In the Hutong
The Wall Street Journal‘s Loretta Chao wrote a thoughtful article about Youku’s financial prospects in advance of its first quarterly results announcement earlier this week. She quotes me liberally, but allow me to embellish.
First to Youku…
It is not unreasonable to suggest that what we are seeing in the share prices of China’s Internet stocks reflects some of the dynamics of the U.S. Internet bubble. Youku’s share price represents, I believe, investors’ implicit belief that what Victor Koo and his colleagues are building is not a web site, but an integrated video entertainment company built around the internet, in essence the 21st century equivalent of what broadcasters were eight decades ago. For that reason, some investors are willing to forgive Youku its cost structure for the same reason they forgave that of Amazon in the uber-bookstore’s post-IPO years: to create the company that could capture the opportunity, you have to be ready to endure a price/profit disconnect as the company builds its capabilities and scale.
Is such thinking correct? Judging the long-term growth prospects for online video in China is a bit like practicing economics: you have to make some debatable assumptions before you can make a call either way. Assuming the online video companies find a scale at which they can sustain profitablity, assuming they are able to continue to grow revenues faster than expenses, and assuming the government will be content to allow private companies to control a medium of growing importance, the online video companies will reward the confidence of their investors. I am hopeful, but it would be unwise to misjudge the risks implicit in those three assumptions.
But Are Prices Right?
As I told Loretta in the article:
“I think there is a reasonable premium you can apply to any company that is in the nexus of both a rapidly-growing industry and a rapidly growing market.”
What that premium is depends on whether you are an investor or a speculator, and that in turn depends on how well you understand the risks. How many investors actually understand the risks? Think of it this way: armed with the best information money can buy (or, actually, armed with the ability to buy that information), executives who run companies with operations in China underestimate or misunderstand the risks here with astonishing regularity, often with disastrous results.
Investors, lacking those information resources and who operate one or more degrees further removed from the realities of the market than executives, are even more likely to do so. Worse, as I said to Loretta,
“…too many people, particularly institutional investors, are worried about missing “the next Baidu.” All of this creates a situation where risks are acknowledged and then forgotten, and that may well be at work in the case of the Internet sector.”
Obviously, none of this is to say that there are not some worthy investments among Chinese internet companies. But if you are going to invest in a stock in China, recognize you are out of your depth and spend a few weeks doing some basic research, understanding the depth and breadth of the risks as well as the ostensible opportunity. To skip the homework and rely on the “China + Internet” formula invites disappointment, if not disaster.
- Reality Kills China’s Video Star (fool.com)