Tech Market WatchBy Perry Wu
Instant Messaging (IM) has been big in China for a long time. With more than 95% penetration for Microsoft's Internet Explorer, this bodes well for the multinational's own MSN IM system. But of all the companies in China poised to take advantage of the IM market, Tencent Holdings Limited is probably in the best position. Partially owned by the South African media group Naspers, Tencent has in the past week raised nearly US$200 million from its heavily over-subscribed Hong Kong IPO.

But this is not just another over-hyped tech company.

The company can claim the largest market share in the IM business in China. As of the end of the first quarter of 2004, the company claimed 291 million registered accounts in China, which is a good quarter of the entire population of the country (if we assume one account per person). How did they leapfrog Microsoft? They got in first, provided better Chinese-language features, and bundled their desktop IM services with mobile short messaging system features before all their competitors.

As with all other companies who depend on China's two major telecoms (China Mobile and China Unicom), there is a great risk when there are only two companies who hold the keys to the mobile phone highway. China Mobile and China Unicom, have a natural advantage over the hundreds of companies that depend on them for their mobile phone platforms.

However, Tencent seems to have a genuinely good relationship with China Mobile, being chosen as a "best performing partner" for its SMS services. And mobile phone users' clear preference for using Tencent for IM could make it more difficult for the telecoms to strong-arm Tencent or create IM systems of their own.

Based on a review of Tencent's financials, the company is doing a lot of other things right. It has a fat profit margin of 44% for the year ended 2003, and the company can boast an exceedingly low debt/equity ration of only 22%. But most notable is the company's current return on assets of 68%. With that kind of return, it is a wonder the owners of the company will let public shareholders–through its IPO–share the benefits of its profitability. With these kinds of numbers, Naspers should probably have kept the company private and kept the benefits to itself.

Tencent is clearly shareholder-oriented in other ways too. For example, it has publicly stated that it intends to pay dividends on an ongoing basis of at least 10% of its profits.

Most impressive is how Tencent has dealt with its stock options. Companies that issue stock options are often criticized. But don't misunderstand: there is nothing inherently wrong with issuing stock options. The problem is how companies usually issue them.

The purpose of stock options is to create an incentive for company personnel to work hard and to have a vested stake in the company's well-being. In most companies, however, it is directors and top management who usually receive the bulk of the options. But directors, who most always have a sizable equity stake in a pre-IPO company, need little further incentive to perform. So it is amazing how many companies issue vast amounts of options to directors as if it were necessary to motivate these people who already might own 10, 20 or 30% of a company. It is not.

It is refreshing that Tencent has issued options, but none to directors. This is the way stock options should be used: reward employees for working at high-risk start-ups, but do not give these to directors.

Perhaps as a result of its Western ownership, Tencent has already shown a knack for good drivers of shareholder wealth. Combine that with a great brand and the explosive growth of IM in China, and that sure sounds like a good story.

About the author:
Perry Wu is a writer and correspondent for 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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