Google Mulls Chinese Withdrawal

Google (NASDAQ: GOOG) will stop censoring its website in the mainland, and consider pulling out of the US$1 bil. China search advertising market if it's not allowed to operate an unfiltered search engine - putting China's tough censorship laws center stage once again.

The US search giant announced Tuesday that it had discovered attempts to access personal email accounts of human rights activists, as well as other sensitive information.

Google lays claim to around 30% of China's lucrative search advertising market, second by a long way to local giant Baidu (BIDU), which controls more than 60%. The remainder is divided among several players, including Yahoo! China, operated by Alibaba Group (1688.HK).

In revenue terms, Google’s search share in China equates to about US$300-350 mil. pa in gross sales, according to MPA, equivalent to barely above 1% of its global revenues. Baidu generates about US$650 mil. pa in gross search revenues and controls more than 75% of search traffic as compared to under 20% for Google.

In this context, should it ultimately exit the search market, Google may not stand to lose a large portion of revenues today though its exposure to long-term search growth and a huge business opportunity will dramatically reduce. Its shares shed 1.9% from Monday to US$589.86 at Thursday's market close.

Chequered Past
Google initially came under fire when it launched its Chinese search engine in 2006, with rights advocates indicating that the company's self-censorship policy in the mainland was at odds with its famous corporate philosophy to "Do No Evil".

Google appears to be taking the higher moral ground to preempt a potential public backlash, should the discovery have been made public later on.

However, Google has also faced challenges in understanding the local market. The company, along with Baidu, was accused by CCTV of spreading pornography in China. It has also had apologize to Chinese writers for publishing their work on Google’s online library without permission. And, outgunned by Baidu’s large sales force, the company decided to invest more in sales at the expense of R&D but was then dealt a blow when CEO Li Kai-fu resigned his post last September.

Local players see opportunity
Baidu is the most obvious beneficiary of a Google exit, although it could also suffer if it is viewed as complicit in restricting freedom of speech. More interesting is the potential battle for second place, with portals with a smaller share lining up to take the space vacated by Google. While Baidu shares gained 15.9% to US$464.23, Tencent (0700.HK) shares were up 2.1% to HK$172.40, from Monday evening to Thursday’s close. Another online major, Sohu (SOHU) gained 2.5% to US$60.40.

SoSo, operated by Tencent, is the third most popular search platform in China in terms of traffic with a 3% market share but has less than 1% of revenues. Tencent’s search partnership with Google expired towards the end of 2009 and the company will likely refocus on developing SoSo further. Tencent’s search revenues for FYE Dec. 2009 are expected to come in at ~US$15 mil.

Upsetting the apple cart
If Google's announcement was meant to serve as a larger debate on China's censorship laws, it seems unlikely other US giants, such as Yahoo and Microsoft, will get on board, and risk destabilizing a more significant portion of their revenues.

Yahoo remains committed to China: in 2005, it sold exclusive rights to the Yahoo China brand – including its mail, messaging and search engine – to the Alibaba Group. The US$1 bil. deal gave Yahoo a 40% stake in Alibaba and essentially reduced its role from an fully operating business to a financial investor, without any control in the business. Most, recently it's been making forays in e-commerce  with a stake in Alibaba subsidiary Taobao. An IPO is expected later this year.

Microsoft meanwhile, has multiple revenue strands embedded in China, including a Chinese language version of its search engine, Bing. In addition, it has invested in research and development centers, and sees a great future in selling its Windows operating software to China.