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Google in China: What's the Endgame?

By Tim Hanson – Updated Nov 9, 2016 at 8:20PM

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It's going to be a while.

The Motley Fool Global Gains team is headed to China in July for research. Ahead of that trip they're taking time to discuss some of the issues facing China and investors in China today.

Odds are you've heard about Google's (Nasdaq: GOOG) drama in China. Back in March, the company, objecting to censorship of its search results, shuttered its domestic China website and began sending users to an uncensored Hong Kong site.

The move raised eyebrows because of China's massive growth potential, but Google has retained certain operations in China. What does the future hold for Google in this exciting growth market? That's an important question for a stock with a seemingly lofty valuation.

Tim Hanson: Count me among those skeptical that Google's recent machinations in China have anything to do with a principled stance. Google is a profit-driven company more than anything and with 1.4 billion people but 300 million current Internet users, China is a massive profit opportunity. So why did Google decide to stop playing ball with the Chinese government, unblock its site, and move it to Hong Kong?

Despite its other flaws, Google is not run by stupid people, and I suspect the company saw the writing on the wall when it came to China. Chinese competitor Baidu.com (Nasdaq: BIDU) owned nearly 60% of the search market by the end of 2009, and Google, so long as it was censoring results, was ceding the only advantage it had (accurate and thorough search results) that it could leverage to fight back.

By moving offshore and taking a high-profile stance against Internet censorship, Google has gained some brand cachet in China. So long as the company holds tight to that stance, time is on its side in terms of re-entering the Chinese market. The Chinese government continues to liberalize its positions on issues such as censorship, and it's only a matter of time before Google's present position isn't all that controversial.

There are, however, some issues in the near term. The Chinese government recently mandated that Internet mapping services acquire a license to keep operating. Google has applied for said license, but the Chinese government, ever the gamesman, could turn it down. If Google allows that type of pressure to compromise its current position on search, it will lose any cachet its earned and likely lose any chance it has to catch Baidu in China.

Sean Sun: Google certainly doesn't want to be left out of the China game for a very long time. As a Google bull, sometimes I ask myself: If I were in Eric Schmidt's shoes, what are my priorities? With the sheer quantity of material projects that the big G is involved in, maybe taking on a hostile Chinese government right at this moment just wasn't the best allocation of resources.

After all, while the Chinese government is tough competition, Google also has to face off against Apple (Nasdaq: AAPL) in the smartphone market and myriad competitors in advertising. And Google's strategy, at least in a few of those segments, is working. The Android operating system, for example, recently passed the iPhone in terms of U.S. market share.

Something that gets overlooked a lot about Google's business is how dependent on the U.S. the company actually is. As Tim alluded to, one of Google's main advantages is its search algorithm -- an algorithm that needs to be relevant and applicable to local users, and it's not clear that Google has so mastered Chinese expectations. Thus, Google could shut down its Chinese operations with minimal adverse reaction throughout the rest of its business, and that probably contributed to why they decided to do so.

That said, while Google has finite resources for now, I expect that it'll return to the PRC with a renewed focus no later than two or three years down the line. It would be dumb to do otherwise.

Nate Weisshaar: With all due respect, you guys are a bit too optimistic about a Beijing free-market epiphany. I can't disagree that Google doesn't want to cede 1.4 billion potential users (that's roughly 2.8 billion eyeballs, give or take), but it's running up against a government determined to develop national-champion companies, as evidenced by Baidu's being able to do what no other companies have -- take a dominant share of search from Google.

If you think I'm being paranoid about Beijing's fear of Western companies storming its shores, I point you to Coca-Cola's (NYSE: KO) attempt to acquire Huiyuan Juice Group, China's largest juice producer, last year. Despite Coke's multiyear presence in China and success operating in the country, the attempt was shut down by government decree. For anyone expecting Coke to continue to grow its operations in China, this was a sobering development and one that needs to be taken into account in any valuation of the company.

The Western companies that do get to enter the market generally have to partner with local firms and share technology, an admittedly smart tactic that ensures Chinese companies can quickly make up any engineering/expertise gap that may exist and soon be churning out their own products that are competitive with anything the West has to offer.

With a company like Google, where the entire secret to success is intellectual property, this model just doesn't work. By backing away now, the company is putting its faith in an evolving attitude toward free markets (and information) in Beijing, which I think remains well down the road.

As Tim said, it is a matter of time, but the Chinese famously measure time in a much more patient manner than the West, especially in the Internet age. Translation: When it comes to Google and success in China, don't hold your breath.

Want to find out what the team learns on the ground? Click here to sign up for regular dispatches from the road and get a free report full of stocks they uncovered on their last trip -- that are still attractive buys.

Neither Global Gains co-advisor Tim Hanson nor analyst Nate Weisshaar own any of the companies mentioned here. Sean Sun owns shares of Google. Coca-Cola is a Motley Fool Inside Value recommendation. Baidu and Google are Rule Breakers picks. Apple is a Stock Advisor selection. Coca-Cola is an Income Investor pick. The Fool owns shares of Coca-Cola. The Motley Fool has a disclosure policy.

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Alphabet Inc. Stock Quote
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Baidu, Inc. Stock Quote
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