Fear and Fascination in Cyber China


By Bruce Einhorn For anybody who has followed the roller-coaster world of Chinese Internet IPOs this year, the pattern is already distressingly familiar. Last week, Tencent Holdings, an instant-messaging outfit based in the southern Chinese city of Shenzhen, made a big splash on the Hong Kong market. Its initial public offering, which was arranged by Goldman Sachs, was 158 times oversubscribed.

When the stock started trading on June 16, the price jumped 12%, and its volume of almost 440 million shares made it the second-most traded stock on the Hong Kong bourse. But by June 18, it had already given up most of its gains and sank below the threshold of HK$4, close to its listing price of HK$3.70.

POST-IPO TUMBLES. Tencent's up-and-down performance shows how investors are alternately intrigued and frightened by the Chinese Internet market. Following the impressive results of China's first generation of Net companies -- portals such as the Nasdaq-listed Netease (NTES), Sohu (SOHU), and Sina (SINA) were among the best overall performers in 2002 and 2003 -- a new crop of Chinese Internet plays is now emerging.

Their businesses vary. Some specialize in delivering Internet content to cell phones, others in providing online games to PCs, still others produce chips for the gadgets that enable the Chinese to get online. But a common theme for them all is the belief in spectacular Internet growth in China. The country now has the world's second-largest Net population, and within a few years it's expected to surpass the current No., the U.S.

With such growth prospects, successful IPOs should be sure things -- or so the dot-commers and their bankers would have us believe. But for company after company -- including outfits such as Tom Online (TOMO), Linktone (LTON), and Semiconductor Manufacturing International (SMI) that have had their stock market debuts this year -- the trip to market hasn't been such a happy one. In each case, the share prices fell sharply in the days following the IPOs.

FOREIGN INTEREST. One of the factors roiling investors' stomachs is the sudden onset of jitters over China's economy overheating, after reading about many months of double-digit growth in the country's gross domestic product. In early 2004, Premier Wen Jiabao started signaling that his government wanted to slow down China's growth. Throw in investigations by New York regulators into allegations of irregularities at one of the biggest recent Chinese IPOs -- for insurer China Life (LFC) -- and it's no wonder that many investors can't decide whether to give China a rest for a while.

The good news for Chinese Internet concerns is that such skittishness may now be fading amid signs that Beijing will probably work to prevent a hard landing for the economy. Tencent was able to pull off its IPO, after all, although it had to price the deal conservatively to attract investors. In May, one of China's most successful second-generation Internet outfits, online-gaming operator Shanda Interactive Entertainment (SNDA), raised $152 million in a Nasdaq listing underwritten by Goldman Sachs. Expect more deals to come in the months ahead.

At the same time that market investors are looking again at Chinese dot-coms, the outfits are attracting growing interest from some big e-commerce powers from outside the country. The foreign players realize that China is becoming an Internet powerhouse. Multinationals that don't already have a China strategy need to come up with one -- fast.

UNCERTAINTY AND RISK. While all eyes in Hong Kong were on the Tencent IPO, Chinese-language search engine Baidu.com was the star in Shanghai. The latter announced last week that a group of foreign investors -- including Google -- had taken a stake in the company, along with U.S. venture-capital firm Draper Fisher Jurvetson and several other investors. Since other foreign Internet outfits, including giants Yahoo! (YHOO) and AOL (TWX), have encountered difficulties entering the Chinese market, it probably makes sense for Google to team up with a local player like Baidu.

Japanese e-commerce retailer Rakuten has a similar strategy. This week it announced that it will acquire 21.6% of Ctrip.com (CTRP) for $109 million. Shanghai-based Ctrip lets Chinese travelers book hotel and airline reservations online or through call centers. Ctrip went public last year on Nasdaq. Its stock price enjoyed a brief surge and then languished for several months below the IPO price, before the Rakuten news helped it climb back to $34.62 as of the June 18 close.

For U.S. and Japanese businesses, the downsides of investing in China include the uncertainty of the country's regulatory environment, since the mindset of a Communist Party cadre isn't one that's naturally in sync with a dot-commer. The Baidu and Ctrip deals also come with significant risks. Baidu may have scored the world's top search outfit, but Google has had its share of trouble in China. Its Chinese-language site has sometimes run afoul of government censors. And teaming up with a Japanese partner could be risky for Ctrip, given the strong anti-Japanese sentiment among some of China's nationalistic youth.

However, with more Chinese Net concerns coming to market, the competition among the country's e-commerce providers is only going to get tougher. Having a strong foreign partner is one way to help them survive the rough patches if investors shy away from China's up-again, down-again Internet stocks. Einhorn covers technology from Hong Kong for BusinessWeek. Follow his weekly Online Asia column, only on BusinessWeek Online


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