China gripped by Internet revival

In a throwback to the Internet heyday of the late 1990s, Chinese dot-coms are attracting more attention than ever as U.S. companies and venture capital firms pour money into the region.

Interest in China’s Internet sector took off after last week’s successful U.S. stock listing by Chinese search engine Baidu.com Inc. The company’s stock quadrupled to $122.54 per share in its first trading day on the Nasdaq, the best opening day for a stock since 1999.

“You see why the U.S. venture capitalists are so interested to get into China when you look at what happened with Baidu,” said Paul Mackintosh, managing editor of the Hong Kong-based Asian Venture Capital Journal.

Other Chinese dot-coms have been attracting attention, too. Yahoo Inc. ponied up $1 billion in cash Thursday for a stake in Chinese e-commerce firm Alibaba.com Corp. and said the two companies will work together in an exclusive partnership in China.

In addition, Netease.com Inc. shares jumped 21.5 percent last Wednesday after the Internet portal, which boasts some of China’s most popular online games, said its second quarter revenue soared 90 percent and net profit rose 147 percent from the same time a year ago.

“We’re seeing massive interest from American venture capitalists in China, the Internet especially,” said Mackintosh. The Asian Venture Capital Journal, which also tracks investment flows, said investment funds in Asia rose to a record high US$111 billion at the end of June. The company cannot break the figure down by country, but much of that money is likely tied up in China, Mackintosh said.

The investment activity is reminiscent of the dot-com madness that hit the U.S. in the late 1990s. Chinese firms began to benefit at the tail-end of that cycle, but when the bubble burst and U.S. stock markets crashed in 2000, investor interest faded and Chinese companies were left to make do on their own. But time and investments in Chinese Internet companies by the likes of Yahoo Inc. and eBay Inc. have healed the wound. The Baidu.com public offering cemented the revival, and new venture capital money is now coming back to China.

“The focus on China’s Internet sector is no big surprise considering the growth exhibited to date and its perceived potential,” said William Bao Bean, who covers China’s dot-com scene for Deutsche Bank Securities in Hong Kong. In terms of Internet users, the numbers are compelling, he says.

China ranks behind only the U.S. in terms of total Internet users, with 103 million, according to the China Internet Network Information Center, the country’s official Internet data collector. While that’s only about half the number of users in the U.S., it accounts for only 8 percent of China’s population, compared to nearly 69 percent for the U.S.

Proponents of China’s Internet revival say the low penetration rate means there’s a lot of room to grow. U.S. companies seem to agree. In February, eBay Inc. Chief Executive Officer Meg Whitman called China the largest e-commerce opportunity around. In five to 10 years, she said, a company’s share of e-commerce in the nation would likely be the defining measure of Internet business success.

EBay pledged to spend $100 million to beef up its presence in China this year, adding to its already formidable presence in the country. EBay bought out Chinese Web auction site EachNet.com Corp. two years ago for a total of US$180 million. The same year, Yahoo paid US$120 million for 3721 Network Software Co. Ltd., a Hong Kong company that operates the Chinese search engine 3721.com. And last year, Google Inc. bought a 2.6 percent stake in Baidu.com.

Interest in China’s Internet sector is growing so fast that some venture capital firms are luring talented executives away from Internet companies like the ones they seek to invest in, which could hurt the industry. Ctrip.com International Ltd., which runs China’s top online travel site, lost its co-founder and president, Neil Shen, to U.S. venture capital firm Sequoia Capital last week.

The loss hurt.

Investment firm Merrill Lynch advised its clients to stop buying Ctrip.com’s stock, reducing its rating on the Nasdaq-listed company to neutral, partly because of the executive’s departure.

“We view this negatively as Neil was an integral part of the team that built Ctrip,” said Merrill Lynch analyst David Cui in a research report Friday.

Some regulatory changes in China have also been a problem. Although a record amount of private investment money stands ready to be deployed in Asia, actual investment to China has slowed because changes in certain rules mean foreign venture capital firms can’t create the business structures they most prefer for their investments.

Still, some analysts argue the regulations could be a blessing in disguise. By forcing the venture capital companies to move slowly, they might avoid some of the reckless investments that characterized the U.S. dot-com bubble.

A splash of new investment money could also end up pitting existing Chinese Internet firms against upstarts, a boon to consumers who would benefit from competition, but harmful to companies that are forced to cut prices in order to compete.

“Too much venture capital chasing too few good opportunities is a potential problem in China that could hurt established players in the Internet segment,” said Bean.

But China’s dot-com boomlet is just getting started. There’s still plenty of time for history to repeat itself — and to doom those who have failed to learn its lessons.