China's Cheetah Mobile Eyes Big Push Into More Markets

Can China's Cheetah Mobile hit pay dirt on the global mobile scene?

While the jury is still out on the answer, the potential for Cheetah Mobile ( CMCM ) to monetize its mobile business in a big way has sparked investor enthusiasm over the provider of Internet security and mobile tool applications.

Cheetah Mobile's shares have risen more than 40% since they debuted on the NYSE on May 8.

The company provides mobile and PC applications that offer security and anti-virus protection. It was spun off by Chinese software company Kingsoft.

Cheetah Mobile is the No. 2 Internet security software provider in China, with more than 362 million monthly active users as of March 2014, according to iResearch.

The company provides its applications free to users and generates most of its revenue from its legacy PC application business in China. The company does so through traffic referrals from its platform to e-commerce companies, by selling ads and by providing value-added services such as online games.

'Huge' User Base

Monetization of its mobile applications is still very early and small, says JG Capital analyst Henry Guo.

"The key to its future is the opportunity to monetize its mobile business internationally," he said. "The reason why investors love (the stock), we believe, is because of the potential on the mobile side over the next several years. The reason why investors see the potential is because it has a huge mobile user base."

During the first quarter, Cheetah's mobile monthly active users (MAUs) surged nearly five-fold from a year earlier to 222.5 million. About 63% of MAUs came from overseas markets, mostly the U.S and Europe.

With a "mature" desktop business, Cheetah has transitioned to a mobile focus over the last year or so, Guo says.

That's a good thing, says Renaissance Capital analyst Will Preston, because "the future is in mobile."

"The lure of this company is they have this huge user base and a very strong presence in mobile," Preston said.

He estimates that in three to four years Cheetah could have $1 billion in yearly revenue "because of the amount of their users and the potential they have with their monetization strategy."

To put that number in perspective, consider that Cheetah had only $123 million in revenue last year.

For now, however, mobile remains a pretty modest business for Cheetah, though a growing one. In the first quarter, mobile accounted for 17% of Cheetah's $50.8 million in total revenue. That was up from 1.6% the prior year and 11.6% during the fourth quarter of 2013.

The company's mobile lineup includes Clean Master, a junk file cleaning, memory boosting and privacy protection application. In March, Clean Master was the world's No. 1 mobile application in the Google Play app store tools category by monthly downloads, according to App Annie.

Another mobile application is Battery Doctor, used for power optimization. It was the No. 1 mobile utility application in China in terms of monthly active users in December 2013, according to iResearch.

Among the ways Cheetah can monetize its mobile business globally is with mobile games that it develops with local developers, Guo says. The idea would be to launch "localized" games that are attractive to users in key markets like Brazil, where Cheetah has a large user base.

Cheetah took a step toward monetizing its mobile business in June when it reached a deal to acquire HongKong Zoom Interactive Network Marketing Technology for up to $30 million, including $20 million in cash and about $4 million in Cheetah stock, payable upon the closing of the deal.

HongKong Zoom operates a mobile advertising business. It is an authorized reseller ofFacebook ( FB ) ads, one of the top resellers of Google ( GOOGL ) ads in Greater China, and a preferred partner for global mobile advertising networks such as InMobi and Millennial Media.

"With this addition, Cheetah will be able to further expand into the overseas market and explore new opportunities for promoting and monetizing our mobile products," Cheetah CEO Sheng Fu said in a statement announcing the deal.

Global Advantage

Analyst Guo says the key difference between Cheetah and other Chinese Internet companies is that Cheetah has strong international brand awareness and a large international user base.

That is a positive in terms of its potential to monetize its mobile business on a global scale.

But Guo has some concerns.

"The company has no proven record that it can monetize its huge international user base," he said.

What's more, Guo adds, no Chinese Internet company has been able to monetize its international user base before. It's not easy, given the amount of competition between international Internet companies.

"It's too early to make a call," said Guo, who has a "Neutral" rating on Cheetah. "I'm waiting on the sidelines to see if there's any traction on international monetization."

Financially, Cheetah is doing well enough with its current lineup of products. The company has delivered seven straight quarters of triple-digit revenue growth.

In the first quarter, revenue climbed 131% from the prior year to $50.8 million. Earnings came in at 4 cents per American Depositary Share. Analysts polled by Thomson Reuters see full-year earnings of 22 cents per ADS in 2014 and 65 cents in 2015.

Read more: http://www.nasdaq.com/article/chinas-cheetah-mobile-eyes-big-push-into-more-markets-cm373225#ixzz38QOYC0I7

A Strategy For Investing In China

Summary

• China's government and the US market explain two-thirds of FXI's variation since 2011.
• The success or failure of China's reforms will likely drive FXI performance over the next year.
• China has become the dominant force over other major emerging economies.
• China's reforms are likely to significantly influence VWO over the next year.
• Since the expense ratio of VWO is 58 bps lower than FXI, an investment in VWO may be a cheap way of gaining exposure to China.

Introduction: This article discusses the current relationships between emerging markets, the U.S., and China, and suggests how they are likely to change over the next year. First, I define a causal model relating China's stock market, the People's Republic of China (PRC), and the U.S. Next, I suggest that China's economic reforms will likely drive the performance of emerging markets over the next year. Lastly, I sketch alternative scenarios that could derail this thesis.

Model Structure: In this section, I propose that both the U.S. and the PRC drive China's stock market. I use the SPDR S&P 500 ETF (SPY), China Construction Bank (0939.HK, OTCPK:CICHY), and iShares China Large-Cap ETF (FXI), and Vanguard FTSE Emerging Markets ETF (VWO) as proxies for the U.S., Chinese Government, and the Chinese Market, respectively. The period under study ranges from December 31, 2011 to June 1, 2014.

To start with, I assume the causal direction between any two countries is the reverse of net imports. For example, the U.S. is a net importer from China, and consequently, I model the U.S. stock market as driving the China's stock market (Figure 1). My underlying hypothesis is that U.S. consumption influences Chinese GDP.

Figure 1 indicates the U.S. stock market influences the performance of China's stock market.

Source: PopperTech

Figure 2 indicates that the U.S. is a significant explanatory factor of FXI; although it only explains 40% of variation of FXI variance over the last two and a half years.

Figure 2 illustrates the results of an ordinary least squares linear regression with FXI as the dependent variable and SPY as the independent variable. Given the magnitude of the T Stat for SPY (test for statistical significance) and model R-Squared (explanatory power)/Correlation, it is pretty clear that a relationship between FXI and SPY exists.

Source: PopperTech and Yahoo Finance

In addition, Figure 3 shows the correlation between China and U.S. is decreasing. It appears more recent U.S. economic events have diminishing importance concerning the performance of FXI.

Figure 3 displays the 90-day rolling correlations between FXI and SPY.

Source: PopperTech and Yahoo Finance

Figure 4 indicates China Construction Bank (CCB) is also a significant explanatory factor over FXI. Although CCB only accounts for approximately 9% of FXI by weight, CCB explains 40% of FXI's variance.

Figure 4 illustrates the results of an ordinary least squares linear regression with FXI as the dependent variable and CCB as the independent variable.

Source: PopperTech and Yahoo Finance

To explain this, Figure 5 shows that the correlations between China's four major banks range from .82 to .90 over this period. Since these account for 27% of FXI by weight and move in tandem with each other, an investment in FXI results in a large, effectively single bet on China's banks.

Figure 5 displays the correlations between China Construction Bank, Industrial and Commercial Bank of China (1398.HK, OTCPK:IDCBY), Bank of China (3988.HK, OTCPK:BACHY), and Agricultural Bank of China (1288.HK, OTCPK:ACGBY).

Source: PopperTech and Yahoo Finance

The influence of the PRC on all of these banks explains the high correlations.According to the 2013 annual report for China Construction Bank (Page 62), the PRC, through its wholly-owned investment company, Huijin, owns 57%, 35%, 68%, and 40% of CICHY, IDCBY, BACHY, and ACGBY respectively. As a result of the high correlations and ownership structure, I use CCB as a rough proxy for the influence of the PRC.

Lastly, Figure 6 corroborates that both the U.S. and CCB drive the Chinese Stock Market. Both SPY and CICHY are statistically significant, and the model explains about two-thirds of FXI's variance.

Figure 6 illustrates the results of a multiple regression with FXI as the dependent variable and SPY and CCB as independent variables. Please note: The T-Stat of the intercept suggests this model is missing one or more factors. At least two other global events occurred over this period affecting FXI: 1) the European debt crisis; 2) the Russian invasion of Crimea. A four-factor model (not shown) including Europe (VGK) and Russia (RSX) has explanatory power of 72%, and both factors are statistically significant (T-Stats of 3.92 and 7.3, respectively). Although both of these add to the historical explanatory power, their influences are marginal relative to the two factors listed. Therefore, I leave them out of the model and disregard them in the rest of the analysis.

Source: PopperTech and Yahoo Finance

Correlation Thesis: In this section, I propose that the correlation between FXI and VWO will increase over the next year, because 1) PRC reforms should increase the volatility of FXI; 2) China significantly influences the other emerging economies in VWO.

On May 17, 2014, the National Development and Reform Commissionannounced China needs faster reforms in nine focus areas. These include investments, market pricing, urbanization, social welfare, and the environment. Then, the State Council stated on June 7 that it plans to send audit teams to inspect the implementation of these policies later in the month. Uncertainty regarding the effectiveness of these changes will likely increase the volatility of China's stock market over the next year.

In addition, China exerts significant influence over the other emerging market countries in VWO. For example, China accounts for a greaterpercentage of exports than the U.S. for 7 of the next 9 largest countries by weight in VWO (Mexico and India are the exceptions). When combined with China, these constitute 74% of VWO. Therefore, VWO should be more sensitive to FXI than SPY.

Figure 7a and 7b indicate the U.S. influence over the emerging markets is declining, relative to China. Figure 7a shows the correlation between VWO and SPY has trended downward over the past two and half years; whereas Figure 7b shows the correlation between VWO and FXI has stayed relatively stable.

Figure 7 displays the 90-day rolling correlations between (a) VWO and SPY (b) VWO and FXI.

Source: PopperTech and Yahoo Finance

Lastly, if the above correlation thesis holds, then VWO may represent a better way of betting on China than FXI, since its expense ratio is 15 bps, compared to 73 bps for FXI.

Alternative Scenarios: Alternatively, the U.S. Federal Reserve is likely to stop asset purchases over the next year, and may raise interest rates. If these actions significantly affect U.S. consumption, and consequently, U.S. market volatility, then the trends in U.S.-Chinese and U.S.-emerging market correlations are likely to reverse. In this case, the correlations are likely to revert to the levels seen in 2006 to 2013, and VWO may actually increase the risk of a U.S.-focused investment portfolio.

Lastly, if both the U.S. and China steady, then the correlations between VWO, SPY, and FXI will likely decline. As a result, other countries will increase their influence over VWO's performance.

Editor's Note: This article discusses one or more securities that do not trade on a major exchange. Please be aware of the risks associated with these stocks.

Additional disclosure: I am long a call option on VWO expiring in 2016.

By PopperTech

Source:http://seekingalpha.com/article/2264403-a-strategy-for-investing-in-china