China is already the second largest economy in the world and some believe it will eventually be the biggest one day. Given how large China’s market is, President Trump has pushed for fairer trade standards and for the government there to open more markets. One potential concession made by the Chinese government is potentially the cloud. According to the Wall Street Journal the government has proposed potentially allowing ‘trial operations of foreign cloud-service providers’ in a move that could provide America’s tech companies with greater access to China’s cloud computing market. Let’s find out how the smart money (hedge funds and elite institutions) is playing the Chinese Cloud trend.
Our research has shown that hedge funds’ small-cap stock picks managed to beat the market by double digits annually between 1999 and 2016, but the margin of outperformance has been declining in recent years. Nevertheless, we were still able to identify in advance a select group of hedge fund holdings that outperformed the market by 32 percentage points since May 2014 through March 12, 2019 (see the details here). We were also able to identify in advance a select group of hedge fund holdings that underperformed the market by 10 percentage points annually between 2006 and 2017. Interestingly the margin of underperformance of these stocks has been increasing in recent years. Investors who are long the market and short these stocks would have returned more than 27% annually between 2015 and 2017. We have been tracking and sharing the list of these stocks since February 2017 in our quarterly newsletter.
In terms of the potential Chinese concession, existing American cloud leaders such as Amazon.com, Inc. (NASDAQ:AMZN), and Microsoft Corporation (NASDAQ:MSFT) could potentially pick up more business from China. Amazon’s current cloud operations in China are not that meaningful. Microsoft is known more for its Windows and Office software than Azure in China. Given Microsoft’s connections with Chinese enterprise, the company could potentially have a leg up versus Amazon, which doesn’t have as much of a presence in the country.
Currently, according from Microsoft,
According to the China Telecommunication Regulation, providers of cloud services—infrastructure as a service (IaaS) and platform as a service (PaaS)—must have value-added telecom permits. Only locally registered companies with less than 50 percent foreign investment qualify for these permits.
Investors of both companies hope that the government could allow for more ownership of cloud operations in China.
Of the around 700-740 elite funds we track, 168 funds owned $19.02 billion of Amazon.com, Inc. (NASDAQ:AMZN) on December 31. Meanwhile, 174 top funds had a bullish position in Microsoft Corporation (NASDAQ:MSFT) at the end of December.
Some other companies that could benefit from the growth in China’s cloud include Altaba Inc. (NASDAQ:AABA), Alibaba Group Holding Limited (NYSE:BABA), Baidu.com, Inc. (NASDAQ:BIDU).
Although it plans to liquidate its Alibaba shares eventually, Altaba has Alibaba exposure until that time comes. Alibaba meanwhile has a percentage of China’s fast growing cloud market. Baidu’s cloud operations are smaller than Alibaba’s, but some analysts nevertheless expect Baidu cloud revenue to hit $624 million by 2020, which is still a nice chunk of change. There will likely be a lot of growth for both companies. According to McKinsey, Chinese companies likely use the cloud less overall in terms of percentage of the IT budget than companies in the U.S. In 2017, 14.4% of Chinese companies’ total IT budget was spent on the cloud versus 29.1% for the United States.
In terms of smart money sentiment, of the around 740 funds we track, 51 elite funds were long Baidu.com, Inc. (NASDAQ:BIDU) at the end of December. 113 elite funds had a bullish position in Alibaba Group Holding Limited (NYSE:BABA) at the same time period. 73 top funds owned shares of Altaba Inc. (NASDAQ:AABA) at the end of the fourth quarter, down 14 funds from the previous quarter.
Disclosure:None
