Later this year, China Music is expected to be one of several Chinese internet companies that go public with multibillion-dollar valuations. Executives and bankers believe the online streaming service could be worth as much as $30bn, making it one of the most lucrative deals in the portfolio of Hong Kong-based private equity firm PAG, and its rainmaker Shan Weijian.
The PAG chief executive, who bought China Music several years ago, will not be the only beneficiary, though. In 2016, he sold half his stake to Tencent at a bargain price and merged China Music with Tencent’s far smaller music streaming operation — the merged entity now carries Tencent’s valuable name.
At first glance, a deal with such favourable terms for Tencent might seem strange. But the value of the business lies in the licences to broadcast music, some of which are as short as two years. When they expire, Tencent’s deeper pockets mean it could easily afford to outbid PAG. Joining forces was the lesser evil, Mr Shan says.
“We were both shareholders of China Music,” says Mr Shan. “A merger made a lot of sense because with the deep pockets of Tencent, the combined business is much better positioned to compete for copyright licences and to grow.”
The China Music story shows just how hard it can be to say no to Tencent — and the other big player in the Chinese tech world, Alibaba. With their large resources and long-term perspective, the two Chinese groups are transforming Asia’s investment landscape, posing challenges for private equity and venture capitalists as well as the start-ups looking for funds. In some parts of the region, SoftBank, the Japanese investment group, is playing a similar role.
Cumulatively, the trio can invest tens of billions of dollars at any time. Their ability to write larger cheques than any other source of capital means that they can determine winners and losers in emerging industries across the region. While traditional investors are primarily focused on financial returns, in many cases these three have different objectives that can range from their own strategic goals to foiling a rival.
The result is that the private equity groups, which have been the traditional investors in disruptive businesses, are now being disrupted themselves.
The more conventional investment groups raise money from pension funds, sovereign wealth funds and wealthy family businesses, which expect high returns in just a few years. Facing such fierce competition from relative upstarts, some of the more established investors are grumbling about whether Alibaba and Tencent are supporting innovation and competition or whether their unprecedented power is actually suppressing economic dynamism.
“It is a reasonable concern,” says the head of one Beijing-controlled private equity firm. “They have to watch themselves. They are so powerful that they are starting to abuse their position.”
Selected Alibaba acquisitions
The companies highlighted are Paytm, Tokopedia, Didi Chuxing, AutoNavi, Youku and China Unicom
The reach of Tencent and Alibaba in their home market dwarfs that of the big tech groups in the US. While the latter accounts for less than 5 per cent of all venture capital flows in their home market, Alibaba and Tencent account for 40-50 per cent of venture capital flows in mainland China, according to data from McKinsey.
“Today, Ali and Tencent are so powerful. They are adaptors, not innovators,” says the China head of one international private equity firm with expertise in technology. “The system needs checks and balances. But will they stop innovation? Can they control their own power?”
For the owners of ambitious young tech companies in Asia, these new investors offer huge attractions, given the resources they have at their disposal and the fact that they are not in a rush for their companies to go public, in contrast to more traditional investors.
The downside is that their new investors might have different agendas than simply the financial performance of the new companies. The risk is that Alibaba and Tencent might be willing to sacrifice their interests in the companies they back if their own goals shift.
Zhen Zhang, founder of early stage venture capital firm Banyan Capital based in Beijing, says some of the more traditional sources of capital are being marginalised because “entrepreneurs need resources and traffic” that only the big internet groups can offer.
But he worries that entrepreneurs might also be forced to prematurely choose sides in the rivalry between the competing ecosystems of one or the other internet giants in ways that can leave a young company exposed.
One of the reasons the motivations of the new investors are not always clear is that Tencent and Alibaba do deals through multiple units. Alibaba will use its own balance sheet, its own venture capital funds or the several family offices of its founder, Jack Ma, to invest in companies. It is also an investor in other funds. An Alibaba spokesperson said its investing strategy was to “champion the most promising local entrepreneurs developing innovative technology”.
Tencent too uses its own balance sheet and venture capital fund and acts as an investor in others’ venture capital funds. Its founder Pony Ma also sometimes writes his own cheques. It has $60bn in funds under management, according to data from McKinsey, separate from its own balance sheet.
For example, Tencent is an investor in Banyan Capital. Banyan provided the initial capital for Pin Duo Duo, a Shanghai-based ecommerce business. Tencent then came in at an early stage, along with Sequoia and JD.com. Now Pin Duo Duo is firmly in the Tencent camp as it takes on Alibaba in ecommerce.
With $217bn under management, according to McKinsey, SoftBank has even more power at its disposal. More than a third of those resources are in its Vision fund, in which firms such as Apple and Hon Hai and sovereign funds from Saudi Arabia and Abu Dhabi are co-investors.
The lure of these new investors can be irresistible. When Wang Jun co-founded Beijing Genomics Institute in 1999, Sequoia Capital China, the Beijing-based division of the west coast venture capital group, was an early investor. But when Mr Wang left BGI to establish a new medical tech start-up, he declined to agree to Sequoia’s valuation and terms. Instead, his first capital came from Tencent’s Mr Ma, who wrote him a cheque for about $200m and gave the new company iCarbonX a valuation of $1bn, virtually on day one. Sequoia, which has to care about making returns of at least 20 per cent for its investors, promptly withdrew.
Alibaba, Tencent and SoftBank are especially attractive to young businesses because they have few of the time constraints of traditional venture capital and private equity firms. Entrepreneurs complain that the latter groups are always pressing to launch initial public offerings in order to recoup their investment, often prematurely.
Tencent’s selected big buys
The companies highlighted are Tencent Music (formerly China Music), iCarbonX, Meituan, JD.com, Nextev and China Unicom
Most entrepreneurs say they seek long-term capital. But one of the reasons Vijay Shekhar Sharma, founder of Indian mobile payments company Paytm, says he took Alibaba’s money, giving the group a 40 per cent stake, was because he “needed continuous capital” — a reflection of a business model that will rely on other people’s funding rather than generating enough of its own cash flow.
The fact that Alibaba and Tencent are increasingly competing with each other across a wide sphere of businesses and geographies means that young companies are increasingly drawn into the camp of one or the other, raising the likelihood that they will become pawns in the battle between the two rivals.
Precisely because they are so powerful, the refusal to take money from one of the tech giants can be costly. The founding entrepreneur of a young content company in the Sequoia portfolio feared the possible loss of independence by accepting Tencent money. However, she discovered that if she did not allow the company to invest, Tencent’s WeChat, the ubiquitous social media platform also used for mobile payments and as an email service, might forever be closed to her content, which would have been far more costly than the loss of independence.
If the venture capital market in China has become a fierce battle between Alibaba and Tencent, in other parts of the region it is often a three-pronged competition that also includes SoftBank.
That is particularly the case in India, where there has been little domestic risk capital available to entrepreneurs. As a result, poorly capitalised Indian start-ups were ill-equipped to compete with the big US groups, such as Amazon, Google and Facebook.
These days many of the leading Indian tech companies have Chinese or SoftBank capital behind them. “I love the fact that foreign risk capital is fighting over India,” says Avnish Bajaj, head of the India operations of Matrix Partners, an early stage investor whose head office is in Boston. “If Indian companies are going to compete with global companies, they need global levels of capital.”
That increasingly means capital from one of the three. Indeed, dependence on money from the trio is so striking that some entrepreneurs now refer to India as an emerging “foreign capital Raj”.
Paytm’s Mr Sharma says he took funds from Alibaba because “whatever is happening in China today will happen in the world tomorrow. You have to look east to see the future”.
At times, younger companies can find themselves caught up in the shifting loyalties of this growing competition.
When Meituan, then part of the Alibaba camp, merged with Dianping to form the biggest online services company in China in 2015, it effectively went over to the Tencent side, which was a shareholder in Dianping. Alibaba then dumped its Meituan shares ahead of an equity offer from the merged company to drive down the price.
A similar dynamic has been seen in Indonesia. JD, a core part of the Tencent empire, last year signed a term sheet for investment in Tokopedia, a local ecommerce platform, but Alibaba swooped in last summer with funding of more than $1bn according to people with direct knowledge of the matter. As a result, JD had to back out of the deal.
One potential danger for the three investors as they expand their presence across the region is that foreign capital could give rise to a protectionist backlash. A company such as Paytm, which is in mobile payments and in which SoftBank and Alibaba account for 60 per cent of the shares, is especially vulnerable. Mr Ma of Alibaba was able to take shares in its payments business Alipay away from SoftBank and Yahoo when the regulations in China changed to bar foreigners from holding stakes in such strategic financial firms.
Some private equity executives fear that there is little they can do in the short term to compete with Alibaba and Tencent, at least in China. “You need to see them in historical perspective,” adds the head of one international private equity firm’s China office. “This is still the robber baron age. It is a process.”
For entrepreneurs, the trick is to find ways to minimise the risks attached with rich new investors. “The important question is what is the quality of the investment,” says Alok Kshirsagar, a senior partner of McKinsey in Mumbai. “The best thing to do is play ecosystems against each other.”
SoftBank joins the fray
In India, the promise of money from SoftBank is particularly attractive for many entrepreneurs. The Japanese group has a reputation for offering the highest valuations — the result, critics say, of the huge amount of money it has at its disposal and the pressure it feels to put it to work quickly. There is a prestige factor, too.
“SoftBank often confers credibility and contacts,” says Alok Kshirsagar of McKinsey in Mumbai.
“Every one of the start-ups from 2011 to 2013 which now dominate the internet in India has capital from one of the three,” says Naveen Tewari, the founder of digital advertising platform InMobi in Bangalore — a reference to Flipkart, the local equivalent of Amazon, ride-sharing app Ola and Paytm. “And the more money we take, the more control we lose. They have had a huge impact on the venture industry.” InMobi itself has funding from SoftBank.
Ola was able to take on Uber in India thanks to a big injection of capital from SoftBank. “They are the first tech fund of scale,” says Ola’s founder, Bhavish Aggarwal. “They don’t think in terms of rates of return. Masayoshi Son [Softbank’s founder] is making history. He is inspiring and aggressive.”
Just like Alibaba and Tencent, however, SoftBank can have conflicting interests. When SoftBank was negotiating with Uber to buy a block of shares in the transportation group at a big discount, one of its arguments was the fact that it had big investments in some of Uber’s principal competitors in Asia that could potentially be given less emphasis.
Those stakes include Ola in India, Grab in south-east Asia and a $5.5bn stake in Didi Chuxing, which has already vanquished Uber in China. Uber on Monday said it had agreed to sell its south-east Asia operations to Grab.
While Mr Aggarwal says he believes that SoftBank is wedded to Uber only in the US and not in Asia, even some of his investors are concerned that Ola might be downgraded in status.
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