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Will Investing in Chinese Information Technology Companies be Another Tulip Speculation?

Monday, August 8th, 2011
tulip speculation

US-listed Chinese IPO (Initial Public Offering) companies have always caught investors’ attention. On May 4th, Chinese social networking site ‘Renren’, also known as the Chinese Facebook, listed in the New York stock exchange at US$14 per share. The stock price soared to $24 during the day before ending at $16 per share.

The company’s IPO raised a total of US$743 million which is 72 times the worth of its sales from last year. Initially the company planned to raise US$584 million, yet eager investors demanded more opportunity, which led the company to raise share prices higher. It is an eye-popping amount of money considering the fact that the original Facebook was valued at only 25 times its previous annual sales in a recent Goldman Sachs investment in the company.

These eager investors have understandable reasons to be eyeing Chinese IPOs. There is huge potential growth in the Chinese Internet market, considering the number of Renren users is only 120 million out of a 1.6 billion population. Since about twothirds of the population is not yet online, the future growth potential is tremendous. Also, the Chinese economy has been growing several times faster than most other countries for decades now. If China continues its 10 percent economic growth expansion, the size of the future market would be much bigger than it stands at present.

Renren is not the only company which has benefited from this consensus. Last year in December China’s largest video sharing website, well known as Chinese Youtube, ‘Youku’, listed in the New York stock exchange. Although the company was then showing losses and is still not expected to enjoy profits over the next couple of years, the share price surged 161% on the first trading day from the IPO price of US$12.80. The company is valued at 100 times that of last years’ sales, based on the May 5th share price.

Chinese computer anti-virus products provider Qihoo 360 also joined the US-listed Chinese companies in March 2011. Its IPO price was US$14.50 per share and it raised US$175.6 million dollars on the first day. The price valued Qihoo 360 at about 30 times of its total 2010 sales. The share price of Qihoo on May 5th was US$27.20, which valued the company value at more than 57 times its last year’s sales.

Baidu, the dominant search engine in China, was also listed in the Nasdaq in 2005. The company raised US$109 million at its IPO price of $24 per share. Baidu is valued at 35 times more than last year’s sales based on the May 5th price of this year. In com- parison, Baidu’s competitor Google’s value is only 5.5 times on the same base. This is surprising considering that Google is the most popular search engine in the world. Baidu’s share price was around US$140 on the same day.

So why has the title of this article made mention of a ‘Tulip speculation’? Of course, the ‘Chinese mania purchasing’ has its po- tential problems as well. As China has be- come the second largest economy, investors have been speculating on anything China- related. People buy Chinese properties, Chinese currency Yuan and Chinese stocks, which is primarily based on the belief that China will continue to grow at 10 percent.

Experts who are familiar with the matter say differently, however. The Chinese gov- ernment tends to focus on wealth equity rather than economic growth for its next 5 Year Plan, and it already lowered the pro- jected economic growth rate from 10 per- cent to 7 percent. Ursula Schaefer-Preuss, ADB Vice President for Knowledge Manage- ment and Sustainable Development, has said that China faces a middle-income trap along with India, Indonesia and Vietnam in a recent report at the annual Asian Devel- opment Bank meeting in May. Expecting continuing high economic growth rates as in recent decades would be too naïve.

Chinese companies also need to inno- vate to surpass their American benchmark companies. Companies such as those mentioned in this article are collectively known as “Chinese something”, as their business ideas came from American companies. Renren took the idea from Facebook. Youku is another Youtube, and even the name is similar. While Facebook is the dominant social network website overall, Renren has many competitors in China. Renren users total only 120 million, whereas popular internet messaging service QQ has 600 million users. That’s why some IT experts claim that Renren is not actually the Chinese Facebook but rather ‘one of the Chinese social network services’. Youku also has similar service competitors in China. Without innovation, these companies won’t stay in their current positions for long.

And without the Chinese government’s overprotection, these companies might not find a place to stay at all. Chinese search engine Baidu enjoys its dominant player position while competitor Google struggles with Chinese government regulatory bodies. Renren and Youku were able to grow fast while the original Facebook and Youtube had been banned in China. Thus, Chinese users didn’t have options but simply chose the Chinese versions of social network and video sharing service when the world’s largest services were blocked in their country. Some skeptical analysts point to a second ‘IT bubble’. In the early 1990’s, companies with IT services were considered as promising ventures. Thrunet was one of them. The first US-listed Korean company Thrunet soared to US$44 per share on its first trading day in Nasdaq in 1999. Considering the initial price was $18, this was a considerable value jump in just one day. This young and promising looking company, however, was delisted in 2003 due to the continuous price listing of less than $1. The company had been losing money due to massive initial investment in its network system. An IPO was the only way to draw in money when the company was on a burying platform, thenCEO Mr. Kim Do-Jin of Thrunet confessed later in his blog.

So is the current Chinese mania based on an IT bubble, or perhaps it is overly generous economic growth expectation, or even overprotective Chinese governmental policies? We don’t know the answers yet. But it is well to remind ourselves that the well known case of the Tulip stock price surged 4 times in 4 months and then plunged to its original price in the next 3 months.

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