Once known for its low-cost manufacturing and copycat culture, China is playing host to an internet innovation revolution that could transform its industrial landscape.

Unlike the country’s previous mutations which had been engineered by its state planners, this metamorphosis is the work of a group of home-grown competitive internet giants that have taken full advantage of China’s ban on Twitter and Facebook.

In less than 10 years, search engine company Baidu, e-commerce company Alibaba and messaging service Tencent (collectively known as BAT) have between them amassed 1.8 billion users. And a study by McKinsey Global Institute projects that the expansion of the internet could add up to 1 percentage point to China’s GDP growth rate to 2025.

The three stocks are giving global investors an opportunity to invest in some of China’s fastest-growing market segments. Today, 27 per cent of emerging market funds hold at least one of the BATs.

And their valuations aren’t unreasonable, given expected earnings growth. Tencent is currently trading on 31 times one-year forward earnings, Alibaba at 24 times and Baidu 28 times. By contrast, Alphabet Inc, the parent company of Google, is trading at 20.99 times.

But BAT aren’t just rewriting the rules of internet in China. These firms now have a growing influence on consumer behaviour, and the sheer scale of their operations threatens a diverse range of industries such as commerce, media or finance.

Dominance

Gaming and messaging firm Tencent, for instance, can exploit its massive presence in mobile, with 650 million active users on its messaging apps WeChat and Weixin. Baidu, China’s answer to Google, dominates the mainland search market with a 70 per cent market share. Alibaba, meanwhile, controls nearly 80 per cent of China’s e-commerce.

In the past few years, each of these companies has extended its reach by acquiring start-up businesses operating across a broad range of industries.

Collectively, BAT accounted for more than 40 per cent of domestic acquisitions in the internet sector in 2015, according to data compiled by Bloomberg. And all three have been locked in a battle for the wallet of the middle-class consumer.

An ever-larger portion of the Chinese is opting for the convenience of online shopping and home delivery rather than deal with polluted air and traffic gridlock. Shopping is increasingly taking place on mobiles, which is how nearly 90 per cent of users in China access the web.

BAT have been investing heavily in local services, in the hope of attracting more users to their own platforms as consumers use their mobiles to order local goods and book anything from cinema tickets to restaurants.

In one day alone, Alibaba sold goods with a value totalling more than bricks-and-mortar electronics distributor Suning’s annual revenue, illustrating consumers’ massive shift to online. It is also rolling out food delivery in hundreds of cities to push out supermarkets, and already controls 50 per cent of the market.

Banking licences

The online-to-offline sector (O2O) market in China is estimated at 12 trillion yuan (Dh6.7 trillion, $1.8 trillion) according to JP Morgan. Another sector that is about to be transformed by the BAT juggernaut is finance. When the government decided to grant five banking licences in 2015, Baidu, Tencent and Alibaba duly responded.

Tencent built a 30 per cent stake in WeBank while Alibaba now owns MYbank, the first online bank in China, which is developing pay-with-a-selfie payment technology using facial recognition.

Alibaba is also active in financial services through its Ali Loans unit, a provider of consumer and business credit. The business could generate as much as $1.7 billion from consumers and merchants within three years — a sum which dwarfs the $730 million in revenues that US- based online lending marketplace Lending Club is projected to generate in 2016.

With half of transactions on Alibaba’s e-commerce sites paid through Alipay, its mobile payment processing platform, the company collects vast amounts of valuable data which can be used to mine insights about customers. Alipay handles $800 billion in e-transactions a year — three times more than US rival PayPal.

Few can dispute BAT’s disruptive potential. But if they are to continue to transform industries such as retail, finance and technology both within and outside China, they must avoid a number of potential pitfalls.

Investing through proxies

Each company is at risk of overstretching itself financially, particularly in areas such as O2O. Although it is the fastest growing sector in China, the service is heavily subsidised, with companies charging low commissions to attract merchants, a business model that looks unsustainable in the long run.

Another threat looms in the shape of the Chinese authorities. As BAT move further into sectors such as finance and media, they venture into areas that have typically been closely controlled by the state.

This may be why Alibaba and its two peers are increasingly investing through proxies, and battling it out not only on their home turf, but also abroad, with Baidu investing in US company Uber while Alibaba and Tencent backing Uber rival Lyft.

Although it remains to be seen how much an economic slowdown in China could affect their growth ambitions, internet-related businesses are here to stay as they form a major part of the country’s transition to a consumer-driven economy. Global technology groups of the West should take note — the real tech revolution is happening in China.

The writer is Senior Investment Manager in Thematic Equities for Pictet Asset Management.