Tuesday, July 19, 2005                                            

Alibaba's Magic Carpet

Russell Flannery

Some of the heat from China's scorcher of summer in 2005 may be finding its way to the country's booming Internet and media companies.

Indeed, shares in a swath of such firms may be ready for a new round of price increases following last week's successful Nasdaq IPO by Shanghai-based ad agency Focus Media and Rupert Murdoch's big bid on Monday for a U.S. Internet firm.

What some investors term a "familiarity gap" between Chinese and Western Internet companies seems to be closing as huge valuations in the U.S. and Western Europe combine with a better understanding of China's burgeoning Internet industry and public offerings that set increasingly robust prices here.

Rising prices may also affect the China strategies of American companies such as Yahoo! (nasdaq: YHOO - news - people ), eBay (nasdaq: EBAY - news - people ) and Google (nasdaq: GOOG - news - people ), which have been targeting the country's growth and in the past acquired or invested in local businesses. Just last week, investors in Focus Media shelled out roughly 30 times 2005 earnings, or a market capitalization of around $700 million, for a company that is booming, but only two years old.

"The interest at the retail level in the Focus Media listing will push up the price of everything else—early stage or otherwise," says Lawrence S. Tse, a partner at Gobi Partners, which has about $30 million invested in digital media companies. Also last week, Euronext-listed Trader Classified Media said it might pay as much as to $200 million to acquire SouFan Holdings, China's No. 1 real estate Internet media.

"Low hanging fruit"—or companies with ideas or business models proven in other countries that seem no-brainers to succeed in China, too—are becoming "fewer and fewer," says Adam Bornstein, a partner in Ymer Venture Capital, a Shanghai venture capital fund that invests in start-ups. "The price of what's left is going to go up for people that want to invest."

Internet investors around the world did a double-take Monday after Rupert Murdoch agreed to shell out $580 million in cash for Intermix Media (amex: MIX - news - people ). In the most recent quarter, the company had revenue of $24 million and a loss of $409,000.

Many Chinese companies offer more profits in a booming market at lower valuations. Among China's most highly coveted "low hanging fruit" is Alibaba.com, whose Taobao.com unit has been putting pressure on eBay (nasdaq: EBAY - news - people ) despite high-profile efforts in China by the U.S. online auction company.

New Chinese restrictions this year on venture capital investments in some local companies are slowing inflows of capital. But the rules grandfathered many businesses with foreign ties, and created some scarcity value for companies able to raise money, says David Zhang, executive vice president for China operations at San Francisco-based WI Harper. "We're starting to see a pick-up in valuations," he says, based in part on buying by U.S. and European investors in relatively late-stage pre-IPO companies.

Prices that foreigners have to pay to buy into China's successful local Internet companies may also be on the rise because of an evolving culture in which cash doesn't carry as much clout as it once did. "What we see is that more and more entrepreneurs don't just want to get rich," Tse says. "They could be $100 million richer or poor from one day to the next, and it doesn't matter. They are thinking that they owe it to the industry to flight the battle for their company, and maybe against some of the foreign entrants." Still, he says, "there is a price for everything. It's just that that price is going higher by the day."

Unlike a lot of flimsy IPOs of the late 1990s, Focus Media's thus-far solid business illustrates how China isn't a bubble. "There definitely is a difference from the dot-com bubble," say Olivier Glauser, a Beijing-based director of Qualcomm (nasdaq: QCOM - news - people ) Ventures, which has four investments in China. Another reason why Chinese stocks don't stand out as particularly expensive, he says, is that they trade at a discount to their U.S. peers.

If anything, that historical gap might close over the long haul with better Chinese management and as U.S. investors become more knowledge about China's uneven landscape. "Chinese Internet companies have historically traded at a discount to their American counterparts" because global investors aren't as familiar with Chinese companies as those in the States, says Victor Koo, a Stanford MBA who recently left his job as president at Sohu.com (nasdaq: SOHU - news - people ) after six years. What Koo describes as a "familiarity gap" should be closing over time as companies learn how to communicate better with overseas investors, he says.

Despite recent debacles on the Nasdaq for some U.S. companies—such as 51job (nasdaq: JOBS - news - people ), a job-search site whose shares have collapsed amid concerns about the company's forecasts—Koo thinks many Chinese companies are doing better at building up operations that make them more sustainable and interesting to U.S. investors. "It is now easier to attract experienced talent, raise equity financing," while problems with payment and fulfillment are being resolved, he says.