Internet -- Making Money On-Line in China: For a lesson in how to cash in on-line in China, look to NetEase; The Chinese Internet portal has emerged from dotcom doom to offer services consumers will pay for, and is finally turning a profit

By Yasmin Ghahremani

A YEAR-AND-A-HALF AGO, Beijing-based Internet portal NetEase looked destined for the dotcom graveyard. Dependent on pallid advertising revenues, it was shunned by once-eager investors. In August 2001 the Nasdaq-listed company's stock price dropped to 53 U.S. cents, more than 96% below its initial offer level of $15.50. Worse, a group of investors had filed a class-action lawsuit against NetEase after it emerged that the company had misreported revenues. NetEase's investigation caused it to miss Nasdaq results-filing deadlines, leading to its suspension from the exchange for the last four months of 2001. Management was in disarray following the resignation of both the chief executive and chief operating officer. "There was a lot of finger-pointing," recalls one former employee, who prefers to remain anonymous. "It was a very tough time for everyone."

Since then, NetEase has risen from its deathbed and is walking tall. Counterparts Sohu and Sina, who also suffered when the dotcom bubble burst, are also enjoying a revival, but NetEase stands out. It was the first China-based portal to become profitable, reporting albeit-modest earnings of $4,600 for the second quarter of last year. And it was the biggest gainer of any company on the hi-tech Nasdaq in 2002, climbing 1,500% from 75 cents to $11.45. A reported $8.3 million net profit and 23% jump in revenues during the first quarter of this year has helped propel the stock price above $20. It closed at $26.67 on May 5.


The secret of its success? It's managed to make money from its 96 million users. It's done that in several ways. An uptick in advertising sales has helped. Ad revenues grew more than 20% in each of the last three quarters of 2002. They dipped slightly in the first quarter of this year, though the immediate post-Christmas period is typically a low season. More importantly, NetEase has found other ways to earn money. Advertising only accounts for 10% of the company's revenue. The biggest share -- 48% -- comes from mobile data services. These services are to portals what a hit record is to an ailing pop star.


Here's how they work: Users go to the NetEase Web site and subscribe to have information, such as news or weather, sent to their hand-phones via short message service, or SMS. They can also download ring tones and icons, and subscribe to dating and SMS chatting services. Payment is deducted from the user's mobile-phone account. NetEase keeps 85% of the revenue and China Mobile, the mainland's biggest mobile-phone carrier, gets the rest. The system eliminates the problem of on-line payment in a country where credit cards are rare. "NetEase's turnaround is clearly driven by its ability to charge via SMS and have a commercial relationship with its customers," says Duncan Clark, an analyst with Beijing-based consultancy BDA China.


While mobile data is NetEase's largest revenue source, on-line games currently provide the most growth. In early 2002 NetEase became the first Chinese portal to introduce a multiplayer on-line game. Developed in-house, it is called Westward Journey Online and has more than 600,000 registered users, making it the most popular home-grown on-line game in China.


Sohu and Sina are now playing catch-up. Both recently entered the market with games licensed by Korean developers. NetEase also introduced a Korean-developed game last year but it plans to focus on using its own team of more than 50 developers in the future. "Because we have more control, we can tailor the game to Chinese tastes, introduce upgrades based on market needs rather than the licensor's timetable, and deal with technical problems such as hacking right away," says Ted Sun, NetEase's acting chief executive. The company plans to release two more games later this year.


But trouble may lie ahead. During the last week of April, the company saw a slight drop in gaming traffic, due to Beijing's closure of Internet cafes in response to the Sars outbreak. Analysts predict that if the cafes don't reopen soon, the damage to this quarter's earnings will be noticeable. But NetEase remains cautiously optimistic. "People have one less venue to play," says Sun, "but people at home may spend more time on-line so that may mitigate the closure of the cafes."


NetEase's rebound was led by founder William Ding. True to his engineering background, he's more focused on technical issues than on day-to-day management. But as the firm's "chief architect" he is also seen as a visionary leader. "[Ding] was focused on nonadvertising sources of revenue, such as on-line games and SMS, long before NetEase's competitors realized that this was a terrific profit opportunity," says Jean Eric Salata, China fund manager for Baring Private Equity Partners Asia.


Sun, meanwhile, focused on putting the house back in order. NetEase's misreporting troubles stemmed from dubious ad revenues it had claimed, such as barter deals it didn't expect to book in the future. Sun brought in new advertising-sales representatives and revamped internal-control procedures. "Similar problems won't happen again," says Sun. "We have very stringent internal control and management control procedures with all of our revenue sources."


All that remains of the scandal is a settlement of $4.4 million to be paid in the next few months. That sum is in escrow and was reported as a one-time charge in NetEase's third-quarter earnings last year.


More legal problems are brewing, however. The company now faces a lawsuit filed in Shanghai by Korean Internet firm Mr K. Mr K alleges NetEase copied its cartoon images and is seeking $1 million in damages. NetEase denies the allegation.


The long-term challenge for management is continued growth. At some point, SMS revenue will begin to level off. And in the me-too Chinese Internet industry, there are dangers that each portal's products will become a commodity. "One way to keep growing is to introduce new services and content," says Nathan Midler, Beijing-based analyst for consulting firm IDC. "NetEase's dating service has taken off well, but they must continue to innovate."


Assuming they do, the outlook is good. "In China only 5% of the people are on-line, so look at the potential," says Changhua Qiu, an analyst at U.S. equity-research firm Forun Technologies. That's not bad for a firm that only 18 months ago seemed to epitomize the death of the Internet dream.


"Reprinted by permission of Far Eastern Economic Review,
Copyright 2003 Dow Jones & Company, Inc. All Worldwide Rights
Reserved".

Contact:

Back