Looking before you Leapfrog

In the Hutong
Waiting for a Conference Call
0934 hrs

The New York Times and my fellow plane-geeks over at Airliners.net have been singing a dirge for Denver International Airport’s automated baggage system, built at a cost of $186 million, never fully utilized, prone to breakdowns, and incredibly costly to operate. The system is being shut down, and it’s 26 miles of conveyers and expensive robots and computing system will gather dust – if they don’t wind up getting ripped out entirely.

One cannot help but think about the current – and planned – airport expansion programs being considered around China, obviously, but also a broad range of government-funded projects – like the Olympics – and worry.

Games, Gambling, Girls, and Gasbags

In the Hutong
2000 hrs

For those of you prepared to give any credibility to the agreement between Japan and China to develop a 4G mobile phone standard, please take a step back. Apart from the historical distrust between Japanese and Chinese, and the failure of China to come up with cash for little things like, say, royalties on the VCD standard, these folks are just late to the party.

The battle over the next generation of mobile wireless has already been joined, between Intel leading the development and marketing of WiMax and QUALCOMM, with it’s purchase of Flarion, holding out the promise of extending CDMA with Flash-OFDM technology. Both technologies are near-commercial. Any expectation that Japan and China may have to slap something together and beat QUALCOMM, Intel, or both to market appears pretty wishful.

This is another one of these feel-good transnational projects that in the end will produce lots of good feelings but, in all likelihood, little of commercial significance.

On the other hand, expect the project to go forward, and fully expect the Chinese to learn much from it that will redound to their benefit moving forward.

When in Rome?

In the Hutong
After a Power Out
2345 hrs

Peter Goodman has written another one of his great features, this time about foreign (American) firms who crack under the pressure of getting China to perform for them, and engage in corrupt practices either directly or through agents.

Goodman was able to get some people to go on record, mostly about cases that are in one way or another a matter of public record. Even the dozen cases he was able to name make it bad enough. He also has people leveling accusations at H-P.

No question, the temptation to take shortcuts in this market can be huge. Pay for a trip for a government official to the U.S. Help his kid get into Yale. Or let your distributor carry a big fat brown paper bag full of cash to a senior government official or a procurement officer. Or even let your P.R. company lay a couple of thousand RMB on a reporter for a sweet story.

But hey, guys. It’s wrong. It’s illegal, immoral, and in the long run damages everyone it touches, even remotely. And here’s the kicker: if you as a corporation can muster the courage to say no, you’ll find you may lose a couple of deals in the near term, but in the long run you’ll do better.

And, oh, by the way. There’s a reckoning coming. That’s right. Sure as a monsoon there is a big bloody s***storm coming that’s going to engulf a lot of companies doing business in this town.

The most politically profitable thing a government official in China can do to fight corruption is to uproot a corrupt bureaucrat or employee of a state-owned enterprise and get them to testify that a big foreign firm made them do it. And then to go after the big foreign firm, make a big public deal, investigate with the SEC and the DoJ in the spirit of international cooperation, slap them with a huge fine or worse, and then shift blame for corruption onto the backs of major multinationals.

So get ready. My advice – start cleaning house now. On your own. Don’t wait for Public Security and the SEC to knock on the door.

Google and Baidu: It’s Not About the Cash

The Silicon Hutong Garage
Door Open
Enjoying the (Somewhat) Cooler Weather
14:25 hrs

Google’s plans to raise $4 billion a year after their stunning IPO debut clearly suggests something afoot at 1600 Amphitheatre Parkway. Speculation naturally lurches toward China, which Kevin Delaney at The Wall Street Journal and Paul Bond at The Hollywood Reporter both picked up, thought about, and then quite correctly put back down.

I agree with Kevin and Paul’s decline to get warped into the China buzz (sorry, Steve). I’m sure China and “what to do about Baidu” is on their minds, but Eric, Sergey, and Larry have a lot more to worry about. China is important to keeping Google growing in the long run, but the Good Ol’ USA is where the real revenue growth potential lies for the next 12 years. Spending to stay competitive at home is job one.

Sure, Google will have to do something strategic about China, and they may not even wait until this whole dispute over Kaifu Lee is straightened out. The longer they can wait the better, though. Baidu’s share price is off 47% from it’s high of 153.98 last week, and 10-day stock chart is starting to look like the path of a 747 on final approach – slowly, steadily downward. Even if they COULD buy Baidu outright, AND were going to pay cash, they wouldn’t wind up spending anywhere near $4 billion to do so.

Google’s chief barrier to buying Baidu isn’t money – it’s the Chinese government, and let’s not forget that. On their best days China’s policy-makers aren’t too terribly comfortable about foreigners owning large chunks of China’s Internet. (Yahoo! found that out when they bought 3721, and I’m convinced that keeping regulators comfortable with the deal was part of the reason Terry Semel only took 40% of Alibaba. Conversation between Jack Ma and his regulators: “C’mon guys, don’t worry. They only own 40% of Alibaba. And we know what that means in China, right? Harharharharhar!”)

Baidu is a home-grown treasure, and the more conservative among China’s leaders going to put some very strict limits on Google’s ownership, either by action or by implied threat of action. What is more, there is a very conservative wind blowing through Zhongnanhai these days. The chill it has placed on the media business is having some severe effects on film and television, and the buzz in the Hutong is that Internet is next. Such an environment would make it even more difficult than normal for a foreign Internet firm like Google to buy enough shares to control a local company like Baidu.

Prediction: If Google doesn’t get Kaifu, and right soon, Google may even pull an Alibaba with Baidu, handing them Google’s local operations in China and a chunk of cash in return for a chunk of equity.

Jack Ma is Running Down Jianwai Shouting “YAHOO!” at the Top of his Lungs

In the Hutong
Ignoring the Humidity

Well, no, he’s not really, but he should be.

I mean, think about it. Yahoo has essentially paid Jack Ma $1 billion to take their China operations off their hands, all in return for a measly 35% of Alibaba’s stock.

Now, I don’t mean to imply that Alibaba’s stock is worthless, and I think Jack’s done a fine job building a nice, little business. But it’s not a US$4 billion operation by any intelligent measure (in the Ben Graham/Warren Buffett sense), even if you count intangibles and the potential value of eBay gadfly TaoBao.com (which may actually be worth something one day, if they can ever get away charging for it.)

There are only three possible conclusions here:

1. Terry and the Boyz have lost it completely and have been sold a real bill of goods;

2. Somebody tipped Yahoo! that they were about to have some serious regulatory challenges resulting from some internal political storms in Beijing; or,

3. Jack Ma has some kind of magic cure for Yahoo!’s ills that we don’t know about and that cannot be disclosed to the public.

The first is not entirely unlikely – big foreign businesses get taken to the cleaners in this country with depressing regularity, often aided in that process by “advisors” promising aid through a mystical and opaque process.

The second is, unfortunately, quite possible. The hailstorm of regulations coming down around the media sector suggests that there are some ill winds blowing across the ponds and through the courtyards of Zhonggnanhai. Somebody is trying to prove their political orthodoxy, and that’s a little worrisome.

The third is the most intriguing. I mean, granted, this is speculative and VERY paranoid, but think about it. Why, after all, has Alibaba steadfastly refused to go public, even during the go-go years of the Internet boom? What is Jack Ma hiding under his shirt – or under his corporate structure – or under his ownership structure – that he doesn’t want anyone to see? And why is it worth $1 billion cash to Yahoo!?

Hmm.

It’s almost enough to drive a guy to wearing an aluminum-foil yarmulke.

Think, Lenovo

Fasting in the Hutong
1049 hrs

Mure Dickie is reporting in the Financial Times that Lenovo is on the verge of announcing a global brand strategy that will keep the “Think” brand (Thinkpad, ThinkCentre) for high-end products, and will keep the Lenovo name for “mainstream” offerings. Good so far.

What is interesting (and I use that word as a euphemism) is that Lenovo is apparently choosing to expunge the IBM brand from its products (as it is entitled to do for five years), forgoing the opportunity to leverage the IBM brand and going direct to tagging their products “ThinkPad by Lenovo” and “ThinkCentre by Lenovo.”

Who the hell at Lenovo is responsible for THAT call?

As regulars here will recall, the primary reason I was a supporter of Lenovo’s IBM purchase (from Lenovo’s standpoint – it was a no-brainer for IBM) was that Lenovo was going to have an opportunity to leverage the IBM brand for five years while it built credibility with customers. Anyone with just a little business sense knows that’s worth something.

In fact, it’s worth a lot. According to the August 1 edition of BusinessWeek and InterBrand, the value of the IBM brand – the third most valuable brand in the world behind Coca-Cola and Microsoft – is US$53,376,000,000.00. My point back in December was that Lenovo wasn’t buying a money-losing business for its $1.7 billion in hard currency, it was renting a highly usable $53 billion brand asset for a mere $350 million a year.

But Lenovo, under the expert guidance of Chairman Mr. Yang Yuancheng, apparently feels that not only do customers not need a transition, but Lenovo is unable to utilize a $53 billion asset to their benefit, an asset that they paid cash for and an asset that, arguably, was about the only useful thing they took from the deal.

Is the use of the brand “Think” worth that kind of money? I’m sure it’s worth something, but I’m not sure it’s worth $1.7 billion. And due to some stupid decision making at Lenovo, that’s all the company is getting for its cash.

If I were a Lenovo shareholder, I’d be screaming. Five years usage of a $53 billion asset tossed into the garbage? In the U.S., that would be grounds for an uprising at the next general meeting, and grounds to question the competence of management, and any auditing firm with a conscience would require a write-off of those assets as a one-time charge against earnings.

The burning question is “why?” I’d suggest one or more of the following reasons:

1. Lenovo leadership just doesn’t understand the esteem the IBM brand retains worldwide. Entirely possible since I’m not sure the Chinese side of the Lenovo house much understands the market outside of China.

2. Lenovo has no clue how to use the IBM brand. Also possible because they didn’t know how to use the “Legend” brand, and they did a poor job building the Lenovo brand in countries where they lacked explicit government support and fawning-lapdog media endorsement.

3. Lenovo is ignoring it’s advertising and PR agencies on a) the value of the brand, and b) how to use it. Having worked with Lenovo in an agency relationship and walked away when they weren’t listening to either us or our competitors, I’d say this is a pretty real possibility. Salesmen and Engineers rank highly at Lenovo. Marketers do not.

4. Lenovo’s advertising and PR agencies are incompetent and not pointing this out to Lenovo, or are terrified to do so because they think they’ll get sacked for talking back. Also possible, because who knows where Lenovo is actually getting assistance these days.

5. Somebody really high in the Lenovo organization genuinely believes that the Lenovo brand means more to businesses and consumers outside of the PRC than what it really does, which is “Made in China by a Chinese Company – Beware.”

Take your pick. I have my prejudices.

I genuinely hope Lenovo’s management reconsiders. If they don’t, I hope they’re prepared for the consequences, which they quite clearly appear to have underestimated. If nothing else, they will have screwed themselves out of the biggest asset they got from IBM.

A Big Picture in Need of Magnification

In the Hutong
Under Clearing Skies
22:58 hrs.

I just finished Edward Jay Epstein’s new book, The Big Picture: The New Logic of Money and Power in Hollywood. I figured it would be a timely read, immersed as I am scribbling a tome about television in China. And I liked the book, frankly, because I thought it was a good 10,000 foot overview of the industry as it stands today. For that reason, it’s a good primer and so for those needing a primer on Hollywood (i.e., if you’ve never been in, on the periphery of, or spent a lot of time studying the industry), it’s worth the read.

But in critiquing my own writing, part of me was reading the book a little more critically that I would normally, especially for something that for me was a recreational read. In the desperate hope of avoiding such issues myself, there are some things bothering me about The Big Picture.

Epstein never seems to want to get too close to his subject matter. Even though his list of sources cites several interviews conducted over a period of 16 years, the book feels exceedingly detached from Hollywood. In fact, the book had the feel like it was written from his Manhattan apartment surrounded by a stack of books, magazine clips, and videotapes.

The tone of the book leaves a lot to be desired as well. Epstein correctly approaches his topic as an outsider (all the better to explain to outsiders.) The problem is that he approaches it as an outsider having a difficult time managing his latent hostility, as one of those literary New Yorkers who have always been a tad perplexed (and secretly jealous) that the movie industry has managed to wrest dollars and eyeballs away from the printed word. His derision, I will grant, is subtle, but it is no less acidic – and slightly distracting – for it.

I don’t begrudge a writer his biases. Lord knows old Hunter S. Thompson had them, and he stands high in my pantheon. But at least people like Thompson come right out and say “hey, this is who I am, this is where I’m coming from, and it’s going to bias my writing, but it would be both stifling and intellectually dishonest to do anything different.”

Epstein doesn’t, and the problem is his work suffers for it. He clearly spent as little time on the left coast as possible, and as little time delving into the the guts of the business. He never rises above the level of critic, and for that reason his book – which at around 350 pages could have afforded to be a lot longer – suffers.

First, when he uses examples to illustrate different points, he uses the SAME examples over and over again. He refers to the terms of Arnold Schwarznegger’s $29.92 million above-the-line fee for Terminator 3: Rise of the Machines no less than 14 times.
Hello? Is this the kind of deal typical or extraordinary? Are there other examples of 8-figure stars apart from the now-moved-on-to-greener-pastures Governator?

Second, he makes stupid errors that belie his lack of familiarity with the system. In referring to Tim Robbins’ character in the movie The Player, Epstein calls him a “studio chief” and marvels how he is unable to greenlight anything. Anyone who spent more than a couple of weeks around a Hollywood studio knows the difference between a development executive and a studio chief. It’s nitpicking, I know, but it’s indicative. And mistakes like this throughout the book cost him credibility.

Third he fails completely to talk about how Hollywood is dealing with the threat of digital content. To read the book you would think that a) Hollywood invented the idea of digital movie delivery, and b) is leading the charge to adopt it. MGM v. Grokster, anyone? Hello?

Fourth, he talks extensively about US distribution system and the Popcorn and DVD economies, but he has no clue about the challenges and opportunities Hollywood faces offshore. The fact that China merits a single mention is just dumb.

Fifth, he never talks about the implicit opportunities Hollywood faces in not only new distribution models, but new production models as well. There’s no discussion of green-screen technology and what it could do for location costs or the cost of talent. No thinking about the Bollywood or Hong Kong production models. No consideration given to people like Richard Rodriguez who, amazingly, have discovered a mystical formula to deliver films ahead of schedule, under budget, and for moderate fees that actually make money. No. It’s much sexier to talk about how Hollywood lavishes ridiculous production budgets on overpriced films that are created by a bunch of artless marketers and overpaid dummies posing as talent.

There are numerous other smaller faults as well, but suffice to say that if Mr. Epstein labored mightily he brought forth a mouse. He indeed gives us The Big Picture of Hollywood, but there are holes in that portrayal that leave a sightly knowledgeable reader asking for more.

Just Baidu It – A Deep Dive on Why China’s Search Darling is Way, Way Overvalued

In the Hutong
1228 hrs.

Baidu’s successful public offering and the punter feeding frenzy that followed has produced a lot of shaking heads among analysts. It’s nice to hear that people outside of China are starting to recognize that this is all a bit much, and I’m personally grateful to Joe MacDonald at AP and Rosalind and Eunice at CNN for giving me a chance to air my views about it all.

Still, I think there’s a lot more to this than people are reporting.

Baidu Ballistics

Clearly, there are three things driving the run-up to preposterous p/e multiples last Friday. First, (and let’s get this out of the way), there was the frenzy that happened among retail investors when a) the words “the Google of China” were carefully whispered into the ether by the professionals charged with positioning the offer, and b) the upward momentum of the issue caught the interest of bored day-traders. We all know where that is going, and most of us are expecting a gradual (or not-so gradual) waning of the passion. So all of the Google/China hype in the price will drain away – in fact, the draining has already begun.

The second thing driving the stock was that Baidu has decent fundamentals – it’s making a profit, it’s weaned itself off of revenue from portals, and it has a management team in place that looks like it will use the proceeds of the offer to improve its search engine technology and market the service.

Third – and this is the big one – is the speculation that at some point somebody with really deep pockets is going to have to buy Baidu, and do so at a high premium over a rational price. The most obvious candidate for that would be Google, who already has a 2.6% stake.

But Baidu is not without challenges.

The Global Competition

Google, long stymied in the market in part because Larry and Sergey had ignored China while building the business at home (a smart move, mind you), is making real progress. They just signed up their first local AdSense client, and pending victory in court against Balmer’s Barristers, they should be soon installing Lee Kaifu as über-Googlian for China. They still have challenges, but their momentum is building. And don’t let the 2.6% holding in Baidu fool you – they’re after building the best position they can.

Yahoo! has been building momentum slowly since acquiring 3721 18 months ago, but that’s about to change. Their purchase of Alibaba, while a head-scratcher, indicates that Terry Semel is once again paying attention to China, and the coming departure of 3721 founder Zhou Hongyi will actually help streamline a preposterously complex management and reporting structure, allowing Yahoo! to be a more nimble player.

MSN has not been much of a challenger to date, and Lee Kaifu’s departure would certainly slow MSN’s Chinese search engine development. MSN is ambitious, however, and will likely start looking for acquisitions.

Competition: The Homeboys

Baidu’s latent challengers are the old men of China’s Internet, Sina.com, Sohu, and Netease, China’s most popular portals, all of whom are developing or upgrading their own search products, Sina’s new iAsk search product (which frankly looks like a Google clone) is of such concern it was mentioned specifically in Baidu’s prospectus.

The strength of these three competitors lies is their experience, their relationship with advertisers, user loyalty, and the high degree of content and functionality they bring to the search product. These will be formidable challengers, and it is widely acknowledged that all are gunning for Baidu.

Whether the competition is the Giants from the Left Coast or the crosstown rivals, the sheer number of competitors and the early stage of the development of the Internet in China (penetration is a mere 7.5% and buying power is still modest) means that search in China is still anyone’s game, and that the likely shakeout is still years in the future. Baidu’s position, however strong today, will be held only against the assaults of at least five other very determined (and in at least three cases, better funded) rivals.

But competition is not the sole challenge Baidu faces.

The Mobile Question

WIth three times as many users as PCs, mobile telecoms has always been the sleeping giant of the Internet in China. Now the mobile Internet is about to explode in China, for three reasons.

First, mobile handset manufacturers are adding more display and data management capabilities to low-end and mid-range phones, and high-end phones are becoming increasingly popular.

Second, China Mobile and China Unicom have both announced their 3G test network plans, plans that are tests in name only. Both call for rollouts that are so wide in geographic scope that it would be more accurate to call them phase-one service launches, including most of China’s “tier-one” cities.

Third, there is now a critical mass of companies offering mobile services that promise carriers sufficient revenues to actually launch 3G.

So with more people walking around with data-ready phones and a network capable of carrying that data, mobile is clearly going to be a large market – probably larger than it is in countries with deeper PC penetration than China’s paltry 3.5%.

And yet, Baidu has very little to show for the mobile net. Nine months ago they introduced a basic search product, but it is short on features and, most important, Baidu hasn’t figured out how to make money from online search. This is a strategic oversight on Baidu’s part, one that is likely to be extremely costly in the long run.

The Acquisition Question

So competition and market changes are not the only fundamental challenges Baidu – and now its shareholders – face. The assumption that Baidu is an acquisition target may be accurate in general, but the event may not be as close as some think.

While a local player might have purchased Baidu in the past, after the IPO the company’s price far exceeds the means of any Chinese Internet firm. This leaves four possibilities.

Yahoo! considered Baidu two years ago, and instead chose to purchase 3721. Having placed their bet on Baidu’s rival (for what now appears to be a comparative bargain price of US$120 million), Yahoo! is unlikely to want a company valued even before the post-IPO run up at nearly $900 million.

Most analysts assume Google is the leading candidate to acquire Baidu, given that it already holds 2.6% of the company. But if Google moves, it won’t move soon. At $3 billion-plus, the price is probably too rich for even Google, and for both strategic and human resource management reasons, Google needs to settle the Lee Kaifu question before it can afford to make a play for Baidu. Further, with its building momentum in China, Google will probably try to do everything it can to prove it doesn’t need Baidu in order to improve its negotiating position.

MSN might move quickly, and it certainly has the stack of greenbacks to snap up Baidu even at its current hype-inflated price. But there are other concerns. Microsoft has made significant strides in improving its standing with China’s regulators under the experienced hand of MS China CEO Tim Cheng and the adult supervision he brought to the enterprise. Nonetheless, Microsoft still makes a lot of people in China nervous, and Redmond paying a huge price for Baidu would make those people even more concerned, perhaps even causing policymakers to wonder whether they were allowing a national treasure slide into the hands of foreigners.

(Kind of like the way Congress apparently felt about CNOOC buying Unocal. And in China, you can bet that Sina, Sohu, Netease, and Yahoo! – via 3721 – would take a few pages from Chevron’s book by sowing FUD among government watchdogs. But I digress.)

Warning Label

So as interesting as this company might be, a bit of due diligence rails against its pricing – not just the pricing at the close of trading on offering day, but the original IPO price itself:

1. A half dozen strong competitors, all well funded.
2. A market in its early stages of development
3. A lack of a compelling, profitable mobile solution in a market where, in the long term, the mobile phone is likely to become the leading Internet access device.
4. The company is clearly an acquisition target, but not anytime soon.
5. An IPO price that valued the company at nearly 500 times trailing earnings, and a first day closing price of four times that.

Baidu is a company to watch. I’m just not putting any money into it right now.