China Technology Internet:Big is better -raising target prices,still bullish;Alibaba CL-Buy

Rolling forward, fine-tuning.

    China surpassed the US to become the largest iOS revenue market in3Q16, despite low iOS penetration, according to AppAnnie. We expectChina internet giants to continue to outperform, with our 12-m target pricesfor Alibaba/Baidu/Tencent implying 20% average upside and our bull casevaluations for the three implying 42% average upside. Despite the 21% 3-month (28% ytd) rally in China’s internet sector, which has outperformedinternet stocks in the US (6% ytd), Japan (18%) and Korea (10%), weremain bullish into 2H16 and 2017 (Exhibit 11). In particular, Alibaba andTencent look well positioned, as tailwinds remain for e-commerce/gameson still rising online penetration and the PC-to-mobile shift. At Baidu, theregulatory uncertainty impacting the medical industry could last for 2-3more quarters. For the more consolidated online verticals (e.g. onlinetravel agencies), we expect further margin improvement. We revise our2016 EPS estimates by -1% on average (Exhibit 11) and raise TPs, as weroll forward to capture estimates farther out.

    Alibaba (BABA; CL-Buy; TP US$130): Remains our top pick.

    We continue to believe the outlook for organic growth rates in BABA’sChina retail business remains robust, as we lapse the ad load-drivenincrease from a year ago. The margin outlook for core businesses alsoremains intact. We raise our 12-m SOTP-based TP to US$130, fromUS$120, as we roll forward the key drivers of valuation by 12 months. Wereiterate CL-Buy on BABA, which remains our top sector pick with 25%upside offering a compelling valuation versus strong growth fundamentals.

    Tencent (0700.HK; Buy; TP: US$256): Gaming/advertising solid.

    We maintain our estimates for mobile/PC gaming revenue as Tencent andSupercell’s titles recaptured their rankings in China and globally. Weixinshould continue driving advertising revenue growth with the introductionof location-based ads inventory catering to long tail SMEs. We raise our 12-m TP to HK$256 from HK$214, rolling forward valuation to 28x 2018E EPS.

    Baidu (BIDU; Buy; TP US$201): O2O/video offset search challenges.

    While Baidu’s search business faces a challenging period, we expectcontinued spend on O2O customer/merchant base expansion and videosegment growth to remain strong. Our SOTP-based 12m TP rises toUS$201, from US$194, on roll-forward by just 6 months vs. 12 months forothers in our coverage, to factor in the greater degree of uncertainty withthe core search operations.