CITIC SEC: Chinese AI assets are expected to be reassessed, optimistic about the convergence and recovery of the Hong Kong Internet sector.

CITIC SEC released a research report stating that the realignment of funds and flows is driving the market from differentiation to convergence. With bottoming performance and resonance with AI narratives, the outlook for the Hong Kong internet industry is positive. Looking back at the global tech market, the pricing focus in the past year has been on the "input side" of AI infrastructure. As model capabilities continue to rise and the path to commercialization becomes clearer, the pricing focus is shifting from the "input side" to the "output side," and the reassessment window for Chinese AI assets is opening. In this reassessment process, opportunities exist in the cloud, models, and applications: the cloud is the first stop for AI demand to land, high computing power drives revenue growth, and the path from capital expenditure to revenue is becoming clearer; models are the core of intelligent supply, with domestic models continuously improving in intelligence and narrowing the gap with global flagship models, serving as the anchor of reassessment; applications are the carriers of commercialization, with scenarios, modes, and end points expanding comprehensively, and the breadth and depth of AI penetration continue to exceed expectations. Based on this, the top companies in the Hong Kong internet sector are core assets for this reassessment cycle. Key points from CITIC SEC are as follows: Structural realignment: The convergence and repair of K-shaped differentiation is beginning. Since the beginning of 2026 (up to July 17), the domestic market in China has shown significant K-shaped differentiation: the hardware side saw a 35% increase in the CITIC Electronics/Communications Index, while the Hang Seng Technology/Chinese Internet Index fell by 16% and 29% respectively, with the internet sector significantly lagging behind. Globally, differentiation is also extreme, with the SOX/KOSPI/Nikkei 225 rising by 65%, 53%, and 24% respectively since the beginning of the year. Since July, there has been a loosening of differentiation: the SOX has fallen by 18%, while Microsoft/Amazon/Google/META rose by 2.5%, 2.3%, -4%, and 5.4% respectively, and the Hang Seng Technology/Chinese Internet Index rose by 3.4% and 12%. The bank believes that K-shaped differentiation is gradually converging and repairing, with the over-crowded hardware positions, along with the expected repair of Hyperscaler's commercialization of models, leading global funds to switch structurally from hardware to cloud and applications; low exposure, low valuations of Hong Kong Internet companies are expected to become important destinations for fund switching, and the bank is optimistic about the convergence and repair of the sector. Flow Rebalancing: Funds are at low levels, and the potential for capital inflows is accumulating. Feedback from overseas investors during a recent roadshow with the bank shows that the mainstream positioning is underweight China and underweight internet assets within China. Since July, significant volatility in the Asia-Pacific hardware sector, represented by storage, has been amplified, with the KOSPI/Nikkei 225 down 18% and 9% respectively since July. Samsung Electronics/SK Hynix/KAIXA fell by 19%, 28%, and 41% respectively, implying that high volatility in the Korean and Japanese markets may drive regional fund reconfigurations, favoring low exposure, low valuation Hong Kong internet companies; coupled with the further rise of the Chinese AI narrative, long-term overseas funds with the prior "long tech short internet" hedge, along with underweight positions in China and the internet, may be motivated to consider rebalancing their holdings, with the momentum for capital inflows accumulating. On the domestic side, according to Wind, Hong Kong ETFs saw continuous net outflows of 5.4 billion and 43.1 billion RMB from July to the present/year to date, indicating that overall allocation to the Internet sector by domestic investors remains low. The sector's funding is in a dual low state, with both types of funds having the motivation to increase their positions, following the progress of rebalancing and the catalyzation of AI landing, there is clear upward potential in the funding. Performance Dimension: Pessimistic expectations have been priced in, and the second half of 2026 is expected to see a turning point in profits. Since 2025, the adjustments experienced by the Hong Kong Internet sector were mainly due to EPS downgrades, driven by revenue pressure under macro pressures, as well as profit pressures and uncertainties brought about by AI and new business investments. As of July 17, the expected profit growth rates for Hang Seng Technology in 2026 and 2027 are 11% and 22% respectively. The bank currently believes that pessimistic expectations have been relatively fully priced in, with traditional businesses such as instant retail experiencing a clear and rapid contraction of losses. According to Visible Alpha's consensus expectations, in the second quarter of 2026, the total revenue of major domestic internet companies is expected to increase by 5% year-on-year, continuing the steady growth trend. Non-GAAP net profit is expected to decrease by 8% year-on-year, a significant narrowing from the 32% decline in the first quarter of 2026, with profit margins expected to significantly improve quarter-on-quarter; Non-GAAP net profit growth is expected to further recover to +12% and +46% in the third and fourth quarters of 2026, with total annual revenue expected to increase by 8%. The growth rate of the sector's performance has bottomed out, and the improvement in core profits will further support continued investment in AI businesses. With the gradual clarity of AI business models, a positive cycle of "core business generation - AI investment - growth realization" will be formed; the progressive recovery of EPS expectations not only provides a safe margin at the current position, but is also expected to become a catalyst for the sector's performance, suggesting a focus on the pace of internet company performance release. Valuation Dimension: Chinese AI narratives restarted, overseas funds revaluing Chinese AI assets. The recent release of Kimi K3 has sparked a significant response overseas, with a shortening time difference of about three months between high ROI Chinese manufacturers and overseas flagship models, leading to discussions in the market about whether a "second DeepSeek moment" is on the horizon. The bank believes that the performance of K3 is the first aspect of the recent acceleration of domestic AI catch-up. In the second half of the year, Chinese model manufacturers will enter a new cycle of intensive iteration, challenging global flagships in terms of intelligence limits and cost-effectiveness, facilitating the transition from "following" to "running alongside." Secondly, with the recent WAIC conference, upstream computing power is accelerating iterative upgrades in super nodes, interconnections, and adaptation to domestic models. Downstream applications are flourishing, covering more diverse scenes (office, programming, physical, consumption and entertainment, etc.), with richer modes (text, images, video, voice, etc.) and carriers accelerating towards end points (AI phones, glasses, Siasun Robot & Automation, etc.), the breadth and depth of AI penetration continue to exceed expectations. The improvement in the intelligence limit of Chinese models and the high certainty of downstream commercialization will drive overseas investors to reassess the competitive advantages and valuation potential of Chinese model companies, with the reassessment likely to transfer from primary to secondary markets related to cloud and model assets. Currently, the NTM PE of Hang Seng Technology is 18.9x (Wind consensus expectations), in the 27.5th percentile over the last five years, and with performance bottoming out and resonating with the AI narrative, the sector has the potential for both valuation and profit recovery. Risks: Loose liquidity leading to a downward shift in market valuations; Slow cost reduction and efficiency improvement of internet companies leading to slower-than-expected performance recovery; New business and market expansions falling short of expectations, or investment losses exceeding expectations; Risks of core shareholders reducing positions, etc.; Policy implementation progress falling short of expectations; Chinese large models catching up with foreign counterparts slower-than-expected.