It happened with automobiles and it happened with personal computers. If you subscribe to Michael Porter's classic "Lifecycle of an Industry" framework - the end of the growth stage is marked by a structural change from a fragmented industry, to one dominated by fewer, more powerful players.
The cycle of this current 'e' business revolution has occurred in a much shorter time frame than any industry in history. Only four or five years after the introductory stage of the internet, analysts are already saying consolidation is required for the industry to mature - a prerequisite if markets are to regain interest in internet and related technology investments.
Even those Asian companies that are already in a position to excite the capital markets without growing through acquisitions are faced with secondary boards in the region that have dramatically underperformed their global peers. Speaking at a Gorilla Asia conference held recently in Phuket, Thailand, Salomon Smith Barney's managing director and head of regional equity research, Otto Wong, said this underperformance was due to, "some fundamental structural flaws in the way they've been established."
But, according to Wong, capital markets professionals and investors cannot be singled out as responsible for the correction we have seen in the last six to eight months. Indeed, an 'at the coalface' survey of 35 global investors and institutions revealed that companies themselves are not doing enough to inspire confidence.
Seventy percent of those surveyed thought internet companies in Asia lacked a clear profit model. Fifty-five percent of respondents thought the companies were taken to market far too soon, and many thought venture capitalists and investors had pushed for this. In addition, around 50% of fund managers and investors thought that internet companies had no idea about the relationship between equity markets, investors, equity analysts, liquidity, trends and - more importantly - information disclosure.
The conclusion is that many companies in their current form are not considered worthy of investment dollars. To change that perception, or to just survive, consolidation is the only answer.
"If anything, I'm surprised how little [consolidation] has happened to date. It's taking a little time for the reality to sink in," says Asiacontent.com CEO Chris Justice, who has, as head of a listed company, been approached regularly by companies seeking to be bought out. This is due in part to inflated expectations of valuation from private companies, he says. "Perhaps the reality of where the public markets are hasn't quite filtered back."
Ravi Chidambaram, managing director at Bear Stearns in London, agrees. "I think the main reason is that the capital markets, both private and public, have been reasonably forgiving." But that is likely to change and institutional shareholders will be the catalyst for the entrepreneurs themselves to drive consolidation.
Rajeev Gupta, executive director at Goldman Sachs, relies on numbers to predict how things are going to play out. He calculates that 20% of the companies currently will wither away. Of the remainder, 75% are likely to get involved in consolidation amongst themselves regionally in Asia and the balance of 25% will be attractive targets for international companies.
Buy or be bought
With the "buy or be bought?" question beginning to be debated in the boardrooms of technology companies across the region, management needs to make a realistic appraisal of where they sit in the food chain. Entrepreneurial egos may be one obstacle to consolidation, but in the end it will be a matter of merge or die for many privately held companies.
Already there has been some consolidation, with listed companies acquiring smaller non-listed companies, for example tom.com boosting its limited stable of content by acquiring Mainland China sports portal shawei.com. But Gupta says we will soon see more mergers between listed companies and eventually an increase in the number of international companies with successfully built brands coming into Asia and making acquisitions.
Regardless of the size of the deal, any acquisition has to be about accelerating the path to profitability, improving the quality of management and revenue stream, or improving products and services. Without any of these, the market won't be responsive to a company's goal of going public, or boosting a flagging share price.
Investment banks' interest in the consolidation process is a strategic one at the moment because deal sizes are quite small, particularly with unlisted companies. "We generally look for deals of $100 million and above in terms of those giving us fees that are justifiable," says Chidambaram. "Our biggest competitor sometimes is NA - no advisor. You will see a lot of deals getting done, especially at this stage, without advisors."
But Goldman's Gupta says he and his colleagues spend a lot of time advising smaller companies for free in the hope of building up a relationship that might see them making money from larger transactions and eventually an IPO.
Dual listings
Once a company is in a position to list, investment bankers are recommending it sets its sights beyond the Asian bourses. Nasdaq is the place where any self respecting technology company wants to be, because despite its ups and downs this year it has dramatically outperformed any secondary board in Asia. Wong says part of the reason for this is the quality of the companies that are listing on Asian growth boards, as well as flexible listing requirements that can differ depending on which company is seeking a listing.
Victor Lai, analyst at Chase JF, says that in Hong Kong the Securities and Futures Commission (SFC) has assured investment bankers that regulations giving favourable treatment to larger market cap companies listing on Hong Kong's secondary board, the Growth Enterprise Market or GEM, will be tightened in the next one or two months.
But even if regulations here do improve, Wong says Salomon Smith Barney is advising clients that are ready, to go for a dual listing on Nasdaq as well as a secondary Asian board. This is a way of countering the problems inherent with Asian bourses, as well as giving the company the extra reputation boost that can come with a Nasdaq listing.
For many Asian dotcoms and technology companies, a listing of any kind could be just a pipedream. But those who can think strategically and play the consolidation game well might end up surviving and even prospering.
