China's e-commerce IPOs coming to the fore

After the portals and SMS companies, a new wave of Chinese start-ups aim to make their presence felt on the Nasdaq.

Following the recent lead of Ctrip in December and Shanda in May, China's e-commerce sector has started to make successful inroads into the US IPO market. Over the coming few months a new wave of internet companies are preparing US listings and for bankers and investors alike, they may mark a welcome diversification from the ubiquitous portals and SMS operators that have been listing in the US since 2000.

International fund managers may find the upcoming pipeline much easier to understand because the companies operate online versions of more traditional business models that have already proven their worth in the US and Europe. The three companies at the top of the pipeline - 51job, Soufun and eLong, respectively operate in the jobs, property and travel sectors - otherwise known as online vertical markets.

The first company in this new pipeline seems likely to be 51job, which is targeting a third quarter listing, most probably in July. Morgan Stanley is leading the deal, which should raise about $100 million to $150 million.

Founded in 1998 by a couple of former Bain consultants, the company's website 51job.com is now China's largest online recruitment agency. At the end of 2002 it recorded revenues of $36 million.

According to a recent Morgan Stanley report on China's internet sector, 51job.com has about five million registered job seekers, generates about seven million daily pages views and sends one million resumes to corporate recruiters each week. It also publishes Career Post Weekly from its base in Beijing.

Its most obvious benchmark is Monster Worldwide Inc, the Nasdaq-listed online recruiter based in the US, which listed in 1996. Monster is currently trading at about 45 times forward earnings and recorded revenues of $199 million during the first quarter of 2004.

Early in the autumn, UBS is expected to lead a similarly sized Nasdaq listing for SouFun, China's largest online real estate broker. Established in 1999 with backing from IDG and Goldman Sachs, SouFun provides updated real estate listings covering Beijing, Shanghai, Shenzhen, Hong Kong, Macau and Taipei. As of May last year it is said to have been registering 27 million daily page views.

It has recently moved into online mortgages and has a well-established research academy that is regularly quoted in the Chinese press.

Again, SouFun should have an obvious benchmark since UBS, in tandem with Deutsche Bank, is currently in the throes of a Nasdaq listing for Ziprealty, an online real estate broker in the US, which netted revenues of $33.8 million in 2003.

According to Shanghai-based iResearch Inc, China's real estate industry spent Rmb72 million ($8.7 million) on online marketing in 2003, with 1,787 developers advertising themselves over the net. This marked a 151% year-on-year increase.

The final deals in the immediate pipeline are eLong, and The9, which have both mandated Credit Suisse First Boston for roughly $100 million Nasdaq listings. The9 provides online gaming, while eLong is believed to derive most of its revenue from online travel, though it also provides media and entertainment services.

However, both companies have to overcome "me too hurdles" since eLong competes against Ctrip, which listed on the Nasdaq in December and The9 against Shanda, which listed in May. Tech bankers say The9 is particularly problematic since most of its revenues derive from a multi-user, role playing, online game called Mu, which it licenses from Korean company Webzen.

The latter listed on Nasdaq in December last year, but has seen its ADR price fall from $11.17 to $7.44. Webzen is said to be less than keen to see The9 cannibalise its own listing. However, The9 may broaden its scope if rumours of JV with Vivendi Games to distribute Warcraft in the US prove to be true.

Shanda also has an advantage over The9 since it has successfully developed its own in-house games, in addition to licensing games from the Koreans. The company raised $153 million from a Nasdaq listing in May, but had to scale the deal back because of nervous market sentiment. Having priced at $11 per share, Shanda is now trading at $14.98, a 2004 PE of about 21.5 times.

Ctrip, which listed on the Nasdaq in early December at $18, is currently trading at $27.32, a 55% increase over its issue price. The represents about 33 times 2004 earnings.

The key question for companies like 51job, Soufun and eLong is whether they can follow Ctrip's lead and capture a valuation premium to the portals and SMS operators.

The three Chinese portals, Sina, Sohu and NetEase are currently trading on a range of 22 to 28 times 2004 earnings, while SMS value-added operators such as Linktone and Tom Online are currently trading at 28 and 16 times 2004 earnings.

The head of tech banking at one US investment bank believes they can. "Most US fund managers don't have a clue whether one ring tone or screen saver is better than another," he says. "But they do understand jobs, property and travel. More importantly they've made money from these types of company in the US and seen the kind of valuations they can trade at."

At the beginning of this year, the same investment bank ran a survey of the top 20 global institutional fund managers invested in the Chinese portals. It found that 18 of the 20 accounts had invested in all three.

"What this tends to suggest to us is that fund managers find it hard to differentiate between them," he says. "And because they don't really understand the nuances well, they're making a sector bet rather than individual stock picks."

He has noticed a discernable shift. "It will be interesting to see how forthcoming SMS-related deals are received," he says. "Interest appears to be shifting towards more traditional internet plays."

Forthcoming SMS-related deals for KongZhong.com and Mtone should, therefore, highlight whether investor appetite is waning, or understanding is increasing as more companies list. UBS is leading a roughly $100 million deal for the former and Merrill Lynch a $60 million deal for the latter.

Both are currently going through the SEC registration process, though fund managers believe KongZhong is likely to launch pre-marketing next week. KongZhong was only founded in 2002, but within a year was providing China's most popular mobile phone game - Bai Bao Xiang.

Over a more longer-term horizon, specialists see IPOs for B2C online trading companies such as Taobao, Alibaba, joyo.com and Dangdang, as well as Google's main rival in China, search engine Baidu. But they also say the former group of companies are further behind because they have not been able to resolve payment and delivery issues. "There are no real online payment systems in China," says one banker. "Some companies are using debit cards, which have greater domestic traction, but the risk profile is different to credit cards, because there is a major question mark over who takes the payment risk.

"The other major problem," he adds, "is delivery. The logistics of ensuring goods arrive at their final destination in China is a nightmare. This is why electronic goods provider like Shanda are the only successful companies at the moment. There's no tangible value to their 'physical' goods. But if you're talking about a company, which delivers books, for example, then even a 5% loss of goods has a heavy cost."

Indeed as many analysts point out, the main reason why the SMS-related companies have dominated China's internet sector is because credit card penetration rates are so low. According to Visa, there have only been about 1.7 million credit cards issued in China. Instead, it has been the mobile phone companies that have stepped up as the main billing agents.

This was one of the main findings of perhaps the most famous global internet analyst of them all, Morgan Stanley's Mary Meeker. In a huge research report published in April, the New York-based analyst said she had been intrigued by the potential in China for more than half a dozen years, but did not think the time was right for a big ramp up in focus until the middle of last year.

"Around that time, based on a variety of metrics, the market for the internet in China began to gain tangible traction," she writes.

"The momentum is real," she comments. "The government mandate is there; the people are especially hungry for news, information, entertainment, communication and connectivity; businesses are using the internet for global expansion efforts; and internet penetration levels (6%) are very low."

She too highlights how the internet has followed a different path in China to the US. "No major market comes close to China's 2003 ratio of 3.5 mobile users for ever one internet user," she comments.

The reason for this appears to be two-fold.

Firstly it is the communications companies, which have been the main drivers of internet development in China rather than B2C companies like Ebay and Amazon in the US. This stems from the lack of credit cards. A company like Ctrip, for example, still derives 70% of its revenues offline from clients ringing its call centres.

The second major reason is that because fixed line penetration rates have always been low, mobile phones have gained a much stronger hold. The country's internet population is also young and very SMS-friendly. Younger people have been more open to the kinds of value-added services provided by China's SMS companies.

In a similarly long research report published in mid-May, CSFB analyst Jay Chang concluded that China is at the same stage of development as the US in 1997 in terms of internet penetration. There are currently about 80 million internet users in China accounting for 6% national penetration and 20% urban penetration. However, unlike the US, Chang says the internet in China is developing in parallel to the overall economy.

He writes, "We believe the addressable market for internet services by 2010 could be as many as 200 million net users online and a market worth over $10 billion, up tenfold potentially from a $1 billion revenue opportunity today.

"This should be driven," he adds, "by potentially 10 times increases in online advertising/paid searches, five times increases in wireless data, three to five times increases in online gaming and 50 times increases in e-commerce."

Where online advertising and e-commerce is concerned, Chang estimates that both markets are worth about $100 million to $150 million each today. Using figures provided by market research firm Interfax, he says online advertising currently accounts for about 1.1% of total ad spend in China. Total ad spend as a percentage of GDP amounts to 0.8%, compared to 2.5% in the US.

E-commerce as a percentage of GDP amounts to about 0.01% compared to 0.5% in the US.

But as both Chang and Meeks warn, the potential may be there, but the winners are by no means a given in a sector where new standards are evolving all the time. The Morgan Stanley report concludes that, "just a decade ago you'd be hard pressed to find anyone who would have accurately predicted that," a company like, "Apple would have a 70% market share of the global online paid-music market."

But the most optimistic analysts believe China's forthcoming listing candidates are well positioned to rapidly expand at home and abroad creating global giants. Like many Nasdaq listed companies, they will be armed with the funding and international recognition a US listing delivers. But unlike many of their listed Nasdq peers, China's winners stand to derive enormous revenue gains and M&A leverage if they can successfully harness the country's potentially vast and fast growing internet population.

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