China Struggling With Fraud and Copyright Amidst Massive Internet Growth

Access to the Internet in China is continuing to expand rapidly. According to the China Internet Network Information Center (CNNIC), last year the number of China’s total Internet users increased 19% to reach 457 million. Not surprisingly, growth in the number of Internet users is driving online sales. In a report published by China e-Business Research Center, Internet sales in China, which includes business-to-business, business-to-consumer and consumer-to-consumer transactions, increased to 4.5 trillion yuan (~US$684 billion) in 2010. Overall, consumer online spending doubled to 513.1 billion yuan (~US$78.3 billion) in 2010 from a year earlier and accounted for nearly 3% of total retail sales in the country. The report predicts online retail sales to grow to over 1 trillion yuan (~US$153 billion) in the next two years.

Alibaba’s Financials
Alibaba’s (HKSE:1688.HK) Q4 revenues grew 37.6% over the year to 1.53 billion yuan (US$232.3 million). EPS for the quarter grew 50% over the year to HK$0.09 (~US$0.01). The company ended the year with revenues of 5.56 billion yuan (~US$714.6 million) growing 43% over the year. EPS for the year stood at HK$ 0.33 (~US$0.04) and grew 44% over the year.

During the quarter, the number of international registered users increased 21% sequentially to more than 18 million, and the number of China-registered users increased 5% sequentially to more than 43.7 million. The number of international storefronts increased 5% over the quarter to 1.7 million, and Chinese storefronts grew 4% over the quarter to 6.8 million.

Alibaba’s Infrastructure Expansion Plans
Alibaba recently announced plans to spend US$3 billion to US$4.5 billion over the next three to five years to expand its warehouse network across China. The company wants to expand its warehouse network in an additional 32 locations in the country. At present, it has warehouses in nearly 20 cities.

Fraud at Alibaba
Early this year, Alibaba was troubled by an increase in fraudulent transactions by the company’s Gold Suppliers network of high-volume members. The fraud involved authentication and verification of vendors despite their offering quantities of goods at attractive prices with payments made in “less reliable” methods. Such transactions had been on the rise since late 2009, and according to management, there were more than 1,200 fraud cases in 2009 and more than 1,100 in 2010. Reports say that the company has paid out $1.7 million to 2,250 customers because of fraud. To address market concerns, Alibaba announced a senior management change and appointed Taobao’s head, Jonathan Lu Zhaoxi, as its new CEO.

Alibaba’s stock is trading at HK$14.81 (~US$1.91), taking its market capitalization to HK$71.33 billion (~US$9.12 billion). It touched a 52-week high of HK$17.70 (~US$2.28) in February of this year.

Baidu’s Financials
Baidu’s (NASDAQ:BIDU) Q4 revenues increased 94% over the year to $370 million and were ahead of market expectations of $361 million. EPS of $0.50 was ahead of the market’s expected EPS of $0.45.

According to iResearch, China’s search market grew 67% last quarter to $487 million. Baidu’s market share grew from 73% a quarter ago to 75% last quarter. During the fourth quarter, the number of Baidu’s active online marketing customers increased 24% over the year to 276,000. Revenues per online marketing customer for the quarter increased 56% over the year to 8,900 yuan (~US$1,358).

For the current quarter, Baidu projects revenues of $360 million to $371 million compared with the market’s expectations of $355 million.

Baidu Works to Controlling Piracy
Earlier last month, the U.S. Trade Representative’s office identified a list of “notorious markets” and mentioned Baidu as an online service “engaged in “deep linking” to allegedly infringing materials, often stored on third-party hosting sites.” The site also came under tremendous pressure by Chinese authors for copyright infringement issues on its recently launched online library, Baidu Wenku.

To address these concerns, Baidu removed 2.8 million unauthorized items from Baidu Wenku. The library is now estimated to have fewer than 700 legally authorized documents for user reference. Baidu is working out distribution and revenue sharing agreements with authors to reinstate those works in the library.

The company is also addressing piracy in the music industry and will launch a licensed music service called Baidu Ting. The ad-supported service will allow users to stream, download, and create libraries in addition to letting them connect with their social networks. Baidu currently has content licenses from record label EMI and is in talks with other labels to add to the library.

Baidu Expanding Offerings
Besides the controversial Baidu Wenku, the document-sharing platform launched earlier last quarter, the company launched a mobile version of Baidu Maps. It also expanded its partnerships with other handset makers and Chinese mobile operators to provide Baidu search services on mobile devices. Earlier last year, the company launched its video site, Qiyi.com. Within eight months of the launch, the site has more than 100 million users.

The stock is trading at $139.10 with a market capitalization of $48.48 billion. It touched a 52-week high of $143.48 earlier this week.

Google’s diminishing role in China is also helping Baidu. According to market reports, Google’s share in the search market in China fell to 19.6% in the December ended quarter last year, compared with 30.9% in the first quarter last year. Google does not report revenues by country, but analysts estimate that Google earned almost $400 million revenues from China last year, a minor contribution to its overall annual revenues of over $29.3 billion. In the coming quarters, China’s contribution to Google’s revenue may decline further. Besides search, Google faces tougher challenges with its mail and map products. China’s State Bureau of Surveying and Mapping requires online map service providers to apply for licenses to operate their services. Google has not applied for the license despite the approaching deadline. The company also recently blamed local censors for disrupting its e-mail service.