Valuation issues of messaging company Tomonline were the key concern for investors today as bankers and investors involved in the spin off of Li Kashing's internet portal tom.com started the pre-marketing process. The company's IPO in Hong Kong and ADR issue on Nasdaq is set to raise HK$1 billion to HK$1.64 billion ($128 million to $210 million), with around 80% to 90% of the issued shares to be primary shares.
Under the lead management of Citigroup and Morgan Stanley, the company is being valued on a 2003 P/E basis and pitched at a slim discount to US listed China internet portals Netease and Sohu. The former is currently trading at around 37 times 2003 earnings and 24 times 2004 earnings, while the latter is at 38 times 2003 earnings and 23 times 2004.
With a likely market cap around the $700 million to $800 million mark (based on a 25% freefloat), Tomonline will be roughly two thirds the size of Sohu ($1 billion market cap) and half of Netease ($1.3 billion).
By contrast market leader Sina is trading at 34 times 04 earnings and a lofty 63 times 03 earnings. All three companies saw massive increases in their share prices last year and investors will be asking what upside can there be from inflated valuations in a sector with ever increasing competition. Sohu, for example, has returned 329% on a 12 month basis, but has underperformed the market on a one and three-month basis following concerns that new SMS companies are starting to eat into the market share of the big three.
Tomonline has already shown strong growth. Whether investors believe it can maintain it will be key. The company has seen net earnings of $600,000 in Q1 2003 (off revenue of $14 million) increase to $5 million in Q2 (off $20 million), $6.5 million in Q3 (off $23 million) and $7.2 million in Q4 (off $23 million).
Tomoneline currently has nine million subscribers and carried out 27 million transactions in Q4 of last year, or almost 100 million transactions for the whole of last year. The market as a whole is said to have generated about 180 billion SMS message in 2003, double the figure for 2002.
Also for the whole of last year, revenue from wireless value added services (WVAS) was $60 million for Tomonline, $65 million for Sohu and $40 million for Netease.
"From an investor's point of view the story is attractive because of the macro story, the phenomenal growth of the Internet in China as well as the 300 million mobile phone users, which people are using in huge numbers at a much earlier stage of their development than in other countries," says one observer.
In addition, the incumbents are making a lot of money, he points out.
As to issues of whether low barriers to entry may compromise future earnings, he adds that technology makes all the difference.
"Tomonline has the track record of investing heavily and doing well in an existing technology and we therefore believe it's likely to continue to do well as it takes up WAP and 3G phones, which enable more data intensive applications to be downloaded," he comments. "The company also has a strong position with regard to content development for the crucial 18-25 age group."
It is likely the company will not pitch itself as competing directly with the acknowledged leader of the pack, Sina, which has so much mass as to be in a class of its own. That enables it to obtain an unusually large proportion of its revenue from advertising.
But Tomonline should be competing with the other portals for the top three slots below Sina, say specialists.
As to whether a price war might break out, specialists agree that the space can probably not hold more than three to four players, but that Tomonline, because of its high grade technology, should be one of the survivors.
"If you look at the pipeline, Linktone is about to the come to the market. But it's nowhere near as well known as Tomonline and doesn't have the Li Kashing connection," says one.
The choice of issuing ADRs as well as listing in Hong Kong was defended on the grounds that portals have a strong following in the US.
"Although you might expect much of the liquidity to flow back to the home market, in fact there is a strong following in these stocks in the US, which justifies the dual listing," says one source.
Shares are scheduled to begin trading on March 11.
