Oxstones Investment Club™By Eric Jackson, RealMoney Contributor, TheStreet.com,
Wednesday’s price action in the new Chinese initial public offerings in Youku and Dangdang was eye-popping. Americans love easy comparisons to for understanding foreign businesses, so we’ve heard endlessly heard that Youku and Dangdang are China’s YouTube and Amazon , respectively.
Dangdang ended its first day of trading up 87%. Youku ended up 161% for the day. It feels like 1999 all over again.
However, any time you see moves like that, you will get the chorus of worriers. “These price-to-sales ratios are crazy!” is one comment I heard during yesterday’s market action. “This is going to end in tears!” One more: “I’m going to short the hell out of these two stocks.”
I wrote about Youku being the monster China IPO two weeks ago, though I’m not some Pollyanna cheerleader. Still, even I was surprised by the giant move the stock made yesterday.
The critics of Youku point out that the company has raised more than $100 million from venture capitalists to date, and that it has yet to turn a profit. In fact, Youku’s losses have only grown along with the company itself. It has faced increasing costs of acquiring proprietary content (think Hulu), keeping up with intense competition, paying for more servers to stream video and large pirating risks. Even if the company can supplement its advertising-based revenue with subscription revenue, critics wonder how will it will convince the Chinese to pay for content when bootleg DVDs can be bought for pennies on the street.
Yet, what Youku has going for it — as I’ve said before — is that it’s the leader in the online video space at the moment. China’s No. 2 online-video company, Tudou, filed to go public first, but Youku is actually the first one out. If it didn’t have name recognition in the U.S. before yesterday, it does now. That will be important for Youku’s continued access to the capital markets in order to fund its growth — assuming its price holds up.
From an operational perspective, market leadership and momentum are key to keeping that top spot. If we’ve learned anything from the growth of the Web in the U.S. it’s that, although people can always choose not to keep shopping at Amazon.com, they will do so as long as it continues to be a great service. Therefore, first-mover advantage is huge, as long as that first mover doesn’t screw up.
We cannot be sure if Youku will be the next YouTube, Hulu, or Netflix of China. They are, however, in the pole position to figure out how best to succeed.
Further, if you’re worried about high price-to-sales or price-to-earnings ratios, remember that China’s Internet-penetration rates are in the 40% range today versus mid-70% in the Western world. What’s more, the amount spent on online advertising in the U.S. is about 7.5 times the equivalent in China. Moreover, this country — which has a huge advertising industry — still sees most of its advertising dollars spent on television. As this more and more of this money shifts to Internet advertising, and as more and more of the population goes online, the whole China Web space will experience a mega-rising tide effect. Suddenly, a P/E ratio of 40 doesn’t look so stratospheric.
Dangdang in some ways is even more attractive than Youku. It’s the leading e-commerce bookseller in China today with real growth and real profits. Still, it hasn’t yet moved into selling other goods — not even e-books. The company, therefore, has strong potential for big ramp-up growth over the next decade.
I recently found this gem of a news clipping from May 1997, the day of Amazon’s IPO. It made me think of the Youku and Dangdang IPOs.
As you’ll notice in the CNET article, many were worried from competition from the new Barnes & Noble website. People also worried about Amazon’s lack of profitability. After all, the company’s last quarter before going public saw yielded only $15 million in revenue, while the bottom line reflected a loss of $3 million. Furthermore, at that time the site saw only 88,000 daily visitors. At the end of their first day of trading, Amazon’s market capitalization was at $438 million.
Since then, Amazon’s value has multiplied by 180 to a market capitalization of more than $79 billion. In its latest quarter, the company reported $7.3 billion in revenue and $260 million in earnings before interest and taxes. Clearly it grew into its market capitalization.
Of course, investors also remember theGlobe.com, Pets.com and Webvan, none of which worked so well. The trick with any of these IPOs is differentiating valid criticisms from ones that simply won’t matter as long as the company retains its leadership in a growing niche. I, for one, expect both Youku and Dangdang to continue to do well.
Tags: Amazon, Asia, China stock market, chinese stocks, dangdang, Equities, internet companies, IPOs, P/E, P/S, Tudou, Youku, YouTube