Internet leader Tencent (OTCPK:TCEHY, HKEx: 700) has just announced a major purchase involving a Korean game maker, in what would normally be leading news on the Chinese Internet. But instead, the company is making bigger headlines on talk that it's nearing a deal to buy 20 percent of leading online video firm Youku Tudou (NYSE: YOKU) for a smaller amount. The 2 deals collectively would be worth about $1 billion, which these days doesn't seem like big news anymore for China's rapidly consolidating Internet.
These latest 2 deals reaffirm Tencent's strategy of buying major strategic stakes in other companies without taking full control. The confirmed deal will see China's largest Internet company pay $500 million for 28 percent of South Korea's CJ Games, which will help Tencent maintain its edge in its core online game business (company announcement). But the bigger headlines are going to another deal that would see Tencent buy the 20 percent Youku Tudou stake for around $300 million. (English article)
Let's quickly review these 2 deals, starting with CJ Games. The Korean company will sell its stake through the issue of new shares, giving Tencent access to its portfolio of online and mobile games. The deal looks similar to another one that Tencent did last year, which saw it participate in a management-led buy-out of leading global game maker Activision Blizzard (NASDAQ:ATVI) from its French owner Vivendi (Paris: VIV) (previous post).
These kinds of stake purchases look rather smart, as they give Tencent preferred access to the games developed by its strategic partners, who otherwise might prefer to sell to Tencent's Chinese rivals. One of Activision Blizzard's most popular franchises, the World of Warcraft series, is currently licensed in China by NetEase (Nasdaq: NTES), the country's second biggest game operator. But I previously predicted that following its Tencent tie-up, Activision could decide to move the title to Tencent once NetEase's current license expires.
Next let's look at the Youku Tudou deal, which has Chinese media buzzing because it involves the nation's leading online video company. Most of China's biggest online video sites have been acquired by bigger companies over the last year after realizing they couldn't survive on their own. But Youku Tudou has resisted that trend, remaining independent up until now.
Youku Tudou's CEO Victor Koo said as recently as last week that he wouldn't sell his firm but could consider a strategic partner, and now that looks like what could soon happen. Media are citing a wide range of sources, all of them anonymous, saying the two sides have struck a deal and a formal announcement could come soon. The deal would see Tencent get the 20 percent of Youku Tudou, and the 2 companies then combine their video assets.
This kind of deal looks quite similar to another one that Tencent announced earlier this month, when it said it would pay cash and inject its own e-commerce assets into JD.com in exchange for 15 percent of the country's second biggest e-commerce company (previous post). In that case, and now with Youku Tudou, Tencent seemed to get its stakes at a relatively big discount, reflecting the value of the connections it can offer to both of these smaller companies.
From a broader perspective, these 3 recent deals and similar earlier ones all seem to show that Tencent prefers to keep its focus on its core gaming and social networking (SNS) businesses, and form equity tie-ups with strategic partners in other areas. This looks like a good strategy to me, as it allows the company to stay focused on what it does best while also reaping benefits from businesses like e-commerce and video.
Of course not all such tie-ups always work, as evidenced by the failed partnership between Yahoo (Nasdaq: YHOO) and e-commerce leader Alibaba. But if they don't work, then Tencent can easily sell out its stake the same way Yahoo is doing now.
Bottom line: Tencent's 2 latest purchases reflect its M&A approach of taking big stakes in strategic partners, in a bid to find new business opportunities while focusing on its core strengths.
Disclosure: No positions.