Caixin
Jun 13, 2013 12:17 PM

Net Deals Must Be about More than Capital

Since late April, a number of major investment and merger deals among Internet companies have been announced in China. The industry has long awaited this development, which is believed to mark the beginning of a deeper consolidation process in the industry.

Most of the recent deals are significant. Alibaba purchased an 18 percent stake in Sina Corp.'s Twitter-like weibo service for US$ 600 million and is entitled to increase its holdings to up to 30 percent in the future. In another investment of US$ 300 million, Alibaba also became the largest shareholder in Amap.com, an online mapping service. Also, Baidu Inc. announced a nearly US$ 400 million purchase of the online video unit of PPStream Inc., a popular TV streaming service it will merge with its own online video service subsidiary, iQYI.com.

There have also been reports that Qihoo 360 is in talks with Sohu.com Inc. to buy a stake in its subsidiary, Sogou. One can foresee that more heavyweight investments and mergers will occur in the Net industry this year.

Three forces have emerged to create this wave. First, the growth rate of the number of Internet users has been slowing, and past dividends that paid for rapid expansion in scale have dried up. This has correspondingly compressed the space for rapid industry growth and intensified competition between Net companies.

Second, beginning last year, the country's Internet walked into a capital market depression. Venture capitalists were cautious in their investments, and the path to a public listing was difficult. Many companies thirsty for funding but unable to list can only hope to merge or be acquired in response to pressure from investors.

Third, the networking industry has been lacking in innovation for years. With no new business growth points, a number of leading companies could only put effort into expanding existing mature businesses in order to maintain financial growth.

In carefully observing this wave of consolidation, one can roughly divide a wide variety of actions into two types: the merger of similar businesses and overall expansion.

A typical case of merging similar businesses is the Baidu acquisition of PPS. The acquisition allowed Baidu and PPS, which were far back in the rankings of online video websites, to jump up to the top three after the merger. The advantage of this type of acquisition is that it expands market share while lowering operating costs and increasing revenue efficiency. The only downside is that the change is quantitative rather than qualitative.

For the so-called overall expansion type, Alibaba is the most typical case. In a short period, the company invested in Sina Weibo and Amap.com, developing horizontally as its own core business approached a peak. Alibaba built bridges to connect different businesses, enlarging its business structure before an overall listing.

Analyzing this from the point of view of development potential, consolidation through overall expansion is better than the merging of similar items. The former, in addition to benefits from the expansion of scale, has potential returns from consolidating innovation. For the merging of similar items, the complementary effect and the potential for innovation are not significant. But fundamentally, the two both emerge from the game of existing market structure competition and the existing capital market. The first consideration is market share, the scale of operations and capital valuation. Tactical considerations are greater than strategic layout.

In Silicon Valley, there is a more respected third method of consolidation, which is the acquisition of capabilities or innovative ability. This type of acquisition in concept abandons consideration of existing market share, revenue level and capital efficiency, and focuses on uncertain future industry trends. The strategic resources reserves component is greater than short-term benefit. Google, for example, looks at the level of innovation in the products of the companies that it acquires then looks at the level of technical architecture and programing code, and then commences in-depth exchanges with the core team. After passing these key points, Google will finally look at the financial statements, market share and more traditional indicators. Well-known Google acquisitions of Google Earth, YouTube, the Android operating system, etc., are all of this type of acquisition of capabilities or innovation.

There is a notable trend in the acquisitions of American Internet companies, which is to broaden the field of vision to outside the industry and enter areas that rely heavily on the Net, like software, telecoms, IT manufacturing, publishing, and film and television. Google's acquisition of Motorola gave it a complete set: handset design, manufacturing, and sales capabilities. By acquiring a series of small publishing organizations, Amazon strengthened its independent e-publishing capability. Today, big data and product companies, electronics design firms and 3D printing companies have become the next wave of acquisition targets for Internet giants.

In short, promoting the development of a company through mergers and acquisitions is a good thing, which can help the industry to maintain strong vitality, promote new industry superseding the old, and enhance the industry's integrated expansion capability. But if there is no advanced strategic thinking and a complete acquisition strategy, if companies are only interested in the present market competition and capital game, and lack the willingness and ability to consolidate innovation, then pragmatic and opportunistic mergers and acquisitions may push companies toward failure.

The development of the Internet industry is entering a new historical stage. On the surface, it is an era where a vast and complex network ecosystem platform is formed and rules as king. Looking deeper, it is an era of big data in which Internet usage data is obtained, integrated and used for innovation. Thus, weighing the value of a merger or acquisition requires more evaluation of the target company's role in platform construction and ability to obtain big data.

The Baidu acquisition of PPS and other mergers of similar businesses provide no substantive assistance in constructing such a platform. An increase in the amount of data does not mean an increase in the types of data. Alibaba's investments in Sina Weibo and Amap.com actually did increase the correlation between overall data types and data, but the challenge lies in how to integrate various services to establish a complete, systemized and powerful platform.

China's Internet industry so far does not have a true network platform. The key to the success or failure of the consolidation of the industry will be wither the various mergers and acquisitions contribute to the generation of this platform. Lacking this platform, the greater the numbers of mergers and acquisitions, the greater the risk of companies collapsing. This is like building a house. If the foundation is not strong, the house is more likely to collapse as it is built higher.

We must draw lessons from previous mistakes. As the Internet industry enters the deeper consolidation stage, only the companies with a clear vision and capacity to integrate their purchase target can achieve sustainable growth after a major investment deal. More important, I hope that through mergers and acquisitions, these companies acquire not only market share and revenue but also more comprehensive and powerful innovative capabilities and sustainable development potential.

The author is a senior Internet commentator

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