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Impact of Google's Possible Departure from China

|Includes: AABA, BIDU, CRIC, CSCO, FMCN, Alphabet Inc. (GOOG), SINA, SOHU

Tuesday night I was shocked. The Chief Legal Officer of Google (NASDAQ:GOOG) announced in an official blog of its intent of negotiating for an uncensored search engine in China and its alternative choice of wrapping up the whole China operation. The blog also elaborated on the sophisticated web espionage activities originated in China to justify its decision. 

Quite a few authors at Seeking Alpha have commented on the event, but I feel I can add some unique observations from a viewpoint of someone who is familiar with both cultures, Chinese and American.

Capitulation. It is Google's capitulation. I don't know what kind of ordeal Google has gone through in China, but this event has all the look of a final showdown. Typically a company's response to the web espionage should be involving CIA and working out the incidents under the table. We, the mob, should hear nothing, at least according to the old rulebook. Plus, web espionage and demanding an uncensored search engine seem quite unrelated in my view. Google certainly demanded an uncensored engine in 2006, and they could not get it. But why should Google test Chinese government's bottom line again today? The true reason of Google's announcement, I believe, roots way beyond web espionage. Google encountered certain enormous frustration in China, so much so that it decided that it had enough. It is going to leave, but before it leaves, it wants to leave a mark in the history. 

It is not too difficult to understand the frustration. Chinese government serves quite a lot of its own interests since its power designation is from top to bottom, not the other way up in the developed countries. For Google to operate in China, it has to bend its belief and culture. To quote a line from the Matrix: "You see -- It is not the spoon that bends. It is only yourself".

Many companies do bend. Maybe every reader of this article knows the Great Wall in China, but I bet that not many of you know the Great Fire Wall in China, do you? Instead of trying to fend off 'uncivilized' nomads like its ancestor, the Great Fire Wall of China filters unwelcome sites, sensitive words, and keeps the 'uncivilized' culture from invading the Holy Middle Emperor-dom in this modern world. Who helped built this Great Fire Wall? It is no secret. Everyone in the industry knows. Cisco (NASDAQ:CSCO). They have equipments custom made for China, so sophisticated that they go really deep in the lower transportation layer to help keep Chinese people free from pornography and free from anti-revolutionary unharmonious information. 

Unfortunately, Eric Schmidt is no John Chambers. Google employees are also 'too simple and too naive' (Famous quote from former China President Jiang Zemin used in another context). They capitulated. Should they? 

Ma Yun, CEO of Alibaba, one I respect for wisdom, commented that it is a failure for Google to give up in face of difficult. I agree with Ma. Keeping engaging is a better way to improve China. But I have to acknowledge that my thoughts could be just selfish as a Chinese. In reality, Google may have found that it is not making money in China and it has to ruin its company culture in order to simply survive. The only rational choice is to disengage.

Gene Munster of Piper Jaffray estimates that the chance for Google to leave China is 35%. My guess: more than 70%. 

Chinese government is the spoon. In reality, it does not bend for Google. If it bends, it bends within. Google knows it, and knows it fully well. Google is saying goodbye to China, for now. And while it is doing so, it is leaving an unforgettable legacy behind. The cause of its leaving is one straw Google puts on the back of the thousand-year-old camel. This straw is not going to be the last one, but it is a straw. It is a regret for Google to give up China, but it is good to know that it does not need to help anything evil any more. I hope Google will survive in the business world long enough to go back to China, because I will like China at that time much better than the China now. Selfish speaking again.

Well, back from politics to business. In the void Google leaves, Baidu (NASDAQ:BIDU) will fill in. It is not surprising that it rises 14% in one day. However, I am speechless, without speech, on Baidu's valuation. If any, that will be "Beauty is in lover's eyes". 

I also believe some of the advertising dollars Google leaves behind will find ways to online portals such as Sina (NASDAQ:SINA), Sohu (NASDAQ:SOHU) and Netease (NASDAQ:NTES), plus the Allyes advertising agency under Focus Media (NASDAQ:FMCN). There are a lot of reasons to like these names. Sina is the best bet in my view. It is the only pure play in the online advertising space. This year there are a lot of factors working as its tailwind. China's still-booming economy plays the macro factor. The management had a successful MBO to keep the top talents and align the interests. A deal with China Real Estate Information (NASDAQ:CRIC) IPO added roughly $9 to its per share value via very smart 'financial magic', as I discussed in my previous article. New regulation in TV commercials pushes advertising dollars towards online platform, raising both demand quantity and price. If Baidu is Google in China, Sina is Yahoo (YHOO) in China, and this Yahoo in China has a market value only one tenth of Yahoo in the US. Now you have the imagination. 

Sohu and Netease are also going to benefit from the advertising dollars. However, they both contain a very significant portion of business in online gaming, and each has its unique idiosyncratic risks that you have to decide if you like or not. Focus Media should do well in 2010 after its bloody big bath it took in 2009 Q3. 

Google dropped a mere 0.5% today, coming back from a deficit of 2.4% at open. The market was responding correctly. Leaving China is not a bad thing for Google; it will only make its balance sheet more pruned and its efforts more focused. Google's action adds its value in the long run. 

Goodbye in Chinese reads Zai Jian, meaning see you again. So see you again, Google. 

Disclosure: Long SINA and FMCN. No positions in GOOG,BIDU,SOHU,NTES,CSCO,CRIC,YHOO