China’s new cash cow: Tech firm spin-offs

By : |December 22, 2009 0

NEW YORK, USA: Chinese Internet firms are eyeing more spin-off offerings after raising nearly $1.5 billion this year as they bank on strong foreign interest in high growth China plays.

Chinese spin-offs have prospered on the back of successful IPOs such as Changyou’s, but pricing issues and corporate governance remain key concerns for investors.

Tencent Holdings, China’s largest Internet firm, China’s third-largest online games operator and Chinese software developer Kingsoft could be prime candidates to spin-off some business units, analysts said.

"I see the trend continuing because, especially for gaming companies due to the intense competition on the ground, they need more resources to compete against one another," said Guo Chenggang, Shanghai-based analyst at research firm JLM Pacific Epoch.

Tencent and Kingsoft both denied any spin-off listing plans were in the works, while NetEase declined comment.

The U.S. IPO market has cooled somewhat since new issues began to pick up around mid-year, but market strategists expect demand to remain robust, though more selective, for China plays.

"It’s similar to the late ’90s when people felt like IPOs were almost uncashed lottery tickets. It turned out not to be true but for a while people would invest in anything," said Bill Buhr, an IPO strategist at research house Morningstar.

"Based on how well some of these early Chinese IPOs did, there might have been a little bit of that same thought process."

Other Chinese firms to spin off units this year include CDC Corp, which listed its business software unit CDC Software; Sina Corp’s joint venture listing of China Real Estate Information; and Shanda Interactive Entertainment’s $1 billion spin off of its online games unit, Shanda Games.

Where’s the beef?

"The risk is the price. The multiples are higher," said Francis Gaskins, president of "When you have a higher earnings multiple it means you are walking a tightrope and if you stumble the stock will get hurt."

The spin-off strategy also risks diluting shareholders of the parent company, and in the case of some firms such as Shanda, the spin-off of the firm’s crown jewel, left the market perplexed.

"The spin-off is just financial engineering, it doesn’t necessarily create any value for the company, they still work under the same holding company," said Elinor Leung, senior Hong Kong-based investment analyst with CLSA.

Shanda Games, which contributes more than 90 percent to Shanda Interactive’s revenue, was priced at the top of its indicative range and fell 14 percent on its debut. The stock now trades at 18 percent below its IPO price.

CDC Software trades 25 percent below its IPO price, while China Real Estate Information is down 17 percent below its IPO price.

Tencent, which is valued at $35 billion, has diversified beyond its popular instant messaging service to become China’s largest online game operator, making the unit a contender for a spin-off.

Tencent’s game unit earned 1.53 billion yuan ($224 million) in the third quarter alone, accounting for 45 percent of the company’s total revenue.

"Tencent’s game revenue is already one of the top in the market, meanwhile its games business is already operating very independently," Guo said, adding the unit was ripe for spin-off.

Analysts said NetEase could spin off its advertising business which made up about 10 percent of its third-quarter revenue, while Kingsoft may spin off its corporate software unit.

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