The five drivers of China’s Internet deal frenzy

You can’t go a week without hearing of a new acquisition by Baidu, Alibaba or Tencent. While China’s Internet giants have been doing acquisitions for years, the last three months can best be described as a frenzy.

Tencent’s recent announcements have been impressive – including:

• They are buying 15% of Leju, an online property agency, for $180 million.
• They are buying 15% of e-commerce website JD.com for $215 million.
• They are buying 28% South Korean mobile game developer CJ Games for $500 million.
• They have paid $448 million for 36% of search engine Sogou.
• They have bought about 20% of review website Dianping.

And in the last few days, Chinese media has been reporting that Tencent is buying 20% of online video site Youku Tudou for approximately $300 million.

Alibaba’s recent moves have arguably been even more ambitious.

• They invested $215 million in mobile messaging app-maker Tango, a competitor to WeChat.
• They have announced plans to take control of China’s leading mobile mapping service, AutoNavi.
• They are investing $804 million for a controlling stake in ChinaVision Media, which has a library of movies, TV shows and sports broadcasts including some Chinese rights for the English Premier League soccer. 
• They have moved into Internet finance in a large way with Yu’e Bao.
• They have launched an entertainment investment fund called Yu Le Bao which lets people invest small amounts of money in TV and movie productions.
• They are investing $360M in a logistics joint venture with the Haier Group, China’s largest maker of appliances.
• And they have an agreement with Midea Group to sell the first intelligent air conditioners on Tmall.com.

Baidu has also made recent announcements:

• They are buying Chinese app distributor 91 Wireless for $1.9 billion.
• They are buying majority ownership of group buying platform Nuomi.com for $160 million.

Overall, the recent deal frenzy is pretty impressive in its speed and scale. And there are lots of explanations floating around for what is going on. That this is because Internet use is moving from PCs to smartphones. That this is mostly about competition between Tencent and Alibaba. That this is mostly about all the cash sloshing around. And so on.

In fact, such surges in M&A are fairly common. And this surge of mostly-strategic deals is quite similar to the one that took place in the US in the 1990’s when the Internet first emerged. It is actually also quite similar to a strategic merger wave that occurred around 1900 as America’s industrial economy first emerged.

In all three situations (there are others), large existing businesses were confronted with a fundamental shift in the business environment. At the start of the industrial age. At the start of the Internet age. And now at the start of a new, but not yet named, age in China.

Then, like now, the leading companies are scrambling to find a new business model for a still changing landscape. And strategic mergers and acquisitions are how big companies evolve quickly when they need to. It is also how entrepreneurs, venture capitalists and investment bankers take advantage of the situation.

Per American M&A guru Bruce Wasserstein, such deal waves are typically driven by one or more of five drivers. In China today, it looks like all five are happening at once.

They are:

1. Technological change
2. The need for scale
3. Fluctuations in the financial markets
4. Regulatory change
5. The role of leadership

Technological change (#1) is the biggest driver here.

There is an acute awareness that mobile phones and e-commerce are technological changes that are fundamentally changing the Chinese economic landscape. And not just in online business. It is also changing significant sections of China’s offline economy. Financial services, entertainment, retail, logistics, transportation and many other sectors are being changed. The Internet economy is both driving productivity and creating new markets. 

Against this technological change, the Internet giants are attempting to protect their current businesses from new threats – but are also rushing after the new opportunities. A lot of these deals are a “land grab” for the best new opportunities.

The need for scale (#2) is the second big driver.

Alibaba’s activity is driving Tencent to act and vice versa. If your competitor becomes twice your size in a service, you are likely at risk and growing organically will not be enough. So you need acquisitions. The race for size often leads to a competitive panic – and all this leads to deals.

Fluctuations in the financial markets (#3) also frequently lead to deal sprees (both financial and strategic). The emergence of junk bonds in the 1980’s and securitization of mortgages in the 2000’s gave rise to the LBO and mortgage deal frenzies of the same periods. Similarly, the new wealth of China’s Internet giants is enabling them to be big buyers. Cash rich Internet companies and the efficiency with which capital is deployed in China’s Internet sector are important parts of the current phenomenon.

Regulatory change (#4) also creates deal opportunities. For example, the creation and later ending of the Glass-Steagall Act started waves of divestiture and later consolidation.

In this case, there is an interesting contrast between the lack of regulation in China’s online businesses and the tight regulations of many offline industries. This has created a tempting situation where the Internet companies can operate with a regulatory advantage in many situations. It appears to be prompting entrances into more regulated industries, such as Alibaba’s move into Internet finance.

Finally there is the role of leadership (#5). This is the most interesting factor.

Deals are ultimately done by individuals. And some business leaders are more aggressive than others. Some people are empire-builders. Some are visionaries. Some are speculators. And the leaders of China’s Internet companies are a highly aggressive and highly competitive group. They are seasoned entrepreneurs and risk-takers in their primes.

So the current Internet deal spree has a lot to do with the individual personalities of Jack Ma, Martin Lau and Robin Li.

We are seeing all five drivers at once right now. It’s impressive. But people are only logical to a point. Sometimes people just do deals to do deals – and frenzies can take on a life of their own.

Our take is that most Chinese companies today, Internet-based or not, have little idea how the new landscape will look in a few years. They mostly do not know what will be the winning business model. And they do not yet know what they need to be in order to survive and / or thrive.

What has happened in previous episodes of transformation (and frenzied deal-making) is that one or two companies figured it out first. They are later called the “Steve Jobs” of the situation for their prescience.

But most of the companies are just doing deals and trying to figure it out as they go. Everyone is running but only a few have a clear picture of the destination. It will be interesting to see in a few years who was actually pursuing the winning strategy and who is the Steve Jobs of this transformation.

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