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China takeover battle in a tangled
web
By Gary LaMoshi
HONG KONG - The Internet has changed
everything around the world. Shanda Interactive
Entertainment's attempted hostile takeover of
Internet portal Sina indicates that China hasn't
escaped this revolution. Sina's roadblocks to the
bid may prevent investors from discovering just
how far those changes go.
On February 18,
Shanda, China's top Internet game operator,
announced it had bought a 19.5% stake in Sina,
China's leading Internet portal. Both companies
have listings on Nasdaq, and Shanda revealed its
holding to comply with United States's financial
regulations. Shanda termed the stake a "strategic
investment", suggesting that it might be the first
salvo in an unsolicited takeover. Sina shares shot
up nearly 23% in two trading days after the
announcement as investors anticipated an offer.
China Internet stocks were market darlings
in 2003 and early 2004 due to growth in the
sector's wireless messaging services. Investors
cooed over US-listed companies, including Sina,
Shanda, Sohu, Netease, and The 9. But interest
cooled last year, in part because mobile phone
companies cut in on wireless service profits.
Pay for play Online games have
replaced wireless services as the new growth
driver. China and South Korea are the two places
in Asia where online gaming has taken off, for
different reasons. South Korea's early and
widespread broadband penetration inspired
innovative uses for the bandwidth. In China, Sony
and Microsoft don't market their game consoles
since the pervasive piracy means they can't make
money from selling game software. So China's
players go online, mainly at cyber cafes due to
the low penetration of home computers, trying
their skill at contests ranging from bloody
shoot-'em-ups to intellectually challenging role
playing.
Netease reported higher earnings
last week, energized by its online games. Income
from advertising on its portal and wireless
services registered double digit drops, while
online gaming revenue rose more than 20% and now
comprises about three-quarters of Netease's
revenue. Best of all, gaming offers far higher
margins than other business lines.
Sina
lags behind its rivals in game development, and
its early February announcement of preliminary
fourth quarter results included a warning that
profits for this year could fall by nearly 25%.
That news knocked more than 15% off Sina shares,
cutting the price to less than half of last year's
highs. That fall set the stage for Shanda to swoop
in. Shanda's announcement of its stake boosted
Sina's share price back where it was before the
gloomy forecast.
In business terms, Shanda
and Sina are a good fit. Sina's popular portal
would put Shanda's games in front of more of
China's Internet users. Shanda's games would fill
in a gap in Sina's online menu. Combined, the two
companies would be larger than any pair of local
online rivals in terms of revenue and profits.
Poison pill Even though Shanda
seems like a good match, Sina isn't ready for
marriage. In reaction to Shanda's 19.5% holding,
Sina's board of directors recently adopted a
shareholder rights plan. Under the plan, Sina can
issue additional shares if any new investor's
stake in the company reaches 20%. That process
would effectively triple the price of a hostile
takeover.
This type of takeover defense,
also known as a poison pill, is designed to ward
off unwelcome bidders, since no one would pay the
inflated price it sets for the company. The term
"shareholder rights plan" is a cynical euphemism
since shareholders lose their right to sell their
stock to a bidder that does not first meet the
management's approval.
The plan would be
more accurately called a "management rights plan"
since it gives company executives a veto over
potential suitors. The poison pill has the
practical effect of either quashing takeover
attempts, leaving the current management to run
the company undisturbed, or ensuring that any
potential bidder has to cut a deal with the
management before it approaches shareholders.
Directors can enact and rescind the poison pill
without shareholder approval. So, instead of
Shanda making a tender offer for Sina - for
example, offering Sina shareholders US$30 a share
for a stock selling at $23.13 two weeks ago - any
suitor will have to satisfy Sina managers and
directors with bonuses, job guarantees, and other
goodies. The cost of those enticements to
executives comes out of the price offered to
shareholders.
Incredibly, poison pills are
perfectly legal in the US. They're also not
unknown in China; Sina's rival Sohu adopted one in
2001 to fend off scavengers after the dot-com
bubble burst. Except for the state making offers
that companies cannot refuse, hostile takeovers
attempts are rare in China. Last year, SABMiller
launched an unsolicited bid for Harbin Brewery,
inspiring a public bidding war with fellow global
giant Anheuser-Busch. A-B got the company, and
Harbin shareholders got a premium price.
Stock analysts say that Sina's poison pill
could inspire a similar competition, which may
explain why the share price dropped only 5% after
the poison pill announcement. Shanda, now valued
around $1.4 billion, would make a complementary
business partner, but experts note that other
potential bidders lurk in the wings. Some
observers see Shanda's bid as a clever strategy to
heighten interest in Sina. Shanda would be glad to
take over Sina, but could also book a handsome
profit (around $50 million at current prices) if
Sina gets gobbled up by someone else. The question
is, who else?
Yoo hoo! Yahoo! US
Internet giant Yahoo! has reportedly been sniffing
around Sina, and Google, sitting on a pile of cash
and major equity value from its pubic offering
last year, would be another logical bidder. So
would Japan's technology investment specialist
Softbank, which already counts a stake in Shanda
among its numerous China investments. Yahoo! also
holds shares in a variety of China Internet
ventures, including a game developer that Shanda
controls.
Those global goliaths have far
deeper pockets than Shanda and could offer
shareholders and management greater incentives to
sell. Google and Yahoo! received analyst
downgrades in February, which knocked a little
froth out of their share prices. While that
reduces their buying power, it makes their stock
more attractive to Sina.
The key question
that no one has asked yet, at least not publicly,
is whether the Chinese government would permit any
foreign company to control an Internet portal or
major service provider. The Internet's
communication and information capabilities have
not escaped the notice of China's censors. China's
portals know the rules and claim that they push
the envelope, but they don't go any further than
the government lets them. Games also face vetting.
Foreign companies play by these rules when
their products, including Internet sites, reach
Chinese users. They tolerate censorship since they
have no choice and no basis for complaint.
However, suppose Yahoo! took control of a Chinese
Internet company and, through some error or
misunderstanding, found its billion-dollar baby
shut down by censors. Such an incident would
undoubtedly have diplomatic impact, with the US
government defending its company by crying free
speech, and making China look bad internationally.
When China lets foreign investors build
and manage factories, it risks a much lower level
of unwanted ideas and information leaking through
its filters. Moreover, it gains substantially from
the jobs created and the technology transferred.
There's little to be gained on either front in the
Internet field - except in online game design, and
that expertise resides in Korea, not the US - and
no indication that lack of foreign investment
hinders China's Internet growth. It's hard to
imagine why China would allow foreign control in
such a sensitive sector.
So where does
that leave Sina shareholders? Sina's poison pill
hands company executives the joystick to decide
whether they'll sell the company and at what
price. Shanda is the only local suitor with the
bulk to make a bid and the complementary business
lines to make a merger sensible. But Sina
management has slammed the door on that idea. For
investors hoping for Shanda to buy their shares at
a premium price, Sina management has declared
"game over" before it even begins.
Gary LaMoshi has worked as a
broadcast producer and print writer and editor in
the US and Asia. Longtime editor of investor
rights advocate eRaider.com, he's also a
contributor to Slate and Salon.com.
(Copyright 2005 Asia Times Online Ltd.
All rights reserved. Please contact us for
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