Talking Point

Dollars and censors

Should IPO investors be nervous about government’s internet crackdown?

If you want to get foreign investors to subscribe to your internet IPO show them photos like this...

The world’s first internet bubble began to inflate in August 1995 with the listing of the web browser, Netscape. Jim Clark – the company’s major shareholder – later confided to author Michael Lewis that Netscape’s hugely successful IPO “made anarchy respectable”.

There are some who feel the world’s second internet bubble is frothing away, and this time it’s in China. Sky-high valuations, no profits and huge first day trading gains are again on the cards, but there’s a difference this time round: unlike Clark, the Chinese government has no interest in ‘anarchy’ whatsoever.

In fact, just as the latest crop of Chinese internet firms list in New York, Beijing is imposing new regulations on the web – concerned about the net’s potential to foment social unrest. In these circumstances could internet business models be harmed? Should foreign investors still be buying?

Full steam ahead, for investors…

That seems to be the message from the US, where at least 17 Chinese internet or tech firms will try for an IPO this year, according to iChinaStock.com.

Two Chinese firms managed it last week: social network Renren (clumsily but successfully, see WiC105) and NetQin Mobile, a maker of internet security software for cell phones.

This week there were two more, from Phoenix New Media (a content provider for internet, TV and mobile phone firms) and Jiayuan.com (an online dating site).

Youku, China’s leading internet TV platform, has also been in the news, announcing it plans to raise $600 million via a secondary offering in the coming weeks. Youku’s listing last December was one of those to trigger the recent flurry in IPOs, which still shows little sign of abating.

Hang on, isn’t there a clampdown underway?

China has long put restrictions on how its internet functions. But the situation has got tighter – at least, from the perspective of those who view the web as an open platform.

The blocking of sites like Facebook and Twitter first began in 2009, shortly after the Xinjiang riots. But efforts to restrict access to numerous international websites (and to block mention of particular news stories) are said to have stepped up again this year, following events in North Africa and the Middle East, where social media is purported to have played a role in stirring unrest.

Much of the evidence is anecdotal. A wider range of sites is said to have gone on the forbidden list, and more terms have been identified for blocking. The providers of virtual private networks (services that allow users to sidestep many of the restrictions of the Great Firewall by routing traffic through servers beyond Chinese borders) have also been complaining of more instances of disruption.

More widely reported was Google’s claim earlier in the year that its Gmail service had been hacked by a sophisticated team based within Chinese borders. Google alleges that the email accounts of local activists were targeted.

A new sheriff in town, too?

Something more concrete was announced on the policy side last week – the creation of the State Internet Information Office, a new agency to coordinate online rulemaking and enforcement.

Previously, oversight has been fractured across at least 14 separate entities, leading to overlap and dispute (see WiC38, for one example). The new agency is tasked with streamlining the administration of China’s web world, and refocusing efforts on the supervision of content.

That includes becoming the lead party to “investigate and prosecute websites for violating the law”, something that foreign media has been quick to pick up on, viewing the regulator as a souped-up ‘Big Brother’, policing the web against dissent. But Xinhua bristled at the interpretation, seeing only a thinly veiled attempt to “tarnish the image of China”. Instead, the new entity is charged with dealing with the “current bad environment” online, the news agency insisted, including problem areas like fake information, obscene material and online gambling.

What role for foreign investors?

Fund managers are much more bothered by China’s growth metrics than the small print on the role of the State Internet Information Office, it would seem.

That’s a pragmatic response. After all, those money managers who bought into the earlier IPOs have watched their investments flourish in spite of censorship. Most of the top Chinese internet stocks are already listed in the US, including Sohu and Netease (which censor their own information services) and Youku (which censors its video content too).

Another star performer is Nasdaq-listed Sina which, thanks to its Twitter-like Weibo service, has seen its stock surge 260% in the past year. It employs 700 staff to censor its users’ content.

But if investors themselves won’t rock the boat, might the regulators in the American capital markets be made to make more of a stir themselves? That seems to be the backdrop to an open letter sent by US senator Richard Durbin to Baidu CEO Robin Li last week, urging him to do more in areas like freedom of expression and privacy.

Further, Durbin warned that he is working on legislation that will require Chinese technology companies to protect human rights or face penalties – and that Baidu will be subject to such legislation because its shares are traded in the US.

Needless to say, Durbin’s correspondence drew immediate rebuke from the Global Times, in an editorial that again rejected any notion of the internet as a “boundless media”. There could never be a one-size-fits-all approach, it warned, as China’s policy priority would always be the “grand scheme of social management”.

At this stage, quite how any proposed legislation could work is unclear. But given China’s sensitivity to perceived breaches of its sovereignty, it would soon become a major point of contention.

Stock-pickers like the status quo?

Internet stocks have never been for the faint-hearted. But with the recent China IPOs a strong case can be made that fund managers are buying into something that they do not understand. Pessimists say this could later become all too apparent if newly listed players see their businesses hit when they do something to earn official rebuke. In particular, Reuters wonders if social networking sites like Renren are more at risk of running into trouble, and whether official constraints could undermine some of the sector’s commercial potential.

The risk factor section of Renren’s recent prospectus pointed out that it will be operating in a heavily regulated environment, for instance, in which it is required to prohibit content that “impairs the national dignity of China”, or that is “socially destabilising”.

In fact, Renren mentioned the word “regulation” nearly 300 times in its securities filing, Reuters notes. (For comparison purposes, Skype used the same term only 170 times in its prospectus, seen by Reuters earlier this year).

But concerns that prospects might be suffocated in red tape look overblown. The most successful incumbents – those like Baidu, Sina and Tencent – have all learned to work within the official rules. Indeed, doing so can lead to huge commercial opportunity, especially if you are first to grab a leading position. Then, the restrictions on foreign entrants can help to prevent greater competition in a market growing spectacularly fast. As of the end of 2010, the number of Chinese internet users had climbed above 450 million, but that was still only a third of the population. E-commerce revenues also doubled last year to $70 billion, and the industry is expected to grow another 60% to 80% this year, according to China Market Research Group.

For foreign fund managers, these combined traits mean the new IPOs look worth a punt, especially if, like Baidu, some of those on the list go on to win dominant market share (Baidu accounts for 75% of Chinese web searches).

And the foreign internet giants?

That same ‘big number’ opportunity continues to fascinate foreign entrants too, of course. And although Google may have given up on trying to bridge the two web worlds in its search business, there are plenty of others ready to try again themselves.

Foremost among them, if rumours are right, is Facebook, which is said to be making every effort to overturn its current ban. There is talk of a tie-up with Baidu in a standalone site disconnected from Facebook’s international network, presumably replete with the controls that the Chinese authorities will demand.

Any deal would be ripe with symbolism for a company credited with exasperating authoritarian regimes elsewhere (although a company spokesmen told the Wall Street Journal last month that it had found itself in “uncomfortable positions” by “allowing too much free speech in countries that haven’t experienced it before.”)

And if Facebook does ink a venture with Baidu, that would be yet another sign that China’s approach to walling off its web – and getting internet firms to play by its rules – is proving more resilient than many in Silicon Valley and Washington thought possible.


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