insight newsletter - February Issue
Internet Investment - the Next Wave
By David Burroughs
Are investments still available
Popular opinion suggests that the first Internet wave in Asia is dead or dying. Many proponents support the view that the Internet still has a long way to run, and in respect of the impact on the way business is carried out in the future, this is likely to be true. However, the markets and market sentiment (and consequently, the views of the investment community including the venture capitalists) are moving against the previously held view that the Internet means winner, which so dominated 1999 and the first half of 2000.
Why has this happened? Clearly, one of the key reasons is that many businesses that were funded did not have a viable business concept in the first instance. Many businesses that are still surviving on their first round of funding will not get a second round-their only hope is consolidation or buyout.
But this does not mean the money has run out. Hundreds of millions of dollars (billions globally) are still available for investment; held by private equity funds, venture capitalists and investment banks. Some of this money will find its way back into traditional business. But just as the driving force behind much of the Internet investment was the belief in the opportunity for significant returns, so investors are likely to seek out new, high-potential opportunities.
New opportunities
Although the Internet seems to be languishing at the moment, it has set off a surge of entrepreneurialism and a thirst for new technologies. For investors, new technologies can mean new markets with the potential for great investment opportunities.
Two key areas of development are currently attracting attention. Firstly, "wireless technology", which has the potential to inspire another Internet-style rush (although we hope with a more rational approach to investment this time). The second development is the shift toward Internet-enabling traditional businesses. This is not to ignore other areas of development such as broadband, streaming media, data centres, etc., but wireless in particular is likely to be in the spotlight.
Already we can see that much of the interest and investment in the Internet in Asia has shifted to mobile communications and wireless Internet. DoCoMo, with its highly successful "i-mode", is a case in point, but should be put into context, because outside Japan most people who have ventured into the world of WAP and mobile Internet so far have emerged disappointed. This is despite excellent mobile penetration here in Asia (54% in Hong Kong, 45% in Korea, 41% in Singapore). Wireless Internet is on its way, but there are barriers.
For investors, new technologies can mean new markets with the potential for great investment opportunities.
The existence of these various barriers to success will not discourage investment, but it could extend the time frame for implementation. Investors have learned from the last wave of investment to be more judicious in their ventures and this should improve the quality of the next wave. This time around, business models will need to be very sharp and companies will have to come up with leading edge technology if they want to be in the game. Big players, such as Nokia, Motorola and Ericsson, could win out again over the small entrepreneurs who were responsible for taking the Internet forward. The role of entrepreneurs will ultimately rest with the investors 'level of confidence in the future of wireless.
The impact of Internet
The Internet is still prominent in the minds (if not actions) of many existing business investors. This is likely to drive investment toward the e-enablers. Perhaps the real value and monetizeable benefit that the Internet provides, especially in Asia, is in helping to streamline production time, cut resource waste and source supplies more cheaply. This is not the domain of the dotcoms but of the enterprises-the big complex organisations. Only recently, after watching and evaluating, have enterprises begun applying the Internet in upgrading the processes and systems that they use to conduct business. The impact of this transition is just now beginning to trickle down to the rest of the economy.
The era of the pure Internet company may be over as virtual companies acquire assets (Amazon.com is an example) and the brick-and-mortar companies seek new virtual channels. The Internet (i.e. the operational philosophy that drives it) should prove an effective enabler ensuring the transition from bricks to clicks does not lock up or disable an enterprise's core functions. Implementing these new e-initiatives, old economy companies need the experience and skills of today's smaller Internet industry for the still emerging Internet-enabled economy.
Although the IPO front will likely see less investment activity in the current market conditions, viable companies will still offer exit strategies through acquisition-either by an enterprise or a more established Internet company. If the business is real and the exit is viable, there is every reason investors will step back into the marketplace, and that might just start happening sooner than we think.
The State of the Internet in Greater China
Article contributed by Brandon Geithner
Gorilla Asia
Struggle for survival
The easy money days are over for Greater China's Internet stocks, and cautious times are upon us.
China's portals appear ill-equipped to survive the lack of investors and the collapse of advertising revenues. B2B companies are racing to come up with some ways to sustain revenue and low computer penetration continues to keep the market small, as few people in the poorer regions can get access to the Internet.
But there is good news: the technology for wireless Internet access via mobile phones is just around the corner. Given the relatively high mobile penetration in Greater China, this should produce a surge in Internet use.
Asian technology markets, reflecting the situation in the US, enjoyed a boom echo during the past two years. Jasmine Koh, Associate Director of Regional Internet Research at UBS Warburg, notes that US Internet stocks reached a higher plateau of maturity than did those in Greater China before the Nasdaq tumbled last year. Consequently, many companies in Greater China had only completed their initial rounds of funding before investors fled for the hills. With high cash burn rates and insignificant revenues, Netcos throughout the region are having cut back, and many are looking to be bought out.
The tide appears to have turned. The dotcoms may have pioneered Internet advertising, forcing bricks-and-mortar companies into the medium to stay competitive, but now dotcoms cannot even afford online advertising, bus ads and other forms of brand building. This has given traditional companies the luxury of being cautious toward the Internet. As a result, previously optimistic estimates for online advertising spending in Greater China are being revised sharply downward.
Deutsche Bank estimates that three Chinese portals, Sina, NetEase and Sohu, account for approximately 70% of online advertising budgets in the Mainland. Optimism about these portals has evaporated as their abilities to generate ad revenue have decreased. The China portals have had to streamline their businesses to stay afloat. Sohu merged with ChinaRen in September, only to be forced into drastic layoffs. Consolidation looms for other companies as well, with weaker players likely to be picked off by the strong.
Consolidation looms for other companies as well, with weaker players likely to be picked off by the strong.
Overseas competition
China's entry to the World Trade Organisation (WTO) could loosen restrictions on foreign competition allowing US companies such as Yahoo!, MSN and AOL to target Sina, NetEase or Sohu and gain a foothold in the Chinese market. In August, LycosAsia became the first wholly owned foreign company to receive a license to operate as a content provider in China. LycosAsia is in the process of acquiring a China portal to secure access to Chinese content.
Yahoo! acquired Taiwan portal, Kimo, in November, but Koh doubts that Yahoo! will bid for one of the China portals just yet, because it is coping with its own advertising slowdown. "Profitability for these companies is still a few years out," says Koh, "and Yahoo! may not want to add any loss-making companies to its portfolio."
One Netco that market analysts favour is Hong Kong-based Chinadotcom, which could become the top local player. Its business is not built on portals alone. It also owns a leading Asian web consultancy, The Web Connection, and an online advertising network, 24/7 Media Asia. Moreover, Chinadotcom has deep pockets. Its USD485 million cash bankroll gives it the freedom to acquire smaller players that offer operational synergies.
B2B and B2C development
The future of B2B in Greater China is cloudy at best. "The Global Sources B2B model of catalogue-based companies going online has potential," says Koh. She suggests that the real challenge for Asian B2B sites rests in the back end-in clients realising efficient delivery of purchased goods. "There are many catalogue-type B2B exchanges in Asia," says Koh. "But I haven't seen any with a real transaction engine that can efficiently fulfill orders."
The conundrum for B2C is that areas with high Internet penetration in Asia usually do not have a critical mass of consumers. Conversely, countries like China have enormous populations but low rates of Internet penetration. South Korea and Japan are perhaps the only countries currently equipped to reap the benefits of B2C.
The future
Given the absence of online advertising revenues, investors are shifting their focus from Internet content to infrastructure. While broadband will continue to grow, it faces infrastructure problems, especially in China. By contrast, use of the Internet over mobile phones, which are widely used in China, Hong Kong and Taiwan, overcomes the issues of PC penetration and infrastructure.
"Wireless is huge, "says Koh. "In this sector, Asia leads the world. WAP usage is bound to accelerate as GPRS [general packet radio service] gets rolled out later this year." Mobile phone users will soon be able to receive larger messages and transfer significant amounts of data quickly and efficiently.
The coming year promises to be very interesting. With the US Federal Reserve trimming interest rates and the Nasdaq showing signs of recovery, there is a chance we could see a revival of Asian Internet stocks. However, it remains to be seen whether any comeback will be substantial enough to boost investors confidence and lift the gloom currently hovering over the Internet in Greater China.
The future of B2B in Greater China is cloudy at best.
The Changing Economy - Facing Up to New Challenges
By Ilona Tse
European and HK SMEs in comparison
Facing a rapidly changing economy, small and medium sized enterprises (SMEs) in Hong Kong are encountering challenges they have never seen before. And highly skilled labour is one of the biggest concerns. During the eighth European Business Survey conducted by Grant Thornton in the UK, it was clear that SMEs in Hong Kong and Europe share similar challenges arising from the rapid development of high technology and globalisation.
The recovery in continental European economies during 1999 has clearly affected the views of European SMEs on their prospects entering the 21st century. The smooth start to the introduction of the euro ended one area of uncertainty, while the relaxation of some constraints on governments, which were trying to hit the Maastricht targets, has also had a positive effect. As a result, businesses are more optimistic about turnover and profitability than at any time since 1995, and more expect to increase employment now than anytime since the survey began in 1993.
The expected growth in turnover, along with no increase in inflation, implies that there is likely to be a low rate of inflation, helping to sustain business expansion by reducing the likelihood of significant rises in interest rates.
Expansion brings its own constraints
Labour shortages are particularly critical when employers want to expand. For the first time since the beginning of the survey, a shortage of skilled labour is more significant than the proportion of firms citing a shortage of orders as a constraint. Moreover, the latter is at its lowest level since the start of the survey.
As a shortage of skilled labour becomes more of a problem every year, companies are putting an emphasis on training. This year the balance of European Union (EU) SMEs expecting an increase in training over the coming year is at 38%, the highest since the survey began. The correlation is also fairly clear across countries. The shortage of skilled labour is most acute in Germany, Ireland, Italy, Luxembourg, Spain and Sweden. In these countries, training is expected to increase more than average.
SMEs are more likely to make an effort to motivate and develop existing staff, in order to keep their skills within the company. Nearly 40% of SMEs have some forms of incentive or development scheme. Share ownership schemes are relatively rare, but more likely in Germany, Norway and Switzerland.
When labour markets are tight, human resources management tends to take a higher profile. Outsourcing personnel functions is less popular than having a personnel manager across countries.
Labour shortages are particularly critical when employers want to expand.
Key issues
Of the issues thought to be most important to the European business environment in the 21st century, those most commonly cited were changing information and communications technology, and globalisation. These issues were, generally, slightly less important for EU countries outside the euro zone than for those within it, while SMEs in southern Europe were more likely than those in the north to see globalisation as a major issue.
Competition from e-commerce business may well be the cause of these concerns. The pressure is on for SMEs to embrace an e-commerce working culture, even if they lack the budgets or inherent skills to support the resourcing of such an enterprise.
Implications for Hong Kong SMEs
Hong Kong is undergoing a rapid transformation to a higher value-added and knowledge-based economy, but several key elements have a significant influence on SMEs. Globalisation and liberalisation of trade and investment, the surges of IT and e-commerce, and China's accession to the World Trade Organisation (WTO) all have an impact. With reference to the European Business Survey, similarities exist in the attitudes, plans and trends between European and Hong Kong SMEs.
Maintaining a highly skilled labour pool is the primary example. In order to cope with development and expansion, the need for manpower will grow at an average annual rate of 1.8% between 2000 and 2005, according to the Census and Statistics Department of the Hong Kong Special Administrative Region. With increased competition from China, SMEs need to allocate resources for training and retraining of employees to develop and enhance their abilities.
The adoption of IT is not high among SMEs-"only a small percentage have a website. Among those who do, few are enthusiastic about conducting e-commerce, but the majority are willing to provide information about their companies and products or services. Concerns about adopting new technologies include investment costs, availability of in-house expertise, security and reliability of the IT system. The increased usage of IT across industries, together with globalisation of the economy makes adoption a top priority. According to the Census and Statistics Department survey on "Manpower Training and Job Skills Requirements" the increased use of IT within the company is at the top of the list in coping with changes in the economy. We would hope that this attitude will prevail and that Hong Kong SMEs will continue to invest in their technological development.
Such investment is necessary for businesses not just to cope with the changes, but to ensure that Hong Kong remains competitive; and when the opportunity presents itself, that it is able to produce its own market leaders.
To cope with development and expansion, manpower needs to grow at a rate of 1.8% between 2000 and 2005.
New U.S. Withholding Tax Regulations
By Tom Corkhill and Rowena Chow
In order to identify the ultimate beneficial owner of income and to prevent improper claims for benefits under U.S. tax treaties, comprehensive new U.S. withholding tax and reporting regulations have come into effect from 1 January 2001. The U.S. securities which will be subject to these new rules are: U.S. treasury bonds, corporate bonds (other than Eurobonds in bearer form), corporate stocks, depositary receipts, regulated investment companies (or mutual funds) and real estate investment trusts. These new regulations will impact investors differently, depending on their classification as either a U.S. person or a non-U.S. person.
Effects on investors
A U.S. person is defined as an individual having U.S. citizenship or residence (including holders of green cards, persons with dual citizenship and persons who have been in the U.S. for a substantial number of days during the last three years, regardless of domicile), a U.S. trust or a U.S. partnership. From 1 January 2001, a U.S. person holding or acquiring U.S. securities is required to furnish a W-9 form, which requires U.S. citizens to provide a taxpayer identification number and certificate. If the investor does not comply, the investor is treated as a non-U.S. person, and its agent will withhold up to 31 percent of any earnings from U.S. source dividends, interest and certain other income.
A non-U.S. person is anyone not corresponding to the definition of a U.S. person. Under the new rules, all non-U.S. persons are required to file the relevant forms in order to claim a reduced tax rate or exemption. ?/span>If the U.S. securities were acquired before 1 January 2001, these forms would have had to be submitted on or before 31 December 2000. Otherwise, earnings from the U.S. source of income generated since 1 January 2001 are subject to a withholding tax up to 31 percent.
If the investor does not comply, its agent will withhold up to 31 percent of any earnings from U.S. source dividends, interest and certain other income.
A beneficial owner can make a claim of foreign status by submitting a W-8BEN form (Certificate of Foreign States of Beneficial Owner for United States Tax Withholding). This entitles the owner to an exemption from U.S. withholding tax on portfolio interest, and U.S. source interest on deposits in a bank or insurance company. The regulations require a non-U.S. person who wishes to obtain a reduced rate of withholding tax on dividends, to claim for treaty benefits by making a certification on the form.
Results and impact
An intermediary is any person who acts as a custodian, broker, nominee, trustee, executor, or other type of agent for another person, regardless of whether that person is the beneficial owner of the amount paid. The new regulations require an intermediary to furnish a withholding statement that provides sufficient information for them to perform withholding at the correct rate and to prepare the necessary information returns. A qualified intermediary, typically bankers, brokers or securities custodians, is not required to disclose the identity of the foreign investor to the U.S. government. A non-qualified intermediary has to disclose the identity of the beneficial owners of the income and furnish copies of the respective U.S. tax forms.
Investors who are holding U.S. securities that were acquired before 1 January 2001 should have filed the appropriate U.S. withholding forms. New investors need to consider seriously the tax implications and the new disclosure requirements when they purchase U.S. securities whether they are buying direct or through a bank or broker. For details, you may refer to the Form W-8BEN and Form W9. Consideration may also be given to investing indirectly through mutual funds, insurance policies or personal investment companies, some of which may require tax to be paid at a reduced rate or offer full or partial exemption.
New investors need to consider seriously the tax implications and the new disclosure requirements when they purchase U.S. securities.
Investing in China (part III)
With China's entry into the World Trade Organisation (WTO) seeming more likely, more foreign investors are interested in setting up their establishments in China. There are, however, several ways to establish an entity or operate in China, which require different application procedures and documents. In the last issue, we discussed the setting up of foreign investment enterprises and representative offices. Here we take a closer look at the application requirements of three other forms of establishments in China.
Assembling and Processing Contract
Foreign investors may set up their manufacturing bases in China by entering into an assembling and processing contract (APC) with a Chinese party. Under such an arrangement, the foreign party does not technically own any subsidiary or office in China. Rather, the foreign party provides technology, machinery, spare parts and raw materials, and the Chinese party provides manufacturing facilities and services for subcontracting fees. Finished products are exported by requirement. It is not surprising to find thousands of workers in a large-scale APC factory that is actually run by foreign investors.
To set up an APC factory in China, foreign investors must go through application procedures similar to those for foreign investments enterprises (FIEs)-approval of project proposal and subcontracting agreement by the supervisory authority of the Chinese party and the Ministry of Foreign Trade and Economic Co-operation (MOFTEC). As it is the Chinese party that "owns" the factory, it will, in practice, handles all the application procedures for the foreign investors. Application documents include:
*Application form completed by the Chinese party.
*Duly signed subcontracting agreement.
*List of machinery and equipment provided by the foreign party.
*Incorporation documents and financial credentials of the foreign party.
Chinese Holding Company
Foreign investors can apply to set up Chinese holding companies (CHC) pursuant to the PRC Provisional Regulations for the Establishment of Investment Companies by Foreign Investors. Through the CHC, the foreign investor can make investment into FIEs and provide various kinds of co-ordinating services to them. The foreign investing party must fulfil the following conditions in order to apply for establishment of a CHC:
1. Good credit standing and financial capability:
a) Either have total assets of not less than USD400m in the year prior to the application, set up FIEs in China of more than USD10m registered capital paid up by the applying party and have at least three project proposals accepted by the Chinese authorities, or
b) Have set up more than 10 FIEs engaging in production or infrastructure construction and an aggregated capital contribution of not less than USD30m made by the applying party; and
2. A minimum registered capital of USD30m for the intended CHC.
The application has to be submitted to the Commission of Foreign Trade and Economic Co-operation (COFTEC), the provincial level of MOFTEC, and then the ministry for approval. In addition to the documents required as those for FIEs, the application documents should also include:
There are several ways to establish an entity in China, which require different application procedures and documents.
Foreign-funded Joint Stock Company
The application for establishing a foreign-funded joint stock company (JSC) in China is governed by the PRC Company Law and the Provisional Regulations concerning establishment of foreign-funded joint stock companies. A foreign-funded JSC may be set up by means of promotion, public offering and conversion of a joint venture or wholly foreign-owned enterprise (WFOE).
The establishment of a JSC by promotion requires at least five promoters, of which more than half must be domiciled in China. Unless specified otherwise by the State Council, the minimum registered capital for a foreign-funded JSC is RMB30m (approximately USD3.6m). The foreign party must subscribe at least 25% of the total registered capital. Contribution in the form of patented and non-patented technology expertise is limited to 20% of the total registered capital. The application is subject to approval by the central government.
Procedures
1. Appoint a promoter to handle the application.
2. Submit application documents (application letter, feasibility study report, asset valuation report and prospectus for JSC by public offer, etc.) to the relevant supervisory authorities at the provincial level for approval.
3. Submit the application documents together with the shareholders' agreements and articles of association to MOFTEC for approval (provincial level followed by the ministry). The authorities will accept or reject the application within 45 days.
4. Open a special bank account within 30 days of approval and pay up the subscription within 90 days of MOFTEC approval.
5. File a company registration and obtain a business licence.
To convert a joint venture (JV) or WFOE to a foreign-funded JSC, the original FIE must have recorded a profit for the last three years. The application documents shall include the following:
Post-approval registration formalities
There are still some formalities to go through, including registrations with tax bureaus, customs authorities, financial bureaus, State Administration of Foreign Exchange, State Statistic Bureau and Public Security Bureau after the issuance of the business licence. To avoid non-compliance penalties, it is important to observe the respective statutory time limit of the above registrations.
The above serves as a general reference. Practice may vary from location to location. It is not surprising for local government to have different practices and requirements. You must also be sure that the Chinese set-up has obtained all proper approvals and necessary registrations.
We are experienced in assisting clients prepare applications for establishment and handling official registrations in China. For further information please contact:
Wilfred Chiu kwc@gtb.com.cn
Desmond Yuen desmond.yuen@gthk.com.hk
Alice Law alice.law@gthk.com.hk
It is not surprising for local government to have different practices and requirements. You must also be sure that the Chinese set-up has obtained all proper approvals and necessary registrations.
PRC Newsflash
The PRC Regulations on Telecommunications
On 25 September 2000, the State Council issued the PRC Telecom Regulations (Telecom Regulations). Effective on that date, the Telecom Regulations set out the framework for regulating the China telecom sector.
Pursuant to the Telecom Regulations, telecommunications business is separated into two classes: basic and value-added. The Telecom Regulations classifies the list of activities, but the division still seems blurred. Whilst both categories of business need the approval and licensing of the supervisory authority of the industry, i.e. Ministry of Information Industry, the basic telecom operations are subject to more stringent control. Basic telecom business, which includes the provision of public network infrastructure, public data transmission and basic voice communications require a minimum 51% stake be held by the State. For value-added telecom business, there is no corresponding requirement of state ownership.
The Telecom Regulations also contain provisions facilitating fair competition, protection of the legitimate right of consumers and operators, safety operations of telecom services and healthy development of the industry.
New Amendments to Laws on Foreign Investment Enterprises
The revised PRC Law on Sino-Foreign Co-operative Joint Ventures and the Law on Foreign-Funded Enterprises came into effect on 31 October 2000 upon announcement. The amendments abandon the stipulation requiring maintenance of foreign exchange balance as well as purchase preference for local, versus overseas suppliers.
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