The magic carpet ride

IRG CEO discusses the ups and downs of the Asian internet sector over the past five years.

As I sit reflecting over the past half decade, the words from the 1970's band Steppenwolf keep ringing through my head......"close your eyes, look inside...well you don't know what we can find...well why don't you come with me......on a magic carpet ride......".

Living through the highs and lows of the Asian tech sector over the past five years has truly been a "magic carpet ride". At times, "magical" in the sense of bewitching and baffling. At other times, a "carpet" in the sense of feeling stepped on and downtrodden. And a "ride" because... well, because one always has the feeling that things may just stop abruptly, for good or for bad.

Having been in Hong Kong off and on since the 1970s, I have witnessed the vibrance and volatility, which makes Hong Kong such a great place. Being involved in the telecom, media, and technology ("TMT") sectors for over 10 years has exponentially increased that sense of vibrance and volatility. This article revisits some of the events over the last five years and compares Then (1999/2000) and Now (2005) in an effort to draw conclusions to employ for investments in the future.


The numbers above won't tell the entire story, but they do serve to remind us of all the ups and downs of the last five years in the technology sector in Asia.

- The first chart represents the share price of Pacific Internet from IPO to all time high then down to its all time low before rebouding slightly to today's price. Pacific Internet was the first Asian Internet stock to list on Nasdaq in February of 1999 and its IPO ignited the Asian Internet frenzy. Pacific Internet's market capitalization has ranged from approximately $15 million to $1.2 billion over the last 5 years.

- The second chart represents the share price of the chinadotcom (not which is now named chinadotcom, but parent company CDC Corporation which was the original chinadotcom, and listed as The company's market capitalization has ranged from approximately $200 million to over $6 billion over the last five years.

- Finally, the third chart is the share price of Softbank Corporation which, catalyzed by the release of a 200 page Lehman Brothers research tome on June 4 1999, began its meteoric rise and fall and rise again. Softbank has not changed its name three times in five years, but it has migrated its business model aggressively (and successfully) to become a viable competitor to NTT in the broader telecom market. Since the publication of that Lehman research report, Softbank's market capitalization has ranged from approximately $2.5 billion to $183 billion.

Other China Internet stocks of 1999/2000 vintage include AsiaInfo, Sina, Sohu, Netease, Tom and PCCW. And then there are the other Chinese and Asian ones that got away - Thrunet, Renren, ICG Asia, Asiacontent, and iAsiaworks to name a few.


The collective statistics give pause for thought in their magnitude for AsiaInfo, CDC, Netease, Sina, Sohu, and Tom (the "China Six") (see below table)

- $20 billion in lost aggregate market capitalization from High to Low

- $4.4 billion gained from low point to now. Even assuming a 20% average public float to reflect what public investors have experienced, these are not small numbers - $4 billion lost and U$800 million gained in six stocks.


Today's China stocks include the "mini-bubble" in 2003 - 2005, companies which timed their IPOs quite well, and once again reaffirming that global institutional investors are enamored with all things Chinese and that most cannot resist another Carpet Ride:

- 51jobs - eLong - Linktone - Tencent
- China Finance - Hurray - Ninetown's Digital - The9
- Ctrip - Kongzhong - Shanda  

Of this list, only three (Ctrip, Shanda, and The9) are trading significantly above their IPO price. There has been $5 billion in aggregate market capitalization change from high to low and, thanks largely to Shanda, a similar amount to the China Six ($4.3 billion) gained from low to now.


The Japanese technology companies have generally stuck to accessing public capital in home markets (as have most of the Koreans). There are a few that did not and have flown away (Crosswave Communications), or struggled (IIJ). These markets, which include newer exchanges such as MOTHERS, Helix, JASDAQ/Herculus, have remained surprisingly buoyant from an IPO issuance perspective particularly when compared to Hong Kong's GEM market. While there is more to the story, one can only marvel how global and Japanese securities firms' have been able to place shares to the retail segment of the market in Japan. (It may have something to do with the approximately 50 million households in Japan moving their savings from the post office to equities versus Hong Kong's 2.2 million households moving their paycheque from HSBC to Shatin and Happy Valley).

What is different about Japan? Aside from a mini-van taxi which holds four people and charges a flat rate thus making the airport commute almost affordable, you need only to have the taxi take you to Roppongi Hills to arrive at some part of the answer. From the perspective of a technology investment banker, you may never have to leave Roppongi Hills, the office address of Yahoo!, Rakuten, Livedoor and Cybird among others.

Roppongi Hills is also home to Goldman, Lehman and the well-known corporate governance fund MAC. To build an entire business community in a brand new area in five short years is a testimony to the sheer size of the Japanese economy (or Tokyo economy?) and developer Mori's business acumen.

For Japan, the following observations can be made: .

- The incumbents still dominate their respective markets (DoCoMo, NTT, Yahoo! Japan).

- That being said, the market is large enough to support viable new entrants (Softbank/Japan Telecom, Rakuten, Index, For-side).

- A new breed of post-Softbank entrepreneurs have emerged who are as aggressive as Masayoshi Son (Mikitani-san of Rakuten, Horie-san of Livedoor). Incidentally, in one of the smartiest moves of the half decade, all three have or have tried to get their own baseball team over the last five years, increasing their brand awareness to 95% plus and generating huge advertising dollars as a result.

- The alternative exchanges in Japan have worked reasonably well and IPOs, while not comparable in absolute size to the US, continue to get done and done often.

- Global private equity investors can make money in the TMT sector and lots of it (Japan Telecom/Ripplewood et al, eAccess/Carlyle).

- Online banking is now the norm and Internet stock trading now accounts for about 70% to 80% of total trading in Japan by individual investors with approximately 6.9 million online trading accounts at the end of March 2005.


There are obvious differences between the technology companies being funded now versus those back then. Gone are the one page business plans, which promised to someday monetize eyeballs and page views, and eventually deliver profits upon the achievement of sufficient scale (which at times required a user base multiple times the addressable population!).

Instead the current generation of companies bear definitive and focused business plans, operationally savvy management teams and many are profitable early on in their development.

Most of the companies in the "first wave" of the Asian technology market (1998 - 2000) exhibited some or all of these characteristics:

  • Replication of US business models, whether proven or not
  • Internet focused
  • Net income and net cash flow negative
  • IPO process a necessary part of the business plan, and in some cases critical to fund burn rates

The now companies, the "second wave" of Asian technology companies that have successfully accessed capital, are:

  • Net income and cash flow positive
  • Not necessarily Internet focused, but have a technology reliant business strategy
  • Some with business models which are unique to Asia, and China in particular
  • Funded via several rounds of venture capital financing
  • IPO targeted as a strategic (i.e. growth capital) or a liquidity event

For publicly listed companies, valuation parameters and metrics have changed significantly with a return to the parameters utilized in other industries. No longer are page views and eyeballs the metrics used to underpin valuations; instead companies are valued on P/E and cash flow multiples, although there continue to be a few whose valuations are underpinned by revenue multiples..... but these tend to be exceptions rather than the rule.

Today's companies are also much better capitalized, having gone through two to three rounds of venture capital and/or strategic fundraisings prior to accessing the public markets. These companies were thus able to develop meaningful operational and financial performance prior to an IPO event - contrast this with the "zero to IPO" mentality of 1999. And most are meaningfully cash flow positive, making an IPO less of a "do or die" situation.

What else has changed since 1999?

Broadband usage and penetration have become a reality. Thanks partially to the continued decreasing costs of technology (see next point), meaningful broadband penetration has proliferated across Asia - China now has the largest number of broadband users in the world; Korea the highest penetration rate; and Japan the most aggressive pricing. Ubiquitness of broadband has made content-based business models viable, even those with micro-payment revenue models such as online gaming, avatars, music, etc.

The rise of China as the world's manufacturing centre combined with manufacturing advances from Korea and Taiwan have driven down costs of consumer goods and technology.

Technology has become more affordable and the resulting ubiquity (including broadband internet and mobile access) has underpinned businesses, which would not have been viable five years ago. A case in point is Shanghai-based Focus Media and Target Media, LCD advertising companies with a nationwide networks in China. Their operational successes are a tribute to their management team and the VC firms which funded them, but were also made possible by the falling hardware costs of their LCD terminals.

Evolution in software technology has helped revitalize online ad spending. Compared to the simplistic banner ads of yesteryear, today's pay-per-click and targeted advertising channels enable advertisers to get feedback on their effectiveness and has further driven ad spends.

Compared to the US and Europe, the online advertising market in most of Asia is still in its infancy (with the exception of Japan and Korea).... and a gauge for the potential of this market will be reflected by the upcoming IPO of China-based search engine Baidu, which has just filed for an IPO on Nasdaq.

Improving economic prospects. Recovery from the Asian financial crisis have made Korea, Hong Kong and Southeast Asia attractive consumer markets again. In addition, Japan's economy has finally shown signs of promise after over a decade of recession and asset price deflation. And it would be naïve to understate the emergence of China's and India's booming consumer class.


Given the above, what if any inferences can be drawn upon from the last half-decade that will allow us to generate investment returns in the future? One overriding positive development is the amount of credible information available on the Asian technology markets - the benefits of a research community based in region for several years, the ability to search the world through the internet, and the growth of the market size of the sector which justifies focus and investment.

Unlike "then" when the exercise was extracting information from the US and Europe and applying that information to Asia, fundamental research on the Asian markets can be undertaken.

Over the last few years, IRG has driven its investment themes and idea generation based on a comparison of global trends and local market knowledge.

In broad macro-economic terms and at the risk of over-generalizing, we are a believer in consumerdriven TMT business models - almost anywhere in the region. IRG identified the following themes in 2003/2004 - some of which have developed quite rapidly and some likely to develop over the second half of the decade:

  • Portals back from the Dead based on an Integrated Business Model (2003)
  • Online Gaming Companies and the Emergence of the China and Korean Markets (2003)
  • Wireless Services and the Growth of Mobile Data as a Major Contributor to Profits (2003)
  • The Demise of the Incumbent Fixed Line Operators in Hong Kong, Japan and Taiwan (2003)
  • Business Process Outsourcing as the Growth Engine for Asia IT (2004)
  • Mass Emergence and Adoption of Converged Devices in Asia (2004)
  • Software Solutions and Consolidation in Asia (2004/2005)

In addition, we believe the following themes warrant attention, research and increased focus:

New Advertising Models based on Enabling Technologies - Whether it be in-building and instore advertising through LCD screens or readable barcodes on your computer/television/PDA which allow you to transact or research a product further, we believe that new enabling technologies produced at a low cost will drive new advertising models which will generate sustainable business propositions. The continued fragmentation of consumer audiences will continue to drive ad dollars to alternative media channels.

Digital Content - The digital music market has the potential to be over $5 billion globally in the next five years. Illegal downloads are on the decrease in most parts of the world, albeit slowly and not quite yet in Asia. We believe enabling technologies will increase the ability to restrict illegal downloads and may be an area where piracy can be seriously curtailed over time - even in China.

We also believe that most of the money will not be made in the rental or single download sector, but in the total customer experience which involves radio, video, music - and the revenue streams that come with it - advertising, sponsorship, premium subscription services, etc. (And we would keep an eye on the trading of online game-related virtual assets, a market worth over $800 million in 2004).

IPTV - Japan and Korea will lead the world in this effort in our estimate. Content again will be in high demand in the near term as competitors race to lock in exclusive arrangements.

Online and Mobile Gaming - Mobile content, whether games, ringtones, music or other content, will continue to have promise in Asia. Asia has proven to be early adopters of mobile content and businesses of scale existed in Asia long before the US consumer "discovered" ringtones.

As 3G and mobile WiMax networks proliferate, we expect the sophistication, availability and variety of mobile content to increase. And while the market will continue to become increasingly competitive, online gaming will continue to hold promise, especially in China given its large addressable population and the significant operational leverage inherent in the online gaming business model.

For those about to sign on to the ride in the hopes of creating one's fortune, one should also take heed of the lesser-known lyrics of the same Steppenwolf song:

Last night I held Aladdin's lamp

So I wished that I could stay

Before the thing could answer me

Well, some came and took the lamp away

I looked around, a lousy candle's all I found.


At the time of the completion of this article, FocusMedia, China's leading in-building and in-store advertising company (see above: New Advertising Models based on Enabling Technologies, Consumer Driven Business Model, Low Production Costs) has just priced its IPO in New York at $17.00 per share, $1.00 above the filed price range and implying a pre-money valuation of $510 million.

Similar to other "now" deals, the deal was priced off of a solid earnings base and was rumored to be 20 times oversubscribed with over 70% of the demand from the US. This valuation is estimated to be three times the last private round (completed in November of 2004, a mere eight months ago), which is a valuation record in and of itself. And Chinese search engine Baidu just publicly filed for an initial public offering of up to $80 million, a significant uptick to the rumored $100 million valuation of its last round of funding a little over one year ago......

Close your eyes, girl....

This article was prepared for FinanceAsia by Matt Burlage and the rest of the IRG Team (with thanks to the usual Team of Juliette Chow, David Tee and Agnes Wang)

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