The valuation has peaked, what will Chinese concept stocks compete in the second half? UBS highlights: AI, profit margins, new markets

After experiencing an increase since the beginning of the year, the Chinese internet industry is at a critical turning point.

According to news from Chasing Wind Trading Desk, UBS stated in a report on June 16 that the KWEB China Internet ETF has risen 18% year-to-date. This is mainly driven by valuation rather than profit improvement, particularly for stocks with AI concepts. Small and mid-cap stocks have outperformed the broader market, and domestic investors have shown stronger pricing power, sometimes taking a different long-term perspective from overseas investors.

UBS believes that investors need to focus on AI monetization, overseas expansion, and margin restructuring in the second half of the year, as these factors will profoundly impact the investment value and stock price performance of Chinese internet companies.

DeepSeek Innovation Drives Industry Revaluation

UBS stated that in the first half of 2025, the Chinese internet industry experienced significant revaluation. DeepSeek's innovative breakthroughs have introduced a structural growth perspective to the industry, coupled with the government's supportive attitude towards private enterprises and the attractive valuations after significant reductions in previous years, driving the KWEB index up 18%, which is roughly in line with the Hang Seng Index's 22% increase.

UBS's analysis shows that this round of increase is mainly driven by valuation expansion rather than fundamental improvement. Stocks with AI concepts, such as Alibaba Cloud and Kuaishou, have performed particularly well, but actual profit expectations have limited upward revisions.

In terms of growth prospects, different sub-industries show significant differentiation. Emotion-driven consumption, such as online gaming and music, is expected to continue performing well, benefiting from a favorable competitive landscape, strong pricing power, and low price sensitivity, enabling visible revenue growth amid macro uncertainties. In contrast, advertising growth is expected to slow from 14% to 10%, while e-commerce growth is expected to remain stable at 6.5%.

AI Commercialization Path Becoming Clearer

UBS believes that investors need to focus on AI monetization, overseas expansion, and margin restructuring in the second half of the year.

Analysts believe that the commercialization process of artificial intelligence is accelerating, with three areas showing early visible monetization including cloud services, advertising, and AI agents.

In terms of cloud services, by the first quarter of 2025, the average proportion of AI revenue among major cloud service providers in China reached 10-20%, with consensus expectations rising by 6-13 percentage points since the beginning of the year. UBS estimates that GenAI-related cloud service demand accounts for about 5% of total cloud demand, maintaining triple-digit year-on-year growth.

The effects of AI applications in the advertising sector have already become apparent. Tencent, Kuaishou, and Weibo all reported significant contributions of AI to advertising revenue growth in the first quarter, with click-through rates improving. UBS's channel research shows that AI-driven improvements in return on investment can achieve single-digit to over ten percentage points increases in click-through and conversion rates.

In terms of AI agents, vertical agents may present a clearer return on investment, with stronger willingness to pay from enterprises and professional consumers. Content creation, professional services, and scientific research represent the main use cases. UBS estimates the potential market size for enterprise-level AI agents to be around 1.6 trillion RMB, with vertical agents at about 250 billion RMB, while general consumer-level AI agents, although strategically important, may have a more gradual monetization process.

Overseas Expansion as a New Growth Engine

Chinese internet giants are actively replicating successful models to expand into overseas markets. In the cross-border e-commerce sector, Pinduoduo's Temu operates in over 70 countries, with GMV expected to reach 55 billion USD in 2024.

UBS analysis shows that Temu has quickly adjusted its strategy: most fully managed models have been closed and shifted to semi-managed models, actively expanding into markets outside the United States, focusing on the EU and Latin America, while testing new fulfillment models such as Y2 and X2. Despite implementing several countermeasures, UBS expects Temu's operating losses to expand to 50 billion RMB by 2025.

In terms of overseas expansion in food delivery, Meituan's Keeta is showing excellent prospects in the Middle East and Brazil markets.

UBS estimates that the combined market size for food delivery and instant delivery in the Middle East and Brazil reaches 80 billion USD. Although smaller than China's 220 billion USD market, the growth rate exceeds 20%, and the profit margins are higher. Assuming Keeta achieves a long-term market share of 20% and an operating profit margin of 4%, it could realize 480 million USD in operating profit.

Trip.com’s overseas business now contributes 13-14% of the group's revenue, with a growth rate exceeding 50%, rapidly gaining traction in the Asian market, with operations in Hong Kong and Singapore already profitable.

Restructuring Profit Margins: From Commissions to Advertising

In the face of a more challenging macro environment, e-commerce platforms are shifting from consumer subsidies to merchant support and ecosystem health. This also echoes the government's request to alleviate the burden on merchants, as reflected in the draft guidelines on platform fees released by the State Administration for Market Regulation in May.

The draft consultation document on platform fees released by the State Administration for Market Regulation in May encourages: reducing the burden on merchants, with a focus on supporting small and medium-sized enterprises; increasing transparency and simplifying the fee structure.

UBS expects the commission rates of internet platforms to tend toward uniformity, shifting from commissions to advertising revenue.

Ways for platforms to increase advertising rates include: more efficient use of advertising inventory, such as providing merchants with full-site marketing tools that guarantee return on investment; collaborating with other platforms to gain additional traffic; Upgrade advertising technology using generative AI to improve overall click-through rates and conversion rates; provide targeted subsidies to enhance advertising conversion rates.