Captial burn-out

Only a matter of months ago, Beijing was gushing with investors caught up in a mania for China internet plays. For once Beijing, traditionally the city that likes to talk, was eclipsing its traditional rival, Shanghai, the city that likes to do. While Shanghai was taking the road to growth through government regulations as it established massive portals to act as industry pillars, Beijing was demolishing regulations to let the new industry bloom.

An influx of young netpreneurs flooded in, adding vitality to the city. As funding surged for Chinese start-ups, demand for office space soared, first stabilising and then boosting the struggling property market.

China's mushrooming number of internet users in China – there are now 17m compared with 9m at the end of 1999 – are served by more than 15,000 websites. But the day of reckoning that took five years to arrive in the US has cast its shadow over Beijing in less than one year.

Unfortunately for the thousands of e-commerce pioneers in Beijing, the country's huge pool of internet users are not opening their wallets. According to a Salomon Smith Barney report, online advertising revenue for China won't exceed a paltry US$26m in 2001. Pessimistic forecasts abound that most of the sites opened in the past year are about to hit the casualty wards. The China Business Times puts the failure rate of domestic internet start-up companies at 90 percent before the end of this year.

Others are less pessimistic, but only just. One Chinese venture capitalist believes that thousands of companies will shut or he merged within months as they fail to raise second or third-tranche funding: "I think at least 70 percent of them will die," he says.

Mr. Zhang Yongqing, manager of egou.com, a lifestyle and retail website based in Beijing, says his peers are belatedly coming to recognise that only those with a good business model will able to access money.

Burn rates have soared, not on recruiting graphic artists and the other technicians that make a website distinctive, but on renting expensive office space, paying top-of-the range salaries and splashing out on high-profile billboard campaigns that project the website name but little else that is unique about the service.

While the money was flowing freely and the emphasis was on spending, that was an advantage but when the wind changed and the emphasis turned to revenue and profits the failure to conceive websites that extracted money from people's pockets shattered investor confidence.

The crash of the sector was also precipitated by the advent of central government interest in the technology industry, which served to undo much of the good moves by Beijing to allow the animal spirits of the webmeisters to emerge.

Overseas Chinese who had returned to the mainland to work in the industry and had benefited from concessions such as rent-free periods and tax concessions at the Qinghua University-run business park, suddenly found themselves hamstrung by central government rules when it came to second- and third-stage funding from foreign investors. Bureaucratic meddling resulted in a sudden reduction in the flow of foreign investment to the internet sector.

Damaging ruling
The most damaging ruling came from the powerful Ministry of Information Industry. It now stipulates that net companies must exclude their Chinese internet concerns when listing a corporate entity abroad, a move aimed at restricting foreign involvement in China's corner of the worldwide web.

The ruling has forced Chinese portals to undergo a convoluted restructuring that has transformed listed vehicles into corporate shells registered in the Caribbean, while ownership of operations that generate the real value have remained in the hands of Chinese investors. Although underwriters and netpreneurs insist that the manoeuvres have no practical implications, the queue of investors looking for Chinese internet stocks has as a result been whittled down to the brave or the determined.

Coming around the same time as the huge crash on Nasdaq, the regulations were a huge blow for the Beijing internet industry. The collapse in confidence could not have happened at a worse time. Bad news flooded out of the sector. One Beijing-based bookstore said it was selling only five or six books per 300,000 hits. It attempted to boost performance by collecting its main income from processing lees but then was hit by a business operations tax, which caused it to lose a percentage on each transaction.

Soon, every week there was an announcement of job cuts by the industry leaders amid a desperate search for merger partners by struggling companies whose funding was running low.

Even cashed-up overseas-based operators joined in. Industry observers were, for example, shocked when Chinadotcom said it was shedding 48 Beijing-based staff after a review of over-lapping resources. Mr. Daniel Mao, chief operating officer of Sina.com, the country's leading portal, believes massive shakeout is underway in which all players in China will be forced to revise their business models, target markets and cost structures.

The immediate objective for most operations is to merge their way to profitability. Mao predicts that companies will use the mergers as opportunities to cut back staffing costs by sharing backroom functions.

One beneficiary of the downturn has been Li Ka-shing's infamous tom.com operation. Its management team has been trawling Beijing in recent months and has recently entered into agreements to acquire 163.net, shawei.com and Yang Cheng Press, a sports advertising and event management company. Although tom.com has retrenched by cutting 80 staff from its 420-strong payroll, it remains in aggressive frame of mind because of the vast proceeds it accumulated in February when tens of thousands queued in the streets off long Kong desperate for a share of the company.

Other potential buyers include big names such as Chinadotcom, Ren Ren, Sohu, Sina and Netease. Indeed some people predict a merger between one or all of the top four. In September, Sina.com bought out ChinaRen.com. It is a process in which cash will win out. As Mao has put it: "Cash is king, not page views."

This is a telling statement coming from the man whose company has topped the China Internet Network Information Centre poll for the third time in 18 months as China's most popular website.

Mao says the company's most important asset in the shakeout is not its huge popularity but the USS 130m in cash on its balance sheet that it can use to snap up other fines operating in China's internet space.