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Halloween and China's IT
stocks
By Gary LaMoshi
HONG
KONG - Halloween came a day early in Beijing when Mickey
and Minnie Mouse appeared with Charles Zhang, the
founder, chairman and chief executive of Sohu.com, on
October 30 to celebrate the Internet portal's deal to
zap Disney content to computers and mobile phones across
China. Mickey and Minnie may have been actors in
costume. The mystery is whether Sohu.com and its
high-flying Chinese portal counterparts are turkeys
dressed up as winning investments.
At Halloween
time, Sohu, NetEase, and Sina, among Nasdaq's leading
performers over the past two years, reported quarterly
earnings, providing evidence about whether they qualify
as investing tricks or treats. These are stocks that are
all up more than 400 percent in just the past year,
raising concerns that, well, here we go again - we're in
for yet another Internet bubble.
The portals are
in a neighborhood where you'd expect to find sweet
stocks. China is the world's second-largest Internet
market, with some 70 million users, poised to overtake
the United States as No 1 by the end of 2004. Best of
all, in a country of 1.3 billion, that user count leaves
plenty of room for growth. The potential medium-term
market is estimated at about 350 million. Short-term,
220 million people have mobile phones, a primary tool
for accessing the services of China's three websketeers.
Sohu spooks
The quarterly numbers from
Sohu were a bit spooky for a stock trading at more than
10 times its 52-week low with a price-earnings ratio of
more than 75. Sure, year-on-year net income increased by
more than 2,200 percent and revenues tripled. But in
these vertiginous growth situations, it's the
quarter-to-quarter numbers that matter, and those
contained a scare or two.
Sohu set aside 71
percent of net earnings for the quarter against future
taxes. Company accountants claim this move will reduce
taxes to single digits through 2005, benefiting
shareholders in the long run. So that decline in
earnings, from US$0.21 per share in Q2 to $0.07 in Q3,
wasn't as bad it seemed, with Q4 earnings projected at
$0.24-$0.28 per share.
Overall, Sohu posted its
13th consecutive quarter of double-digit
quarter-to-quarter revenue growth. Advertising revenue
increased 28 percent. However, revenue from Sohu's
subscriber services, such as short message services
(SMS) and e-commerce, grew 6 percent. While founder
Zhang called it a quarter of "strong, diverse, and
balanced growth", gravity took its toll on the growth
trajectory for subscriber revenues.
Over the
past year, Sohu proudly shifted its revenue profile from
65 percent advertising to 65 percent subscriber services
by quadrupling the latter segment. Rather than
trumpeting the growth of their online community, this
quarter Sohu executives cited increased acceptance of
the Internet as a "mainstream" advertising medium while
subscriber revenue took a "breather" after spectacular
growth.
Investors forgave the minor glitches.
Sohu shares gained 13 percent in New York trading the
day after its earnings report.
Sina reported
next, with a valuation of nearly 100 times trailing
earnings to justify. It matched Sohu with a mix of
double- and triple-digit growth figures, but Sina's
numbers included healthy 24 percent quarter-to-quarter
growth in revenue from its subscriber services. Sina
shares gained 5 percent following the announcement, and
Sohu and NetEase also rose in the wake.
NetEase eases
NetEase reported the
next day. Its profits and revenue grew, but there was a
bombshell in the figures. SMS and e-commerce revenue
fell 20.7 percent from the previous quarter. Explaining
the decline, NetEase cited the decision by China's
mobile-phone duopoly to stop billing cooperation on
gambling and (ahem) adult content. (China Mobile and
China Unicom collect from the customers and parcel out a
share of that revenue to the content providers.) Later
in the week, NetEase got a further fright when its
founder, William Ding-lei, topped Forbes' list of the
richest people in China; that designation has been a
ticket to unwelcome government scrutiny and state
(prison) hospitality in years past.
Investors
might tolerate slower growth, but not declines for a
stock selling at 65 times earnings. NetEase shares
dropped 23 percent after the earnings announcement and
kept falling, off 34 percent by the end of last week.
Shares in Sina and Sohu took lesser hits and remain
down.
While NetEase's numbers showed Sohu's
subscriber revenue problem writ large, the decline can't
be dismissed as simply a bigger breather. The fall in
SMS revenue points up some frightening issues for
Chinese portal business models.
First, the
decision by the two state-controlled phone companies to
try to steer users away from certain types of content -
in this case, gambling and adult themes - highlights the
uncomfortable censorship issue. As no less an expert
than Rupert Murdoch observed, the free flow of ideas
without regard to national borders threatens dictators,
so China keeps close tabs on what content providers
Sina, Sohu and NetEase provide.
Content and
discontent
Much more than Yahoo!, these Chinese
portals are content providers. Because government
controls the old media, these newcomers provide China's
young, hip urbanites with a substitute for newspapers
and television. The portals' work in this sensitive area
of news, along with special content from the likes of
Disney, helps create their brand identity. Regulators
and portals perform an elaborate dance that acknowledges
censorship yet pushes the envelope, but the basic fact
is that Beijing's mandarins can zap portals on this
issue - whether it's news, downloadables, or even SMS,
as a dangerous tool enabling anti-state activities -
whenever they may desire, through a variety of methods.
Of course, people who thought long and hard
about the political implications of the Internet in
China didn't push the price of Sina to more than 100
times earnings. Censorship aside, there are hardheaded
commercial issues in the relationship between the
portals and mobile-phone companies that should worry
investors.
The portals and the phone companies
have a mutually favorable situation. The portals drive
SMS traffic with their various services, and mobile
operators get a piece of the action. These relationships
are governed by contracts, and observers believe the
next round will be less favorable to the portals. The
portals have no choices beyond the mobile duopoly, so
the operators can play hardball.
More troubling,
mobile-phone companies could try bypassing the portals
by producing their own content. "The state telecom
companies lack the creativity to create content," a
portal executive assured me recently. But with tens of
thousands of engineers weaned on cyberservices
graduating every year, telecom companies could easily
build capacity to create content. Unlike the portals,
these have the financial flexibility for experimentation
and mistakes.
The scariest part of the story for
investors may be this number: $24.6 million. That was
the total quarterly profit for the three Chinese
portals. With a current collective market cap of $4.5
billion, it'll take the portals nearly half a century to
justify current prices.
Valuations at current
levels demand that Chinese portal stocks connect on all
cylinders. The quarterly numbers showed some blips that
have brought a price pullback - NetEase shares down 34
percent from their October 28 close - that represents
either an outbreak of sanity, or a buying opportunity.
In other words, trick or treat?
(Copyright 2003
Asia Times Online Co, Ltd. All rights reserved. Please
contact content@atimes.com for
information on our sales and syndication
policies.)
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