China fuels internet bubble re-inflation

OIL price panic and rumblings of industrial discontent have prompted talk of a return to the ungainly economic fashions of 1970s. But in the craze for spotting similarities, are we failing to spot a revival of a more recent era - the 1999-2000 internet bubble?

A rash of recent deals (see below), and reports last week that Microsoft is in talks to buy a major stake in America Online - a name synonymous with irrational exuberance - have sharpened the sense that business judgment is once again losing out to web-head, dot.com mumbo jumbo.

As Didier Lombard, chief executive of France Telecom, put it at the weekend: "We see that the bubble is re-inflating. The price of operators being bought on the market is getting higher and higher.

"Valuation multiples are increasing, probably because there is a lot of money in the market due to the rise in oil prices. Investment was flowing back into businesses with assets that are 'virtual' or at least, as yet unproven."

Even if the figures involved are still dwarfed by the $150 billion (84.5bn) AOL paid for TimeWarner, the case that came to symbolise the hysteria of the bubble's bursting point, a sense of critical mass is building.

Microsoft's potential stake in AOL, the fruit of "discussing co-operation between their internet search and advertising networks", comes soon after the net auction giant eBay last week paid $2.6bn for Skype, the internet telephone specialist, despite Skype's impeccably profit-free history.

Other examples include News Corp's $1.2bn purchase of the video-gaming site IGN, and the social networking site Intermix Media. Then there is Yahoo's $1.2bn purchase of a stake in Alibaba.com, a deal that combines two bubbly elements: the net and China.

What the recent deals have in common with each other, and with the rash of deals that bought the roaring 1990s crashing down, is an underlying conviction that everything is about to change.

Nobody can say specifically what this change will involve, but companies are prepared to take big punts in unproven business models, defying the lessons of recent history.

Fear of not being among the first to spot the tearaway successes of the next decade is reflected in the stratospheric prices they are prepared to pay.

Critics of the new bubble mentality are hard on the business logic behind such deals as the Skype purchase, justified by eBay's finance managers on the grounds that it cost a smaller proportion of eBay's market cap than the highly successful purchase of PayPal, and that its growth was faster than eBay's own.

The obvious difference between the late 1990s bubble and the current era is the relatively tame share prices net companies command. US investors have not regained their appetite for initial public offerings (IPOs) in companies that are bigger on hype than on concrete business plans.

The major development that has come into the market since 1999 and now is the same difference affecting everything in the world economy, from the price of oil to the outlook for the Scottish tourist industry - China.

If internet IPOs fail to get pulses racing in the west, this is more than made up for in China, where internet stocks are causing a familiar kind of excitement. The eye of the storm was the IPO of "the Chinese Google", Baidu, in August (see below), which caused the kind of market hysteria not seen since the days when some thought the Millennium Dome was a good idea.

Yahoo stoked the mood in China last month with its $1bn acquisition of Alibaba, the Chinese auction company, on the grounds that it was China's market leader; it was managed by Jack Ma, a familiar industry name; and that Yahoo trusted Japanese financiers Softbank, a major investor.

"Yes it's risky," said one internet analyst, "but doing nothing is unacceptable and they wanted to do something to get a stake in the game."

Mary Meeker of Morgan Stanley, since the 1990s the doyenne of internet analysts, says the buzz about Chinese internet business should come as no surprise. Meeker said: "China is the number two market in the world, based on the number of users. It will probably be number one in the next two to five years. So far there hasn't been a tremendous amount of global innovation in the China internet market."

The leaps of faith required to justify the astronomical prices commanded by recent deals is familiar.

Certainly much is still being discovered about market behaviour related to the internet.

Distinguishing the industry's gems from its turkeys is by no means a science, more like a lottery. Big potential prizes make it a game for the deep-pocketed. Previous burst bubble notwithstanding, history provides enough examples of deals whose rewards dwarfed the stakes paid to encourage others to dig deep once again.

Eastern promise?

THOSE who are betting that China will dominate the next phase of internet business development do so despite the country's reputation for lack of innovation and its poor management structures.

Mary Meeker of Morgan Stanley, author of a new report on the Chinese internet market, says: "We have never previously seen innovation bubbling up at universities and that is happening now. We can't tell what exactly is going to come out of that because we don't know. But you put that ecosystem together and stuff just starts to come out of it. That's what we have seen in the past."

But cheerleaders must factor in China's political realities. There were reports yesterday that Skype's VoIP service to Beijing had been blocked by state phone operator China Telecom.

Vast sums commanded by the untested

Baidu.com: Known as "the Chinese Google", the search engine Baidu made the best US stock debut in more than five years in August when it rose 354 per cent on the Nasdaq from its offering price. The price looks to many like another case of speculative excess. The company, which estimated it had net income of $1.5 million for the three months ended in June, now has a market capitalisation of about $4 billion. China bulls calmed fears by calling this "the exception rather than the rule" in Chinese internet stocks.

EBay/Skype: VoIP ("voice over internet protocol", or free net-based phone calls) may be the next big thing but eBay has paid $2.6bn for a loss-making firm that this year will bring in revenues of only $60m. EBay is gambling that its buyers and sellers will welcome the ability to make free "click to call" voice contact to confirm big purchases, even if at present, few consumers know what VoIP services are.

InterActive/Ask Jeeves: $1.9bn seemed a lot for IAC/InterActive, owners of Expedia, to fork out for the search engine, which, despite being the fourth most popular, has a market share of only about 2 per cent. Fans of the virtual butler argue that, despite the paltry market share, it is a highly profitable venture, due primarily to advertising revenues. But the potential reflected in the price premium is for "local search" - the relatively untapped market for city-specific entertainment and dining guides. Ask Jeeves could give IAC/InterActive a stronger foothold in this growing area.