China tech M&A: Friends or rivals?

Mergers of equals, once a rarity in China's technology space, have emerged as a logical means of ending financially draining warfare. Rival companies, having spent years and countless dollars fighting for market share, are encouraged to consider a tie - in the form of a tie-up. The cessation of hostilities allows the focus to move from subsidies for customers to sustainable business models, and it means investors on both sides no longer see their capital in terms of cash burn.

Two transactions from the last 18 months stand out: ride-hailing platforms Didi Dache and Kuadi Dache, backed by Tencent Holdings and Alibaba Group, respectively, completed their merger in mid-2015 and soon rebranded as Didi Chuxing; by the end of the year, Meituan and Dianping, one-time rivals in online-to-offline (O2O) local services such as restaurant bookings and take-out delivery, followed suit. Both entities have since gone on to raise further funding at valuations higher than their aggregate worth when operating independently.

In the purest sense, these mergers of equals involve two companies combining their business operations, management teams and financials, and then creating a new entity. Shareholders on each side are expected to receive equal treatment through share-swaps or cash compensation. Post-merger, one of the two companies is dissolved.

In practice, it does not necessarily work out this way. The merger between US-listed classifieds player 58.com and its closest competitor Ganji.com saw the former acquire a significant minority stake in the latter, which remains privately held, and agree to "jointly realize major cost, revenue, and strategic business synergies." They remain separate brands. Meanwhile, tourism sites Ctrip and Qunar - both US-listed companies - agreed an all-share merger that favors Ctrip, the larger player, and online retailer Mogujie.com assumed control of Meilishuo through a stock-swap deal.

With weaker investor sentiment and an IPO backlog, further consolidation is expected for consumer technology companies in China. However, the landmark transactions that saw the creation of Didi Chuxing and Meituan-Dianping are not being replicated. The new wave of M&A is being driven by smaller deals, as industry participants broaden their portfolios incrementally and strategically, focusing on core operations and expanding in a more measured fashion.

"Industry consolidation will continue to happen," says James Mi, co-founder and managing director of Lightspeed China Partners. "All data point to M&A becoming a big trend in China, giving investors and alternative exit channel to going public. That's similar to the US. But the bulk of M&A activity will be slightly different from what we have seen over the last year or so, with two large competitors merging. There will be more typical acquisition-type deals."

Changing mentality

According to Mergermarket, announced M&A in China's tech sector amounted to $70.7 billion across 307 deals last year, driven by transactions involving computer software, the internet and e-commerce businesses. The 2015 total is greater than that for the previous four years combined. In the first nine months this year, M&A in the sector reached $61.2 billion, with the same sub-sectors dominant.

Didi Chuxing's most recent funding round was worth $7.3 billion, including $4.5 billion in equity, and it valued the company at more than $25 billion, while Meituan-Dianping raised $3.3 billion - at a valuation of $18 billion - not long after the merger. They have proved that M&A is not necessarily to be feared. Indeed, the potential improvements to cost structures and scope to explore new market opportunities these transactions allow is increasingly appealing to all concerned.

"Chinese entrepreneurs are becoming much more open-minded. They are more willing to consider mergers of equals, leaving one founder to run the combined company as CEO while the other leaves with his money and lets the baby grow in its own right," says J.P. Gan, managing partner at Qiming Venture Partners. Didi Dache executives now occupy the top positions at Didi Chuxing and the company will soon absorb Uber China as well; over at Meituan-Dianping, Meituan founder Xing Wang runs the operation.

Ride-hailing is not the only industry segment characterized by brutal competition and heavy marketing costs; baby-related e-commerce and online medical consultation platforms are other examples. But M&A ticket sizes will be smaller, largely because these are relatively niche markets in which no single player has achieved substantial scale.

In areas where there are dominant, well-funded operators, large transactions will not necessarily be forthcoming. Food-ordering platform Ele.me raised $630 million last year with a view to preserving its market position, but the company has yet to make any significant acquisitions. While the local delivery space - ranging from take-out delivery to last-mile logistics - is considered ripe for consolidation, it is likely to be strategic: acquisitions of smaller players that fill technology or services gaps as well as partnerships that can accelerate the growth of core operations.

This approach is already apparent in other market segments. In June, vacation rental site Tujia.com bought its smaller rival Mayi.com, which focuses on short-term rentals specifically. As part of the deal, 58.com, the controlling shareholder in Mayi, took a minority stake in Tujia. The acquisition of Mayi and partnership with 58.com means Tujia is better positioned to counter the threat of US-based Airbnb, which is seeking to expand in China.

Meanwhile, Meituan-Dianping is concentrating on broadening its product offering, as evidenced by the recent acquisition of third-party payments provider Qiandaibao. Meituan initially launched an in-house app to process payment for O2O services available on its platform but pulled back when Chinese regulators starting looking into whether the company had provided a payment product without the relevant license. Qiandaibao possesses that license, but this was not the sole driving factor behind the deal.

"Apart from acquiring the license, there are many synergies between two companies," says Zhen Zhang, founding partner at Banyan Capital. "Qiandaibao has a strong product development team, led by the founder who is a serial entrepreneur. In addition, it is profitable and has a user base that overlaps with Meituan in areas such as small merchants. So Meituan is buying into a company that can help improve its cash flow."

Stella Yuan, China central leader in EY's transaction advisory services practice, agrees that privately-held large companies - which have no shortage of funding - will be cautious in their acquisitions. The focus is on identifying targets that are a good strategic fit rather than greenfield projects that have little relevance to the core business, or offer purely asset expansion and financial gain.

Shifting focus

In this respect, the approach taken by the latest generation of internet giants is different to that of their predecessors. Indeed, Baidu, Alibaba and Tencent (BAT) have played an active role in the development of the likes of Didi Chuxing and Meituan-Dianping in recent years, as they sought to differentiate their businesses by pouring cash into O2O services, payment and e-commerce. As listed companies with access to a variety of funding channels, they were well equipped to do this.

Now, though, with China's internet industry highly penetrated and in consolidation mode, acquisition is not the default optimal solution. The BAT will review their diversified portfolios and consider spin-offs or mergers of certain business units with outside competitors, according to Jeremy Choy, head of M&A at China Renaissance. Flexibility is at the heart of this strategy. It allows companies to get stronger in certain existing verticals and allocate resources to explore emerging areas such as artificial intelligence, virtual reality, and entertainment.

Spin-offs are likely to fall into two categories: active and passive. JD Daojia, an O2O unit that came out of online retailer JD.com, falls into the first category. The company, which provides grocery delivery services, merged with Dada Nexus, a VC-backed crowdsourced delivery platform. Dada continues to operate its existing business under the Dada brand, in which JD.com owns a 47.4% stake, having injected $200 million into the venture.

A passive spin-off happens when the parent company retains no equity interest in or influence over a business unit. Last year, Baidu launched an initiative to open certain businesses to external funding as part of broader efforts to foster an innovation ecosystem. Desktop app 91 Desktop, online food ordering platform Baidu Takeout Delivery, and education Q&A platform Zuoyebang - formerly Baidu Zhidao - were restructured as independent companies. Baidu Takeout Delivery is now reportedly pursuing a merger with Meituan-Diaping.

"Last year was a year for a certain kind of merger. Going forward, spin-outs will be quite a big theme," says Choy. "All the internet companies are becoming more sophisticated and more strategic in terms of what businesses they should focus on, and where they should use partnership approach."

Even for the second generation of internet giants, flexibility is key, whether it means partnerships, minority investments or M&A. Didi Chuxing is once again an instructive example, having made minority investments in three of its overseas counterparts - Grab in Southeast Asia, Ola in India and Lyft in the US - and forming a strategic global partnership with them.

Smaller players still making their way through the initial institutional funding rounds have adopted a similar way of thinking. EY's Yuan notes recalls hearing start-ups at the Series A stage telling investors that a portion of the proceeds will be earmarked for acquisitions that enhance core products.

"It's not only big companies that are acquisitive, even start-ups are looking for smaller start-ups," she adds. "In today's competitive environment, founders realize they need to be stronger and grow quicker than the others through M&A."

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• Topics
• Greater China
• Buyouts
• Technology
• Consumer
• Expansion
• Early-stage
• China
• TMT
• M&A
• Banyan Capital
• JD.com
• Baidu
• Qiming Venture Partners
• Lightspeed Venture Partners
• Transportation
• Logistics