Giant Steps for China's Net


By Scott Kessler, Standard & Poor's I visited China some 10 years ago, in the summer of 1995 (about a month after Netscape's IPO). The country was literally being built around me. The highway between Beijing and its airport was just completed. The Orient Pearl TV Tower was the only major edifice in the now burgeoning Pudong business district of Shanghai. There were relatively few indications of U.S. influence, except for fast-food restaurants and a couple of billboards.

What a difference a decade makes.

The Internet has become arguably the world's most important medium for information gathering, communications, and commerce. And China is now an economic superpower. It's no surprise to us at Standard & Poor's that at some point these two developments would come together in an extremely palatable way, and earlier this month, I think this happened, largely due to U.S. interests.

"GOOGLE OF CHINA." On Aug. 5, Chinese search company Baidu.com (BIDU

: $92) went public in the U.S. After generating only $13.4 million in net revenues and $1.5 million in net income in 2004, the outfit was valued at as much as $4.9 billion on its first day of trading. The stock soared from $27 to an intraday high of $151.21. The shares have since fallen, but the interest in what has been dubbed "the Google of China" has been astounding, in our view.

Less than a week later, on Aug. 10, Yahoo! (YHOO

: 4 STARS, Buy; $34) announced a major transaction in China that it valued at some $4 billion. Pending necessary approvals, Yahoo would take a 40% stake in Alibaba.com, a leader in Chinese e-commerce, in exchange for Yahoo's China assets and $1 billion.

The planned deal would combine Alibaba's domestic and international business-to-business online marketplaces, online auction company Taobao, and Internet payment service AliPay, with Yahoo's namesake Chinese portal, search properties, and majority stake in auction joint-venture 1pai.

AMERICAN INTERESTS. Chinese Internet companies such as Netease.com (NTES

: $76), Sohu.com (SOHU

: $20), and SINA (SINA

: $29) have traded in the U.S. for years. Over the last couple of years, several major U.S. Internet companies have purchased or taken stakes in online outfits based in China:

Amazon.com (AMZN

: 3 STARS, Hold; $44) bought online retailer Joyo.com in September, 2004.

CNET Networks (CNET

: 2 STARS, Sell; $13) acquired two Chinese Web sites in October, 2004. ZOL is focused on technology-related content and shopping services, and Fengniao is a digital-photography property. In April, 2005, CNET bought 90% of China's PCHome, which operates a personal-technology Web site.

eBay (EBAY

: 3 STARS, Hold; $40) acquired Internet auction company EachNet in July, 2003, after having acquired a minority stake in the company in March, 2002.

Google (GOOG

: 3 STARS, Hold; $286) took a stake in Baidu in June, 2004.

IAC/InterActiveCorp (IACID

: 3 STARS, Hold; $26) acquired a majority stake in Internet travel services company eLong (LONG

: $12) in January, 2005.

However, these were all relatively small transactions, the largest of which was eBay's purchase of EachNet for $175 million ($30 million for the initial minority stake, and $145 million to purchase the remainder).

NOTABLE APPEAL. In February, 2005, China's Shanda Interactive (SNDA

: 5 STARS, Strong Buy; $36) got into the act, by announcing that it and an affiliate had taken a 19.5% stake in SINA for $230 million.

We believe the multibillion dollar valuations ascribed to Baidu and the proposed Yahoo/Alibaba transaction indicate the market for Chinese Internet companies may have reached an inflection point.

With China's burgeoning economy, more than 100 million Internet users (making it the world's second-largest online population, behind the U.S.), and distinctive and challenging cultural, political, and regulatory circumstances, we believe that Chinese Internet outfits will continue to offer notable appeal.

MEASURING STICK. Corporate and individual investors seem to believe the opportunities offered by these companies more than offset the related risks. Until this notion is proven incorrect, we expect additional capital to pour into the segment. Perhaps some of the $4 billion Google hopes to raise with a proposed stock offering announced on Aug. 18 will find its way to China.

In February, 2005, eBay CEO Meg Whitman stood in front of a group of analysts and proclaimed that within a couple of years, success in China would be the measuring stick by which Internet companies around the world would be assessed. Her company plans to spend some $100 million there in 2005 alone, which, in our opinion at S&P, seemed like a pretty large amount when it was announced.

However, based on some of the recent activity described above, $100 million this year might not be enough. As I witnessed 10 years ago, things can happen pretty fast in China, and if eBay isn't sufficiently aggressive, it could end up failing to live up to the benchmark it pronounced earlier this year.

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In the U.S.

As of June 30, 2005, research analysts at Standard & Poor's Equity Research Services U.S. have recommended 30.2% of issuers with buy recommendations, 57.5% with hold recommendations and 12.3% with sell recommendations.

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For residents of the U.K. this report is only directed at and should only be relied on by persons outside of the United Kingdom or persons who are inside the United Kingdom and who have professional experience in matters relating to investments or who are high net worth persons, as defined in Article 19(5) or Article 49(2) (a) to (d) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2001, respectively. Kessler covers Internet Software & Services and Internet Retail stocks for Standard & Poor's


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