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WSJ March 15, 2000
Betting on Firms' Continued Growth
Might Imperil Asia's Stock Markets
By HENNY SENDER
Staff Reporter of THE WALL STREET JOURNAL
Asia's stock markets this year have been dependent on a surprisingly small number of big Internet investment companies whose business models, in turn, are heavily
dependent on a rising stock market.
In Japan, Internet-related sectors have risen from 9% of the market to 24% in the 18 months ended February. The 10 largest shares by market capitalization now account
for one-third of the entire market. In Hong Kong, meanwhile, the total stock-market value more than doubled last year, but only 15 shares accounted for 90% of that
increase. And of the 15, only three didn't have a technology or telecommunications angle.
The peril is that if the stock prices of the big Internet investment companies stop rising, in fact, they have fallen considerably in recent trading sessions, the investment
companies may have to slow their acquisition activities, which have helped lift Asian markets to records this year. They may also find it harder to launch initial public
offerings of the companies they've bought. In the meantime, falling stock prices mean the paper profits on those investments are dissipating.
Major Players
The major players in this league are companies such as Tokyo-based Softbank Corp., which ended February with a larger market cap than Sony Corp. or Toyota
Motor Corp. In Hong Kong, Pacific Century Cyber Works Ltd., which is less than a year old, has seen its market cap surpass major conglomerates such as the Hang
Seng Bank Ltd. unit of HSBC PLC.
"In a rising market, to make multiple investments is a very successful strategy," says David Williams, who now runs the Asian investments of Silicon Valley venture capital
firm Draper Fisher Jurvetson. "But to succeed long term, you have to ensure that you scale back in more difficult markets," he adds.
To be sure, these companies currently own, or are beginning to acquire, assets that generate significant cash flow. Softbank is about to buy a bank. Hikari Tsushin Inc.,
another Japanese Internet-investment giant, is a major seller of mobile phones in cellphone-mad Japan. PCCW recently agreed to buy the leading Hong Kong
telephone utility from Cable & Wireless HKT in a stock-driven deal valued at US$38 billion. That pact, once completed, will bring PCCW so much cash flow that with HKT
shares as collateral, PCCW was able to sign up bankers to provide it with US$13 billion to help finance its purchase. Last year, HKT produced US$30 billion in revenue.
Nevertheless, these acquisitions may not be enough to offset adverse currents in the stock market. Indeed, Moody's Investors Service Inc. gives Softbank a junk-bond
rating on its 270 billion yen (US$2.56 billion) of unsecured debt. The rating agency cautions that comfort for bondholders has to come "primarily through substantial
growth in the market cap of the portfolio, rather than through cash flow from each operation." Moody's analyst Tatsuya Mizuno adds that the concern is that if Softbank
were to attempt to realize the value of those holdings, in other words, by selling its shares it may drive down those values.
In fact, to avoid having to write down the value of their investments, the investment companies often prohibit the companies they invest in from seeking additional
financing at lower valuations.
Midas Touch
Until last week, much of what these companies touched seemed to turn to gold. For example, at the end of January, Soft bank took a 61% stake in Cheung Wah Development Co., a Hong Kong-listed garment maker, for 207 million Hong Kong
dollars (US$26.6 mil lion). In just weeks, that company's market cap rose to HK$10 billion. At the same time, these stocks have proven quite volatile. Softbank closed
Tuesday at 89,200 yen per share, less than half its mid-February peak of 182,000 yen.
The business model of these investment companies is closely linked to their stock prices, since companies use their shares to pay for investments in other Internet
companies. "I like to use public-company shares as currency," says Yoshitaka Kitao, president and CEO of Softbank Finance Corp.
One advantage is that the cost of capital is almost nil. The investment companies can then rely on capital gains from their portfolios of acquired companies to fuel profit
growth and drive their share prices ever higher.
In a rising market, the model operates smoothly. "These companies create the currency (in the form of their shares) to keep the boom going," says Steve Roach, chief economist for Morgan Stanley Dean Witter. Their ultimate goal has been to launch IPOs of the companies they invest in. Often, the resulting spin-off company is then asked to put money into the investment funds of the company that launched it. "It's self perpetuating," says one senior Softbank executive, adding, "The money comes back."
Very Incestuous
The investment companies themselves also partner with one another through share swaps and joint investments in third companies. "It's very incestuous," says Hanson Cheah, executive director of AsiaTech Ventures Limited.
PCCW for example, has exchanged shares with CMGI Inc., an Andover, Massachusetts-based venture holding company. Then, when PCCW bid for Cable & Wireless HKT last month, the U.K.-based phone company gave CMGI US$500 million in PCCW shares, and took CMGI shares instead, according to documents from the takeover. The following week, PCCW and CMGI announced they were each putting US$500 million cash into a new fund, along with a Dallas lverage-buyout fund thathad subscribed to US$500 million of PCCW securities, and was also putting up US$500 million for the new fund.
PCCW also coinvests with Softbank. The last day of February, for example, PCCW and Softbank, through its newly acquired backdoor listing in Cheung Wah, both took
stakes in Goodwill Investment (Holdings) Ltd., a Hong Kong investment company that is now transforming itself into a technology company in addition to its original
financial-services operation.
PCCW and Softbank both argue that cross-shareholding arrangements are beneficial and allow them to expand each other's markets with the aid of a strong and knowledgeable local partner. A CMGI spokeswoman said an executive was
unavailable to comment.
The strategy the investment firms have adopted has been fabulously successful so far. In fact, they've been more successful than the carefully focused and selective model of
more traditional investment firms, which are also scouring Asia to make investments, albeit with cash as opposed to shares. "None of the old rules of venture capital apply
to Internet investment," says Rajiv Lall, a managing director at E.M. Warburg, Pincus & Co., Asia Ltd., a firm that typifies the traditional approach. "The new model is a
much larger flow of smaller deals," he adds. "And the sequence is reversed. They go public and then they acquire real earnings." |
