China's Dot-com Darlings Tap Cheap Global Credit

Umesh Desai and Pete Sweeney
Bloomberg | Getty Images

Chinese search enginecompany Baidu paid a lower interest rate thanGoogle when it sold $750 million in 10-year bondslast month.

China's three dominant dot-com names - Baidu, Alibaba and Tencent Holdings - havesuccessfully tapped global funding this year, stockpiling acombined $6 billion in debt despite investor skepticism aboutopaque Chinese companies.

The big three plan to use the money to pad their industryadvantage at home, to compete better abroad, and perhaps to buycash-starved rivals.

Ultra-low interest rates on U.S. government bonds, thebenchmark against which most debt is measured, have driven downborrowing costs around the world. That has been a boon tocorporate borrowers who are finding plenty of yield-hungryinvestors willing to extend long-term credit.

"The mature guys, Alibaba, Tencent, Baidu, these guys needto fund new growth. They are incredibly dominant in China, sothey need to expand into international markets and create newproducts," said Sean O'Rourke, an analyst at Shanghai-basedRedtech Advisors.

O'Rourke said the money that Baidu raised in November - atotal of $1.5 billion in 5- and 10-year bonds - would be morethan enough to buy some of its smaller rivals, and said therewere "dozens" of potential takeover targets.

While Baidu said it intends to use this tranche of funds forcross-border acquisitions, it could potentially spend it onbuying domestic competitors that have listed abroad.

Baidu's bond sale was notable both for its size and itsreception in the market, which has been skeptical of U.S.-listedChinese companies after a rash of accounting scandals. Thehurdle was especially high for Baidu because it lacks thephysical assets bond investors prefer, and it was seeking a10-year term, which is a lifetime for a technology firm.

Yet it managed to sell the debt at a yield of 3.518 percent,just 185 basis points over the risk-free rate that is normallyassociated with U.S. Treasury bonds.

Google sold 10-year bonds in May 2011 with a yield of 3.734percent. Treasury yields have fallen since then, so if Googlewere to tap the market now it might obtain a lower rate.


The bond market embrace comes at a good time for technologycompanies because corporate the governance scandals have all butshut down another popular funding avenue - listing of shares onU.S. exchanges.

Just two Chinese technology companies have successfullylaunched U.S. initial public offerings this year, includingnewly listed YY. That's down from 15 in 2011 and wayoff the 41 issues in 2010.

These IPOs have raised only $153 million this year, comparedwith $2.17 billion last year and $4.01 billion in 2010, ThomsonReuters data shows. By contrast, Tencent and Baidu raised $2.1billion via bond issues this year, while Alibaba has raised amassive $4 billion in loans.

"It's a lot faster and simpler to raise bonds - raisingequity would result in share dilution and takes a longer time,"said Thomas Chong, Internet analyst with BOCI Research in HongKong.

Chong said the companies were keen to borrow even thoughtheir balance sheets are loaded with cash because they need U.S.dollars but their revenue is primarily in yuan.

Tencent is expected to nearly double its free cash flow inthe current year to 18.3 billion yuan ($2.94 billion), accordingto Nomura. Baidu's free cash flow this year is estimated to hit8.0 billion yuan, Credit Suisse said in a report.

China's tax laws provide another incentive to borrow in theinternational credit markets. If Chinese companies use domesticcash to repay foreign borrowing, they would have to pay aremittance tax of as much as 10 percent, said Catherine Chan,head of investor relations at Tencent.

"Raising offshore capital to repay offshore loans throughbonds issues will help optimize our tax obligation whileallowing us to take advantage of the higher deposit rates inChina by parking cash generated from our operations onshore,"she said.

Size Matters

Credit investors and analysts doubt that the positivereception afforded to China's tech giants will trickle down tosmaller players whose prospects may be less certain. That meansdebt markets won't replace IPOs.

Many Chinese Internet companies could use cheap bond fundingright now, especially those in gaming and e-commerce. But thelesser known firms are eyed suspiciously because they lack solidassets and their cash flows are unpredictable.

"It will take some time to educate the bond market aboutInternet companies, given we are usually asset-light and have ashorter track record than traditional brick-and-mortarindustries," said Tencent's Chan.

Even for established names, market perceptions can changerapidly: Yahoo lost 80 percent of its market capitalisationsince its Internet peak in 1999 while Google's stock has risenmore than six-fold since its stock market debut in 2004.

"If you look at the rapid rate of changes in technology andconsumer behaviour, I would be concerned about holding debt inthe longer term. You could, for instance, have some newplatforms or delivery medium emerging and taking over from thesesites," said Tim Jagger, Singapore-based portfolio manager atAviva Investors.