By Perry Wu
Here they go again. Yunfan Zhou and Nick Yang, both veterans of ChinaRen and Sohu, are back with a new company called Kongzhong. And two weeks ago Kongzhong Corporation submitted its IPO filing to the U.S. SEC. Roughly translated into English, "Kongzhong" means "in the air", and investors would be wise to take a little air out of Kongzhong's profit figures.

Kongzhong is a provider of second generation (2.5G) services to Chinese mobile phone carriers with such services including online games, news and message boards, all delivered via mobile phone. Until a few months ago, the only provider that it did business with was China Mobile. Now Kongzhong also provides services through China Unicom.

As noted in an earlier article on Linktone, another provider of wireless services to mobile phone users, there are particular hazards in such dependence on China Mobile. Most importantly, China Mobile is known in the industry as a very slow payer on accounts receivable. Why does China Mobile behave like this? The quick answer is because it can. It is, along with China Unicom, the only game in town.

Take particular note of the growth in Kongzhong's accounts receivable as a percentage of profits. For the three months ended March 31, 2004 the company had profits of US$3.1 million, but its accounts receivable increased by $1.6 million, casting doubt on the company's ability to generate cash, not just book profits. This is an unavoidable consequence of the company's almost total dependence on China Mobile and the interminable wait for payment on its accounts receivable.

Zhou and Yang sold ChinaRen to Sohu.com in 2000, and joined Sohu as executives. With Sohu's stock price hitting single-digit lows in early 2002, the two-person team showed their concern when the going got tough by jumping ship in March 2002. Only two months later they struck again and founded Kongzhong.

With Zhou and Yang's prior experience with public companies, Kongzhong was able to move quickly to its IPO. Even for an Internet company, Kongzhong's speed from start-up to IPO has been rapid. It took just two years from inception to IPO.

And rapid this IPO is. Kongzhong's whole success rests on the fantastic quarter it just had in the first three months of 2004. Its net income for just that first three months of 2004 was US$3.1 million, while its net income for the entire year of 2003 was only US$2.4 million.

Unfazed by the enforcement actions in the U.S. by Elliot Spitzer due to peddling tech companies it knew were garbage, the investment banking arm of UBS has embarked on a similar quest with Chinese tech companies. Clearly, the management team of Kongzhong has a cozy relationship with the bankers at UBS. The relationship has allowed them to pounce on Kongzhong's good quarter, and immediately pull together Kongzhong's SEC filings, executing the IPO at the earliest possible opportunity.

But a quarter does not make a company. Kongzhong isn't even close to showing that it can be a reliable cash generator in the months and years ahead. It is simply unclear whether Kongzhong's first quarter of 2004 was a fluke or a sign of more good times ahead. Judging from the management's past history, investors should be especially wary.

The Zhou and Yang gang doesn't have a good record on creating shareholder value. They seem to be wheeler-dealer stock flippers with proven little regard for shareholders. The day that Sohu announced its acquisition of ChinaRen, which led to Zhou and Yang joining Sohu (September 14, 2000), Sohu's stock price closed at US$7.63. This proved to be a raw deal for shareholders as Sohu's stock price only shrunk during Zhou and Yang's tenure. By the time the two bid farewell to Sohu, Sohu's stock price was a mere US$1.01 (March 31, 2002). To paraphrase a famous American baseball executive, Sohu could have finished last without them. Incidentally, Sohu's stock price is now many times higher since Zhou and Yang left.

But we have only concentrated on their past. Let's look at their future.

Kongzhong is in a business with hundreds of competitors. Not only are mobile-only companies offering the same services, Web-based businesses and offline businesses are all clogging the market.

Dozens of brave foreign investors trudge into the Chinese wireless landscape only to come out with totally different (usually non-wireless) business models, or bankrupt. The business models of Sunday, Virgin, or Orange might work in other parts of the world, but they do not work in China. A company just can't get a large enough percentage of each message sent: at 1 jiao (0.10 CNY) a message, it takes a million messages to earn US$12,000 and after deducting a 10-15% uncollectable rate and then China Mobile's 30-60% take, a business is left with very little. Don't forget that to get a million messages sent it might have cost upwards of US$10-30,000 of advertising and marketing. Go and invest in China Mobile if you want to be with a company that has real earning power.

Finally, in China you have to deal with China Mobile to make the real money. And when China Mobile's thumb goes down, a company can lose a lucrative revenue stream. Take eBay for example. A few weeks ago China Mobile pulled the plug on one of eBay's local Chinese entities' wireless services. Can the same thing happen to Kongzhong? Of course. And then Kongzhong, which is a 100% wireless company, sits moored on a dry riverbed.

So kudos to the Kings Kongzhong for knowing how to enrich themselves. But serious investors should stay away from this latest attempt at cashing-in on the China Miracle.

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.