The rivalry between China’s top three internet firms – Baidu, Alibaba and Tencent – is well documented. But the contest to challenge their dominance is equally fierce.
After phonemaker Xiaomi completed a fundraising that valued it at more than $40 billion in late 2014, there was talk that it could be the “X factor” in extending the acronym to BATX, with “X” standing for the smartphone challenger.
However, Xiaomi has stuttered over the past two years (see WiC311), and fast-growing LeEco, another pretender to the internet throne, has also fluffed its lines, racing headlong into a liquidity crunch (see WiC345).
The most likely challenger to the big three lacks the rebel aura that tech analysts seem to have expected. Step forward NetEase, one of the China’s oldest internet firms.
In the social media era, the glory days of the ‘portal’ have passed – witness the failing fortunes of the once-iconic Yahoo. In China three firms dominated that space in the early days of the web: Sohu, NetEase and Sina. Back then NetEase might have been considered as the weakest link among the three, and one commentator on Zhihu (the local equivalent of Quora) reckoned that its founder Ding Lei didn’t have the steely edge of his rivals. “Charles Zhang [the founder of Sohu] has a gaze that seems to see what you are thinking. Sina has had the most ambitious management from day one. But Ding looks friendly and is always smiling. Probably no one would see him as a threat. You might not even notice that he has come into the room and sat down beside you,” he opined.
As that analyst now admits, it’s dangerous to judge a person too much by their demeanour. As of this week, Sohu’s market value stands at $1.5 billion. Sina is larger at $4.9 billion (though much of its worth comes from Sina Weibo, now an affiliate of Alibaba). NetEase is worth more than $40 billion.
The value of NetEase’s NASDAQ-listed shares has jumped 1.7 times over the past year. It is now trading at 23 times earnings and last month the firm posted a record net profit of Rmb11.6 billion ($1.7 billion), up more than 72% on the prior year.
“The 2016 financial report is strong evidence that NetEase could be the biggest challenger for the number four spot on the power rankings of Chinese internet firms,” China Entrepreneur wrote last week. “How did NetEase achieve this? The answer can only be found in Ding Lei himself.”
Ding was born in 1971 in Ningbo, a city in Zhejiang that has given the world some of the most influential Chinese tycoons. Unimpressive at school (his teacher blamed him for “slowing the progress of the entire class”, Nanfang People’s Weekly claims), he proved to be a late bloomer. After getting into a decent technical college in Chengdu, he worked for a state telecom firm back in his hometown. It was a job-for-life type of arrangement but in 1994 Ding logged onto the internet for the first time. Realising its transformative potential, and despite strong opposition from his family, he quit his government post and began exploring the online world.
In 1995 Ding joined US software firm Sybase’s newly established office in Guangzhou. Two years later he founded NetEase as an internet service provider. Under the domain “163.com”, it started offering email services, competing directly with the likes of Hotmail and Yahoo.
Many of China’s more famous internet bosses started out at a similar time. Charles Zhang, a PhD graduate from the Massachusetts Institute of Technology, founded Sohu in 1996. Sina was established in 1998. Pony Ma set up Tencent in Shenzhen in the same period and a year later a certain teacher in Hangzhou would found Alibaba.
Back then the portals were the hottest internet assets, and Sohu, Netease and Sina were frontrunners as investors chased opportunities in China. Ding floated NetEase on NASDAQ in 2000 (Sohu and Sina did so around the same time) but the internet bubble burst and Ding was soon struggling with his first major crisis.
He reinvented himself, according to Nanfang People’s Weekly, after watching Forrest Gump five times in a row (it inspired him not to give up, it seems). A timely investment from Duan Yongping (see WiC49) helped and NetEase began to offer online video games. Ding was emulating Tencent but the move was the masterstroke that set the company apart from Sohu and Sina as a games developer. Much of NetEase’s success since then has been based around mobile gaming, where it shares more than two-thirds of the market with Tencent, selling more than 100 titles, including several strong franchises.
“When it comes to first mover advantage or pioneering spirit, few would think of Ding Lei as an example. However, the strange thing is, in several key battles fought by internet firms over the years, NetEase is always one of the last few standing after the dust settles,” China Entrepreneur concludes.
Indeed, as Nanfang People’s Weekly notes, NetEase seems to have missed out on most of the big new ideas in the internet sector in recent years, including e-commerce, social media, video streaming and the sharing economy.
“Ding believes that chasing after the industry’s hotspots too quickly will usually backfire,” China Entrepreneur suggests. “NetEase usually adjusts its strategy more slowly and it won’t waste time exploring the wrong path. What NetEase has really been doing is building a strong entry barrier over its existing businesses through long-term investment. Ding doesn’t like speed. He prefers preciseness.”
The strategy is paying off in areas such as mobile games, the company’s core business. This segment serves as the engine of earnings growth, with income rising more than 62% to Rmb9 billion in the most recent quarter. Email and e-commerce contributed about Rmb2.5 billion in sales. Ding has invested in other products including a Spotify-like music service and Koala, an e-commerce platform that sources goods for Chinese consumers from overseas.
Will Ding do enough to redesignate the internet landscape as BANT rather than BAT, though? Baidu, the smallest of the current trio, is now worth $61 billion. NetEase is trading at $40 billion, some way back. In its favour, Netease has a pipeline of new games to sell and it will earn high margins on some of its existing blockbusters. But TMT Post reckons that Ding needs to adopt a more aggressive stance to catch up, perhaps grabbing a leadership position in artificial intelligence (AI) or virtual reality (VR). The shares are already looking a little toppish too. In mid-2001, they traded at $0.31 apiece. Now they are worth $302.58.
“It is not easy to maintain the number four spot in China’s internet industry – not to mention to challenge the BAT,” TMT Post concludes. “Many pretenders have tried but soon found themselves falling down the pecking order.”
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