BUSINESSWEEK ONLINE : JULY 17, 2000 ISSUE
INTERNATIONAL -- ASIAN COVER STORY China's Tangled Web (int'l edition) Will Beijing ruin the Net by trying to control it? Like other entrepreneurs caught up in Internet fever, Joseph Chen figured the opportunities in China were almost endless. Last year, he and two Chinese classmates at Stanford University launched portal ChinaRen Inc. and quickly lined up millions of dollars from investors. Within months, Beijing-based ChinaRen was regarded as a contender in the race to become a powerhouse in the world's fastest-growing Internet market. Chen, 31, is now rethinking ChinaRen's future. As with Net companies everywhere, outside investors want profits. But Chen can't rely heavily on ad revenues, since China's dozens of portals are competing for a tiny online ad pool. Electronic commerce isn't the answer, because so few Chinese consumers have credit cards. And thanks to harsh restrictions by Beijing on new stock issues--not to mention waning worldwide investor interest in Net plays--Chen can't easily tap equity markets to raise fresh capital. ''The market is very tough,'' concedes Chen, who is hoping to muster new business by setting up e-mail services and internal networks for corporations. FRIENDS UP HIGH. On the other side of town, in a dingy central Beijing office building down the street from Communist Party headquarters, the mood couldn't be more buoyant. There, a 39-year-old bureaucrat named Li Ying is building up CCIDNet.com, a government-backed site focused on the electronics industry that offers news, e-commerce, and consulting services. Li has been busy promoting the company in Hong Kong and says she has little difficulty raising money to finance her huge ambitions. ''CCIDNet wants to grow from being a local company into a global one,'' she says. Varying business models may partially explain the divergent fortunes of the two companies. But another key difference lies in their ownership. Like many among the country's first wave of Net highfliers, ChinaRen is owned by its entrepreneurs and private financiers. CCIDNet's main shareholder is a subsidiary of the Ministry of Information Industry (MII), the body that regulates the industry and has the power to grant licenses and approve initial public offerings for Chinese dot-coms. That should give CCIDNet a big edge, says Li. ''The MII really trusts and believes in us, so it can give us more support,'' she boasts. Even the Nasdaq correction has been ''a positive thing'' for the company, Li says. Now, ''venture capitalists will be looking at companies with strong backgrounds like CCIDNet.'' Call it the Internet with Chinese characteristics. A year ago, when a little-known but well-connected portal named Chinadotcom raised $84 million in a hugely oversubscribed Nasdaq offering, hopes surged that the Internet would transform China. Western venture capitalists descended on Beijing and Shanghai to fund dot-coms that, they hoped, would bring the Middle Kingdom into the modern world. Savvy, well-educated entrepreneurs like Chen would form the foundation of a new corporate elite, beyond the reach of Beijing and its giant state-owned enterprises. The private sector also would expose millions of ordinary citizens to outside information and turn thousands of industrial dinosaurs into competitive enterprises. In short, after decades during which leaders struggled to reform socialist-era industries and financial institutions, the Net would provide a fresh chance to create a new Chinese economy. Some outsiders went so far as to predict that these new dot-coms would eventually force political liberalization on the world's last communist power. China's leaders, however, have other ideas. Rather than allow entrepreneurial upstarts free rein, the government over the past year has been working hard to ensure that the Internet remains under state control. Bureaucrats from the halls of the MII to the offices of local agencies have awoken to the vast wealth likely to be generated by the Internet revolution--as well as the enormous power that comes with the ability to regulate them. They have issued a blizzard of rules restricting what dot-coms can do and censoring what they can say. Officials also imposed stifling restrictions on new listings, greatly slowing the inflow of foreign capital. That kept the Nasdaq door closed for most Chinese dot-coms. TOO LITTLE, TOO LATE. Even though Beijing has recently relented by opening the door a crack for new listings, the damage was done. The Internet bubble has already burst. Consider the market reaction to Netease.com, a Chinese portal founded by private entrepreneur William Ding and whose investors include News Corp. (NWS) and Goldman Sachs (GS). After months of delays, Beijing allowed it to go public on June 30 on Nasdaq under complicated rules that prevent foreigners from buying a share of its mainland operations. Its stock price promptly sank 22%. That may make it harder for Netease.com or other companies to raise more funds on Nasdaq. But the real harm goes well beyond denying opportunistic tycoons a chance to make their stock market windfalls. By burdening the Chinese Internet with rules, Beijing is burdening it with many of the flaws that have retarded development of other industries. In the Chinese cyberworld, creative private entrepreneurs need to make room for civil servants or for businessmen whose main asset is guanxi, or connections. It will be hard for foreigners to invest in Net businesses with the most financial potential--and they'll never know when Beijing's fickle bureaucrats will change the rules again. China's chances of becoming an enormous Internet market are still viewed favorably by many, of course. Indeed, with the strong backing of President Jiang Zemin and Premier Zhu Rongji, the government has been slashing access fees and urging everyone from factory-floor managers to elementary-school students to go online. As a result, the online population jumped from 1.5 million to 8.9 million just during 1999. Many experts still believe China will live up to lofty forecasts. For instance, Goldman Sachs predicts Net usage will soar to 81 million by yearend 2003. Those who figured the grandiose predictions would translate into huge profits, however, are likely to run into a reality check. For starters, China's progress in establishing electronic payment systems, which have made e-commerce viable in the U.S., has been slow. The country also lacks a big base of affluent consumers. ''The amount of hype and hot money going into the China Internet was preposterous,'' says London-based PricewaterhouseCoopers consultant John B. Stuttard, who until 1999 was chairman of the firm's China operations. He notes that only 2 million Chinese have disposable income of $20,000 a year or more. ''The Web is growing fast, but what the Chinese really are doing with it is sending e-mails or surfing for free information,'' Stuttard says. ''China is not ready for e-business.'' That's why e-commerce pioneers like Chen of ChinaRen are scrambling for other ways to support themselves. Wang Juntao, head of online retailer 8848.net, is following a similar strategy. The company has developed one of China's top consumer brands and even sponsors a soccer team in Shanghai. Still, Wang says 8848.net is getting the bulk of his revenue from B2B sales and corporate-solutions work. ''From the outside, it may look strange,'' Wang concedes. Beijing's regulatory assault has further chilled some investor enthusiasm. For instance, bureaucrats have decreed that companies could be punished if anyone revealed ''state secrets,'' a term that can apply to practically any unauthorized information, on their sites. And they've shown a willingness to take action: In the central city of Wuhan, officials shut down China Finance Information Network, a private-sector financial portal, for 15 days in May. Restrictions on IPOs, meanwhile, have caused uncertainty about whether investors can get their money out of a Chinese dot-com. That has spooked venture capitalists like Hsu Ta-lin, chairman of Palo Alto (Calif.)-based H&Q Asia Pacific Ltd. Hsu has put about half of a new $750 million Asia technology fund into Japan and Korea, but only $7 million into China. He plans to stop there for now. Had there been a clear exit strategy for investors, ''I could have put $100 million into Chinese Internet companies,'' Hsu says. LIKELY SURVIVORS. Such lost opportunities mean that the shakeout taking its toll on dot-coms worldwide is likely to be even more brutal in China. According to the state press, even MII Minister Wu Jichuan predicts the demise of 70% to 80% of the country's 16,000 dot-coms. Last month, prominent auction site ClubCiti, which had formed a partnership with eBay, was acquired by a rival, Beijing Guardian Online E-Commerce Co. Among the most likely survivors will be the connected--and those who were lucky enough to build a war chest early. A big reason Hong Kong-based Chinadotcom Corp. (CHINA) was able to beat the rush to list was its financial backing by Beijing's official Xinhua news agency. Beijing nixed such IPOs for other Chinese portals. As the only China play on Nasdaq at the peak of the bull run, Chinadotcom's stock soared. It also raised over $450 million in subsequent offerings for expansion across the region. Thanks to this head start, its China portal has grown from 1 million daily page views a year ago to 16 million today. ''We spent the time and money,'' crows CEO Peter Yip. ''Others don't have the time and money.'' Government support also is proving important in B2B services, which promise to be vastly more lucrative than the consumer sector. As it prepares to lower import barriers in order to join the World Trade Organization, Beijing is urging hundreds of thousands of state enterprises to use the Web so they can learn to cope. While many B2B entrants are privately owned, some are relying on the MII's support to gain an edge. Take Beijing-based ECantata.com. It helps companies cut their costs by allowing them to choose the lowest bids from a number of competing suppliers. Buddy Ye, ECantata's founder and CEO, has forged what he calls ''a strategic partnership'' with the MII. The ministry promises to open the doors to state-owned enterprises for ECantata. In May, the MII co-hosted a lavish party for the company at Beijing's Diaoyutai Guest House, the site of many government soirees. Trouble is, even great guanxi is no guarantee of success. Consider ChinaWeb, a Beijing company whose portal provides online financial information. It's hard to find a Chinese entrepreneur with better connections than Chairman Wang Boming. Wang, 43, is executive vice-president of the Stock Exchange Executive Council, a government-backed group that has helped shepherd the development of China's equity markets. His investors include China International Trust & Investment Corp. (Citic)--the country's biggest conglomerate--and state-owned China Merchants Bank. Another is Hong Kong's South China Morning Post newspaper, controlled by billionaire Robert Kuok, one of Beijing's favorite foreign tycoons. Even Wang, though, is peeved about the government's Internet policies. ''The players in the Chinese market are strangled by the bureaucracy,'' he complains. By not allowing companies to go public during the crest of Internet fever, Wang figures, Beijing cost the industry a good $2 billion that could have been spent on R&D and might have enabled China to catch up with developed countries. Even under the new IPO rules, companies must adopt a complicated corporate structure and win over Beijing's fussy regulators. ''The CEO has to spend all of his time dealing with the bureaucrats instead of dealing with his own business,'' Wang says. Officials counter that they are doing a good job of encouraging the Net's growth. ''We think the Internet is very important for China,'' says Chen Ying, planning director of the MII's telecom bureau. ''So we try to do our best to let the industry grow faster.'' But that growth would likely be much faster if the government didn't keep some key sectors fenced off from the private sector. Huge bottlenecks in Net traffic have emerged, for example, because investment in the country's network infrastructure by state-owned telecom companies hasn't kept pace with the millions of Chinese that are going online. To make matters worse, Beijing prohibits foreigners from installing high-speed cable to link China to the rest of the world. The result is slow Internet speeds. To access sites in Beijing, surfers in Shanghai often travel an information highway that takes them through the U.S. over normal phone lines. WTO membership, which will require China to allow more foreign telecom investment, may address that particular problem. But it may not help solve another hurdle to explosive growth: China's woeful financial infrastructure. The scarcity of credit cards makes it difficult to conduct online auctions or market goods, and the country's banks don't have a unified system for clearing payments for Chinese who do have cards. That means buyers and sellers on eBay-style auction sites must find each other in cyberspace and then figure out how to conduct a transaction with cash. To cope, Shanghai Mecox Lane International Mailorder Co., which sells everything from clothes and jewelry to sex toys, has set up a payment system that relies on postal money orders. ''The system is far from perfect,'' concedes CEO Andrew T. Tsuei. ''But it's functional.'' For China's economy to get the full benefit of the Internet, however, it needs to be more than merely functional. Indeed, China could be in danger of slipping behind other developing nations. Companies in India, which has seriously lagged China for the past two decades, are leagues ahead in e-commerce and Net-based software. Whereas Beijing will limit foreign ownership of Web businesses to 49% even after it joins the WTO, India allows foreigners to own 100%. New Delhi's bureaucrats ''are very accommodating and really welcoming to foreign companies,'' says Savio Chow, Yahoo! Inc.'s Asia managing director. Yahoo has just opened its India portal. But in China, Yahoo's plan to operate a joint venture with a Beijing company remains on hold some nine months after it was announced, because of uncertainty about the regulatory climate. ''We don't know how long it is going to take,'' Chow says. SECOND THOUGHTS. WTO membership will improve the climate somewhat. Besides allowing more foreign investment in information industries, investors hope it will prompt China to end the rule that dot-coms listing on Nasdaq divide themselves into two companies: a foreign-invested one that controls the brand and online content, and a domestic one that owns the licenses to operate in China. Also, officials have reconsidered some of the more draconian rules, such as one requiring companies to register with the government if they wish to use encryption software to ensure confidentiality, which is vital for e-commerce. Still, China will hardly be a level playing field. With restrictions likely to remain in place for several more years, Chinese state companies will enjoy a valuable head start in crucial new businesses, such as wireless Internet services. ''Clearly there are opportunities in wireless,'' says David Williams, head of the Hong Kong office for Silicon Valley venture capital firm Draper Fisher Jurvetson. ''But most will accrue to China Unicom and China Mobile,'' the two state-owned mobile operators. Draper is looking for private mobile plays, but ''we want to know about the company's connections with those two before we invest,'' says Williams. Even if China opens up as much as optimists hope, some dot-com executives can't help but bemoan the opportunities already squandered. Had they set up the Internet correctly from the outset, it could have been used to narrow China's economic gap with more developed countries. The Internet will surely change China. But by making control their top priority, Beijing's mandarins are putting the brakes on a transformation that should occur at Internet speed. By Bruce Einhorn in Beijing, with Alysha Webb in Shanghai and Pete Engardio in Palo Alto _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP					RELATED ITEMS China's Tangled Web (int'l edition) ASIAN COVER IMAGE: China's Tangled Web INTERACT E-Mail to Business Week Online

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