Uber's China Merger Is The Right Move

| About: Uber (UBER)

Summary

Uber and Didi are competing fiercely for market share in China.

A combined entity eliminates the competition and will make the market profitable.

Didi is a better player for the market given it is a Chinese company.

Uber needs the cash to fight its battles in other areas around the world.

Uber (Private:UBER) is planning to merge its China operations with those of Didi Chuxing (Private:DIDI), a Chinese ride-sharing company. The combined company will be valued at $35 billion, of which Uber and others will own 20%. Didi is also making a $1 billion investment in Uber, valuing Uber at $68 billion.

While the Chinese ride-sharing market is a huge opportunity, I believe backing out of the market is the right move for both companies, and will set them up for greater success around the world in the future.

Competitor Consolidation Means Higher Profitability

Uber and Didi have been dueling intensely over market share, resulting in heavy losses and cash expenditures for both companies. The pro forma entity will capture a huge swathe of the market, while eliminating expenses associated with much of the competition.

Uber Needs Cash to Expand Elsewhere

While China is a great opportunity, it is not the only opportunity. Uber is currently undergoing worldwide expansion, and that expansion doesn't come cheap. It has faced staunch opposition in other markets around the globe, and needs the cash to fund A, legal battles against established taxi businesses; and B, advertisements to recruit drivers, riders, and build goodwill. s

This is especially true considering Uber's slash and burn strategy to opposition. It doesn't fight for turf, it wages all-out war. This has especially become true under the watch of David Plouffe, President Obama's former campaign manager. Plouffe has been successful at pushing many politicians (and therefore laws) in favor of Uber, but those wins don't come cheap.

Uber Remains Exposed to China

While it will no longer directly conduct operations in China, Uber will remain exposed to the market via a stake in Didi (Note: Uber will maintain its presence until the deal formally goes through). Uber, Baidu, and a set of other investors will maintain a 20% stake in the pro forma entity, valued at $35 billion. They may have lost the battle, but they're not losing the entire war.

Didi is a Better Competitor

Much of Didi's competitive advantage boils down to it being a Chinese company. While the Chinese government is obviously open to American companies operating in its country, there is no question that the government favors Chinese companies. Didi, a local operator, will benefit from this. I do not think it's a coincidence that China is legalizing ride-sharing a mere week before this deal went through - there is clear proof the government is heavily involved and is willing to look out for a local company.

Didi, being a local operator, also has the home-field advantage with regard to understanding the business environment. By consolidating operations, Uber can take advantage of both Didi's government ties and understanding of the market.

There are Other Competitors in the Chinese Market

While Uber and Didi were huge players in China, there are other competitors they will need to deal with. Ride-sharing is a commoditized business, as there are few traits that can differentiate one company from another. If they want to be the dominant provider in China, consolidating now under one well known brand is a solid move. That way, they can focus capex on beating smaller competitors instead of a battle between the giants.

This is a Step Towards an IPO for Uber

Investors in Uber were disappointed with the significant losses the company had incurred in China. If it has aspirations of going public, eliminating the China hurdle is a crucial step towards eliminating fears of potential institutional and retail investors.

Conclusion

While surrendering the China market is not ideal for Uber, it is a wise decision strategically to merge their operations with Didi. It eliminates large capital expenditures that they can focus elsewhere, gives them exposure to the market with a strong player, and helps them slowly move towards an IPO. Overall, Uber should stand to gain from this deal.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.