By Perry Wu
Linktone, the Shanghai-based provider of wireless entertainment in China, recently did its IPO on NASDAQ. With much fanfare, its listing was accompanied by a party at the NASDAQ market site in New York's Times Square. Linktone's share price gained 24% on its first day of trading.

The company has a lot going for it and is basing much of its success on its production of mobile entertainment applications. You don't need to search very far in China to see that there is a substantial segment of the population that is addicted to electronic games and entertainment. Go to any Internet cafe in China, and most of the patrons will be playing some sort of game. Rather than desktop-based games, Linktone uses a wireless platform to deliver content to the fast-growing segment that uses mobile technology for communication (and hopefully leisure and entertainment). And Linktone has the advantage of high-quality entertainment partners, such as Turner Cartoon Networks and Star TV.

The numbers that Linktone released in its IPO prospectus look rather promising. Linktone in 2003 reported a nearly threefold increase in sales, from US$4.3 million of gross sales in 2002 to over US$16 million in gross sales in 2003. And unlike many Internet companies of yesteryear, Linktone actually turned a net profit of US$3.6 million. It also had substantial cash generated from its operations of US$2.9 million so the quality of earnings appears to be high.

So there is little quarrel with their current state of finances and their current market position. Indeed, the economics of a mobile games company should be very promising. The company only needs to concentrate on the content itself, while leaving the costs of building a distribution system up to the mobile service provider. But this is where trouble potentially lurks.

Linktone's banner sales year in 2003 allowed it to show a net profit, thereby tipping the scales in favor of doing its recent IPO. But a staggering 88% of its sales in 2003 came from just one customer–China Mobile. Generally, the only situation where it is viable for a company to be nearly totally dependent on one customer is where the customer is the government. This is possible because governments tend to be longer-lasting than companies. Additionally, governments tend to be better credits than companies. China Mobile, though vested with much government influence, is part of China telecommunications landscape that is quickly being decentralized and de-monopolized.

But China Mobile is a strong company so why should investors in Linktone be concerned? Indeed, for 2003 Linktone only booked US$164,000 of bad debt expense, an extremely small portion of its total sales, proving one benefit of dealing with one very strong customer. Yes, China Mobile has a very strong balance sheet and appears to be a long way off from having any sort of financial troubles that would endanger its ability to pay its bills to Linktone. However, an ability to pay bills is only one aspect of being a good customer, the other important aspect is having a good business relationship.

Currently, China Mobile collects fees for Linktone and takes a cut for itself of between 9% and 15%. It is easy to imagine a situation where China Mobile gets a little more greedy and decides to take a higher cut; in this situation Linktone would have little recourse. Even more ominously, China Mobile could provide similar services to Linktone's services, thereby cutting Linktone totally out of the picture. Linktone's rivals in China–Sohu.com, Sina.com, and Netease.com–have long done this with smaller mobile applications partners, so there is much precedence for China Mobile to do the same with Linktone.

Linktone is far too dependent on China Mobile and China Mobile knows it. This gives China Mobile an extraordinary amount of negotiating power with Linktone–one bad meeting between these two companies and this relationship could be imperiled. There are now a lot of good content companies in China and new ones are starting all the time, but there are very few companies with the power of China Mobile.

So China Mobile holds the key to Linktone's major distribution channel and Linktone would be finished if not for China Mobile. As long as Linktone uses wireless networks for its distribution, this will remain the case. In the future, one of a few outcomes may occur:

The first is that China Mobile, feeling increasingly under pressure to generate profits, will try to squeeze Linktone and other content providers into giving China Mobile a larger cut of sales from content. In the short term, Linktone will have little choice but to cough up more money.

A different positive outcome may be that the mobile operators may decide to take a page out of cable television's play book and buy Linktone and other content companies. This is exactly what happened recently when Comcast Cable in the U.S. made a failed bid for Disney. The idea was to forget about paying fees for content and just buy the content company outright.

Finally, another outcome may be that feeling squeezed by China Mobile, Linktone may decide to use an altogether different distribution channel. This channel could be something that already exists like the Internet or could be a new technology that hasn't even arrived. Something like UWB (ultra wide band) technology may present a threat to mobile operators sometime in the future, and that is why wireless companies in the U.S. are already using the levers of government regulation to try to stop it.

In addition to the pitfalls mentioned above, here are other caveats for Linktone in the future:

1) China Mobile and Unicom both are known for having incredibly long receivable cycles–sometimes more than 24 months! For a company like Linktone, ready cash will be more important in the future, and the only option is to take out loans based on China Mobile's repayment sometime in the future. Debt is bad. In an article posted here (https://www.chinatechnews.com/index.php?action=show&type=news&id=1) in September 2003 we highlight some of these delayed payments from China Mobile to mobile content providers.

2) Mobile gaming has been around for at least a decade–it's nothing new. Many mobile companies are banking on creating a new system for gamers to play their games. Many journalists are helping to create a mobile game buzz bubble around the world by regurgitating the business plans and dreams of marketing professionals from these wireless companies. The unfortunate downside is that gamers are still playing desktop-based games and mobile games are relegated to only being fads. Linktone will need to develop better non-gaming applications in order to survive.

3) Microsoft beat Netscape because Bill Gates made the browser the focal point of the desktop computer. In the same way, with faster mobile data speeds, the mobile browser will centralize the mobile experience and make the current selection of online content viewable on mobile devices (Ericsson and Handspring already have great mobile browsers). Linktone's competitors are not other mobile game companies; Linktone needs to worry about the thousands of websites and online services that already have large established user bases.

Whatever Linktone finally does in the future, its central issue will continue to be its relationship with China Mobile. Any faint rumors of troubles with this relationship should send shivers through investors' wallets.

About the author:
Perry Wu is a writer and correspondent for ChinaTechNews.com and can be reached here at the site. Perry Wu does not hold any positions, long or short, on any of the Chinese or American company securities mentioned in this article.