Here comes China 2.0

Forget about Google and Yahoo. Chinese Internet stocks are truly on fire, and analysts see more upside ahead.

By Paul R. La Monica, editor at large

NEW YORK ( -- As Google's stock slouches toward $600 a share and Wall Street debates the future of Yahoo following the ouster of Terry Semel, it's easy to forget that there are other Internet stocks out there competing for investor attention.

But for those who prefer to take a more worldly view of the World Wide Web, paying attention to areas outside of the U.S. has been incredibly rewarding, particularly for investors that have discovered the booming Internet sector in China.

Chinese Internet portals, search and gaming stocks have thrived this year...
...but wireless content stocks have taken it on the chin as China Mobile puts the squeeze on them.

Several Chinese Internet stocks trade in the U.S. on Nasdaq so investing in these companies is as easy as buying shares of Google (Charts, Fortune 500) and Yahoo (Charts, Fortune 500). And many Chinese Internet stocks have far outperformed America's big two Net giants this year.

Shares of search engine Baidu, portals Sina and Sohu, online gaming companies The 9 Limited and Shanda Interactive and online travel site are each up at least 20 percent this year, compared to gains of 8 percent and 14 percent for Yahoo and Google respectively.

Still, investing in China is obviously very risky. And analysts say that not all Chinese Internet stocks are created equal.

The top picks from analysts are Sina (Charts), China's largest Internet portal and Baidu (Charts), the country's leading search engine.

James Lee, an analyst with W.R. Hambrecht, said both companies should benefit from strong gains in advertising this summer.

Even though the summer months are typically seen as a sluggish time for dot-com advertising in the U.S., Lee said a combination of several consumer product launches later this summer in Chin as well as an increased pickup in travel in July, should lead to healthy increases in online advertising from retailers and leisure companies during the third quarter.

Steve Weinstein, an analyst with Pacific Crest Securities, also thinks Sina and Baidu are the best positioned Chinese Net stocks. He upgraded both earlier this week. He said that for Baidu, recent changes to the company's sales force should enable the company to increase its advertiser base.

And like Lee, Weinstein said he sees big gains in online advertising revenue for the latter half of the year. In fact, he thinks Wall Street is underestimating how much growth there will be. According to consensus estimates, analysts are predicting a revenue increase of 15 percent for the third quarter and an earnings increase of 8 percent.

"I just get the sense that second half numbers are too low and they were probably going to continue to take share for rest of this year. Basically Sina is the place to be with the decision makers in China, a must buy for branding campaigns," Weinstein said.

But these two aren't the only companies that are likely to benefit as more and more Chinese consumers go online. Companies taking advantage of the popularity of video games should also thrive.

C. Ming Zhao, an analyst with Susquehanna Financial Group, said he likes Shanda Interactive (Charts), a leading developer of online games. Analysts are projecting earnings growth of 27 percent a year for Shanda, on average, for the next five years.

And Hambrecht's Lee said that Sohu (Charts), which is China's second largest portal but also has a big presence in the gaming area, should do well in the next few quarters thanks to the recent release of "Tian Long Ba Bu", a 3D online game based on a popular Chinese novel and later, a television drama.

Still, Lee cautions investors to steer clear from some Chinese Internet stocks. Companies with more exposure to wireless content, companies like Tom Online, KongZhong, Linktone and Hurray! Holding have suffered as China's big wireless carrier, China Mobile, has started to muscle its way into the content business.

"The wireless content providers are getting squeezed," he said.

But there's one factor that should bode well for most Chinese Net stocks. Analysts said that as strong as growth may be in 2007, the real excitement for these stocks will come next year, especially since the Summer Olympics will take place in Beijing in August 2008.

"These companies are in a very nice position in the market and we are looking for more growth in the online advertising industry. We should see a pretty good pickup in 2008, with the Olympics as a catalyst, and with that in mind, there is still a good opportunity in these stocks," Zhao said.

But is this already priced into the stocks? Baidu trades at 51 times 2008 earnings estimates. Sina and Sohu each have multiples of almost 30 times next year's profit projections.

Pacific Crest's Weinstein admits that Chinese Internet stocks, like their U.S. brethren, aren't bargains. Still, he believes the stocks are reasonably valued given their growth rates. Analysts are forecasting average annual earnings growth of more than 20 percent a year for the next few years for Sina and Sohu and a whopping 50 percent a year for Baidu.

So he suggests that investors looking to buy them do so with a longer-term horizon, and not just 2007 and 2008, in mind.

"I really wouldn't describe any of these stocks as cheap or value oriented but you are looking at sustainable long-term growth rates that are very high. So if you want to buy them, you need a three to five year horizon," he said.

Analysts quoted in this story do not own shares of the companies mentioned and their firms have no investment banking relationships with the companies. Top of page