Winners And Losers Of China's Taxi War

| About: Alibaba Group (BABA)

Summary

Uber is selling its China operation in a share swap in which it will receive 20% of the combined company.

This marks the end of the costly taxi war between local Didi Kuaidi and Uber China that has lasted over the past two years.

Winners: Alibaba and Tencent given their higher economic share in Didi Kuaidi. Loser: Baidu.

Just when millions of veterans in China were celebrating August 1st Army Day, some investors in China celebrated the end of the costly taxi war between Didi Kuaidi and Uber (Private:UBER) China. WSJ reported that Uber is selling its China operation to rival Didi Kuaidi in return for a 20% stake of the combined company. Other Uber China investors such as Baidu (NASDAQ:BIDU) will hold roughly 2% of the combined entity. This marks the end of the costly taxi war between Uber and the incumbents (see - Alibaba (NYSE:BABA) And Tencent (OTCPK:TCEHY): Sharing A Taxi, But Not An Uber) and confirmed my prior view that Uber had no chance of becoming a major player in China's ride-hailing landscape (see - Kuaidi/Didi And Uber China: A Tale Of Two Taxi Apps). Additionally, investors should also be aware that the Chinese regulation will favor domestic innovation over foreign innovators. This is logical in that any government will encourage local innovation and prevent foreign innovators from achieving the majority of the economics (see - Alibaba: Combing Through China's Taxi Regulation).

That said, investors should not be overly bullish on Western tech firms dominating the Chinese landscape. Making entrance is not as same as local dominance. Google (NASDAQ:GOOG) (NASDAQ:GOOGL) certainly learned its lesson. Apple (NASDAQ:AAPL) is learning its lesson (see - Apple: Respect The Middle Kingdom and Apple: Sell On Strength) and Uber is the latest Western tech casualty in China.

This transaction effectively ends the costly subsidy war in the industry (see - Alibaba: Taxi War Heats Up and Alibaba: Taxi War Heating Up) should improve long-term profitability of the combined entity going forward given the other local players have much smaller scale to compete against Didi Kuaidi. This is a positive for Tencent and Alibaba given that both companies have roughly equal shares (although Tencent has slightly more shares than Alibaba) and Apple given its backing of Didi Kuaidi earlier this year. The recent funds that Didi Kuaidi raised can be used towards network expansion and potentially driverless taxis (see - Alibaba: Taxi Giant Beefs Up Its War Chest). I believe that this will be a long-term positive for both Alibaba and Tencent, although I also acknowledge that Tencent's WeChat payment has been gaining grounds so TCEHY will be the bigger beneficiary, in my view.

The loser in this transaction is BIDU given that it was the biggest backer of Uber China and relied on the integration of Uber and Baidu Map to drive its O2O projects. With both BABA and Tencent as majority holders of the combined entity, both firms clearly have better economic benefits than Baidu and could potentially pressure BIDU to pursue other partners or consolidate the smaller players by bringing them into its BIDU ecosystem. This move could further pressure BIDU's profitability given that its core business is likely to be in stagnation in the coming quarters due to competition and a diminishing ecosystem (see - Baidu: Time To Punch Out). BIDU could differentiate by maintaining its current pursuit of driverless technology (see - Baidu: Getting Aggressive On Driverless Cars), but I question whether the company can have sufficient FCF to fund this costly project in the future.

Bottom line, my pecking order for the Chinese internet remains BABA, Tencent and BIDU.

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