The Great Digital Wall of China

The famous ‘great digital wall’ that the Chinese Communist Party (CCP) has built over the years has been very effective in keeping unwanted foreign media, content and websites from the domestic population. Any content deemed unwarranted by the CCP has been in a metaphorical sense, stonewalled over the years. Those cumulative actions have allowed home-grown internet champions to thrive in China. You might recollect that Google, after trying to build its search business in China, decided to quit the country in 2010. The requirement for censorship was onerous and Google decided it was not willing to abide by the rules of the CCP. As a result, Baidu became the de facto monopoly in China’s search business. Other media content properties such as YouTube, BBC or New York Times (NYT) are similarly banned or severely restricted in China. On my past travels to China, I could download NYT and BBC’s content on their respective apps. After the NYT reported on alleged financial dealings of some senior party and government officials, the NYT was completely banned in China. Other technology giants—Amazon, Facebook, Netflix and Microsoft to name a few, are similarly absent from China.

“China might be able to teach the west a few tricks in how to monitor the web”

Generally speaking, freedom of the press is essential in an open, transparent society. The CCP has opted for control over the press and media in order to retain political power and social stability. It is with great irony that recent events in the west about ‘fake news’ have had the Chinese social media agog. China might be able to teach the west a few tricks in how to monitor the web. Facebook announced it will hire 3,000 more people to review content, bringing the total to 7,500 monitoring staff. That number might appear large, but consider an app in China called Inke. It has been downloaded by some 50 million users and it is used to broadcast live videos of events like concerts as well as mundane user-generated content. It claims to have 1,000 people who monitor these videos and take down any that might fall foul of the CCP’s directives. In contrast, Facebook has close to two billion active users spread across the world interacting in a multitude of languages across several time zones. This is certainly an area where Facebook can take a leaf out of China’s book of controls.

As I grow older, I realise things are never really just black or too far into cuckoo-land. Yet should I not be elated to some degree that China imposed these controls on foreign internet sites? Had it not been for the clampdown on foreign content and websites, would we as investors have had the chance to own businesses like Tencent and Weibo which have flourished in China? Across the world, it’s almost exclusively the US internet giants that have slowly but surely extended their global dominance to the detriment of local competitors. There might be a few exceptions but, as we all know, the inherent advantages of a network effect combined with the vast lead in artificial intelligence and data analytics will likely make it very hard for local competitors to thrive against the American internet giants.

A walled island

This is why China is unique from an investor’s perspective. Sure, competition in China is still intense. With so much capital sloshing around, venture capital funded start-up firms are always looking to disrupt existing businesses. However, is it not a fact that thanks to the work of the public policy officials in China, this competition is merely local Chinese competition and not the international behemoths? In this segregated island of information and content that is China, the very same network effects which helped Facebook or Amazon in the rest of the world, have allowed the likes of Tencent, Alibaba and a few others to flourish in China. That this walled island happens to be the second-largest economy in the world with a large population, positioned perfectly to take advantage of mushrooming technological advances is a massive bonus for us as investors. Despite all we might complain about in China – debt overload and overcapacity in basic industries – internet-related businesses have flourished. For any business that succeeds in getting it right, the scale of its opportunity can be exponential. Look no further than Weibo, a current holding in our portfolio.

Weibo: part Twitter, part Facebook

The best way to think of Weibo’s business is to imagine a part-Twitter (without the 140 character constraint), part Facebook social network platform. In China, social networks have changed the way public figures (including celebrities, media outlets, businesses, government agencies) communicate with their fans. Thanks to its large user base and an open platform, social networks have significantly lowered the entry barrier for becoming famous in China and monetising that success. Prior to the emergence of Weibo, China was dominated by a few highly centralised, tightly controlled media channels such as government-owned TV and newspapers. Weibo’s decentralised model has nurtured a large group of Key Opinion Leaders (KOLs). Weibo is the preferred channel in China through which average people can interact with celebrities. Commenting on/re-tweeting celebrities’ posts has a viral aspect to it; similar to many other societies. Like in other societies, China’s idol worship and exchange of gossip is a de facto cultural phenomenon.

In March 2014, Weibo had 143.8 million monthly active users (MAUs) and 66.6 million DAUs (daily active users). In the three years since, MAUs climbed to 340 million (of which 91% were mobile users) and DAUs to 154 million. Growth in users combined with increasing monetisation per user has meant a staggering scalability in revenues and profits. Weibo’s gross profits have improved by shifting its infrastructure expansion onto Alicloud, while network effects have done the rest for operating profits.

Source: Bloomberg

With growth projected to continue in the near future, this business does not trade cheap. That is the nature of its operating scalability. The future potential growth that Weibo will likely harness might come from video ads (much higher revenue per viewer) and possibly e-commerce revenues. If history is any guide, the revenue per user and margins that Facebook enjoyed in the past five years points to the runway for growth and improvement in margins for Weibo.

I do need to bear in mind the risk of competition, especially from Tencent’s WeChat platform. At the moment, I do believe that a closed, message-based app network like WeChat has very different qualities to an open media-based network like Weibo. They attract users for different purposes. I also realise that China’s per capita income and hence the potential for revenues per user, is much lower than what Facebook will generate in its markets.

Yet there is no escaping the fact that Weibo has so far managed to stay ahead of the competition. The absence in China of international competitors is a very big advantage. Aswath Damodaran, Professor of Finance at the Stern School at NYU, commented on optionality of upside potential in one of his pieces. “People often talk about potential market size alone. That is necessary for optionality but not sufficient in my view. What is as important if not more, is exclusivity. We spend a disproportionately large amount of time on a few sites (Facebook for instance). For social media companies, that exclusivity comes from a big and involved user base.” To what extent will Weibo monetise its user base? Only time will tell.