GraphOn and Zi's VC-30 Risk Ratings: V-1 and V-2

By Douglas C. McGill

Here are two decent and fascinating China Internet plays. In a market that's vast and expanding, complex and murky, they both have a single overarching strength: their product is easy to understand.

True, neither GOJO nor ZICA are as simple to grasp as a Warren "Coca Cola" Buffett stock. But for Internet stocks they're perfectly straightforward, fitting perfectly into the overall China Internet story. They do so by claiming to plug giant gaps that need plugging in order for the China Internet to fulfill its enormous promise, so obvious to all.

The vast majority of 1.4 billion potential Web surfers, for example, don't speak or type in English, and so won't be able to get on the Internet without being able to control their computers by writing in Chinese. Presto: Zi's Chinese character input software and keypads. Similarly, there's no way China's 260 million schoolchildren can keep up with their counterparts in the West, if the schools are forced to pay for every upgrade of their computers and software. Presto: GraphOn's "thin client" software gives the most primitive PC's the ability to access and download sophisticated computer applications.

But will GraphOn and Zi turn out to be the companies that do fill these gaps in China's Internet development -- and so reap rewards for their investors?

Here's how Stir Fry rates the odds. Because Virtual China has previously published lengthy articles about these companies, the ratings are shortened from the regular "Seven Questions" format, and the company names below are linked to our earlier stories:

1. Zi Corporation: One of the great "story stocks" of the China Internet explosion, Zi's promise to embed Chinese character input software into PC's, wireless smartphones, and TV set-top boxes in China has caught investors' imaginations in a big way. The share price has soared 1,600 percent in the past year, from 1.90 to 34. Is there more to Zi than its story? A lot remains to be seen. The steady stream of acquisitions and licensing deals the company has lined up are impressive. Legend, China's top computer maker, said it would bundle Zi's programs into its computers; the company bought the Beijing Oz Education Network that develops and distributes Internet-based courseware; and a set-top box maker that is affiliated with China's powerful Ministry for Information Industry, which regulates the Internet in China, said it would incorporate Zi software. The company has a strong balance sheet for an Internet company (i.e., it has cash in the bank but no earnings), and has no problem raising money privately. Last Thursday, the Alberta-based company closed a $25 million private placement with eight institutional investors including Baystar Capital, New World Investment, and Morgan Stanley Dean Witter. Yet the company's sky-high share price is justified only if its many deals bear fruit, and it's unclear when they will. Sudden shifts in the competitive and technological landscape in China leave it vulnerable. For example, Zi's early emphasis on getting its software into set-top boxes now looks a bit misguided, as wireless applications become China's Internet access device of choice. And Zi's big payoff -- using its widespread acceptance as a computing platform to develop and sell applications of all kinds -- is even farther down the road. The company's done a great job so far, but there are still too many variables in the China Internet market to say Zi's chances are better-than-average at becoming the powerhouse its share price demands. One of the threats is serious competition: Tegic Corporation also makes a character input system; there are handwriting recognition programs available; and in the area of wireless, where character input could be a killer app, global telecommunications companies like Motorola and others are developing their own smartware typing applications. If ZICA were still trading at 10 it would get a V-1. (V-2)

2. GraphOn Corporation: The GraphOn story is every bit as compelling as Zi Corp's, and investors have reacted almost as avidly. An Internet startup specializing in server-based computing, GraphOn makes software that allows computers with aging microprocessors to run the most sophisticated computing applications. It does that by putting those applications on remote servers and turning the desktop personal computer into simple graphics display devices. The fact that tens of thousands of Chinese schools are unable to afford the constant upgrades that the Wintel duopoly is pushing on China (just as it's pushing everywhere else) gives GraphOn quite a potential market. Late last year, a number of promising deals in China helped push GOJO up more than 200 percent, from a low of 3 to a brief high of 27; the stock's settled down now to around 16. Deals signed in November with Beijing-based Minmetals Townlord Information Technology Inc., an education infotech company, and Sundiro Information Industry of Hainan, which makes security software, gave GOJO much of its end-of-year boost. The deals included a planned rollout with a 1,500-student school in Beijing, and more than 1,000 schools slated to be upgraded with GraphOn software by the end of this year. This year, so far, the company's offered no further updates on its China plans, instead focusing on marketing in the U.S. and Europe for its Bridges software, which enables Windows-Linux compatability. With Bridges, a person on a Linux PC can download a Windows program off a remote Windows server. It's wonderful that we haven't heard a thing about GraphOn's China plans in several months and that the company is keeping it's eye on, first, its product, and second, marketing to its U.S. and European customers. That diversification gives the small company a stronger base. GraphOn is going steady-as-she-goes in China, which is the best way to go. If Bridges really is the best Windows-Linux connector, it will eventually pay off big in China, where the Linux operating system has strong support from the government and student computer users who actively dislike Microsoft. If GraphOn were still trading at 27 it would get a V-2. (V-1)