Hands on, hands off
China’s internet giants are battling to dominate the local services sector. Tencent, Baidu and Alibaba are spending billions of yuan to connect the country’s web users to real-world goods and services, like taxis and takeaway food. However, the three are deploying very different strategies. As costs mount amid uncertain returns, investors seem happier with less risk.
As China’s 649 million web users turn to their smartphones to order food, buy movie tickets or book manicures, so-called “online-to-offline” services have become the web’s fiercest battleground. Though the industry represents a small slice of the services economy in the People’s Republic, opportunities are huge. Analysts at CLSA forecast transactions will grow by 46 percent a year to hit 2.3 trillion yuan ($362 billion) by 2019. Search engine operator Baidu reckons the market will be more than four times as big.
This promise has sparked a venture capital onslaught. Top car-hailing app Didi Kuaidi and recently merged discount sites Meituan Dianping are valued at more than $15 billion each. Social media and gaming group Tencent and e-commerce giant Alibaba are among the investors in both companies.
As their core businesses mature, China’s tech giants are looking to O2O as a source of future revenue growth. Yet their strategies are very different. Baidu has concentrated on taking control of its new ventures. The $67 billion company recently committed to spend 20 billion yuan over three years on Nuomi, its wholly-owned group-buy site that competes head-on with Meituan and Dianping.
Tencent, which focuses on gaming and messaging, prefers to take minority stakes in start-up companies. It has investments in food delivery app Eleme and property services site 58.com. Alibaba does a bit of both. The $205 billion e-commerce group holds minority stakes in Meituan and education startup TutorGroup. But Alibaba and its financial services affiliate announced in June that they would jointly invest 6 billion yuan into a food delivery venture. Alibaba’s Hong Kong-listed subsidiaries are making bets in online movie ticketing as well as in healthcare.
Baidu’s emphasis on control reflects the importance of the new operations, which it proclaims is building the “Next Baidu”. By contrast, Tencent mainly sees its partnerships with local upstarts as an opportunity to lock in more users for its popular WeChat messaging service and its payments platform. Executives also say the scattergun approach allows the company to invest in more categories like healthcare, education and real estate.
Sales may be soaring, but the struggle for market share is hugely expensive as O2O start-ups reach into their own pockets to offer subsidies that will help to attract new customers. The financial damage is most visible at Baidu. The cost of investing in its O2O ventures knocked a staggering 32 percentage points off the company’s adjusted operating margin in the three months to September. As a result, earnings fell by over a quarter to 2.84 billion yuan.
By contrast, Tencent’s minority investments have a smaller impact on its bottom line. The $184 billion giant’s share of losses reported by its associates rose more than fourfold to 702 million yuan in the three months to September. Even after absorbing this hit, earnings grew at an impressive 32 percent to 7.4 billion yuan.
Look beneath the hood, however, and the new ventures are sucking up cash. Last year, Tencent spent 34 billion yuan on acquisitions and joint ventures – more than its full year operating cash flow. Purchases have drained half of operating cash in the first six months of this year as well.
Investors seem to prefer Tencent’s lower-key approach for now. The company’s Hong Kong-listed shares are up by more than a third since the start of the year while Baidu’s have dropped some 14 percent over the same period. Yet it remains far from clear which of these start-ups will be able to deliver sustainable earnings. Though Tencent’s diversified approach appears to carry fewer risks, shareholders may still be left wondering where all the money went.