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Renewed Activity in Internet Sector Boosts Chinese Portals

Recent rally reflects optimism in consolidation, upcoming WTO vote and the vast potential of the Internet in China.

The Chinese Internet market is in many ways a more intense version of that in the U.S. It has potential and then some, given the hundreds of millions of consumers who will someday take to the Net. And with stocks that rise and fall in double or triple percentages, it can put the volatility of U.S. tech highfliers to shame.

Now the sector is entering a phase very familiar to U.S. Internet companies: consolidation. With venture capital drying up throughout Asia, more and more Chinese tech companies are seeking alliances and acquisitions to secure a top spot in an extremely competitive marketplace. Expect the industry to enter a big shakeout over the next few months, clouding the prospects of the big Chinese Internet players that trade on the

Nasdaq Composite Index


This week, Chinese Internet portal


(SOHU) - Get Limited Sponsored ADR Report

announced it was buying rival


. The deal would considerably increase Sohu's number of registered users to around 7 million. Although it is difficult to accurately assess the success of various portals in China, the deal certainly makes Sohu a far more formidable force in the field. The news helped boost Sohu's stock 1.85% on Tuesday to $6.88. However, it has nonetheless declined 47% since its initial offering in July.

The move undoubtedly puts pressure on fellow China Internet portals,

(SINA) - Get SINA Corp. Report


(NTES) - Get NetEase, Inc. Sponsored ADR (NTES) Report

to make similar acquisitions. Netease rose 6.25% on Tuesday, while Sina edged down, losing 0.62%. Sina, meanwhile, announced this week that it was creating an extensive Web site to provide coverage of China's teams at the Olympics. That may not sound newsworthy, but it is worth remembering that Sina has gained a reputation as a source for reliable and independent news for the Chinese people. Thus the site will most likely prove to be popular for the Olympic coverage, which will help increase Sina's users.

Overall, China's Internet plays have enjoyed a pretty impressive rally the last few weeks: Sohu is up 45% since late July; Netease is up 28% since it started to rebound in mid-August, while Sina is up 19% in the same period.



, which was the first Chinese Internet company to go public in the U.S., and which has broadened its scope to include other Internet ventures such as advertising in addition to its portal, rose around 19% but has since dipped.

Part of the rally might be explained by the upcoming vote in the Senate on China's accession to the

World Trade Organization

, bringing the country one step closer to its eventual entry. Whenever China gets in the news in that way, it usually helps Chinese stocks a bit. More importantly, there seems to be a sense that the sector might not be so overvalued after all, especially in comparison to U.S. tech stocks.

Yet overall, many fund managers still prefer "The difference

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among Sina, Sohu and Netease is Sina has a global perspective," says Richard Gao, portfolio manager at

Matthews International Funds

, since Sina is a portal for the Chinese-speaking community worldwide, not just for mainland China. The firm has in both its

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Asian Technology Fund and its

(MCHFX) - Get Matthews China Investor Report

Dragon Century China Fund. The Tech fund is down 27.6% this year, while the China fund is up 7.7%.

Yet Gao also thinks Sohu and Netease are undervalued. "The market is big enough to have at least two to three winners," he says.

Mido Shammaa, assistant portfolio manager at the new


Global E-Fund has bought as well as Chinadotcom. The fund, which was introduced in May, requires an initial investment of $1,000. While the fund managers are allowed to buy U.S. Internet companies, they intend to invest only in Internet companies outside the U.S. The biggest percentage of its holdings are currently in Europe, with 60%, with Asia second and Latin America third.

Others steer clear of the whole sector: "The Chinese Internet sector is growing quite fast," says Eswar Menon, manager of the

Loomis Sayles Emerging Market Fund

. "But I haven't seen any companies that have a way to monetize that growth," he says, pining for paths to profitability.

One thing everyone agrees on though is the enormous potential of the Internet in China. Usage has been doubling every six months, although it still pales in comparison to the U.S. Yes, China is still a very poor country, but if even a mere 10% of its population gets on to the Internet -- not an unreasonable assumption -- that equals 100 million people. So the consolidation of the sector is important especially if a clear leader emerges.

After all, just remember how



emerged as a dominant player after gobbling up




-- and how well the stock performed.

David Kurapka's Global Portfolio column appears Mondays, Wednesdays and Fridays on TSC. In keeping with TSC's editorial policy, he does not own shares in any companies or mutual funds mentioned in this column. He also doesn't invest in hedge funds or other private investment partnerships. He welcomes your feedback and invites you to send it to

David Kurapka.