China tech players in SE Asia: Strategic outpost

Over the course of four months in 2015, Chinese online ride-hailing platform Didi Chuxing invested in three foreign peers and bound them together under a global partnership intended to take on Uber. The four companies would leverage each other’s technology and resources with the ultimate objective of allowing customers to use their local app when visiting markets in which the other services operate.

In addition to backing US-based Lyft and India’s Ola, Didi participated in a $350 million funding round for Grab, which has turned a Malaysia-focused business into a Southeast Asia operation with Jakarta the main battleground.

“There were strategic reasons why each side wanted to work with the other,” says Jixun Foo, a managing partner at GGV Capital, an earlier investor in both Didi and Grab, and who helped facilitate the arrangement. “While the markets are different, there are similarities in terms of the density mix of the cities, solving traffic problems. There is also the proximity factor: an increasing number of Chinese are going to Thailand for vacation, so there will be more traffic across both regions and more reason for these companies to try and make the user experience transferable.”

Travel is a logical move for companies that want to follow Chinese consumers into Southeast Asia. But Didi is just one example of second-tier Chinese internet companies joining Alibaba Group, Baidu and Tencent Holdings (the BAT) in venturing overseas. Southeast Asia is a conveniently located high-growth market, although it remains to be seen how quickly interest becomes into action, and what M&A strategies are best suited to different business models.

“We saw a lot of signals in 2016, with the strategics reaching out to VCs and asking to meet companies,” says Khailee Ng, managing partner at 500 Startups. “With the BAT there were some outcomes, like Alibaba buying [Southeast Asia e-commerce platform] Lazada and Tencent partnering [Thai digital content platform] Ookbee. The non-BAT are showing interest but we haven’t seen as many outcomes. One can only imagine there will be more outcomes in 2017.”

Expected expansion

The growth potential of Southeast Asia’s internet economy is well-recognized. A study published last year by Google and Singapore’s Temasek Holdings noted that the six major ASEAN markets – Indonesia, Malaysia, The Philippines, Singapore and Thailand – constituted the world’s fastest-growing internet region, with the existing user base of 260 million projected to reach approximately 480 million by 2020. And at 700 million, the number of mobile connections exceeds the population.

Driven by young demographics, a weak big-box retail market compounded by access issues to urban centers in certain countries, and a growing middle class, the internet economy is expected to be worth $197 billion by 2025, up from $31 billion in 2015. E-commerce will be the big contributor, with online spending set to rise from $5.5 billion to $88 billion. Online gaming and ads will be worth $19.6 billion and online travel will contribute $89.6 billion.

The study doesn’t include areas such as education, entertainment, healthcare, financial services and marketplaces trading in second-hand goods, on the grounds that they have yet to be materially disrupted by the internet in Southeast Asia. All of these will likely be more significant participants in Southeast Asia’s internet economy by 2025. So too could frontier markets such as Cambodia, Laos and Myanmar.

The challenge for some Chinese strategic investors is justifying a sizeable investment or acquisition in based on current market size. “The fact that growth has slowed in China means they need to look at new areas,” says Roderick Purwana, managing director at SMDV, a venture capital firm backed by Indonesian conglomerate Sinar Mas. “You see people from business development arms looking at this part of the world but it’s exploratory and they often come away from their trips thinking the scale is too small. Southeast Asia is supposed to be the next big thing but it is nowhere near China right now.”

Even considering the region as a single “next big thing” is problematic, given it comprises a collection of nations that are not necessarily suited to cross-border expansion. Indonesia is by some distance the largest e-commerce market in Southeast Asia with a value of $1.7 billion, and it is projected to reach $46 billion by 2025. However, it would still be dwarfed by China’s online shopping gross merchandise value (GMV) of RMB3.8 trillion ($550 billion) in 2015.

GGV’s primary focus is China and US, often targeting start-ups that offer crossover between the two markets. It is one of a number of Chinese VCs now looking to stir Southeast Asia into the mix. Foo says he looks to identify teams capable of scaling their businesses across multiple markets and addressing different cultural, commercial and regulatory environments.

It is rarely a question of satisfying all 600 million people in Southeast Asia or 250 million people in Indonesia. To tap into the urbanization driving household incomes and spending power in these markets, most start-ups are thinking about the 30 million people in metropolitan Jakarta. Depending on the business model, exposure to no more than a dozen or so cities across the region – with the major hubs to the fore – might generate sufficient scale.

“I call it the story of cities,” says 500 Startups’ Ng. “It’s like in China where you look at Beijing and Shanghai first and then move to tier-two cities later on. For Southeast Asia, people look at Singapore, Kuala Lumpur and Jakarta as the initial roll-out cities: that’s where the middle class is concentrated. This is based on the assumption that 90% of start-ups target people with income to spend. There are exceptions – some start-ups target a mass market or even rural markets – but most need to pay attention to the story of cities.”

E-commerce angst

E-commerce is arguably the most resource-intensive business model when it comes to achieving scale, and in Lazada Southeast Asia has a classic example of an e-commerce business that entered multiple markets but was nearly consumed by the effort. According to various sources, the Rocket Internet-incubated company was nearly bankrupt or technically bankrupt when Alibaba paid $1 billion for a majority stake last year, half in new shares and half in secondary shares, at an announced valuation of $1.5 billion.

Rumors abound as to why the Chinese e-commerce giant didn’t allow Lazada to slip into insolvency and pick up the assets through a bankruptcy process – notably, Temasek, which led Lazada’s last funding round before the deal, did not exit any of its shares. Nevertheless, Alibaba’s move in for the ailing business does suggest it saw value in a readymade brand and customer base in Southeast Asia that it would have taken years to replicate organically.

Subsequent to the deal, Lazada purchased RedMart, a Singapore-based online grocer that was looking to expand into other markets but was said to be struggling to raise the necessary capital. “Alibaba seems to be rushing,” one industry participant says. He adds that many Chinese internet companies look at mid-size market access plays in Southeast Asia and conclude they could do it cheaper in house, though their expectations of the time and capital required are often unrealistic.

Lazada could also be seen as evidence of Chinese strategic investors’ willingness to absorb a short-term hit for a longer-term pay off. “With later-stage investments in particular, Chinese groups are not afraid to take risks. I’ve never heard of them having an issue with cash burn, even for long periods; their biggest question is always, ‘How big is the market?’ and whether there is sufficient scale to recoup the cash that is being burned,” says SMDV’s Purwana.

There is, however, a difference in bringing a Chinese strategic into a Southeast Asian start-up that needs capital to cover marketing costs one that does not – and it is reflected in the terms of an acquisition or the contractual rights tied to an investment. Much rests on the Chinese strategic’s general philosophy on M&A. VC investors say that Alibaba and Tencent are open to looking at participating in Series A or B rounds as minority investors, but they differ in their attitudes towards control when writing larger checks.

Although it is difficult to generalize, Alibaba is seen as preferring to take full ownership where possible, while Tencent has on numerous occasions opted for minority positions and treated its investees as ecosystem partners. Several sources compare the approach to that of South Africa-based Naspers, which first invested in Tencent 16 years ago and still owns 33.5% of the company. (This connection has also played a role in Tencent’s investments in Southeast Asia: it bought a stake in Thai web portal Sanook from Naspers in 2010 and acquired the business outright last year.)

The best example of Tencent’s minority-first stance in Southeast Asia is arguably Singapore-based Garena, which established itself and achieved financial sustainability through online gaming before branching out into e-commerce and payments. Tencent first backed the company in 2013 and has participated in several subsequent rounds of funding that saw investors such as General Atlantic and Ontario Teachers’ Pension Plan come in. An IPO is reportedly planned within two years.

“The schism was between the financial investor who would take a minority position with a view to an IPO and the strategic investor who wanted the right to acquire control in the future. We now see financial buyers looking for control, while strategic investors come to the conclusion that when they buy companies outright it can be difficult to maintain an organization’s culture and entrepreneurial zest if it becomes a wholly-owned subsidiary, so they are willing to incentivize management teams and create a sense of independence. That lets them get strategic value, but at the same time the company may have an independent future,” says Nick Nash, group president at Garena.

The Garena-Tencent relationship is described in terms of mentorship. Garena has absorbed Tencent’s management processes and sought to learn from the company’s experiences in China and apply those lessons in a Southeast Asian context. While there is an element of commercial crossover between the two companies, Nash stresses that cross-border relationships begin with an investment for a commercial contract but the best ones persist because of mutual recognition of unique skill sets. “Ours is our truly local nature – local knowledge, local operations, local leadership,” he says.

Friends or rivals?

Potential engagement scenarios between strategic players and start-ups have played out in China ever since the BAT started pursuing domestic M&A opportunities as a shortcut to diversification. On the one hand, a strategic would typically offer access to suppliers, customers, resources and expertise that can transform the target’s growth prospects. On the other, there are plenty of examples of start-ups that were either forgotten about by their strategic partners or overwhelmed by them.

Shane Chesson, founder and partner at NSI Ventures, is currently working on a follow-on round for one of his portfolio companies for which there was interest from a Chinese strategic investor. The investor recognized the business model as innovative not just for Southeast Asia but also for China and suggested forming a partnership, with local support coming from its complementary businesses. However, it is important to set out clear boundaries and responsibilities for such partnerships before entering into an investment agreement.

“There are always flags raised when you take in money from a strategic, from any country,” Chesson says. “Are you narrowing your M&A options? Are they asking for too many rights when it should really be purely financially driven for at least another couple of years? You have to take into account those factors and judge them against the value added by a strategic.”

Leading the VC affiliate of an Indonesian conglomerate, Purwana has first-hand experience of start-ups that are wary of aligning themselves with a particular group. “People used to say, ‘Don’t you just want to own us?’ and it took a while for them to understand that we are a minority investor along the lines of a Western VC firm,” he explains. “Even now, start-ups that are familiar with us have a very positive or negative view.’”

Chinese companies may also find communication with Southeast Asian start-ups difficult. As a result, requests to see all the user data generated by investee start-ups could be received with suspicion. The central concern, whether dealing with a local player or the BAT, is that they haven’t been active long enough to prove that if the market moves in a particular direction they will continue to act in the best interests of the portfolio company.

According to GGV’s Foo, it is difficult to provide an upfront answer to the engagement question simply because relationships often have to be redefined in response to shifts in the commercial landscape. The best preparation is to ensure these relationships are based on mutual respect with the start-up having an acceptable degree of autonomy.

At the same time, these considerations might be premature for many companies in the region. “If a $250 million valuation is on the table, Southeast Asia start-ups tend to follow the Vespasian principle of pecunia non olet – all money is green – and sacrifice degrees of strategic freedom for access to capital,” says Dmitry Levit, founder at Digital Media Partners.

For investors and investees, the deal dynamics will evolve. First of all, Southeast Asia’s internet economy achieving its potential is contingent on attracting more industry talent, improving internet, payment and logistics infrastructure, and making consumers comfortable with transacting online. It is hoped this would accelerate start-up growth and help fill the funding gap for late-stage VC and M&A.

Second, Chinese strategic players will develop investment strategies that fit their needs. It is worth noting that Baidu barely gets a mention, largely because there are few logical acquisition targets in a Google-dominated search world. So far the company has focused on finding ways to launch Chinese products in Southeast Asia and develop localized products. Companies will establish through trial and error which products are suited to organic expansion and where they need to pursue M&A – and indeed how aggressively it should be pursued.

It is unlikely to be an entirely smooth process. Peng T. Ong, managing director at Monk’s Hill Ventures, observes that too many groups operate under the assumption that models from China and the US will apply in Southeast Asia without the need for adaptation, and he expects some investments, particularly in e-commerce, to struggle. This may give investors pause for thought, but the macro fundamentals mean Chinese activity in the region will only rise.

“I have been going to China frequently to pitch the opportunity. It has taken a couple of years but they have started to listen,” says Adrian Li, founder and managing partner at Indonesia’s Convergence Ventures. “I just spent two weeks there and at one event I was the only Indonesian investor present. There were a lot of questions about the market and people asking to make visits and see opportunities. The tide has turned and it is only going to gain momentum.” 

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• Topics
• Southeast Asia
• Greater China
• Technology
• Consumer
• China
• Tencent
• Alibaba Group
• Baidu
• 500 Startups
• Sinar Mas Digital Ventures
• GGV Capital
• NSI Ventures