Foreign Capital Floods China in Internet Frenzy

Only days ago China’s first big Internet takeover battle ended, but it’s unlikely to be the last.

Propelled by foreign fantasies of 1.3 billion computer junkies, the Internet is sweeping across China and Hong Kong like a tsunami, barely slowed by the government’s half-hearted efforts to steer a different course.

Some of technology’s biggest names have thrown hundreds of millions of dollars at China’s Internet market and found influential local partners in recent months, even while the government was issuing new restrictions on cyberspace.

This foreign capital, much of it flowing into start-ups launched by Chinese graduates of America’s leading business schools, has triggered a feeding frenzy on China and Hong Kong stock markets that has sent tech shares sky-high and triggered fierce bidding wars for coveted properties.

It has also sparked a reverse migration among U.S.-educated Chinese, who are helping turn parts of Beijing and Shanghai into Chinese versions of Silicon Valley.

“The magic words are Chinese-born Harvard MBA,” said Matthew McGarvey, an Internet analyst in Hong Kong.

The most dramatic validation of China’s arrival on the Internet scene came Tuesday when a Hong Kong Internet start-up, Pacific Century CyberWorks, succeeded in taking over Hong Kong’s biggest phone company for nearly $40 billion--a huge prize in winning Internet access to the Greater China region.

Started less than a year ago by Richard Li, son of powerful Hong Kong tycoon Li Ka-shing, the company has no profit, and its only real assets are stakes in more than two dozen Internet start-ups. But it prevailed in a bidding war against Singapore Telecommunications and media billionaire Rupert Murdoch.

For China’s leadership, this cyberspace boom--and its attractiveness to wealthy foreign companies--poses a major dilemma.

The Internet could provide a powerful boost to the nation’s economic reforms by streamlining the nation’s banking and manufacturing systems. China’s manufacturers, for example, must rapidly upgrade their technology or lose out to competitors as the world’s largest automotive, apparel and electronics firms move their supply chains online.

Indeed, without embracing the Internet, China stands little hope of catching up with the industrial world. Thus the government is modernizing its telecommunications and computer infrastructure, while trying to lure back would-be tech entrepreneurs who studied abroad.

Yet the Internet also hands a powerful tool to those interested in getting access to forbidden information or challenging the government’s authority.

In recent months, China has tried to tighten its hold over the Web, concerned about its role in the spread of news about a major government corruption scandal and the banned religious group Falun Gong. The new measures included expanded penalties for spreading “state secrets” and restrictions on popular encryption software that protects privacy.

China’s seemingly contradictory attitudes toward the Internet reflect its ongoing struggle over how best to promote economic openness without relinquishing political control. Although more regulatory fits and starts are likely, the government will be forced to relax its grip on the Internet further as the technology overwhelms its policing abilities, predicted Daniel Lynch, a China telecommunications expert at USC.

“The Chinese government is just putting its finger in the dike, but it’s not able to hold it off in the long run,” Lynch said.

Still, Internet firms in China are advised to avoid sensitive areas such as pornography or politics, says Stella Jin, a Silicon Valley-based investor in several Chinese Internet firms. “You have to work with the Chinese government, or you really don’t have a future,” she said.

By late last year, China boasted at least 163 e-commerce Web sites, including 30 shopping malls, 18 bookstores and 10 auction sites, according to a study by Boston Consulting Group.

But the risk that surrounds any Internet start-up is magnified in China by the heavy-handed political leadership, bureaucratic red tape, low personal computer usage, primitive telecommunications and an undeveloped credit card system.

“At the moment, there is a massive wave of hopefuls, and later there will be a core of survivors,” said David Michael, a Boston Consulting Group Internet expert based in Hong Kong.

Still, China’s Internet market has increased eightfold during the last two years--an irresistible lure to Internet firms. With a current subscriber base of 9 million, China is expected to become Asia’s leading market by 2005, according to Computer Economics, a consulting firm in Carlsbad, Calif.

China’s “more than a diamond in the rough, it’s the Hope diamond in the rough,” said Abbey Silverstone, co-founder of Silicon Graphics.

Silverstone is now president of Multacom, a Southern California firm that has partnered with a Chinese firm to build and manage a high-speed data transmission network along railroad tracks linking Beijing, Shanghai and Guangzhou.

Many foreign firms are tying the knot with powerful Hong Kong business interests that know the turf and have fostered close relationships with top Chinese leadership.

For example, Priceline.com, the fast-growing U.S.-based Internet firm, has teamed with Hong Kong’s Hutchison Whampoa, the giant conglomerate founded by Li Ka-shing.

“Hutchison is not only extremely well-connected in China but also has a lot of other Internet business and strengths in areas Priceline offers, such as retail stores, hotels and airlines,” said Richard Braddock, Priceline’s chief executive.

Meanwhile, CMGI, a prominent U.S.-based technology investment firm, has partnered with Pacific Century CyberWorks, the firm that succeeded this week in acquiring Hong Kong Telecom from Cable & Wireless of Britain.

Chasing a cyber-dream is far less expensive in China than in the U.S., thanks to low start-up costs and a talented, low-cost pool of programmers and graphic designers willing to work for $5,000 a year.

China’s promise has attracted Harvard MBAs such as Jack Ma, founder of Alibaba.com, an online registry of China businesses; Anthony Cheng, president of Renren.com, a Greater China portal; and Dave Chang, president of Web portal Etang.com. All have received recent infusions of venture capital ranging from $5 million to $40 million.

To encourage the development of its high-tech sector, the Chinese government has established “overseas scholars pioneer parks” featuring free or low-cost rent, one-stop registration, free accommodations and reduced taxes.

After getting his doctorate from Stanford University, Jason Wu worked at the Xerox Palo Alto Research Center for nearly five years before succumbing to the entrepreneurial bug.

Two years ago, he established NetFront Communications, an online security firm that uses digital watermarks to protect documents from tampering. Wu developed the technology in Beijing but decided to base his company in the U.S., betting that he would be more successful building a U.S. brand name that could be exported back to China and other promising markets.

NetFront’s technology is now used by America Online, Yahoo and several other leading Internet firms to provide e-mail security. The firm also leads the pack in China, where its customers include People’s Bank of China, Beijing Bookstore and the government of Macau.

“We have all the characteristics of a Silicon Valley start-up, but are leveraging our strengths, our access to Asia and a development team in China that is one-eighth of the cost of engineering in the U.S.,” said the 35-year-old Wu, who hopes to go public by the end of this year.

E-commerce remains a primitive exercise in China, where few people use credit cards and poor transportation makes it difficult to deliver online purchases.

However, the use of debit cards is expected to expand rapidly as Web firms team with banks to promote their use for online transactions. And despite the dearth of personal computers, investors are betting that China will be a huge market for Internet access using inexpensive boxes hooked up to televisions or through cell phones and Palm Pilot-like wireless devices.

Companies such as ChinaWeb, operator of China’s largest financial portal, Homeway.com, are finding a well-heeled audience for their online financial news and company analysis, brokerage services and electronic transactions. Homeway.com boasts 15 million hits a month and just launched an English-language site.

“These guys love to gamble, love to invest and trade in stocks,” says Geoffrey Tirman, vice chairman of ChinaWeb and an executive with Talisman Capital, a U.S. investor. “If you think the Internet frenzy is bad [in the U.S.], it’s a feeding frenzy in China.”