Mergers And Acquisitions
China's Internet M&A Bang Likely To Last
Russell Flannery, 12.01.03, 2:04 PM ET

China's Internet industry ended November with a bang--at least three mergers and acquisitions were announced in the last two weeks of the month, highlighted by Yahoo!'s agreement to purchase keyword search company 3721 Network Software for as much as $120 million. And there's more to come.

That's because global and local competitors alike are scrambling to tap into the country's fast-growing market. "Internet companies that want to be global players will have to be here given China's market size, and so more consolidation is likely," says Eric Xu, co-founder and executive vice president of Beijing-based Baidu.com. Xu ought to know what's ahead: Baidu, China's biggest locally-owned search engine and one of the world's 25 most popular websites, is widely considered one of the country's most coveted Internet takeover targets. The company was also honored with a visit today from Morgan Stanley's luminary Internet analyst Mary Meeker, who is traveling in China.

"People see China as a viable market, and so there's going to be more tie-ups" among local Internet companies and foreign ones, too, says Tom Tsao, an ex-Merrill Lynch investment banker who is now a partner at Shanghai-based investment firm Gobi Partners. Search companies such Baidu are hot among investors that believe users in the future will need more help in sorting through all of the material that's becoming available on the Internet--the same reason that Google's stock offering is attracting so much interesting in the United States, Tsao says.

China's Internet market is thriving as more and more of the country's 1.3 billion residents go online. The number of users is going to reach 77 million by the end of this year, versus 59 million at the end of 2002, and will climb to 150 million in 2006, according to iResearch, a Shanghai-based Internet research company. Shares in China's three big portals--Sohu.com (nasdaq: SOHU - news - people ), Sina (nasdaq: SINA - news - people ) and NetEase.com (nasdaq: NTES - news - people )--have multi-fold gains this year, even after recently falling back from their 2003 highs. NetEase chief William Ding topped Forbes' list of China's richest people with $1 billion; Sohu CEO Charles Zhang ranked No. 20 with $270 million. (The figures were based on Oct. 17 stock prices.)

Pressure to keep profits growing in key businesses--messaging, online games and advertisements--will force more acquisitions. In the past two weeks, Sohu said it would acquire local online games site 17173.com for $20.5 million in cash, and that it would also buy Focus.com, a real-estate information site for $16 million in cash and stock.

"If you want to be a major player, you need to have enough size, and the way to get there is by merging," says Lily Zou, research manager at Shanghai-based Internet research firm iResearch. Smaller local companies will sell out because it's easier than listing, and the bigger players--Sohu, NetEase and Sina--all have plenty of cash following bond sales this year.

But it's not just the local companies that are doing the buying. Overseas companies have been getting involved, too. Yahoo! (nasdaq: YHOO - news - people ) said on Nov. 21 it would purchase 3721, and eBay (nasdaq: EBAY - news - people ) in July bought the two-thirds of Chinese auction site EachNet that it didn't already own. The price, $150 million, was more than double the cost per share that it paid for one-third of the company in March 2002. Baidu's Xu reckons that not only U.S. portals are looking at China--Japanese and South Korean ones are trying to get in. "There are a lot of ideas about how to work together. With such a big market and such good growth, people can have a lot of imagination," Xu says in an understatement. Among those companies that he thinks "may well take some action in China": the AOL unit of Time Warner (nyse: TWX - news - people ), Microsoft (nasdaq: MSFT - news - people ) and Google.