We initiate coverage on China software & IT services with an outperform view. We believe the New Infrastructure Plan on cloud and using AI to upgrade traditional industries should drive multi-year growth for the sector. We identified 1) IDC operators, 2) Enterprise SaaS, 3) Managed Cloud service providers and 4) AI companies to benefit from the trend. By pecking order, we initiate coverage with BUYs on GDS > Chinasoft > Glodon > Hikvision, and HOLDs on Ming Yuan Cloud > Dahua.
- China software industry is consistently growing at 15-20% YoY. China software market grew at 19% CAGR during 2012-19, per our data from 155 A/H software companies. Sector achieved resilient growth even with COVID-19 (11M20 revenue +12.5% YoY as per MIIT). Labor-intensive IT services is the largest constitute (59% of total market), but we expect structural change with increasing contribution of software products as enterprises accelerates IT spending (vs. prior gov’t projects-driven). Our in-depth VAT analysis suggested that sector leaders with proprietary software products should derive 30% above revenue from self-developed software.
- New Infrastructure Plan and digitalization to drive IDC and SaaS markets. In response to government’s call for New Infrastructure Investment, Alibaba/ Tencent have announced RMB200bn/ RMB500bn investment plan in the coming 3-5 years. We expect China public cloud market size to grow at 37% CAGR in 2019-22E to RMB177bn. We believe more enterprises will migrate to SaaS post COVID-19 given the advantages of higher flexibility and lower initial IT cost. We identified 1) Carrier-neutral data center (IDC) operators 2) Enterprise SaaS and 3) Managed Cloud Services providers to benefit.
- AI to propel traditional industries upgrade. China AI market size is expected to grow at 38% CAGR in 2019-22E and reach US$28bn by 2022E, which we believe is largely driven by expanding AI use cases to non-public security (e.g. AI camera being used during COVID-19 to track cases). U.S. has imposed sanctions to China top AI companies since 2019, but we see minimal supply risk during de-Americanization with capable Hisilicon-substitutes such as Novatek, SigmaStar (subsidiary of Mediatek) emerging.
- Software sector will continue to outperform in FY21E. We believe China software leaders will continue to re-rate given solid growth and margin expansion. Our stock pick preference is based on growth visibility: Cloud spending > SaaS > AI. Lower market liquidity and tightening U.S. sanctions are the biggest downside risks to the sector.
