Tencent launches pre-marketing

China''s largest instant messaging company battles on with IPO.

Tencent Technology began pre-marketing on Monday May 17 for an IPO that looks likely to raise up to $200 million. Goldman Sachs is leading the deal, which is being pitched on an exceptionally wide valuation range in a reflection of deteriorating market conditions particularly for China-related plays (Editor's note: this article was first published on Wednesday May 19).

Fund managers say the all new share deal is being pitched on a range of 15 to 25 times 2004 earnings and if market sentiment fails to improve, it seems almost certain to price at the bottom end. Based on a 25% freefloat and syndicate consensus 2004 profit forecast ranging from Rmb400 million to Rmb450 million ($48.38 million to $54.43 million), the company should raise around $180 million to $190 million.

Tencent is currently 50% owned by its founding shareholders led by Poney Ma and 50% by US-listed, South African-based multimedia giant Naspers. The latter purchased its stake for $34 million and holds it through MIH.

Following two weeks of pre-marketing and two weeks of roadshows, the deal is scheduled to price on June 16. Alongside the lead, co-leads are Cazenove, Guotai Securities, HSBC and Merrill Lynch.

Tencent is China's Mobile's biggest service provider and the country's dominant instant messaging company (IM) with a 74% market share at the end of 2003. The other major players are Microsoft MSN with an 11% market share and Netease on 4%. Yahoo has yet to make its presence felt.

The main difference between standard SMS services and IM services is that the latter operates on the basis of a closed system. Customers can only message other users of the system, but the system itself has a far wider range of applications than phone based SMS services. IM users, for example, can send messages between computers, mobiles and pagers.

Tencent's IM service, known as QQ, has become one of China's most recognisable brand-names, although it has virtually no name recognition outside the Mainland. According to a 2003 People's Daily study of Chinese internet usage, QQ ranked among the top 10 most used words alongside the likes of Bin Laden.

Like all of the China internet players, Tencent has seen sharp growth both in terms of subscribers and profitability. It has posted a profit for the last 11 consecutive quarters and recorded revenues of $85.7 million for 2003, resulting in net profit of $38.9 million.

One of the main measures of success is the number of simultaneous users on the network. Since the company was founded in 1998, it has seen the figure rise from one million in February 2001, to three million in February 2003 and six million in March 2004. It currently has 291 million accounts, of which 97 million were active subscribers at the end of the first quarter of this year.

Chinese industry consultant iResearch estimates that subscribers will grow by about 35% in 2004. It also estimates that peak simultaneous usage in China hit 5.5 million during 2003 versus 590 million globally.

Tencent's business model is based on a free service that builds critical mass and a premium service that enhances revenue. One of its main challenges will be to maintain market share in the face of a growing number of new entrants. China Telecom, Alibaba.com and China Online, for example, are all at various stages of launching IM services of their own.

In response, Tencent is moving towards becoming a portal and has broadened into value added services such as online dating and gaming. Where the latter is concerned, it has a multi-user, role-playing game called Sephiroth.

Its online dating services allows users to download profiles of other users, although as some observers have pointed out, this exposes it to the dangers of online prostitution and a potential crackdown by the Chinese government.

Some also highlight that whereas Microsoft MSN tends to attract higher-spending white collar workers, Tencent is hugely popular with low spending students and blue collar workers.

Yet company supporters say that Tencent has now built enough critical mass and brand recognition to make the entry barriers for new competitors very high.

But the company's biggest challenge is undoubtedly market conditions and a growing risk aversion among investors that have already been burnt by the poor performance of other Chinese internet plays. Some say that having a Hong Kong listing might be a good way to counter this, since it may attract new funds that have previously been unable to invest in portals Sina, Sohu and Netease.

The three are currently trading on PE multiples in the low 20's, but have performed poorly year-to-date after a spectacular 2003. Sina and Sohu are now down respectively 15% and 40%, while Netease is still holding on, up 3%.

Recent IPO's in the China tech space have also not performed well. Tom Online is now trading at HK$1.06 compared to an IPO price of HK$1.50 and has seen its PE contract from 21 times 2004 earnings to 16 times.

So too, Shanda Interactive is still only just holding on to its $11 IPO price after being forced to downsize its deal last week. It priced at about 15 times 2004 earnings.

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