Late last year I noted that life after Uber would not necessarily be a picnic for Chinese ride-sharing giant Didi. While an 85% market share looks unassailable, it will need a lot more money to secure its position.
I was prepping a post on why that is the case, but Dr. Richard Windsor at Radio Free Mobile beat me to it. Read the whole post. His bottom line:
Rising prices and lower reliability is likely to drive many users back into the arms of the taxi industry thereby achieving exactly the result for which the rules were created.
Windsor believes that the only logical response for Didi is a change in strategy, but finds it hard to see how any strategic choices open to Didi justify its $34 billion valuation. Fair enough.
Now, second-order effects time. Uber and Apple are Didi investors. As I mentioned in December:
Didi is a rapidly-growing company with a need for a huge war chest in order to secure its market position. Payback to investors will be some time down the line, and others will decide when and if Uber [or Apple] will ever see a dividend. Even if it does, the question will remain as to whether that dividend was a fair compensation for the price and a fair return to investors on the risk.
If you are an investor in either Uber or Apple, and you count the company’s holdings in Didi as a part of the firm’s underlying value or future earnings, have a look at Windsor’s post. You may want to re-run your numbers.
The rule for disruptive companies in China, regardless of provenance, is this: your future depends on more than just being able to make a handsome profit off of disruption. You have to convince a host of powerful individuals and groups that China is better off with the industry disrupted than with the status quo.
Chinese Internet giant Tencent Holdings Ltd. (TCTZF.PK) is raising some $600 million from a senior note offering this week. Given that in the second quarter they posted $492 million in profit on $1.7 billion in revenue on top of having some $3 billion in cash, the question has to be “why?”
There could be several reasons, one of which could be a desire to buy back the shares of one or more major shareholders. Keep in mind that South Africa’s NASPERS Group is a major shareholder, and in a volatile regulatory environment policy could shift against foreign holdings in Chinese internet companies at any time. A full or partial buyout of foreign shareholders could insulate Tencent from that problem quickly.
What I think is more likely, and what I told Josh at TNW, is that the company will use the money to support expansion in two non-core but highly strategic areas of its business.
Fighting the China E-commerce War
First, the money will go to e-commerce. The company has already made a huge push into the area, and told analysts at the end of Q2 that it was planning on expanding its effort.
As Amazon discovered when it reached a certain point in its growth, to be truly competitive in e-commerce you need to make major investments in logistics infrastructure. That is especially the case here in China. Being an online e-commerce platform with lots of online bells and whistles is not enough: you have to support merchants and customers with a logistics infrastructure.
At the risk of getting too granular, Bill Schereck, who was the driving force behind the founding of Australia’s TV Shopping Network and its expansion across Asia in the 1990s, defined e-commerce logistics as the effort to surmount five challenges:
1. Get the signal to the customer (i.e., get your portal online, and get people to find it.
2. Get the customer to place an order.
3. Get the order to the customer.
4. Take the payment from the customer
5. Be able to take a return in a way that is both convenient for the customer and economical for the firm.
For Tencent, the first challenge is a matter of having a good website, and the second a matter of marketing and the quality of merchandise being sold.
In many parts of the world, the last three are easy. In certain parts of China, like the downtown areas of major coastal cities, this is all relatively simple, especially if scale is modest. But Tencent wants to sell to users in all of China, and it wants to scale to a point that is likely to exceed the capacity of locally-available package couriers. That is going to mean investments well into the hundreds of millions of dollars, especially if they want to match Alibaba‘s Taobao.
Tencent’s leadership also understands that Taobao will not be standing still, and that to pass the market leader they will need to outpace Alibaba’s rate of investment, innovation, and improvements in customer service.
For these reasons, I suspect that if this new war-chest is allocated to capex and not buyouts, this is the largest direction that the allocation will take.
Tencent on the Street
The second direction is mobile. Tencent has made some excellent progress in this area with its Weixin/WeChat messaging service, which in its most recent iteration also incorporates much of the functionality of Instagram.
The challenge with mobile is that nobody has quite figured out how to turn a great mobile experience into revenue. People are using the services, but somehow the industry has yet to figure a way to get someone to pay for it all.
Tencent has the sheer mass of users, and it has them engaged not only in social media and chat, but most of the top online games as well. They need to create a mobile platform that replicates their PC experience, and I would wager that is where they are going to focus their efforts.
A case can be made that the future of mobile involves finding a way to mix three technical capabilities: fourth generation wireless broadband networks (4G); the ability to make web pages to essentially become powerful applications that is implicit in version 5 of HTML; and a new, slick version of rule set that governs how the web operates, IPv6. I know that might sound like a lot of technical hogwash, but together these three technical changes mean that the smart phones of the future may be web-based rather than based on apps running on a computer-like operating system.
If and when that change happens, it will give companies like Tencent a phenomenal degree of control over the experience they can offer on a mobile device, and, by extension, the things that they can do to turn that experience into cash. Tencent understands this, as does search giant Baidu, portal/socials Sina and Sohu, and e-commerce leader Alibaba. Each is investigating how to offer web-based mobile operating systems.
The stakes are immense for Tencent. If it can create an immersive, sticky mobile experience, it can tie that into its e-commerce infrastructure and bring both merchants and advertisers to its half-billion plus users via the mobile phone. This looks tiny now, but it could be what makes the difference between decline (as users shift from desktop to mobile) and dominance of mobile social media, mobile commerce, and mobile advertising in the country with the most mobile users of any in the world.
If that’s not worth taking out a little $600 million loan for, I’m not sure what is.
Update: Peter Schloss, who in over two decades in China has been in the middle of some of the most interesting and complex deals in the media and internet industries, makes an excellent point about why Tencent is doing this deal now. “Tencent was able to tap the markets at a good time for the company, and getting money was cheap,” Schloss noted. “They also wanted to break new ground for Chinese issuers.”
I think Peter offers a reasonable explanation for Tencent’s timing. I do not think the company intends for the money to sit idle, however, hence this post.