By Perry Wu
What's the first thing you think when you hear "Chinadotcom" (Nasdaq: China)? If you knew nothing about the company before, you might assume it was an Internet portal focused on China. But you'd be wrong. This company is much more than that. And that is the problem.
Chinadotcom, initially true to its name, started out as an Internet portal in 1996. By successfully capitalizing on its enviable URL name, China.com, and riding the Internet wave of the late 1990s, the company completed an IPO on NASDAQ in 1999 that raised US$86 million. Not satisfied, the company went back to the equity markets the following year and raised an additional US$304 million in 2000. For the coup de grace, the company then turned to Hong Kong investors on the Growth Enterprise Market in Hong Kong, and raised US$169 million.
So by the end of 2000, the company's capital-raising days were complete and its hell-raising days were just beginning. At first, Chinadotcom stayed within its sphere of expertise by focusing on buying URLs that were complementary to its business, such as hongkong.com and taiwan.com. But by 2003, the company had thrown off the Internet portal yoke, and was buying dissimilar companies.
First came a database marketing business, then came a business management software business, then an IT consulting business, then an SMS (short messaging service) business, then a systems outsourcing business, then a CRM (customer relationship management) software business, and on, and on.
The company has now made around 11 different major acquisitions in the past three years (not including two pending acquisitions). Such an appetite would strain the stomach of even the most well-managed and experienced companies in the world. But Chinadotcom seems blithely confident of its strategy.
But really, what is the direct relationship between a vendor of CRM software and a web portal? Or, an SMS business and an IT consulting business? Individually, these might be good businesses but there is no real relationship among them. And if you chat with managers at these Chinadotcom subsidiary companies you will find that synergies among the businesses are not utilized effectively–they seem to operate in their own bubbles. Chinadotcom is spreading its expertise very thinly, and there is no semblance of a coherent strategy. This is a sure recipe for mismanagement.
In Chinadotcom's defense, many of its acquisitions actually have real products, real customers, and real sales. And in many ways their businesses appear much more stable than the businesses of other China Internet darlings like Sohu (Nasdaq: Sohu) and Netease (Nasdaq: NTES). One of their companies, Pivotal, has a CRM software package that is used in the U.S. and the UK by such companies as Allied Capital, Visa International and the U.S. Federal Home Loan Bank. But it strains the imagination to think that Chinadotcom is devoting its full energy to its companies in the midst of its buying binge.
Chinadotcom is simply interested in buying, not managing, companies.
A diet is long overdue. Stop with the acquisitions, already. Could someone please make them stop and maybe buy them while the company still has assets to spare? Where's KKR when you need them?
On the face of it, Chinadotcom's current market value of US$450 million is only a 7% premium to its book value of US$421 million (per the company's 30 June 2004 financials). And much of the company's assets consist of high-grade debt of U.S. government-sponsored enterprises and international corporations. At first glance, that would seem to make the stock a good value.
But therein lies the trap. If management of the company continues to make unfocused acquisitions, then its cash position will only deteriorate further, and its book value accordingly. If it tries to raise new cash through rights offerings or other equity deals, that will only further dilute its shares.
And if the company ever gets around to seriously writing down some of its acquisitions to their true values, Chinadotcom's book value could take a smack that would make the Chinese Olympic ping-pong team proud.
In my view of the world, a corporation can get away with owning so many different businesses only under two strategic scenarios:
1. Berkshire Hathaway Strategy: This is where Warren Buffett chooses companies that have such great management, great track records, and great profits that he considers them all "Rembrandts". He just buys a company, doesn't mess with it, keeps existing management, and milks the cash.
2. GE Strategy: This is where GE has such a strong management infrastructure, sound systems integration ability, keen financial reporting and talented managers that it can integrate varying types of businesses and has a proven record of creating shareholder value by doing so.
If you are not utilizing the above two strategies then you better stick to buying companies that are basically the same as your existing business, otherwise there will be bad times ahead. Chinadotcom is not following either of the above two scenarios.
If you are running a public company, diversification is not your job. It's the shareholders' job. If a shareholder buys into a portal company, but then decides he wants a business software company to diversify his portfolio, it's the shareholder's job to then buy into a business software company. It is not the portal company's job to buy a business software company. Anybody who has been through an MBA program should have heard that First Commandment drilled into their heads multiple times. So in true pedantic style, let's repeat: "If you are running a public company, diversification is not your job. It's the shareholders' job."
Anyway, unless you are Berkshire or a GE, it is going to be really hard to pull off anyway. I challenge you to provide me with examples of publicly-traded companies that would contravene what I am saying as I would be interested at looking at them.
The trend is clear: Chinadotcom has managed to take the hundreds of millions of dollars raised in 2000 and has steadily depleted it. At December 31, 2001, before the company's major binge-buying began, Chinadotcom's cash and securities totaled US$483 million (cash plus available-for-sale securities plus restricted debt securities). By June of this year, the same number was US$279, a decrease of US$200 million in two and a half years.
And Chinadotcom provides no information for me or other investors to decide that Chinadotcom's route is the best path to follow. There are no separate financial statements for the companies they have acquired. No cash flow, balance, or income statements can be found. Under SEC regulations, those forms are not required, but it would make sense for investors to see these documents so they can make sure that these are good acquisitions to go by. Just because gambler Mary Meeker suggests China is hot doesn't mean we should blindly buy China technology stocks and believe their hype. (Quick note: Meeker is already headed for Failure Part II as many of the companies highlighted in her April 2004 China Tech report have bubble financials and poor service offerings. It seems her research team spent too much time listening to PR people and not enough time with their ears to the ground.)
So if the company wants to prove its case that it is making good acquisitions, they certainly do not show it. They are following the letter of the law, but this is not helping investors. The onus is on Chinadotcom to prove they are good acquisitions.
NewPalm illustrates this example very well. When Chinadotcom acquired NewPalm, many in the Chinese Internet industry snickered and rolled their eyes. NewPalm had a very short lifespan and was rumored to have a reputation for breaking contracts, losing money, and not fulfilling commitments with vendors. Their software applications were simplistic and their relationships with government entities were apparently nothing special. But an investor would never know these things because: a) many investors don't work and live in a Chinese technology business world; and b) Chinadotcom did not provide separate financials for the company.
NewPalm suckered Chinadotcom into acquiring it, and Chinadotcom then yelled "You suckers!" to its investors. If you are investing in a European or North American company, its easier to get good information, news, and commentary on that company. But Chinese companies don't have the same type of English-language information publicly available, so investors must "trust" the investor relations professionals at these companies for honest forecasts and background information. Investing in a Chinese publicly-traded company is like opening a fortune cookie and hoping that inside will be a slip of paper forecasting you with many riches. Or maybe it will just say you are destined to take a trip up a creek without a paddle.
In a fantasy world, shareholders of Chinadotcom could schedule a long vacation for the top management to keep the executives away from the "acquisition button". But we live in the real world so the market is justified in assigning a steadily lower value to Chinadotcom's shares.
In spite of all this, the company is sure to be making noise in the months and years to come. Chinadotcom still has sizable reserves of cash and securities, and more importantly, its appetite for acquisition place it in the position of acquirer. This company is not about to fade away yet. We'll be hearing plenty more from Chinadotcom.
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.