China Finance: How to trade China's new R&D boom (Buy Google?)

If you still think China's competitive advantage is cheap labour, you are about a decade behind the times.  

Right now, China's chief competitive advantage is the ready access to cheap capital.  Commercial banks pay regulated and low interest on deposits to keep costs down, while policy banks have provided strategic cheap credit.  But that paradigm is already changing.  Bad loans are slowly forcing the banks to readjust this strategy, which is leading to  a new transition, this time towards cheaply-produced intellectual property.

Investment in research and development is booming, and met with a continued strong supply of competent, well educated, new science graduates for hire.  And many international companies - like Microsoft, Pfizer, and Novo Nordisk -  have jumped on the opportunity to move significant parts of their R&D activities to China.

Mobile will lead

In the high-tech sector China is looking to dominate the international market segment of cheap mobile devices and tech, which is an area with extremely large growth potential in the developing world. Key to this push will likely be the continued availability of Android as a free and open OS, as this is the preferred OS in this field. This fact is also highlighted by the Chinese government conditionional approval for Google's acquisition of Motorola on the company promising to keep android openly available for at least another 5 years.

This also means that buying Google (NASDAQ: GOOG) is another play to benefit from this future expansion, as it looks exceedingly likely that Android will be the primary OS in a future push. Another company looking to use their cheap R&D to expand internationally seems to be Tencent (HKSE: 0700.HK), especially with their new Weixin/Wechat app that's currently gaining some traction in southeast Asia and has doubled its userbase to 200 million in the last 6 months alone.

Source: Saxo Bank

Traditional medicine

The medicine sector, meanwhile, is still split along the lines of Western vs. TCM (Traditional Chinese Medicine), with the latter facing difficulties in expanding internationally regardless of R&D success due to public perception. While many people may think there's no R&D in TCM this is simply not true. New versions of these traditional cures are being developed and tested very year. In 2011, the Chinese government pledged over $750 million to help develop R&D in the industry. This could change the international perception of TCM, but that change will likely require a switch in attitude which will not come quickly, so growth potential here is likely limited in the near term.

One way around this is to look for producers of medical equipment, such as makers of disposable polymer medical equipment Shandong Weigao group (HKSE: 1066.HK), as these products are much more internationally viable yet still take advantage of China's cheap IP. This industry is also likely to see some good traction from the growth of the healthcare and eldercare industries within China.

Source: Saxo Bank

Clean tech

Clean-tech is an industry with massive growth potential internationally, and China already has a key role. But the benefit of leveraging cheap R&D is likely offset by the near-term crisis of overcapacity. The industry needs to adjust to weakened global demand, so we'll likely see bankruptcies and consolidation before an eventual winner emerges. There will be lots of volatility to trade,but picking winners and losers won't be easy.

Hazarding a guess as to the winner in the clean tech field I think it'll come down to two factors: Size and government relationships. Two potential winners here long term could be Goldwind (HKSE: 2208.HK) and Trina Solar (NYSE: TSL), which are among the industry leaders. These two factors make it more likely that these companies will emerge at the end of this industry crisis still kicking and rearing to go, as they are big enough to pick up some of the smaller players and look likely to have government backing, which in China often means economic relief packages and cheap credit to finance consolidation.

Source: Saxo Bank

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I write regularly about Chinese equities, mainly those listed on foreign exchanges. If you'd like to comment on this story or be notified by email whenever a new China Finance story is published, become a member - it's free, and you can use your Twitter, Facebook, Google or LinkedIn login - and "follow" the China Finance blog during the signup process. You can also bookmark the China Finance blog page.