China diversified dot-coms avoid Facebook pitfalls

May 22, 2012

By Wei Gu

The author is a Reuters Breakingviews columnist. The opinions expressed are her own.

High-growth Chinese internet companies may be surprisingly defensive investments. True, fears about the cyclical advertising business have driven down shares in Renren, China’s Facebook lookalike. But other Chinese dot-coms should suffer less. Strong roots in gaming, whose revenue is still surging, makes diversified players like Tencent and Sohu comparatively recession proof.

Facebook’s poor showing in its first few days as a public company has damped enthusiasm for social networks. GM, a large U.S. advertiser, recently dropped Facebook ads for fear it may be a less effective channel than other forms of internet advertising. Facebook’s ads garner just half the clicks per page view of the average ad-hosting website, according to internet ad consultant Wordstream.

China’s advertising spending can be particularly cyclical. Developers and auto companies, the biggest spenders on advertising, are suffering due to Beijing’s home purchase restrictions and slower domestic demand. Renren’s first-quarter advertising revenue tumbled 46 percent from the previous three months. Sohu’s Brand advertising dropped 22 percent quarter on quarter.

But China’s dot-coms have been focusing on a more resilient line of business: gaming. Sohu’s online game revenue rose 3 percent quarter on quarter to nearly a record high. Tencent’s gaming revenue grew 15 percent in the first three months of 2012. Internet games are cheaper than a night out, making them attractive during economic downturns.

The gaming business is not only steadier; it can also be more lucrative. Games tend to have a longer shelf life than movies and news, and it takes fewer people to develop. The gross margin of Nasdaq-listed Changyou is almost 90 percent, compared with under 60 percent at Sina, which mainly relies on advertising. The increasing popularity of mobile devices also favours gaming over social networks, as it is harder to display ads on small devices.

Online games are no longer just a peculiarity of the Chinese market, where entertainment options are relatively few. Tencent has seen robust growth in online games from the United States, Europe and Korea, which helps offset weakness in domestic advertising. Now investors are focused on Facebook’s flaws, diversified Chinese internet conglomerates may be worth a look.

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