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Re: Fred Langford post# 132126

Saturday, 07/19/2003 10:38:30 PM

Saturday, July 19, 2003 10:38:30 PM

Post# of 704019
here ya' go, Fred -

Sino.com

As China's Internet and cellphone markets burgeon, related stocks once again show feng-shui
By ERIC J. SAVITZ

WITH A FIFTH OF THE WORLD'S POPULATION, the vast potential offered by China is dazzling. Lately, U.S. investors have, for the second time in recent years, become enraptured by the country's rapidly changing Internet sector. Let's hope things turn out better this go round.

Over the past five years, the number of Chinese Internet users has grown from a little over one million to nearly 60 million -- more than in any country other than the U.S. Meanwhile, China now has 230 million cellphone users, more than in any other land. The total is rising by three million to four million a month, according to Duncan Clark, managing director of the Beijing-based research firm BDA China. Clark notes, too, that those people are sending 100 billion text-based phone messages a year, using the SMS short-messaging standard.

The rapidly expanding Internet and cellphone markets have triggered a new round of enthusiasm for the Nasdaq-listed Chinese Internet portals, Sina, Sohu, NetEase and China.com. Even after losing ground in last week's tech selloff, they trade far above their 52-weeks lows, which all were under $2 a share. As of Thursday's close, China.com had gained 522% from its bottom last year, while Sina was up 1,333%, NetEase, 2,357% and Sohu, 2,992%. Gains this year alone range from 205% for NetEase to 480% for Sohu; all four have market caps above $1 billion.

This latest outbreak of China Internet mania is even more intense than the first, which began in late 1999 with China.com's IPO. The company followed with a secondary offer in January 2000. Sina came public soon after. Shares of both Sina and China.com skyrocketed early in 2000; both stocks, in fact, remain well short of their previous peaks of $58 and $78, respectively. Their performance set the stage for initial offerings by Sohu and NetEase later in 2000, but both barely made it out before the Internet IPO window slammed shut, and their shares headed south. Things turned ugly, as Internet mania subsided. By early 2002, the stocks teetered on the brink of delisting. NetEase suffered the most, enduring an accounting scandal, a lengthy trading halt, a resultant evaporation of ad revenue and a management shift.


With the sector's collapse, Wall Street gave up -- which meant a lot of people missed the signs when the business turned around. Michael Mahoney, a portfolio manager with EGM Capital in San Francisco, which owns stakes in NetEase, Sina and Sohu, says the stocks got "ridiculously" cheap. "They were offshore companies at a time people were scared by everything outside the U.S., and they were in the Internet business at a time when there was nothing you could say that was worse," he says. "Add the fact that they were overhyped in the bubble period, and it resulted in complete disinterest."

Indeed, if you're trying to sort out what's happening in the Chinese Internet sector, you won't get much help from the Street. Of the major U.S. investment banks, only U.S. Bancorp Piper Jaffray has an analyst, Safa Rashtchy, actively covering the sector, and he started coverage just last month. He also might not be the most astute observer; he's based in Palo Alto and has yet to travel to the offices of any of the Chinese portals.

Still, investors' appetite for the sector is growing, even without analysts beating the drums. In recent weeks, NetEase, Sohu and Sina have raised a combined $290 million via the sale of zero-coupon convertible bonds. There's a remarkable turnaround unfolding here. But is this another bubble?

One problem facing anyone trying to answer the question is that the stocks aren't easily differentiated. Sina, Sohu and NetEase all have similar market caps, and operate in the same business. All three operate widely used Chinese-language Internet portals, offering e-mail, dating services, message boards, news, stock quotes, sports scores, and the like, with as many as 100 million registered users each. (China.com operates several portals as well, but also has a software and services business, and is widely considered a second-tier player. Its stock received an extra boost from its April acquisition of SMS provider Newpalm.) Over the past year, they all have done what Yahoo! has been trying so hard to do: diversify revenues to reduce dependence on ads.

Still, the Web portals' ad revenue has been blossoming. Sina's ad revenues rose 46% year-over-year in its March quarter, and Sohu had a 78% gain. Hurst Lin, Sina's chief operating officer and co-founder, notes that ad spending per capita in China is among the lowest in the world, and that the proportion of the advertising market spent online is far lower than in the U.S. So there's plenty of room to grow.

The portals' revival, however, has less to do with ads than with the emergence of two new revenue streams -- cellphone-based text messaging and online multi-player games. China's vast population of cellphone users is obsessive about SMS, the text-based messaging service. While it never gained traction in the U.S., in China it's changed how people communicate. Pyramid Research, which tracks the market, sees SMS-related revenues hitting $16 billion by 2007, versus $234 million in 2001.

About 80% of SMS messages are peer-to-peer, with all revenue going to China Mobile, the leading Chinese cellular carrier, or China Unicom, its smaller rival. But the rest of the pie involves content providers, including the portals.

Mobile users can subscribe to news alerts, sports scores, horoscopes, stock prices and the like -- and they can download icons and ring tones. Among the most popular features are dating services -- think of using Match.com and messaging hot prospects via your cellphone. Sina, for instance, expects its SMS-related revenues this year to more than double from 2002. In the first quarter, Sina reported a 97% rise in non-advertising revenues, largely due to the growth in SMS services; non-ad sources accounted for 60% of revenues in the first quarter, up from 30% a year earlier.





Billing for SMS services is handled by China Mobile and China Unicom, which keep 15% of each transaction, according to Sina's Lin, and take about 15% more for transmission costs, leaving the other 70% for the portals, making them highly profitable.

The other hot area is online games. NetEase, the category leader, reported 630,000 active players in December, many for a wildly popular game called "Westward Journey;" gaming is now 30% of NetEase's revenue. It's a business that operates in a peculiarly non-Western fashion. Most people play not from home, but rather from Internet cafes where they can buy PIN-enabled plastic access cards. Sohu and Sina are scrambling to catch NetEase, creating their own games, as well as licensing some from Korean software firms.

The improving ad market and the rise of the SMS and gaming sectors has turned companies that were money losers as late as 2002 into profit machines. Piper's Rashtchy expects Sina to earn 56 cents a share on $100 million in revenue this year, growing to 81 cents and $150 million in 2004. For Sohu, he sees 85 cents a share in profits on $82 million in revenues in 2003, growing to $1.46 a share on $144 million in revenue next year. And for NetEase, Rashtchy projects $1.08 a share, on $64 million in revenues, growing to $1.29 on $98 million in revenues in 2004. And those earnings come with fat margins -- NetEase, the most profitable of the group, brings more than 50% of its revenue to the bottom line.

While Sina's Lin says there's no reason to expect the growth to soon slow, he cautions that "12 months ago I would have given a different answer, and right now as far as I can see is the next couple of quarters. And things look very, very good for the remainder of 2003." Growth in 2004, he says, could depend in part on the pace of adoption of color phones and China Mobile's rollout of multi-media messaging, with animation, color and games. And those more complicated messages will likely require more coding, making them more expensive to produce than text-dominated SMS messages limited to 160 alphanumeric characters or 80 Chinese characters.

Still, EGM Capital's Mahoney insists that the stocks aren't overpriced. "Sohu has a forward P/E of about 50, and long-term growth could be 40% for the next few years, or even higher," he says. "It's probably trading at less than one time its growth rate for the next 12 months. I look at that versus Amazon.com, which has a P/E to growth rate of about 3, and I think I'm more excited about Sohu than I am about Amazon."

However, the stocks look rich within the universe of Chinese stocks. For instance China Mobile, which gets the bulk of SMS revenues in China, trades for less than 12 times expected 2003 earnings.

Peter Conley, an analyst with MDB Capital Group, a Santa Monica, Calif., investment firm, recently cut his rating on Sina to Hold from Buy on a valuation basis.

Despite the impressive turnaround, the stocks face significant risks. For one thing, the unearthly growth rates are built from a very small base, and as we learned in the Internet bubble days, forecasting the size of new markets like SMS text messaging and online role-playing games is difficult.

In an obvious sign of an over-heated market, the enthusiasm for the portals has sent investors scrambling for secondary plays, including Internet Initiative Japan, a Japanese Internet-service provider, Rediff.com, an India-focused Web portal and Internet Gold, an Israeli Internet-service outfit.

It's all reminiscent of the days when a company like K-tel International could whip-up a trading frenzy by announcing plans for an online store. The fact that K-tel overhyped its prospects didn't mean Internet retailing was a hoax, it just meant that the phenomenon had been blown out of proportion. A similar ending for the latest Chinese 'Net boom wouldn't be surprising.


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