Others call it another Internet bubble. Analysts warn that the Chinese portals are wildly overvalued, and that even some of their top executives are selling off lots of shares. The three portals all earned less than $10 million in the last quarter, and yet the market value for Sina and Netease is well over $1.5 billion; for Sohu it’s more than $1 billion. “The valuation we’re seeing is mad,” says Morgan Stanley economist Andy Xie, who expects a crash. “It’s not going to be pretty.”
Yet there are some not so crazy reasons why investors might be seduced. These stocks offer global investors an unusually safe way to invest in China’s booming economy. The Chinese stock market is largely off-limits to foreigners, and it is virtually unregulated, dubbed by some Chinese as an “ATM” for corrupt company officials who need quick cash. Listing on the NASDAQ gave the portals credibility, and the China tie lends them an air of limitless opportunity. Nearly 60 million Chinese citizens already have online access, and according to government figures, that number will reach 100 million by 2005. More than 220 million have mobile phones, for which the portals can provide Internet content. “All three of our companies are seeing triple-digit growth,” says Hurst Lin, chief operating officer for Sina. “So the investors are finally coming around to say, ‘Well, these guys have finally realized the potential of the China market’.”
It took some time before the portals figured out how to turn a profit. At first, they relied on online advertisers, a strategy that had fared poorly in the United States and worked no better in China. They’ve had much better luck selling online content to China’s mobile-phone users. Users were already swapping short text messages (or SMS) over their mobile phones, so for a couple of dollars, the portals offer them news updates, sports scores or even dating services. State-run China Mobile tacks the fees onto the customers’ bills. Although China Mobile takes about an 80 percent cut, the strategy allowed all the portals to turn a profit for the first time, and it still accounts for about half their revenue. “The one major concern we had before was that our [customers] were like comets, coming and going and not paying us anything,” says Charles Zhang, Sohu’s chief executive officer. “We wanted to find a way to get money, and then SMS exploded.”
Most analysts who follow the companies say that their profits are genuine, and not the result of dot-com accounting tricks. All of them have learned from the mistakes of many U.S. companies, as well as their own in some cases. Netease was nearly delisted in 2001 after an accounting scandal prompted shareholder lawsuits and scared off advertisers. Still, it’s not clear how long the profits can last.
Their dependence on text messaging is worrisome. Although that market in China is huge, it’s controlled by China Mobile. Recently, the monopoly has stalled payments to the portals, which could hurt earnings. In addition, other companies could easily set up similar arrangements with the state behemoth, which doesn’t sign exclusive deals. Or, China Mobile could wake up to the value of its customer base and demand a bigger cut.
To protect themselves, the portals are trying to develop new services. Sohu has tried to push multimedia messaging. Zhang climbed part of Mount Everest to promote the subscriber service, beaming regular updates of his trek to customers. But there is nothing on the horizon as promising as SMS, and no real customer loyalty. “It’s the same old China story again. As soon as you have a profit, everyone wants to do the same thing,” says Xie. “This SMS thing will lead to hundreds of businesses. I’d bet on that.” It’s harder to say which ones will survive.
