Seeking Alpha
Foreign companies, long only, tech
Profile| Send Message|
( followers)  

I have a lot of respect for Tencent (OTCPK:TCEHY,HKEx: 700), China's largest Internet company and now one of the world's most valuable web firms based on the meteoric rise in its stock over the last few years. But that said, I'm starting to have some concerns about the company's future due to its sudden move into many unfamiliar areas, including the latest which reportedly has it looking to buy a cellphone maker. In a somewhat ironic twist, Tencent's cellular foray would come just a couple of months after Google (Nasdaq: GOOG), the world's largest Internet company, admitted failure with its own cellphone adventure by selling its Motorola Mobility unit at a major loss.

China's "Big 3″ Internet companies have all embarked on a major buying spree over the last year, with Tencent, Baidu (Nasdaq: BIDU) and Alibaba snapping up billions of dollars in acquisitions as China's Internet undergoes a much-needed consolidation. But of the 3 companies, Tencent was relatively conservative until recently, making only a limited number of purchases mostly in areas closely related to its core gaming and social networking services (SNS) businesses.

Perhaps the company is worried that it is falling behind Baidu and Alibaba, which have moved much further from their core areas in their recent buying sprees that have taken them into everything from online mapping to financial services and app store operation. Tencent began breaking with its conservative stance late last year, and since then has moved aggressively into financial services - a new direction that this week saw it become one of the first companies to get a banking license under a scheme by Beijing to liberalize the sector (previous post).

Now the latest reports say that Tencent is in talks with several companies to buy a cellphone maker, as part of a broader drive into the market for Internet-connected devices (English article). The reports cite unnamed sources, and mention several names as acquisition targets, including the recently launched OnePlus, as well as Chuizi Technology, and Meizu Technology. Tencent hasn't commented on the reports, though this name list indicates that it is probably chasing smaller, start-ups whose main asset is more intellectual property rather than actual manufacturing operations.

As I've said above, this acquisition, if it's really happening, would closely mirror Google's own disastrous foray into mobile phones. Google purchased Motorola Mobility for $12.5 billion two years ago, but then in January announced it would sell the money-losing unit to PC giant Lenovo for $2.9 billion (previous post). Google excluded most of Motorola's patent portfolio from its sale to Lenovo, but most observers said the U.S. Internet giant still incurred a huge loss on the overall Motorola experience.

With all that negative history, it's hard to see why Tencent might want to chase a similar deal, even if its targets are much smaller and don't have the same troubled history as Motorola. One reason Tencent is probably chasing this deal and others with increasing distance from its core competency is market expectation. Put simply, the company is probably feeling incredible pressure to justify its current market value of $140 billion, which owes to a 4-fold increase in its share price over the last 2 years alone. The company is now one of the world's most valuable Internet companies, even though its business is currently all in China.

Obviously a company needs to expand beyond its core business to keep growing, which is what Alibaba, Baidu and now Tencent are all trying to do to justify their high valuations. Google has also taken such an approach, moving beyond its original search business to become the Microsoft (Nasdaq: MSFT) Windows of the smartphone sector with its popular Android operating system (OS). But the expansion strategies of Alibaba, Baidu and now Tencent look much less focused, and are also highly dependent on major M&A. That could lead to headaches in the future, as many of these big investments turn into new cases similar to Google's Motorola hangover.

Bottom line: Tencent's reported pursuit of a mobile phone maker reflects a growing lack of focus as it tries to expand beyond its core SNS and gaming strengths to justify its high valuation.

Disclosure: No position

Source: Tencent M&A On Steroids With Handset Bid