Pharcyde22 (< 20)

eLong's Misunderstood Story - The Macro (Part 2)

August 30, 2011 – Comments (0) | RELATED TICKERS: LONG , CTRP

“A trader looks far ahead instead of considering the particular shot before him. It gets to be an instinct to play for position.”Jesse Livermore

 

China’s export and infrastructure focused economic policies have resulted in an uneven distribution of wealth. The state owned enterprises within China’s coastal cities have become very rich, and the population’s few who have been fortunate enough to be at the corporate level within these narrow industries have been reaping the majority of the country’s economic benefits. To illustrate, only 12 coastal provinces accounted for 65% of China’s GDP in 2009.[1]

This imbalanced phenomenon is reflected in China’s service-related industries. Within the online travel agencies (OTA), CTrip has emerged as the current dominant winner, primarily catering to this privileged socioeconomic group.  CTrip provides service for the wealthy and the business travelers by providing white glove service. A customer calls one of CTrip’s representatives, who then provides full service travel concierge, taking care of every detail, including hand delivering tickets to their customer.

But with the impending slowdown of the U.S. and European economies and the end of its massive infrastructure focused stimulus, the Chinese government has acknowledged that the same economic model that has done them so well in the past, will no longer be valid going forward as a means to continue China’s economic growth. They’ve accepted that a transition must be made to a more consumer-driven society if China has any chance of surviving. The government earlier this year passed its newest five year plan (FYP) to guide the country’s economy from 2011-2015, explicitly outlining their focus to make this transition a reality. As a result, the business landscape will change dramatically, and I believe eLong has quietly set itself up to benefit the most.

 

The 12th Five Year Plan (2011-2015) and other Government Policy

12th FYP is focused on balancing the current economic model with more consumption and innovation. The plan is comprehensive, but I will only touch on the few that will affect eLong and China’s OTAs down the road. Some of the state’s goals and tactics include:

 

Goal - Consumer-Focused Economy – By accelerating the establishment of a middle class

One of the ways Beijing wants to redistribute income is by forcing companies to increase wages via mandatory wage growth targets. In 2010, provincial governments raised minimum wages by 20-30%[2] and all provinces (both inner and coastal cities) are experiencing large y/y jumps in wages. This forced jump in wages, combined with the government’s proactive fight against inflation through a rapidly rising yuan will put more money into the pockets of consumers.

The economic committee also realize that the savings rate in China has been stubbornly high (~25%) in part because of lack of social security, health insurance, and affordable housing available to the vast majority of people. They want to improve social programs, dedicating more of their budget to health care and pension. They also want to expand social/affordable housing. This sense of security will undoubtedly be the key to unlocking the pent up savings to flow into more discretionary purchases such as travel.

The FYP has also touched on the longer term goal for urbanizing the 300 million people from rural areas into cities over several decades. Doing this will provide centralized, cost effective sources for human capital for companies. It will also modernize one quarter of China’s population, unlocking more internet usage, discretionary consumers, and obligatory travel amongst provinces.  

 

Goal - The Establishment of a Continental Economy (favoring central and western provinces vs. coastal cities) – This will create more permanent business and travel among provinces

Beijing as reiterated the importance of high speed rail, and they’ve continued to invest heavily in its production. Despite the recent train crash set back, these bullet trains have shown no signs of slowing down, as tickets are often sold out.[3] The government has also been gradually phasing out preferential tax policies in coastal cities and increasing tax incentives in interior cities. Many local governments are desperate for revenue, and face increased pressure to occupy vacant towns/cities. The rising wages, higher input costs, and unaffordable real estate of coastal cities will force many companies to move inland to control their rapidly increasing costs. This transition will also cement the need for inter-provincial business travel, and make train and hotel usage more inelastic.

 

Goal - Private sector growth

In order for more domestic companies to thrive, there must be a dramatic liberalization of the financial sector. Even today, it is still very difficult for smaller companies to get the financing they need to grow. Beijing must also be more proactive in its stance against monopolistic behavior. Although this aspect is not stated in the FYP, the government must take a hard stance considering the negative effects on job creation and innovation.  

 

 

Other Positive Trends

Although offline and cash transactions are still the most popular means of booking travel, eLong has been anticipating a major consumer shift. Around December of 2010, eLong announced they no longer accepted cash as payment. In their most recent quarter, they announced that 55% of their hotel bookings were done online. I believe their focus on online transactions and credit cards will improve their margins. I will talk about this in more detail in the next write up.

 

The Growth of Online & Mobile

According to the China Internet Network Information Center (CNNIC), China’s total Internet penetration is at about 34% compared to the U.S. and Japan, which are both around 75%. By the end of 2010, an estimated 457 million Chinese used the Internet, more than double the 210 million in 2007.[4] Yet only 8% of people in China book travel online compared to 35-50% in the U.S.[5] Part of the reason may be because online and mobile data speeds in China are slow compared to the rest of the world. The average Internet connection speed in China is only 1 mbps, where the U.S.’s average is 5 mbps and South Korea’s is almost 15 mbps.[6]

But with last year’s government’s approval of a $22 billion dollar plan earmarked for investment into fiber optic networks, and China’s Internet providers shooting for 100 mbps speeds by 2013-2016, speeds will likely be more competitive with the rest of the world in the next few years, making online purchasing more convenient for China’s consumers.

 

Regarding mobile, the entire industry is now moving towards 4g technologies[7]. China’s 3g was unsuccessful – using technology that was painfully slow. As a result, 3g was only partially built. Today’s slow speeds are likely one of the main reasons why only about 9% of China’s 300 million mobile users make purchases on mobile.

The Growth of Credit Cards

According to a McKinsey report published in 2009, in 2008, 124 million new cards were issued in China (more than in any major country) compared to a paltry 11 million in 2004. They expect about 300 million cards to be issued by 2013, with one in every five middle-class Chinese consumer as a cardholder[8]. In a survey conducted in April 2009 by Global Institute, 42% of urban consumers said they already had a credit card. And with only 5% of Chinese having credit cards (as of 2008), there is tremendous room to grow as 60% of the U.S. population owns at least one credit card.

Although cash still represents the dominant form of payment in China (in 2007, 76% of personal consumption was done in cash[9]), the trend still favors consumers’ shift toward credit card usage over the long run.

 

The last write up will go into eLong's positioning, and its competitors.

 

[1] “China’s Great Rebalancing Act,” Eurasia Group

[2] “China’s Great Rebalancing Act,” Eurasia Group

[3] http://www.bloomberg.com/news/2011-08-25/sold-out-beijing-bullet-trains-show-passengers-unfazed-by-crash.html

[4] http://techrice.com/2011/07/28/chinas-netizens-reach-485-million-almost-2x-americas-cnnic-report/

[5] http://techcrunch.com/2011/07/22/qunar-baidu-deal-closes-how-this-could-ripple-through-chinese-startups/

[6] http://www.akamai.com/stateoftheinternet/

[7] http://online.wsj.com/article/SB10001424052702304584404576439541765717016.html

[8]http://www.mckinsey.com/clientservice/Financial_Services/Knowledge_Highlights/Recent_Reports/~/media/Reports/Financial_Services/China_Card_Market.ashx

[9]http://www.mckinsey.com/clientservice/Financial_Services/Knowledge_Highlights/Recent_Reports/~/media/Reports/Financial_Services/China_Card_Market.ashx