Chinese Web Firms That Lack Suitors Appear Undervalued

[HenryTo]

Pretty good article on Chinese Web Firms. Even if you don't agree with the analysis, it's good to know what's going on at some of those companies.
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Chinese Web Firms That Lack
Suitors Appear Undervalued

By REBECCA BUCKMAN
Staff Reporter of THE WALL STREET JOURNAL
March 29, 2005

HONG KONG -- Several Chinese Internet stocks have taken off in recent weeks following news that online-gaming giant Shanda Interactive Entertainment could make a play for Chinese Web portal Sina.

Now, some investors reckon other companies, including portals Netease.com and Sohu.com, could be takeover targets as well.

But don't bet on it. While some analysts tout Netease's prospects, others say the best buys in the Chinese Internet business right now might be Web outfits that don't figure into takeover talk and whose shares haven't gotten a lift lately -- including smaller companies that provide entertainment and other services to mobile-phone users.

Among such companies are Beijing-based Tom Online, backed by Hong Kong tycoon Li Ka-shing, and Linktone, headquartered in Shanghai and run by Silicon Valley-trained entrepreneur Raymond Yang.

The wireless-Internet sector in China has been extremely risky, and some big investors still won't touch it. The main damper has been a continued regulatory crackdown by the Chinese government, which has been trying for nearly a year to stamp unethical marketing and billing practices in the industry.

One bad practice, for example, involves making it difficult for users to halt subscriptions to certain mobile services, such as special "ring tones," or even horoscopes delivered to wireless phones. (Some people unwittingly signed up for the services after receiving "spam" e-mail on their phones, and then had no idea how to cancel them.) The government crackdown has dented profits at several mobile-content companies.

But much of the cleanup is now done, and China's wireless market remains huge, with more than 330 million subscribers. While the market has been volatile for some of the stocks, "things will stabilize," predicts William Bao Bean, an analyst with Deutsche Bank in Hong Kong. "The underlying point is that demand for these services is still quite strong."

Indeed, Tom Online, a company that derives about 92% of its revenue from wireless services, earlier this month reported a 73% profit increase for 2004, despite the regulatory clampdown. Linktone recently said profit for the quarter ended Dec. 31 more than doubled from a year earlier.

In a research note in February, analysts Safa Rashtchy and Aaron M. Kessler of U.S. investment bank Piper Jaffray called Tom Online "one of the most undervalued stocks in our China universe." At the time, the stock was trading at about 14 times calendar year 2005 earnings, compared with 45 times 2005 earnings for Shanda and 20 times for Sohu. China's wireless sector remains "a major opportunity," the analysts wrote.

Since mid-February -- when Shanda unexpectedly said it had taken a 19.5% stake in Sina and might try to take a controlling interest in the company -- shares of both Linktone and Tom Online have stayed roughly flat.

Meanwhile, shares of Netease.com, which is a Web portal like Sina, have surged 15% and Sohu.com's stock price has climbed nearly 14% -- driven higher partly by investor speculation that the companies could be takeover targets.

Still, many analysts are taking a wait-and-see attitude on Sohu.com's prospects. Since early 2004, the company has lost some top executives including its chief financial officer and Victor Koo, its president and chief operating officer. In November, Sohu.com said that Mr. Koo would leave his post by the end of this month, although he will stay on temporarily as a consultant. A company spokeswoman says Sohu.com has managed "smooth transitions" through the departures and has capable and experienced managers at lower levels.

But Sohu.com, the No. 2 portal player behind Sina, also has struggled to build top-notch search and online-games businesses, says Duncan Clark, a partner with consulting firm BDA China Ltd. in Beijing. The company needs to rebuild its management ranks and refocus is strategy -- or else "look at a partnership or be sold," he says.

Mr. Clark and some investors don't think Sohu.com's founder and chairman, Charles Zhang, will ever sell out. Mr. Zhang still owns 25% of the company and Sohu.com has had a "poison pill" takeover-defense plan in place for years. "I'm not sure they're going to be taken over," says Jerry Zhang, an analyst with Evergreen Investments in Boston who is no relation to the Sohu.com chairman. Indeed, in an interview, Charles Zhang said he, "the management, and the board are very unified to...remain independent." Netease.com, too, is still controlled by its founder, board member William Ding.

Analysts say founder control means a suitor isn't likely to snap up Netease.com anytime soon, either. But unlike Sohu.com, Netease is excelling in the hot area of creating online games and could be a good buy all by itself. In 2005, revenue from games could provide 80% of company sales, according to Piper Jaffray.

J.P.Morgan has an "overweight" rating on Netease.com while Piper Jaffray rates it "outperform" with a US$63 price target. Last Thursday, in their latest trading, Netease.com's American depositary receipts closed at $45.50.

Some analysts say smaller Chinese Internet players shouldn't be overlooked, either. Tom Online, with backing from companies controlled by Hong Kong tycoon Mr. Li, could turn into an acquirer and build itself into a bigger, more diverse Internet player. It recently bought 80% of Indian mobile-gaming company Indiagames Ltd.

Linktone, while it remains relatively small, saw its sales triple during 2004 to reach $50 million The company is also moving into new types of wireless businesses that haven't been targeted as much by regulators from the Chinese government.

Indeed, despite changes in the regulatory environment, wireless content remains "a profitable, sustainable business model" in phone-happy China, says Wang Lei Lei, Tom Online's CEO.

Write to Rebecca Buckman at rebecca.buckman@wsj.com