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Headline: Asia's bubble -wrapped hi-tech future
Source: Euromoney
Date: July 2000
Author: Matthew Montagu-Pollock
Can Singapore learn to take more risks?
The crash in Asia's tech stocks in April had its benefits. For a start, it could signal a return to realistic valuations and analysis of fundamentals. It certainly doesn't mean the boom is over. Matthew Montagu-Pollock, in an article that first appeared in Asiamoney, asks why Asia reacted so strongly to Nasdaq's fall and where the market is likely to head next.
The CLSA conference is perhaps the region's largest and most glittering annual fund managers' conference. It is designed to impress, to entertain, and occasionally to educate. Tellingly, the dominant theme at this year's conference at Hong Kong's Grand Hyatt was you've guessed the internet.
CLSA's stage was flanked by two enormous screens. Each showed huge bubbles slowly, majestically, floating upward until they reached the sky. It was a subtly ironic commentary, an indirect dig at the inflated valuations of many of the region's internet and technology stocks.
There was certainly worry in the room. The scrum of fund managers barging their way to ensure a seat at presentations was matched only in intensity by the dozens more crammed in the corridor outside, straining to hear. These were not academically interested, dispassionately curious investors. They were people caught in the classic dilemma between greed and fear, its intensity magnified by the internet's promise.
For these managers, Nasdaq's crash had ruined the party even before it began. Suddenly, in mid-April, billions were wiped off Asian tech and internet stocks, as the region followed Nasdaq's sell-off. Says John Colman of Hong Kong-based Geometrix. "Everybody is coming up with technology IPOs and you are saying, 'yes, yes, yes' and then the bubble bursts and you are stuck with something which has fallen 50%. To be honest that is what actually happened to me."
The debris is scattered across the region. Kosdaq has slumped 52% on the year, after trading volumes peaked in February this year, streaming past the main board. Daily turnover in 1999 surged from an average of W5.5 billion ($4.8 million) to a recent record of W2.2 trillion a 400% increase, mostly driven by retail investors.
An estimated 150 unregistered share offerings raised W150 billion last year, according to Jung Yong Sun, head of the disclosure review office at the government's Financial Supervisory Service. Many investors had thrown caution to the wind. When Jeong Seung Mo, who runs Zettasoft, a small and unknown electronic commerce software developer, offered his company's shares online, he received W7.7 billion within the first five minutes from complete strangers.
Fluffy aura
In Japan, the internet-related sector rose from 9% of the market at the end of 1998, to 24% of the market at the end of February.
Hong Kong's total stock market value doubled last year, but only 15 shares accounted for 90% of that increase, and of the 15, only three didn't have a technology or telecom angle. Li Ka-shing's Tom.com was only the third Hong Kong dot com listing, but it drew 300,000 investors, no less than 5% of the entire population of Hong Kong. Says Colman: "Everybody wanted a piece of Tom.com when it was listed. You knew you were going to make four to five times."
The Asian dot com boom always had a fluffy aura. Two investment banks have dominated Hong Kong's dot com IPOs: Lehman Brothers and BNP Prime Peregrine (now BNP Paribas Peregrine).
Neither are regularly applauded for independent research. Moreover, BNP's managing director Francis Leung had almost single-handedly engineered the 1996-97 red-chip boom.
After Peregrine's bankruptcy, Leung spent two years in relative obscurity. Then he got going again. In December he arranged the Growth Enterprise Market (GEM) listing of Timeless Software. In January, he helped Hikari Tsushin in its acquisition of shares in Golden Power International Holdings, giving it a listed Hong Kong vehicle.
Then came the Li family's deals: February's $1 billion equity placement for Pacific Century CyberWorks (PCCW), and the launch of Tom.com. The master of bubbles had pulled it off again.
Not surprisingly, there was almost no negative comment on internet stock valuations from analysts: the primary side was in the driving seat, not the secondary market. "People here [in the research department] do scratch their heads over the valuations," says an analyst at a leading investment bank. "But obviously you're not going to be negative on the sector, when you are trying to take companies public."
Vested interests were all-pervasive. For instance, PCCW's February purchase of Hong Kong Telecom involved more than half of the major investment banks active in the region. Goldman Sachs worked for Singapore Telecom; HSBC, UBS Warburg and Bank of China for PCCW; Merrill Lynch for Cable & Wireless; Morgan Stanley for Telstra; ING Barings for the minority shareholders of HK Telecom; and BNP and Barclays Bank led the debt syndicate, alongside HSBC and Bank of China.
Young internet entrepreneurs bowed to enormous pressure from their sponsors and investors to appear in the media more. Many became overnight celebrities. Net entrepreneur Patrick Grover, CEO of Catcha.com, received an e-mail from a female fan asking for a sperm donation. "I want my child to be just like you," she said.
His colleague Nic Lim, Catcha.com's 24-year old CEO, was named one of the 'Nine Men to Watch' by the Malaysian edition of Marie Claire. Non-net companies began to lose staff to net start-ups, attracted by the option culture. According to Russell Yeomans, regional director of search firm Morgan & Banks, recruiting work for internet-related companies had increased exponentially in the second half of 1999.
Feverish rate
Why did the Nasdaq sell-off occur? On March 25, US publication Barron's revealed that 52 of the 205 listed US net companies it had studied would run out of cash within a 12-month timeframe, including Amazon.com, Ask Jeeves and Medscape. Two days later, the crash began.
What may have particularly disturbed investors was the revelation that there was little confidence in internet valuations among internet insiders. Already listed firms had been raising fresh capital at a feverish rate.
Barron's revealed that, rather than raising equity to finance their firms, more than 40% of these second-round capital-raisings involved insiders selling their shares, meaning that much of the fresh capital was not going on the companies' books but into the entrepreneurs' pockets.
In two-thirds of the secondary stock offerings in the year's first quarter, 25% or more of the stock was sold by insiders a far higher proportion than was typical among established companies. Entrepreneurs were rushing for the exits. If insiders had no confidence, what should the US investing public do?
By the following Monday, Nasdaq had fallen 627 points, or 13%. Between April 7 and April 14 the market went into free-fall and dropped to 3,205, or 31% down on its peak. Asia followed. On April 17, an estimated $200 billion was wiped off the value of Asian stocks, as index after index round the region followed Nasdaq's fall to earth.
"The internet generally is no different from previous technology bubbles," says ex-investment banker David Webb, who runs the Hong Kong-based Webb-site.com. "Whenever you have had a major technology change and let me be clear that the internet is a major technology change like the motorcar, aircraft or the telephone or the railroad, everyone wants to buy into the action." Webb cites Warren Buffet's observations about how poorly investments in the aircraft industry have rewarded investors. Between Orville Wright's first machine-powered flight in 1903 and the year 1992, the net profits of the US aviation industry were precisely zero. Buffet also points out that once there were no less than 520 car manufacturers in the US.
"No one knows which businesses will succeed, so they throw large amounts of money at it," says Webb. "Then there is a bust. But the technology goes on developing regardless, while most companies go under." The moral? Early investors in such fiercely competitive fields are likely to be net losers, even though the public undoubtedly gains enormously from these technological advances. "If you buy all the tickets in a lottery, you'll end up losing," says Webb. "Similarly if you buy all the internet stocks, you will end up with a loss." That's because, as in a lottery, early-stage technology boom investments return less than 100% of the invested sum to investors. "There was an unintentionally funny piece by [Jardine Fleming] the other day saying that since they didn't know which GEM stocks were likely to succeed, you should simply buy every one," says Webb.
But this cold philosophy does not appeal to many investors. "For the first time now, you can actually get value," says Catherine Tan, who manages the Asian Internet Fund at Lloyd George Management. "When something seems cheap, we pick it up." Says Kevin Chan, head of technical investments, Asia, at Advent International, a venture capital firm managing $3.5 billion globally: "We have just decided at the very top level that we are going to get into the internet and technology game in Asia. With this market correction, there are going to be a lot more opportunities for us to get in, and to fund these companies."
Advertising model failed
So which companies should an investor buy? One clear trend: the advertising model has failed even in the US, except in the case of Yahoo.
In Asia, advertising-led models face an even tougher struggle, because total advertising spends are lower, proportionate internet ad spends lower still, and the Asian market is fractured into different language-groups. Warns Jeffrey Markley, business director at Ogilvy Interactive in Hong Kong: "As far as Asia is concerned, sites should not be developing e-business models with advertising as their main revenue source."
Sohaib Umar | Second trend: first movers and leaders have an overwhelming advantage. Says Sohaib Umar, CLSA's regional internet analyst: "Seventy-five percent of US traffic now goes through only five websites. The thousands of others must be content with 25% of the traffic. Their share of the pie will shrink. The acquisition of Lycos by Spanish ISP Terra Networks, a huge acquisition [$12.5 billion], indicates that even among the bigger boys, the need to grow even bigger is rising."
The biggest companies' lead is enlarging stock valuation disparities. "Amazon has shown record losses for the first quarter, but its share price went up by 14% within three days," notes Umar. "E-Bay returned 100% higher profits than the market consensus, and its stock also went up by 4%." It seems the market is willing to be patient with who it sees as the leaders, who are going to turn profitable sometime in the future.
"Up to now there has been a perception that the internet is egalitarian, and you can work from your basement, and later have an IPO. Eventually you will have to sell your stake, because you will not be able to resist the competitive onslaught," says Umar. "The end result will be there will be more concentration in the economy in general, because of the internet."
Unprecedented M&A activity will follow, Umar believes with few winners, but many losers. "About 90% of the companies in the dot com world today are not going to exist in their present form in future," he says. "They will either be acquired or go bust."
Agrees Douglas Kim of ING Barings, Korea: "I think what is happening [in Korea] is that the market leaders are receiving a lot of the valuation versus the third and fourth-tier players. Daum Communications is trading in terms of valuations at a much higher valuation than a company like Digital Josun, which is not in the top five. In many cases, this is a winner-takes-all ball game."
Third trend: traditional bricks and mortar companies have woken up to the need to go online. This is rapidly reducing valuation differentials between traditional players and e-businesses.
For instance the major stockbrokers in the US are now all online. E*Trade's stock, listed on January 4, 1999, initially hugely outperformed Charles Schwab but it has now surrendered all its early outperformance.
This is echoed across the board: E-Toys' share price, which soared after its May 19, 1999 listing, is now running parallel to Toys R Us.
Clarion call
This phenomenon is likely to be more pronounced in Asia, where the lessons of the US experience were learned at an earlier stage of the cycle. For instance in Japan, last October's liberalization of stockbroking commissions was immediately followed by the leading bricks and mortar brokers, Nomura Securities and Daiwa Securities, adding many more on-line accounts than their pure internet competitors.
With the stock market booming, these brokers have since raked in more commission revenue during the first few months of liberalization than during any quarter in years.
"I think in the next three to four years you will see a series of corrections [in internet stocks]," says Umar. "By 2004, the valuation anomalies between old economy and new economies will disappear in the US." He believes the Nasdaq correction is a signal, marking the beginning of the end of cannibalization of the eating away of old economy's profits by the new.
Certainly in Asia many investors are treating Nasdaq's plunge as a clarion call to return to conservative business models, and to an emphasis on profits. "The companies we are overweighting are companies with solid visible earnings growth, and very good order books," says Martin Lau, a fund manager for Invesco Asset Management in Hong Kong, which runs a $42 million technology fund. "They are the beneficiaries when people start to build internet infrastructure, or people start to use handsets." Lau likes hardware stocks like Samsung Electronics, ASM Pacific in Hong Kong, Hansul Electronics, KSMC or UMC in Taiwan.
Says Guy de Tonquedek, fund manager at Indocam: "The house view is that in a gold-rush, you sell the shovels. We try to concentrate on the more robust component and hardware manufacturers."
Agrees Tan at Lloyd George: "What we are looking for is people who have got a business strategy, who know how to fund themselves, and have a nice niche. I would say the core of our strategy is nimble incumbents. I like some of the internet enablers. If you look in Asia, you find more companies with positive cash flow, which you cannot find in the US technology sector."
Her colleague Samir Mehta says Lloyd George normally looks for high return on equity, free cash flows, and growth at a reasonable price.
"Some of our biggest holdings were Indian software companies, which have real earnings and earnings growth and strong management," she says. "Clearly the valuations did go out of whack. But if you were to ask me, is it better to hold an Infosys or a PCCW, I would say Infosys, because five years from now I know that there will be something meaningful waiting for Infosys."
Mehta is less certain what the future holds for PCCW. "The other companies that we are focused on are the chip assembly companies, like Unisem in Malaysia, and ASM in Hong Kong, who make equipment for chip testing and packaging," she says.
Richard Tsiang of Allard & Partners argues that Asia's special contribution to the internet will be business to business companies."The B2B model probably has more relevance in Asia, because we have such a strong manufacturing base, and we are closer to the logistics side," he says. "In Asia, you typically find very solid logistics, manufacturing, and that is where we are going to excel."
But whatever model they follow, venture capitalists will continue to fund internet companies. And internet IPOs are still being done. For instance, when the Korean auction company, Internet Auction Co, was listed in May on Kosdaq, its listing price of W39,500 was nearly 100% up on the target W20,000 IPO price.
The reason? The Internet Auction Co is by far the largest online person to person auction site in Korea, with one million registered members, and a W400 million daily transaction volume. It has an 87% brand recognition among Korean 'netizens', compared with Yahoo's 70% recognition.
But more important, it expects to break into profit this year. "This kind of auction forum does not develop offline in Korea," says Internet Auction's executive director, Victor Lee. It makes a compelling investment story: overwhelming market dominance, superior technology, low operating costs, few staff, almost non-existent incremental marginal costs with growth and a target break-even date.
Says Greg Feldberg, regional internet analyst for WI Carr: "If you meet a company with a good case for transaction-oriented revenues, then I don't think that story has been killed by the Nasdaq drop. I still see people adopting it in the private equity business. But you have to focus on where companies are actually making money, not where they are also-rans in very crowded sectors."
That means avoiding the speculative froth. Warns Fung Kwok On, a technology fund manager at Indocam: "Sentiment is very uncertain. Nasdaq has not confirmed its bottom yet, which could continue to affect the Kosdaq."
More listings for Kosdaq
Kosdaq is likely to see more IPOs in the near future, mopping up a significant amount of liquidity. "Kosdaq companies' earnings growth forecasts are not reliable, and overall they are still quite expensive in terms of earnings multiple," says Fung. "It is still mainly a story-driven market, they have a lot of concept stocks. That scares me."
So has the Nasdaq crash killed the internet boom? "Asia is two or three years behind the US, so intuitively, it would seem that the whole trend for internet-enabled business models can't be over yet, because it has barely started," says Stephen McKeever, an internet analyst at Lehman Brothers.
McKeever predicts people are going to be more careful to differentiate between real technology and businesses, and pure concept plays. "Hopefully [Nasdaq's correction] will be the end of the reverse takeover construction companies. That will make my life easier," he says.
"It will mean that, as an analyst, I won't have to waste time chasing around trying to find out what these people do and then find out that they don't do anything."
Can Singapore learn to take more risks?
One year on from the launch of Singapore's technopreneurship initiative, billions of dollars of venture capital have been brought in and restrictive legislation removed. But the bigger challenge is a change in the national mindset away from stability and towards risky entrepreneurship. Deputy prime minister Tony Tan talks to Chris Wright.
Last year, Tony Tan was mingling at Singapore's MIT club when he struck up a conversation with several successful young executives from both the government and private sector. They told the deputy prime minister about their ideas to launch their own technology ventures. All of them sounded good; so why weren't they getting off the ground?
"They had ideas to launch enterprises, and they were quite willing to take risks: to forego the perks of their jobs and the security of their incomes," says Tan. "What held them back, they said, was not the risk they had to undertake, but that they could not explain to their spouses or their parents why they were giving up their safe, secure jobs with good income and prospects, to go and launch a start-up in a poky little hole somewhere. If they did, they would be regarded as irresponsible, or simply as having gone mad."
Unfair image
The image of the cream of Singapore's future business leaders constrained by fear of what their mother would say is comical, but a tad unfair. It nevertheless touches on a key challenge in Singapore's bid to become a haven for technology investment and development. Nobody doubts the country's infrastructure, or the technical nous of its people. But, to foreign eyes at least, Singaporeans do not thrive on the upheaval and challenge to normality that the new economy covets. In short, they crave stability.
Partly to challenge that mindset, a year ago the government launched the Technopreneurship 21 initiative, a wide-ranging plan covering education, infrastructure, regulatory change and a $1 billion venture capital fund, among the most ambitious in the region to date. Tan heads the ministerial committee in charge of the initiative. Asiamoney met him in a spartan office within Singapore's Ministry of Defence building. (In a rather disconcerting display of what the government sees as synergy, Tan is simultaneously deputy prime minister, defence minister and head of the technopreneurship initiative. His comment on this curious alignment: "Singapore is small, and located in a very uncertain part of the world . . . let me put it this way, without strong armed forces there is no Singapore, never mind technopreneurship.")
One year in to T21, Tan believes major changes are afoot in Singapore and not just because of the increasing availability of venture capital. "Singaporeans are now more ready to strike out on their own, to launch new enterprises and take a risk." He says the initiative has been sufficiently successful to have caused problems to the government itself, which has started losing its own staff to start-ups and has had to review its remuneration schemes in order to keep people. "I have never doubted that Singaporeans had entrepreneurial skills otherwise we would not be where we are today," he says. "But what I felt when we launched [T21] was that we were not releasing these entrepreneurial skills, because there were a number of things that were constraining Singaporeans from doing so."
Several of these restrictions were regulatory, and by July, a string of changes had been brought in. Bankruptcy laws, which previously had more or less guaranteed that no one who had been declared bankrupt could ever launch a business again, were relaxed. Restrictive regulations on working from home were removed. And stock listing requirements were eased, with a preliminary stock option scheme put into place.
Another barrier was financial. So a $1 billion Technopreneurship Investment Fund was set up in September to draw more venture capital in to Singapore. "At the present rate the whole amount should be committed within a few months," says Tan. He claims that, so far, every one dollar spent by the government has brought in about two dollars from elsewhere 3i, Sequoia Capital and Doll Capital are among the 24 funds to have committed capital. If that rate of commitment continues, the total pool of venture capital funds available will reach $13 billion (it stood at $10 billion by the end of 1999).
"We should set a target of about $20 billion within four or five years," says Tan. Does that mean another fund will be launched when this one is fully committed? Tan is awaiting a July review from NSTB before deciding on this question. But pushed on what a new fund would cover, he says: "If we launch a new fund we could target life sciences as one of the areas that should be invested in."
And then there is the social issue the MIT go-getters inhibited from striking out in new ventures by national attitudes towards failure and risk. Here, too, Tan argues he has seen a difference, prompting a grand statement: "By the government having gone into this field, the most important achievement of the technopreneurship initiative is that we have made entrepreneurship socially acceptable."
If that's true, and risk has become the new driver of Singaporean business, this could have a destabilizing effect on Singapore. "Not economically destabilizing," corrects Tan. "I think we really have no choice. If you look at how the world moves today, changes are coming more rapidly, we have to respond more quickly and effectively to what goes on in the rest of the world, and competition is keener. I would accept that as being part of what Singapore has to do if we want to grow rapidly." And it carries a cost. "What concerns me a great deal is how this will impact on the worker in Singapore, particularly those with limited education in their 40s or 50s. Entrepreneurship and the new economy are very exciting for young people and professionals, but for men and women used to a factory job for the last 20 years, there is a sense of trepidation."
Tan's crusade continues: he is not long returned from a conference in San Francisco organized by Singapore's technology board, set up predominantly as a networking forum for Singaporeans to meet venture capitalists and companies in the Silicon Valley. He is pushing for further reform to legislation governing stock options. Last July's amendments allowed taxes on gains from employee stock options to be deferred for five years. "I don't think that is sufficient. It was an interim step."
But further liberalization in the listing process for tech companies is unlikely. "Feedback has been that the present regime is adequate for the time being; I would not be in haste to relax regulations further. A stock exchange listing means giving you a means to advertise your company to the investing public. There has to be a certain amount of responsibility there." |