A new article about our portfolio company Feilio (Noank Media) in today’s New York Times titled “Building the Tools to Legalize P2P Video-Sharing” by Janko Roettgers. 

Would you be willing to pay your ISP five bucks a month to be allowed to download as much as you want from torrent sites and other file-sharing hubs? The idea of legalizing P2P through such a flat-rate licensing scheme has been getting more and more traction within the music industry in recent months. Noank Media CTO Devon Copley believes his company can be an essential part of such a flat-rate model.   

Click here for entire article. 

Over the next couple of days, I’m sure the wires will be burning with chit chat from pundits, portals and web jockeys about a regulation that has been re-approved by State Administration of Radio, Film and Television (SARFT) and the Ministry of Information Industry (MII) that will ban (effective 31 January 2008) Internet Service Providers and portals from broadcasting video that, according to a Canadian Press article, involves:

“…national secrets, hurts the reputation of China, disrupts social stability or promotes pornography…providers will be required to delete and report such content…those who provide Internet video services should insist on serving the people, serve socialism…and abide by the moral code of socialism…”

And by re-approved, we mean that some form of this regulation has been on the books for several months but it was only this week that SARFT and MII decided it was now time to set about enforcing it.

The market is a bit unsure how this will play out and/or how this will impact existing user-generated video hosting services, such as Tudou.com (which claims to hold 22% of China’s vlogging market share) and 56.com (flush with US$20 million in fresh capital from Adobe Systems, CID Group, Steamboat Ventures, and Sequoia Capital).

Indeed, much of the uncertainty (as is the case with most, if not all, policy initiatives spun out of SARFT and MII) rests not in how closely these sites comply to the new regulations (as they won’t necessarily have a choice whether or not they want to work with a state-owned license holder – they just have to or close-up shop) but rather in the government’s interpretation of what “…hurts the reputation of China, disrupts social stability…”.

I’m guessing SARFT will move relatively quickly to provide the market with a “test case” so that they can frame their interpretation, sending a shot across the bow of some of the more adventurous entrepreneurs, especially in light of this summer’s Olympics.

We’ll get more viability on this over the next couple of weeks as more information is made available on the back of several meetings organized between the major portals and SARFT/MII.

Regardless, I’m pretty sure this puts the kibosh on any short to medium-term plans user-generated video hosting services had for raising additional (or seed) capital as investors’ will surely start dragging their feet – not so much because of the blue sky regulatory risk but rather because momentum seems to have been sucked out of the market (at least for the time being).

But…what about those sites legally distributing and hosting content directly from copyright owners (e.g. StarTV, Disney, and Tianyu)…how will this impact the one or two ventures operating in the legal content space? And by the “one or two” I think its obvious I’m talking about one specifically, Feilio, the Beijing based digital content services supplying Chinese ISPs with legal content (MP3, video, educational material).

If anything, SARFT and MII’s new policy places a premium on services which not only guarantee the authenticity of content but also complies with China’s existing content import regs. To wit, if I’m an ISP or a network in China (between now and summer) I’m not walking but running to legal digital content services – why leave anything to chance?

As a parting thought, it is important to note that we’re not advocating tighter regulatory controls as, way more often than not, aggressive regulatory regimes strangle innovation (boo) but you’ve got to adapt to the business environment your operating in…or risk becoming irrelevant…

Today, we received Piper Jaffary’s latest China Analyst research note titled, “Music in China – Monetization Through Mobile Platform.” While we don’t have any major issues with their thesis that “several new developments [in China music industry] suggest that monetization of music, through mobile services, is beginning,” we do want to call them out on how profitable music will be for content providers, distributors and intermediaries.

First, here are some key findings on China’s mobile music market (source: Piper Jaffary 3/06):

We estimate the Chinese mobile music market size to be approximately $200-$400 million in 2006 consisting primarily of ringtone and caller ring back tone sales.

Yet, in both the U.S. and in China, young people who will almost never pay to buy a CD or download legal copies, happily pay $5-$20 per month in the U.S and $1-$4 in China.

What [kids] are telling us and the industry is that they are willing to pay for music, but only on their terms.

Good stuff, yeah? Sure, but wrong conclusion! Kids/adults in China (and everywhere else in the world) aren’t paying for ringtones because they want to, and surely not “happily” – they pay because they have no alternative; the mobile companies control the mobile pipe, the gateway, and without paying for that mobile connectivity kids/adults would be, well, they would have talk to each other a lot more. Come on Piper, get with the game – you guys sound a bit, well, a bit square (“Gee, Beav, I don’t know?”).

This gets us to our point, finally, that content is going to be free, all content that is, the music industry as a content provider will need to own that pipe if they hope to profit from mobile sales; and the reason, moving forward, is one acronym: 3G.

What makes people believe that they can control file sharing through mobile phones anymore then they control it now on PCs? Widespread use of 3G (medium – high end users) in China is a couple years off, maybe 3 years, however we are already witnessing the proliferation of WiFi enabled phones (Dopod 818pro in the house!) and WiFi hotspots in China; we believe this makes any hope of earning a sustainable profit from music in China a pipedream (ex-our carrier friends – love that growing ARPU). And, we haven’t even touch upon “off-line” mobile P2P sharing but that’s out there, too.

For the record, so Piper doesn’t cut us off, we think the guys at Piper do a great job, it is just we don’t agree with them on the medium to long term picture of music in China.

New York Times reporter Joseph Khan reports on comments made by Liu Zhengrong, Head of Internet affairs for the information office of the Chinese State Council, regarding China’s control over the Internet:

“If you study the main international practices in this regard you will find that China is basically in compliance with the international norm,” he said. “The main purposes and methods of implementing our laws are basically the same.”

“Major U.S. companies do this and it is regarded as normal,” Mr. Liu said. “So why should China not be entitled to do so?”

AOL launched its new Chinese portal over Chinese New Year targeting Chinese living in the US – we tried the search feature from Beijing and there doesn’t appear to be any blockage of information.

The timing of the launch is interesting – perhaps a marketing ploy set at distinguishing themselves from Google, Yahoo! and MS – the difference being, AOL servers seem to be hosted State side. No street cred there, AOL.

Most of the commentary we’ve read applauds AOL’s open search, proclaiming “…companies have choices…despite what they may claim…” but this is just ignorant and misses the bigger picture – AOL can’t make it in China and they realize this (otherwise, why they are targeting US based Chinese when ever other US portal/search is in China?)

First rule of doing business in any foreign country (for example, China) is localizing, working within the system, sticking out performance wise, yet remaining under the regulatory radar (as much as possible). AOL recognizes that if they rolled out a meaty China operation (not as Time-Warner, but as AOL the Internet play), such as Yahoo!, Google, and MS have, odds are extremely good that their search parameters and content would echo that of the big three.

(on the soap box)

We aren’t here to defend China, but rather to provide some perspective – which, by being on the ground for over a decade, is somewhat clearer than pundits across the pound. China is an amazing, frustrating, backwards, confusing, quagmire of conflicts, resolutions and more questions but at the end of the day what truly separates the success stories from the failures is sustainability and adaptability (i.e. frequent trial and error) to China’s evolving landscape and power plays. That is why a quality/gritty/grounded management team is more important than the size of the market or uniqueness of IP – other investors feel differently, but we don’t.

(off the soap box)

We have tried very hard to avoid talking about the “Google & China Issue” but in light of last night’s USA Today article about the new bill drafted by US Representative Chris Smith (R-N.J.) we couldn’t hold our tongue any longer.

Rep Smith seeks to…

…force Internet companies including Google, Yahoo and Microsoft to keep vital computer servers out of China and other nations the State Department deems…

We don’t understand the fallout over this issue — the rules of doing business in China have not changed in decades — why the sudden drama!?

If you think about it, is there any difference between what China is asking Google to do and what this new congressional bill seeks to do?

To be honest, we think the US would be better served if Congress worked to protect US corporate IP…

A couple days ago, HBO (Home Box Office) petitioned the FCC (Federal Communications Commission) in the United States to prevent consumers from recording their content (Subscription Video On Demand) – either with a VCR, DVD, or TiVo device. Sure this doesn’t have a direct impact on those of us living in Hong Kong and China – where HBO doesn’t have the traction it has in the US – yet HBO is representative of the losing battle the incumbents (broadcast networks) fighting – and losing dearly.

My general thesis is that all content will be free in the very near future and that DRM (Digital Rights Management) is not a sustainable technology. I’m not supporting piracy; I just believe it will be very difficult to generate any revenue from content alone. Where the money will be made is on product placements and side promotions, for example. Listed companies, such as Tom.com are spending a lot of money in rights to content that they won’t be able to control – in other words, their business strategy is dead wrong.

The companies that will be the winners, the next Google, will be the companies that develop technologies to harness, distribute and monetize this free content. Yahoo, for example, if a big buyer of networks and page views (note its purchase of Flickr’s 8 million users); yet they are not a buyer of technology…

The reason I believe this sector (e.g. BitTorrent) is a massive opportunity for start-ups is simply because there is: (1) demand, (2) users, (3) exits. The “demand” and “users” are clearly defined, but the “exits” – how will they come? I believe “exits” will come from the major portals, such as Baidu, Sina, and Tencent. The reason is simple: these listed companies can’t develop this technology in-house, but it isn’t because they don’t have the capability, it just that they can’t be seen publicly supporting file sharing, for example.

This is why technology start-ups (in this space), especially in China and Hong Kong, are so attractive (at least to us) and why we believe the next MONSTER company will come from this space.

Earlier this month, Starbucks won its copyright infringement case against Shanghai Xingbake Cafe Corp. Ltd. — surprisingly, Starbucks is the first international company to prevail under a 2001 Chinese law meant to protect well-known international trademarks. According to a report on Yahoo! Finance:

A Shanghai court ordered Shanghai Xingbake Cafe Corp. Ltd. to stop using the name Xingbake, the name used in Chinese by Starbucks Corp. “Xing”, pronounced “shing,” means “star” in Chinese, and “bake”, or “bah kuh,” sounds like “bucks”.

This news, while very encouraging (big thumbs up to judge Lu Guoqiang), is chronically overshadowed by daily reminders of blatant IP infringements, such as the photo I took this afternoon of my favorite candy bar, KitKat:

KaKes is manufactured by Hongyi Food — I couldn’t bring up the website so I don’t have much information to report back, my bad.

Anyhow, in the words of the incomperable American singer and dancer, Paula Abdul “…[we] take-two steps forward, [we] take-two steps back…”

Since December 2005, I have had no less than four phone calls from Chinese ISP and domain registrars telling me that some one wants to register a domain name that corresponds to or sounds like our company name in Chinese. I’m told the only way to stop this third party from registering my domain name is by paying them RMB 13,000. Whatever!

I don’t think there is anyone wanting to register a domain. I think they’re just going through the phone book or Googling companies — making this up as they go along. Anyhow, domains don’t have the value that they used to thanks to Google Base, Del.icio.us, etc.

Yesterday, Apple announced that iTunes customers purchased over 1 million videos since videos debuted about 20 days ago on October 12, 2005.

Customers can choose from over 2,000 music videos, Pixar short films and hit TV shows for just $1.99. Top downloads include music videos from Michael Jackson, Fatboy Slim and Kanye West; Pixar’s “For the Birds” and “Boundin’”; and episodes of ABC’s hit TV shows “Lost” and “Desperate Housewives.”

I’ve personally bought several videos, mostly Lost episodes. Music videos are nice, but there are only a handful I’d actually want to watch repeatedly. TV shows are great, though. The picture quality could be tweaked a little, so viewing on a Mac was a little better…

Meanwhile, Sprint Nextel has launched the first US music download service aimed at mobile phone users.

iTunes doesn’t have this functionality…but I know of one IT company based in Hong Kong (just down the street from my office) developing a mobile platform that searches for MP3s and then allows users to download these songs to their mobile phone…they earn money from the download (it works quite well)…interestingly enough the company is listed on the Hong Kong Exchange…in my book this is illegal…and they should be delisted for developing this functionality….

Along the same lines, I read an article from Beijing News reporting R2G’s suit against CDC, Hurray and Any8 for music copyright infringements:

Beijing based online intellectual property piracy monitor R2G will sue wireless value added service providers CDC Corporation (Nasdaq: CHINA), Hurray (Nasdaq: HRAY), Any8 and Altratek for mobile music copyright infringement, R2G told The Beijing News on Monday…

I understand “China is a developing country…blah blah blah” but this does not give companies, especially listed companies, the right to profit from illegal downloads…if fact, I strongly believe after several warnings, if a public company continues to engage in this sort of business they should be delisted…period!

My view is if you aren’t creative enough to come up with unique content or smart enough to structure deals to distribute exclusive content that people are willing to pay for…then there really is no long term business model for your platform…how many “distribution” sites can the market support?

Here is a hint…look at the broadband market in the US…its consolidating…fast! Om Malik from Business 2.0 has a lot of intelligent things to say about this, click here to read more

Last week, we blogged that SAFE would release new rules governing Chinese residents and foreign capital in early Novemeber…well, they jumped the gun…

Shanghai Daily reports on Circular No. 75’s new guidelines:

CHINA’S foreign exchange regulator has relaxed controls on Chinese residents and companies seeking funds from overseas as it hopes to boost the development of high-tech entities and venture capital firms. Residents and companies will be allowed to set up companies abroad, which the regulator called as special-purpose entities, to access the overseas capital markets. The new rule, to take effect from the beginning of November, requires the overseas firms to transfer income back to China within 180 days of them making a profit.

So why is Circular No. 75 an improvement? Well, a couple things: (1) It drops all references to “approval” as per Circulars 11 and 29; Circular No. 75 only refers to “registration” and (2) No valuation required of domestic assets (other than for State-owned
assets, which has long been the position)…

SAFE and MOFCOM delivered drafts of new proposed SAFE Circulars (Notice 11 and Notice 29) regulating offshore restructurings and mergers and acquisitions involving PRC residents. Rumors suggest that the Draft SAFE Circular will become law as early as November 1, 2005.

I was talking to Rob McCormak, Mustang Ventures, about the New Draft Circular and how it might impact the future of venture investing in China. Rob’s general assumption is that the ambiguity and increasingly complexity of Chinese tax and legal system, including SAFE, increases the importance of using “good, high priced lawyers and auditors” for the best possible legal & tax advice.

I tend to agree with Rob that China will become the most litigious society in the world but I think as more local companies organize offshore there will be more resources and alternatives to the “high priced lawyers” currently operating in China…at least I truly hope so…

The Draft SAFE Circular key points (from law firm Lovells Beijing):

– offers no clear application scope: “PRC resident” still open to regulatory interpretation;

– requires registration with SAFE prior to the establishment or acquisition of control of an offshore special purpose company (“SPC”) by PRC residents;

– offers no clear standard of review by SAFE or indications as to the level of difficulty and the time required in obtaining approval;

– requires retrospective compliance by Chinese holders of interests in pre-existing offshore SPCs before December 31, 2005;

– regulates interests held through trusts, nominee arrangements, voting rights, convertible bonds or other such similar methods;

– requires a third party appraisal for share or asset purchases at the PRC level – without clear indication as to the qualification of the appraiser or the cost involved;

– does not allow parking of funds offshore for PRC residents – must repatriate to China;

– requires PRC residents receiving offshore dividends or income to repatriate forex to China within 180 days; and

– requires the reporting of material changes in capital structure of the SPC to SAFE within 30 days of occurrence.