Commentary

Chinese Watered-Down Stock Torture With MTone

Tech Market WatchBy Perry Wu
Mtone Wireless is a Silicon Valley-based tech company doing most of its business in China. Founded by a Chinese who obtained a Stanford PhD in engineering, the company was originally formed ten years ago as a supplier of network hardware. When business went bad with the telecom bust a few years back, Mtone saw the light and completely switched its business to becoming a mobile value-added service provider. Meanwhile, its old network equipment business was taken over by an Mtone shareholder.

Mtone's basic business is simple enough. It provides the wireless content services such as ring tones, entertainment and sports news, and pictures that are now standard fare for Chinese mobile phone users.

Now the company is planning to do a Merrill Lynch-led IPO to raise a relatively modest US$55 million.

On a macro scale, Mtone's market seems promising. At the end of 2003, there were close to 300 million mobile phone users in China and the market continues to grow. Fortuitously for Mtone, China Mobile and China Unicom have adopted the model used by Japan's NTT DoCoMo that allows the services of third party providers to be bundled with the normal phone service.

But along with this growth have sprouted up over a thousand different businesses offering every conceivable variety of mobile value-added service. Mtone has managed to gain a foothold in this market and has 2003 sales of US$21 million of revenue to show for it.

Like Linktone, another supplier of mobile services that recently did its IPO, Mtone relies almost solely on China Mobile and China Unicom to act as its distribution channel. So the company is especially vulnerable to any changes in its relationships with these two telecoms. Any negative change in these relationships could prove fatal for Mtone.

A potential hazard with Mtone is its capital structure. A company that is about to issue stock in an IPO is a lot like a new employee you are thinking of hiring. You necessarily have limited information because you don't yet have a chance to see the employee on the job. So you can only gauge the potential hire by looking at other factors such as previous work history or a criminal background check.

If Mtone were a potential hire, it would certainly have a long rap sheet. Now, I do not mean to suggest it has broken any laws, but its attitude to holders of common stock is deplorable. Here's why:

Mtone's financials show current common shares outstanding of about ten million. But wait–there are an additional 40 million shares of preferred stock. Each of these shares of preferred is convertible into one share of common stock; this calculates to a potential 80% of additional dilution.

Tech companies are known for not being shy about issuing stock options, stock warrants and any other form of non-cash compensation they can get away with. But Mtone takes this to ridiculous extremes. Mtone's 2003 net income would have tripled to $3 million if not for its stock compensation expense.

This sort of watering down of stock is surely only a prelude to even more egregious behavior once Mtone goes public and it can do a lot more stock issuance. No matter how good the company's profits may be in the future, if Mtone keeps printing and issuing its stock so irresponsibly, then its shareholders will never enjoy the benefits of growth and profits.

About the author:
Perry Wu is a writer and correspondent for ChinaTechNews.com and can be reached here at the site. Perry Wu does not hold any positions, long or short, on any of the Chinese or American company securities mentioned in this article.

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