Wall Street on China’s Internet Sector: Distinct Investment Opportunities in AI and Gaming; Caution on E‑commerce
Bank of America Merrill Lynch maintains that, despite a year-to-date gain exceeding 50%, China’s internet sector remains an essential holding and presents differentiated investment opportunities, particularly in artificial intelligence and online gaming. The firm highlights that Chinese internet companies are pursuing AI strategies that prioritize efficiency, tangible use cases and ecosystem advantages, and notes that the sector’s forward price‑to‑earnings ratio is approximately 17 times, a valuation the report characterizes as not demanding. With regulatory tail risks receding, selecting the appropriate sub‑sectors will be central to realizing returns.
Analysts advocate exposure to AI applications and online gaming while urging prudence on e‑commerce platforms, especially those challenged by intensifying instant‑retail competition. The report argues that China’s major internet groups occupy favorable positions for AI commercialization due to closed‑loop ecosystems that enable direct monetization, proven mobile‑era commercialization capabilities, vast user datasets and relatively low token costs. Within the coverage, Tencent is identified as the preferred stock, reflecting a blend of AI‑driven growth potential, a stable competitive landscape, attractive shareholder returns and a compelling valuation. The report praises Tencent’s selective approach to investment—prioritizing AI application development and product‑market fit over an aggressive cloud‑infrastructure cash burn—while adopting a fast‑follower stance on foundational AI models.
Alibaba is favored for its AI and cloud positioning. Analysts point to Alibaba’s leading cloud market share and its full‑stack AI/cloud offerings as key attributes that make it a primary vehicle for exposure to China‑focused AI investment, with accelerating cloud revenue expected to underpin sentiment. In digital entertainment, the analysis gives priority to online gaming, citing enduring blockbuster titles, stable competition and reasonable valuations. Tencent is seen as better positioned than NetEase for near‑term revenue upside from new gaming formats, while Bilibili is highlighted for the fastest projected EPS growth in the entertainment cohort by 2026.
By contrast, the report adopts a cautious stance toward transaction platforms, encompassing e‑commerce and local services, and portrays the fight for instant‑retail market share as a protracted contest likely to persist through 2026 and depress sector profitability. Data cited by the analysts show a marked deterioration in operating profit growth for e‑commerce firms, with total operating profit growth shifting from a year‑on‑year increase of 2% in the first quarter of 2025 to a 23% year‑on‑year decline in the second quarter, and consensus 12‑month rolling EPS estimates for many transaction platforms downgraded since June 2025. Against this backdrop, the report lowers its rating on Meituan to neutral, reflecting limited visibility on 2026 earnings and heightened uncertainty. Despite industry headwinds, Alibaba is judged relatively better positioned among transaction platforms due to accelerating cloud revenue, notable share gains in instant retail and improving momentum in its core e‑commerce business.
The report also underscores a persistent valuation gap for China internet stocks. The Nasdaq Golden Dragon China Index trades at roughly 16 times forward 12‑month earnings, versus 20 times for the Hang Seng Tech Index, 28 times for the Nasdaq‑100 and 33 times for the leading U.S. mega‑cap technology index. Historically, the Golden Dragon index traded at valuations similar to the Nasdaq‑100 prior to early 2023 and at a premium in 2021. At present, Chinese internet equities exhibit only a 20% valuation premium versus the MSCI China Index, below the 40–80% premium observed over the past decade, despite the sector’s role as a principal beneficiary of AI‑driven productivity gains.
