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Government on the Fence
Speculation grew about an IPO. Yet the most likely companies to go public, the
three Chinese portals, had hit a roadblock. Their success was helping popularize
the consumer Internet faster than the government had expected. Four million
Internet users was a drop in the ocean in a population of 1.3 billion. Yet the
things that made the portals popular, especially email and news, made a
government bent on control increasingly nervous.
Within China’s ruling Communist Party a debate was raging over how to
handle the Internet. Conservatives pointed out that the Internet had originated as
the project of a U.S. defense agency. They argued that just because it was new,
there was no reason to exclude Internet companies from the same restrictions
that prevented or severely constrained foreign investment in the telecom sector
or in print, radio, film, and TV. There was no “Ministry of Internet,” but the
Internet touched so many areas that it set off bitter turf battles between existing
regulators. To demonstrate their relevance, China’s regulators regulate regularly,
manifested in the “Great Firewall of China,” under construction ever since the
Internet came to China’s shore, an unceasing effort to filter content they deemed
a threat to the country or to Communist Party rule.
At the same time, with its huge investments in telecom infrastructure the
government had been actually pushing
xinxihua
—informatization—as essential
for developing China’s economy. There was consensus among the all-powerful
politburo standing committee—nearly all trained as engineers—that China
needed a “knowledge economy.”
An inability to adapt to new technology could spell disaster. The fall of the
Qing dynasty is popularly attributed in part to its failure to adapt to modern
military and industrial technologies, leaving it vulnerable to domination by
Western powers. Some in China also blamed the fall of the Soviet Union on a
failure to keep up with waves of technological advances in Silicon Valley, such
as the semiconductor, computer, and software industries.
But the government rejected any notion that the Internet would usher in the
Western concept of an “information society,” something they believed could
pose an existential threat to the Communist Party.
Yet without foreign investment, how could China’s Internet entrepreneurs
finance their ventures? Restricting them to domestic financing channels was
impractical. China’s own venture capital market was in its infancy, and its stock
markets were dominated by SOEs. In any case, the Shanghai and Shenzhen
exchanges required companies to have been in business for at least three years,
and to be profitable. All of China’s Internet companies were new, and operating
unashamedly at a loss.
China wanted a Silicon Valley, but one that it could control, built on its
terms. Yet the distributed, bottom-up nature of the Internet was inimical to
China’s traditions, both imperial and Leninist, of top-down control of
information. For those coming online, this was the Internet’s central appeal.
Professor Xu Rongsheng, who had helped establish the first connection
between the Institute of High Energy Physics in Beijing and Stanford University,
describes the impact of the Internet as an “information bomb” exploding over
China. Another popular description was that the Internet was “God’s gift to the
Chinese,” something echoed by investors and dissidents
2
alike.
Unable to stop the Internet, but nervous about facilitating its rise, how was
the government to proceed?
How could Chinese Internet entrepreneurs raise money overseas without
their companies being classified as foreign companies and walled off from
businesses in China? To resolve the contradiction the three portals attempted all
manner of contortions to secure government approval for their IPOs, arguing
they weren’t even Internet companies.
After months of debate, an accommodation was finally reached: the “VIE.”
The VIE, or “variable interest entity,” is much loved by corporate lawyers in
China for its rich, fee-producing complexity. Still in use today, it allows the
Chinese government effectively to have its cake and eat it, too—in this case
allowing a thriving entrepreneurial Internet, while maintaining control. The VIE
is the subject of ongoing debate for investors in Alibaba—how much protection
does it really give them? The structure allows foreign investors a degree of
control over the revenues generated by a Chinese company (through a
complicated arrangement of interlocking contracts) that, thanks to the personal
engagement of Chinese entrepreneur founders, continues to treat that company
as Chinese.
The compromise was brokered by Sina (and its lawyers) with the Ministry
of Information Industry (MII), amongst other agencies. MII minister Wu Jichuan
had earlier stood in the way of any portal IPOs, but the VIE broke the logjam.
His voice carried weight, as he was the architect of the drive for
“informatization,” the investment in infrastructure without which the country’s
Internet boom would not have been possible. The VIE has its origins in another
complicated investment structure
3
that a few years earlier Wu, ironically, had
taken the lead in dismantling.
On April 13, 2000, the first of the three Chinese portals finally got its IPO.
Sina raised $68 million on the Nasdaq. NetEase and Sohu soon followed.
But the portals were to have a very difficult birth as public companies. The
reason? The bubble had burst.
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