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Chinese Net Growth Hits Wall

Updated from 10:42 a.m. EDT

The Internet is one of the fastest-growing industries and China is one of the fastest-growing economies. Put them together and what do you get?

You might think you'd get the fastest-growing industry of them all. And someday, you may be right. But for now, the mythical land of hyper-growth known as China's Internet sector remains a distant prospect -- and the road leading there is proving to be a bumpy one indeed.

As the leading Chinese Internet companies report earnings for the first three months of 2005, a frustratingly familiar pattern is emerging: Ad-supported content and wireless services, areas where many believe the greatest long-term potential lies, continue to suffer from regulatory setbacks and relatively slow growth. Other areas, like games and online travel, are performing much better, but the stocks are trading at dizzying valuations.

And hints from companies indicate the second quarter will bring more of the same. As a result, many of these names are down for the year. Among Chinese portals, Sina (SINA - Get Report) is down 12% and Sohu.com (SOHU - Get Report) is off 5%. Shanda Interactive Entertainment (SNDA) and NetEase.com (NTES - Get Report), two leaders in Chinese Internet games, are down 22% and 5%, respectively. Travel site Ctrip (CTRP - Get Report) has fallen 8%. Wireless company Tom Online (TOMO) has lost 23%, while jobs site 51Job (JOBS) is the worst performer of them all, dropping 74%.

A series of obstacles kept revenue and profit from rising at most of these companies, ranging from government hobbling of emerging wireless services, slower-than-expected growth in new Internet users, and a bottleneck of Internet access points in cafes and elsewhere (commonplace as many Internet users can't afford PCs).

Sina, perhaps the most closely watched of Chinese stocks and, at more than $2 billion, the one with the largest market cap, posted its first year-on-year profit decline since it first posted a profit in late 2002. Sina's first-quarter net income fell 36% after the Chinese government banned television and radio ads promoting Sina's fortune-telling service through text messaging. The fortune-telling service had been one of Sina's most promising lines of business.

Meanwhile, at Sohu, which is often translated into English as "search fox," earnings continued to be hounded by government crackdowns in the past year on spam, pornography and phantom charges for text-messaging -- moves that have slowed the growth of new media in China. Sohu's profit slid 44% to $5.7 million, in line with what analysts had been bracing for, but the company did indicate that wireless revenue and ad spending could improve in 2005.

Companies have spent the past few quarters working around the regulatory barriers and focusing on new areas of growth less likely to face them. "Wireless business has turned the corner," Sohu CEO Charles Zhang said in a conference call announcing first-quarter earnings, "indicating we have left last year's transitional and regulatory issues behind us."

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