Chinese Internet Bubble Burst?

The question whether there is a bubble in the China internet sector comes up frequently in conversations.  In my views, definitely, yes.  There is a bubble in the sector.  And during the recent market correction, some of the most over-priced saw their share price plunged a lot. But my guess is: it is not over yet, the bubble will swell again, once the market recover from recent Greek debt crisis.

Five or six years ago when I just started following the sector, the Chinese internet companies had to be making profit before they got listed.  Actually, all of them, Baidu, Tencent, Netease, Shanda and so on, made healthy profit and had fast growth.   And that was what supporting their share price.

Today, that is still true for some of them, such as Baidu and Tencent.  But not so much for the others, especially, some of the recently listed.  Last October, ChinaCache, which provides Internet content and application delivery services to businesses and government agencies in China got listed when it was still in red.   Its share went up 95%  on the first day of trading.  Then came Youku.  It too was making a loss when it got listed last December.  Its share went up over 150% on its first day.  Recently, it made another public offer, selling its share at US$48.18, or 3.76 times of its IPO price.  Still, the company is making a loss and will be doing so in the next couple years.

Investors’ thirst for the next hot thing from China Internet do not stop with the IPOs.  Old boys with a pretty story to tell also see their share prices shoot up the roof, even there is no new revenue or profit to speak of.  Although Sina Weibo has only tiny revenue and no profit, it is worth more than Sina’s original business, which consists of its online portal, its wireless operation and a couple other business.  Sina traded as high as US$147 a share.  An analyst friend of mine value all its other business together at around US$50 a share only.  

As the “exit” can be very lucrative, the “madness” is rippled along the whole food chain.  Valuation for Chinese startups is also inflated a lot recently.  China is not cheap anymore for venture capitalists looking for a new star.   “I met with a US startup recently.  The management team are from large companies and with years of experience. They are asking for an investment of $1 million only,” said a China based VC, “Startups with similar background would ask for $5 million in China.”

A VC told me recently Rekoo’s valuation is more than Angle Birds when the U.S. company had the same revenue.  Many VC also though startups from Innovation Works, Lee Kaifu’s incubation center are pricey.

“We think this is bad, too.  That will raise the entrepreneurs’ expectation,” said Chris Evdemon, its general manager for incubation programs.  And, that is not good for their future growth.  “They should spend their money wisely,” he added.

“I believe this is only a temporary phenomenon.  It will not last forever.  I guess by the end of this year or next year, the situation will be different,” said Chris.

Just a few weeks after our conversation, the market got corrected due to the recent Greek debt crisis.  As expected, some of the most over-priced China internet stocks saw their share price plunged a lot.  Youku closed at US$28.04 last Friday, or 60% off its peak of US$69.95.   Sina dropped from its height of US$147 to US$80.57, an 45% decrease. (In comparison, Tencent dropped about 18% from its height of  HK$230.8 and Baidu lost 25% from its height of  HK$156.04)

But my guess is: it is not over yet, the bubble will swell again, once the market recover from the recent crisis.  And when it will truly burst?? Like the burst of internet bubble during 2001.

I think it is hard to tell.  While it is easy to spot a bubble, it is much harder to predict when the bubble will burst.  Japan’s real estate bubble lasted about a decade, and only burst in the 1990.  Nevertheless, the longer it takes for the bubble to burst, the more devastating  will be its effect.  Japan is still trying to recover from its last blow.