U.S. Web Giants Target China

With Internet use exploding in the Middle Kingdom, companies like Yahoo! and Google are hunting harder for deals

As China's internet market sizzles -- 94 million Chinese now go online, second only to the U.S. -- many of its Web companies have rocketed from startup obscurity to stock-market fame. Shanghai gaming innovator Shanda Interactive Entertainment Ltd. (SNDA ) last year raised $100 million in an initial public offering and now stands 249% above its launch price. Ctrip.com (CTRP ), which provides online travel reservations, raised $40 million in an initial public offering in December, 2003, and its shares have since more than doubled. Tencent, which operates China's top instant-messaging service, pulled in $200 million in its Hong Kong IPO last June and has seen its shares rise by 30%.

Now, Net giants from the U.S. want a piece of that China magic. On May 11, Microsoft Corp. (MSFT ) said its MSN portal had formed a joint venture with a Shanghai company to operate a Chinese-language version of MSN. Later in the month, Google Inc. (GOOG ) opened a small office in Shanghai, following a February deal with Tencent to provide search services for the Chinese company. And Yahoo! (YHOO ), Amazon.com (AMZN ), eBay (EBAY ), and Expedia (IACI ) have been on the prowl in China, too. "The sense of urgency among big players has accelerated," says Safa Rashtchy, an analyst with Piper Jaffray & Co. (PJC ) in Menlo Park, Calif. "If you don't have a major stake in China, you could be left out."

It helps that U.S. Net outfits have an easier time getting into China these days. In the past, foreign companies that wanted to invest in Chinese dot-coms had to grapple with restrictions limiting their access to the market. Typically, the Americans would invest in an offshore company that had a contract to provide content to the Chinese company but had no stake in China itself. In late 2003, Beijing eased those restrictions as part of commitments it made in joining the World Trade Organization. Foreigners can now directly own 50% of Chinese Net companies, though getting approvals can still be slow.

The first to take advantage of the more liberal climate is MSN. Its partner is Shanghai Alliance Investment Ltd., which is run by Jiang Mianheng, a son of former President Jiang Zemin. The venture will offer Chinese-language content from government-backed outlets such as the Beijing Youth Daily and the Shanghai Media Group. One target audience is China's 340 million-plus cellular subscribers, who often use their handsets to go online. "Because of the mobile population, there are opportunities for new services," says Bruce Jaffe, MSN's chief financial officer. One such service, for instance, might allow Chinese bloggers to post their thoughts while on the go.

Other U.S. companies have already jumped in, restrictions or no. Yahoo! Inc. last year paid $120 million for a Hong Kong company that gives it control of Chinese search engine 3721. A key attraction of 3721 was the relationships its sales staff had built up with advertisers, says John E. Marcom Jr., senior vice-president of international operations at Yahoo. "3721 has a thriving, on-the-ground sales model," says Marcom. In addition, 3721 understands the local market and has helped Yahoo spruce up its site design and product positioning, he says.

Yahoo's salespeople will have to work hard to stay ahead of Google. The search giant sold about $24 million in ads in China last year and had about a quarter of the search market, according to researchers BDA China Ltd. While other search engines typically charge 3.6 cents a click for ads pegged to keywords, Google in recent months has cut the price to just 2.4 cents. While that could well get more companies interested in buying keyword ads, it is also likely to put pressure on China's leading search company, Baidu, in which Google holds a small stake.

Big e-commerce players are moving into China, too. eBay Inc. paid $180 million for EachNet Inc., a Delaware company that gives it control of Chinese Net auctioneer EachNet, and says it will spend at least $100 million in China this year. China is a "defining measure of business success on the Net," Chief Executive Margaret C. "Meg" Whitman told analysts in February. EachNet's gross sales grew 70% year-on-year in the first quarter, to $100 million. And last August, Amazon.com Inc. bought a British Virgin Islands company that gives it control of Joyo.com, China's leading online bookseller, for $75 million. While Amazon CEO Jeffrey P. Bezos cautioned shareholders at the company's May 17 annual meeting that the venture "will take many years to succeed," he said "it's an investment worth making in a country that's growing so rapidly."

Some Chinese are welcoming the American invasion. Pony Ma is the 34-year-old founder and CEO of Tencent, the Shenzhen company that operates QQ, an instant-messaging service with 77% of the Chinese IM market. Although Ma first turned to Baidu for a search function on the QQ portal, in February he switched to Google. Ma thought Google's search engine was more efficient, and decided it was less risky to work with the Americans. "Baidu could be a competitor," Ma explains. Given what he sees as the more limited goals of the newcomers, he says, "it's safer to work with foreign companies."

Foreigners, though, face plenty of dangers in China. For starters, the market is immature. Paid search, for instance, is just a $150 million market, compared with $3.9 billion in the U.S. In addition, companies that don't have a local operation can find themselves at a big disadvantage. For instance, Google doesn't have any local servers; as a result, few university students can see it, because school networks don't easily connect to sites outside China. And keeping the country's censors satisfied that the Net isn't fostering subversion requires companies to do lots of monitoring of content on their sites.

At MSN, Jaffe says the company is doing its best to make sure that the censors have no reason to move. "We keep a keen eye on being locally sensitive" wherever MSN operates, he says. "This will be no different." That will mean restrictions on what Chinese Net surfers can see and say on MSN's site, of course. But it's a price Microsoft and much of the rest of the U.S. Internet community appear willing to pay.

By Bruce Einhorn in Shenzhen, with Ben Elgin and Robert D. Hof in San Mateo, Calif. and Timothy J. Mullaney in New York

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