UBS: With the end of Double Eleven, the e-commerce industry is expected to bottom out and competition is expected to ease in the fourth quarter.

UBS released a research report stating that from the beginning of 2025 to now, the China Internet ETF (KWEB) has risen by 37%, and has increased by 5% quarter-to-date. However, profit expectations have been lowered by 19%, and most of the increase is driven by valuation. The main reason for the downward revision of profit expectations is due to investments in instant retail by e-commerce companies. UBS has observed the following characteristics for the Chinese internet industry this year: 1) Overall favorable market sentiment driving valuation multiples: the emergence of DeepSeek has improved investor sentiment towards this sector; Chinese stocks have been rebounding this year; in terms of valuation, the valuation multiples of major internet companies have expanded by about 58%, to around 17 times the 2025E adjusted P/E ratio, with a forecasted compound annual earnings growth of about 10% for 2024-2026; in comparison, the valuation of the US "big seven tech giants" is about 31 times, corresponding to a compound annual earnings growth of 18%. It is evident that Chinese internet stocks are relatively cheap. 2) Small and medium-sized companies in vertical sectors continue to outperform: with investors avoiding the competition pressure among e-commerce giants in instant retail, emotional consumption scenarios (such as online games and music) related to virtual consumption have performed well. Overall, stable competitive landscape and high profit visibility of leading companies in vertical sectors continue to drive upward profit expectations. 3) Under-allocated assets have seen significant rebounds in stock prices when performance meets expectations. Structural highlights in the macro environment Emotional consumption: online entertainment sector performing better than expected when content supply is in place and able to capture a share of consumer online leisure spending. This includes online gaming (strong performance of evergreen games) and online music (strong growth in fan-related revenue). Retail: China's retail sales grew by 3.7% year-on-year, with better performance in online sales of physical goods, increasing by 6.3% year-on-year. Extended shopping festivals, platform algorithm optimization, and active subsidies in instant retail have played a role in driving growth. Advertising: Advertising technology and AI-related companies with bottom-up driving factors have positive outlooks from management, while other media or traditional advertising platforms show weaker performances. Outlook for trends in the Chinese internet industry Trend 1: Embrace AI, actively invest China's internet giants are actively increasing capital expenditure and increasing investment in AI. Geopolitical uncertainties have raised concerns among investors about whether chip supply will affect China's AI development, but UBS believes that capital expenditure is more demand-driven. Compared to overseas, Chinese internet companies are more focused on GPU efficiency and utilization, allowing them to adjust investment targets more quickly and flexibly in response to changing demands. Continued development of domestic computing power: 1) At the AI chip level: although there is still a performance gap, performance is rapidly improving due to the continuous self-research investment of Chinese internet companies and the development of local GPU manufacturers. 2) At the system level: UBS also sees positive progress, especially with the adoption of "super node" technology, which expands the number of GPUs in a single server cabinet, partially compensating for the gap in domestic single GPUs, achieving better computing performance at the cabinet level. 3) At the level of large model algorithms: UBS observes that domestic developers are optimizing algorithms for local GPUs, such as the latest v3.2 model from DeepSeek. Chinese cloud providers continue to firmly invest in AI. Second-quarter financial reports show that leading companies are maintaining their annual capital expenditure guidance, focusing on improving chip utilization and deployment efficiency. Faced with supply chain uncertainties, they emphasize flexible selection of chip solutions, including domestic alternatives. In considering aspects related to AI that can drive revenue, the focus is on the following businesses: 1) Accelerated growth in cloud business revenue. 2) Deep integration of existing businesses, including e-commerce, video recommendations, gaming, and education. 3) Independent applications quickly rising, including in content generation, AI search, information processing, and accumulation, and conversational assistants. Trend 2: Investment in instant retail Increasing investment in instant retail is a strategy for platforms to boost low-frequency e-commerce business through high-frequency takeaway transactions and increase user activity. Currently, UBS sees signs that short-term competition is stabilizing, with industry transaction volume growth slowing down, mainly due to: 1) seasonal decline in beverage orders; 2) platform optimizing promotional strategies following regulatory discussions. Additionally, by tracking the proportion of time spent using delivery rider apps on a monthly basis as a proxy indicator for platform order share, UBS finds that market share is stabilizing. UBS believes that with the conclusion of the Double Eleven shopping festival, the industry is expected to bottom out, competition will ease in the fourth quarter, and gradually return to normalcy. In the medium to long term, the industry still faces some challenges, with structural changes not yet reflected in prices. Firstly, intensifying competition; secondly, how to accelerate the online penetration of takeaway in terms of merchant supply and user mentality. From the current investment effects, as order volume increases, users are gradually developing a mentality for instant retail, accelerating the process of online penetration from offline. However, the impact on user experience, merchant profits, etc., in the medium to long term still remains to be observed.