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Chinese techs: Still the yuan?
Wireless and Internet stocks from China have been on a tear. Is it too late to invest now?
August 2, 2005: 1:19 PM EDT
By Paul R. La Monica, CNN/Money senior writer

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Analysts say the revaluation of the yuan will boost earnings for Chinese tech stocks.
Analysts say the revaluation of the yuan will boost earnings for Chinese tech stocks.
Chinese techs KongZhong, Shanda Interactive and Ctrip.com have been solid performers during the past year.
Chinese techs KongZhong, Shanda Interactive and Ctrip.com have been solid performers during the past year.
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NEW YORK (CNN/Money) - It's getting increasingly difficult to ignore the massive growth potential of Chinese tech stocks.

With more and more Chinese consumers going online and buying cell phones that offer premium content like video games and wireless messaging services, tech companies based in China should reap the benefits.

To that end, a slew of Chinese wireless and Internet firms which trade in the U.S. are set to report their latest quarterly results this week and next week. And for the most part, the numbers should be fantastic.

Netease.com (Research), a Beijing-based company that runs several online content sites, is on tap to release its second-quarter numbers Tuesday evening. Analysts expect sales to surge 67 percent from a year ago and that earnings will increase by more than 80 percent.

Online travel agency Ctrip.com (Research), based in Shanghai, will report its results on August 4. Analysts are predicting a nearly 50 percent jump in profits. And Shanda Interactive (Research), an online gaming company also based in Shanghai, is expected to report a nearly 60 percent increase in earnings when it announces its second-quarter results on August 9.

Keep an eye on the yuan and Baidu

And this could be just the beginning of an explosive growth curve. A basket of a dozen Chinese tech firms that trade in the U.S. are expected to report, on average, sales gains of 35 percent this year and 39 percent next year while profits are expected to soar 56 percent this year and 78 percent in 2006, according to data from Thomson/Baseline.

"These businesses are in their early stages in China. Search, e-commerce and wireless are relatively nascent industries," said Jason Tsai, an analyst with ThinkEquity Partners.

There are other catalysts that could keep Chinese techs moving higher as well.

The revaluation of the yuan should be a boost for the Chinese tech firms since most of them are services-oriented companies doing most of their business in China, as opposed to big exporters of industrial goods.

"Obviously, the intention of the revaluation was to put China in a more even playing field with the rest of the world in terms of trade," said Tsai. "For the public Chinese techs, their businesses are all denominated in yuan but reported in U.S. dollars so when they report earnings, they will be getting a one-time boost."

And later this week, Baidu, a popular Chinese search engine that has been compared to Google, is scheduled to go public in the U.S.

The company has already attracted a noteworthy group of investors, including venture capital firms Draper Fisher Jurvetson ePlanet Ventures and Integrity Partners as well as Google (Research), which owns a 2.6 percent stake.

The revaluation of the yuan should be a boost for the Chinese tech firms since most of them are services-oriented companies doing most of their business in China, as opposed to big exporters of industrial goods.

A shakeout on the horizon?

But is all this good news already priced into the stocks? Shares of a dozen prominent Chinese Internet and wireless firms that trade in the U.S. are up, on average, 15 percent during the past three months.

So the key is to not go overboard and embrace every company that has a presence in China. Investors should also not get too caught up with the effects of the yuan, said James Lee, an analyst with Decision Economics Investment Research. "To me, the currency revaluation does nothing for industry fundamentals."

Wireless content firms, which have revenue-sharing agreements with the two major wireless carriers, China Mobile (Research) and China Unicom (Research), are in the best position to thrive, Lee said. His favorite is KongZhong (Research), a Beijing-based developer of games, ringtones and other mobile content.

Lee adds that over the next year there will be a major shakeout in the industry since China Mobile, which is a state-owned carrier, has been cracking down on firms that have overcharged customers as well as those that transmit what it deems inappropriate content, such as pornography. And this could help KongZhong.

"This could drive bad apples out of the business and KongZhong could benefit from buying other small firms," said Lee.

Other analysts also think consolidation is more likely, which could further drive up prices of Chinese tech stocks. Shanda Interactive has expressed interest in acquiring Web portal Sina (Research), for example. Shanda has a 20 percent stake in Sina.

In a recent report, Piper Jaffray analyst Safa Rashtchy wrote that three wireless content firms, Hurray! Holding (Research), Linktone (Research) and Tom Online (Research) are prime takeover candidates. He also wrote that Sina competitor Sohu (Research) and Ctrip are also attractive.

Still, Tsai said he's not sure investors should be betting on deals since the regulatory environment in China will make it more difficult for mergers to take place. But he also likes the wireless content developers.

"We're going to see some pretty good numbers from companies that are focused on wireless. There were improvements in earnings in the first quarter and that trend should continue throughout 2005."

Pay attention to valuation

In addition to strengthening fundamentals, Tsai said the valuations for wireless content companies are more attractive than for some of the online services companies.

Netease, Sina and Sohu trade in a range of 23 to 28 times 2005 earnings estimates, for example, while Tsai's top picks in wireless content, Linktone and Tom Online trade at about 17 times earnings estimates for this year.

Ryan Jacob, manager of the Jacob Internet fund, said the key to investing in China is patience. The stocks will probably bounce around a lot in the near-term so the focus should be on the long-term. He added that investors should diversify their holdings instead of betting on once niche sector like wireless content or online media.

As such, Jacob said that in addition to Sina and Sohu, his fund also owns Shanda, Ctrip and employment recruitment firm 51job (Research), which operates a Web site that has been referred to as China's answer to Monster.com.

"We've owned names in China for a number of years. It's been a volatile group but long-term we're positive on them since the macro story in China is so compelling," said Jacob.

For more about China's decision to revalue the yuan, click here.

For more about international news, click here.

Piper Jaffray's Rashtchy does not own shares of companies mentioned in this piece but his firm has done investment banking for Hurray! Holding, Tom Online, Linktone, Ctrip and 51job. Other analysts quoted in this piece do not own shares of companies mentioned and their firms have no banking ties to the companies.


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