April 29, 2011 / 2:35 AM / 8 years ago

China's frothy Internet sector seen due for a correction

BEIJING, April 29 (Reuters) - China’s red-hot Internet sector is due for a correction, with valuations reaching frothy levels, and some players will be eliminated, industry executives and venture capitalists say.

But the decline will not be as steep as the dive seen in the U.S. dot.com bubble which burst in 2000, triggering a slump in stock prices and put ting a brake on the broader economy.

“There is definitely a bubble and a correction will come. When it will come depends on many factors and it won’t correct as badly as 2000,” said Gavin Ni, chief executive of Zero2IPO Group, a venture fund targeting Chinese Internet firms.

“The situation now is that you actually have the users and the business models to support that growth so it’s not all speculative spending.”

Internet darlings such as Baidu Inc and Youku have seen their stocks climb more than 50 percent this year as U.S. investors bet on the Chinese Internet growth story.

Baidu now is trading at 57 times its 2011 earnings while Sina Corp , which runs the country’s top Internet portal and a popular Twitter-like service, is trading even higher at 77 times.

Google shares, by contrast, are trading at an affordable 16 times its 2011 earnings.

Unlisted Chinese Internet firm 360buy.com raised eyebrows recently when it raised more than $1.5 billion in funds to invest in logistics and prepare for an initial public offering.

Dianping.com, a social rating site, this week raised $100 million, valuing the firm at $1 billion. Venture capital firms are beginning to question these high valuations for unlisted firms.

“It’s hard to find startup companies now with reasonable valuations, it’s all very high,” said the vice president of a Taiwan-based fund, who declined to be named in order to speak candidly.

But many of these firms face increasing competition and the premiums investors pay for their continued rapid growth prospects may not materialise.

Firms such as Youku are in the red and are seeing high content costs and competitive pressures in their industry. Yet, its stock has nearly jumped five times since its listing last December. Its main rival Tudou is also seeking a U.S. listing.

Renren, China’s answer to Facebook, is also loss-making but hopes to raise more than $570 million in a U.S. initial public offering. Sources have said its rival Kaixin001 also plans to list but has not selected banks. [ID:nL3E7FF3CX]

“The global capital firms are rushing to China now because they see the 1.3 billion people and they think: all these people are going to need the Internet,” Charles Zhang, chief executive of Sohu.com Inc , told an industry gathering.

“The result of all this money flooding in is immense competition and inevitably not all this competition will survive,” said James Gwertzman, chief executive of Asia Pacific for PopCap Games.

But Gwertzman said r oom for growth still remained and a correction would open investor opportunities for firms with a solid outlook.

“We do see a lot of mad money chasing deals which seem a little bit frothy but despite all the frothiness, there are still core matrixes to support the businesses,”

China already has the biggest Internet user population in the world. But the Internet penetration rate is still at only around 35 percent, compared with the roughly 80 percent in neighbouring Japan and South Korea.

So venture capital firms, pouring money into firms with large user numbers and a clear monetisation strategy such as Aigou, a Groupon clone and a website for dog-lovers, and Lashou could still strike gold, analysts say. (Editing by Kazunori Takada and Jacqueline Wong)

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