose headsets, it is probably an ASP thing.

Embed from Getty Images

China is very much mobile games driven

One thing that is interesting is that while China accounts for around 25% of active gamers and also 25% of global gaming revenues, their spending seems to be concentrated on the actual games. Among gaming peripheral sales, China only make up 14.3%. For Asia Pacific ex China, the stat is even lower. Asia Pacific ex China gaming peripherals sales is only 7.8% compared to its 22% market share in global gaming revenues.

chart (54)

This suggest that gaming in China and Asia Pacific likely takes place on mobile devices rather than PC or consoles. I guess that’s why this company in question is now planning to launch its own mobile phone, adding it to its stable of mice, keyboard, headphones and laptop computers.

Embed from Getty Images





Mass Consumption Part 6B – How do you build the FedEx of China?

Last week, we discussed the economics of China’s express delivery industry. This week, we review their balance sheet to gauge who is likely to become the next UPS/FedEx of China.

Last week we discussed China’s rising express delivery market and how it has grown together with China’s massive online retailers. As a quick recap, in 2016, online retail sales made up 14.30% of China’s overall retail sales and for the express delivery industry, it delivered 27.9bn parcels and generated overall revenues of US$59.8bn.  chart (29)

With China’s express delivery market expected to double in the next five years, everyone is vying to become the UPS or FedEx of China.

chart (30)

When we reviewed the economics of China’s top express delivery companies and compared their margins and profitability to the top US operators like UPS and FedEx, we came away with mixed feelings (see full discussion here). While we were very positive about the express delivery market’s overall growth, we are concerned that competition from new operators vying for market share would compress margins.

Crunching the balance sheet

Embed from Getty Images

After having some time to digest our initial thoughts, we are still scratching our heads. Something is missing. Why is there such a big divergence in valuation?

chart (39)

One could argue that the high PE ratio of SF Express and Best (net loss) was because of companies sacrificing near-term earnings for long-term market share. But in order to emerge from this fight, you need to either have (1) strong underlying cash flow or (2) a strong balance sheet to sustain you for the long haul.

A look at another conventional valuation metric, price-to-book, shows an even greater divergence. To me, the 3.1x-7.0x price-to-book ratio that ZTO, FedEx, STO and YTO are trading at would be within my range of expectations. But what about UPS at 81.6x and SF Express at 11.3x PB?

chart (40)

Although labour costs is a major component of the express business but there are also a lot of hard assets as well. What about the trucks, the planes, the computer systems, the conveyor belts, not to mention the drones?

Embed from Getty Images

PPE make up 50% of US express company assets and only 13-28% for China

This is where we see one of the big differences between the US and China express companies. For UPS and FedEx, property, plant and equipment (PPE) was the largest component of their assets. Even after accumulated deprecation, PPE still made up around 50% of UPS and FedEx’s total assets. For the Chinese express companies, SF, ZTO and YTO have PPE around 26-28%. Best and STO’s PPE are only 13-15% of assets.

chart (41)

Since some companies sometimes classify their software as intangible assets, we further consider intangible assets and goodwill. Again, we see that UPS and FedEx are fairly close with intangible and goodwill making up around 14% of assets. Grouping PPE and intangibles together, we see that these make up around 65% of the US express companies’ asset base.

Need to buy more trucks and build more sorting facilities

For the China express companies, SF, ZTO and YTO are hovering around 39-45% but STO and Best are only around 20-22%. This suggest to me that if these companies want to institutionalize their business and expand their market share, more investments and capex is needed. They must buy more trucks, more planes, build more sorting facilities and build out their logistics network.

Embed from Getty Images

On this basis, it is no surprise that SF Express and YTO have higher PPE and intangible assets. Their revenues have already started to scale.

chart (33)

Capital structures reflect the early stages of investment

For the China express sector, one silver lining is that they appear to have anticipated this need and have already tapped the capital markets. As of June 2017, four of the five China express companies are sitting on net cash. Although SF Express had US$73mn net debt, its 2% net-debt-to-equity ratio suggest there is lots of scope for it to borrow.chart (42)

In comparison, given the relative maturity of FedEx and UPS business, their capital structure is optimised to boost ROEs.

Incumbents best positioned to become China’s UPS/FedEx

If we apply the filter of (1) normalised margins and (2) high PPE-intangibles, this would suggest that the two largest incumbent operators, SF Express and YTO, best resemble FedEx and UPS. That said, one would still have to decide whether the current PE ratios of 52.8x and 37.2x is too high a price to pay for that potential future.

Embed from Getty Images