Analyzing The Ctrip-Qunar M&A Scenarios

| About: Qunar Cayman (QUNR)


I expect Baidu and Ctrip to merge their online travel units by year-end.

Such a merger would allow Baidu to focus on search while maintain a relevant presence in the OTA space.

Ctrip on the other hand would become the largest OTA in China via merger with Qunar.

According to Bloomberg, Baidu's (NASDAQ:BIDU) listed online travel unit, Qunar (NASDAQ:QUNR), is in discussion with Ctrip (NASDAQ:CTRP), China's largest OTA, on a potential merger, or a partnership. In my view, a partnership on revenue/traffic sharing between Ctrip and Qunar is unlikely as Ctrip and Baidu would jostle for the majority control over strategic planning and execution. In particular, Baidu looks to leverage its search capability to explore new vertical integration opportunities, which may conflict with Ctrip's future plans.

That said, I expect an acquisition to play out, and I outline the three possible scenarios below.

First scenario: Baidu acquires Ctrip

I believe that Qunar is unable to fund the acquisition of Ctrip on its own. At the end of 2013, Qunar had $269m in cash and short-term investments. Acquiring Ctrip, which is valued over $7b, would require Qunar to issue a combination of debt and equity. However, Baidu, which has 59% voting power in Qunar, is likely to reject the deal.

A more probable scenario is one in which Qunar acquires Ctrip with the support from Baidu. At the end of 2013, Baidu had $6b in cash and short-term investments. However, Ctrip's hefty price tag is equally difficult for Baidu to swallow, in my view. I think Baidu's cash could be better used. For example, Baidu can deploy cash to scale up Qunar's operation. From a technological point of view, Qunar's model is superior to Ctrip's in terms of user experience. Therefore, it does not make sense for Qunar to invest in an inferior competitor.

Second scenario: Ctrip acquires Qunar

Ctrip may buy out Baidu's stake in Qunar to consolidate China's OTA market, just like how Priceline (NASDAQ:PCLN) purchased Kayak a year ago. By adding travel meta-search into its business portfolio, Ctrip will immediately become the leading online travel provider in China with a strong network of hotels and airlines. Under this scenario, I expect Ctrip to fund the acquisition with a combination of cash and debt. As of 2013, Ctrip had $1.9b in cash and short-term investments. In order to purchase Qunar, Ctrip will have to issue at least $2b in debt.

However, Baidu is unlikely to sell Qunar. I believe Baidu wants to stay relevant in the online travel space.

Third scenario: Ctrip takes majority stake in Qunar, while Baidu takes a strategic stake in Ctrip.

I believe the most likely scenario is a share-swap between Baidu and Ctrip. Under such an arrangement, Ctrip can purchase a partial stake in Qunar via Baidu. At the same time, Baidu can take a strategic stake in Ctrip. I estimate that if such a scenario were to materialize, Baidu will have ~20% strategic stake in Ctrip and retain ~20% stake in Qunar, while Ctrip will take majority stake Qunar. This outcome is ideal for all three parties as it minimizes conflicts and maximizes business potential. With a majority stake in Qunar, Ctrip will become the clear leader in China's online travel space. Baidu, although with a reduced ownership percentage in Qunar, will continue to play a strategic role. The revenue potential behind this partnership is attractive. All the parties can focus on their core competencies and R&D efforts. In my view, a common pitfall of today's Chinese internet giants is to pursue multiple businesses and lose focus on their core competencies. In the end, they risk becoming "Jack of all trades, master of none." Sohu (NASDAQ:SOHU) is a classic example. Sohu was always the no. 2 or 3 player in portal, online gaming, search and video, but never became no. 1. I believe Sohu's inability to dominate is a key reason behind its depressed valuation.

By giving Ctrip majority stake in Qunar, both Ctrip and Qunar can focus on OTA and travel meta-search, while Baidu can focus on refining its search engine while still holding a significant stake to be relevant in the online travel space.

I expect this deal to be completed by the end of the year. Alibaba's IPO is on the horizon. Alibaba can use its IPO proceeds to pursue M&A. If Baidu does not take actions, then Alibaba's lead over Baidu will widen.

Disclosure: I 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.

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