A Blog by Jonathan Low


Oct 18, 2018

Has China's Tech Boom Become A Dot-Com Deja-Vu?

Investors are saying the same things they did 150 years ago: the market is so huge that the opportunity dwarfs the risk.

But the question is whether global competition, traditional market forces like reversion to the mean - and the Chinese government's penchant for control will stifle the boom. JL

Phred Dvorak and Liza Lin report in the Wall Street Journal:

A startup that lets consumers order coffee via smartphones raced to a $1 billion valuation seven months from launch. Crazy spending, stratospheric valuations: where some investors see dynamic exuberance, others see a market increasingly threatened by onerous domestic regulations and global trade tensions. Beijing has grown wary of the clout of private tech firms and the biggest players burn through cash in price wars with hardly a hint of when they might become profitable. “But potential is huge. And Chinese companies’ growth is much faster than their peers out of China.”
We’ve seen it before: the crazy spending, the stratospheric valuations. Twenty years later, it looks like the dot-com boom all over again, but this time the players are much bigger—and Chinese.
A Beijing-based startup that lets consumers order coffee via smartphones raced into so-called unicorn territory—a $1 billion valuation—in seven months from launch. The value of another firm, billed as an “Uber for trucks,” has soared to 300 times 2017 revenue; Uber Technologies Inc. itself is worth only about 10 times revenue.
But where some investors see dynamic exuberance, others see a market increasingly threatened by a confluence of forces including onerous domestic regulations and global trade tensions. The biggest risk? Another dot-com reckoning, the Chinese version of a cycle that erased billions of dollars of value from America’s tech sector in the 2000s and chilled tech investment for years.
There are already signs of such a shake-out as China’s publicly traded tech companies were buffeted this past week by a global tech-stock selloff and jitters from the escalating trade spat between Beijing and Washington. While the broad Shanghai Composite was down 7.6% this past week, the tech-heavy Shenzhen market lost 10.1%.
Also, Washington recently accused Beijing of tech-related spying and raised concerns about human-rights violations. Potential U.S. sanctions against Chinese tech companies could result in the disappearance of a major market for their products.
Between government pressure at home, tensions with the U.S. abroad and stock-price falls, China’s internet giants, which support a good deal of the country’s tech growth, “now somewhat suddenly find themselves between a rock and a hard place,” says Paul Triolo, a technology analyst at think tank Eurasia Group. “These problems are only going to get worse.”
For now, the boom times continue in the startup arena. Not only are China’s 109 unicorns worth more than the 127 U.S. billion-dollar-plus startups—$535 billion in total compared with $478 billion—but they also became unicorns considerably faster than their U.S. peers, data from Dow Jones VentureSource shows.
Sequoia Capital, among Silicon Valley’s most prestigious venture-capital firms, may for the first time invest the bulk of its newest global fund, up to 60%, in China, people familiar with the fund say. That fund is expected to be $8 billion, Sequoia’s biggest ever.
For the first time, Chinese startups are getting more money than their U.S. counterparts—$71 billion versus $70 billion so far this year, VentureSource data shows. The pace, with investment volume 18 times what it was five years ago, hasn’t been seen since the 2000 tech-stock bubble, feeding the perception that China is on its way to overtake Silicon Valley as the world’s tech hub.
But the threats to Chinese tech dominance are mounting as Beijing has grown wary of the clout of private tech firms and many of the biggest players burn through cash in punishing price wars with hardly a hint of when they might become profitable.
Outlays on discounts to gain market share can pay off big in a market as large as China’s. But there can be a hangover even for winners: Consumers treated to freebies tend to peel away when subsidies end.
There could be global reverberations as around 45% of the investment in Chinese startups this year came from outside China. Some investors have already gotten burned.
For a glimpse of the potential pain, consider Chinese bike-share companies. Only last year, they couldn’t spend fast enough. After putting millions of cycles in Beijing, Shanghai and other cities, several looked to conquer metropolitan areas in the U.S. and Europe.
Now, cash-flow problems are setting in. Mobike recently sold itself for nearly $1 billion less than it was valued after its last funding round, people familiar with the matter say. Ofo is reversing course on its international expansion and the No. 3 bike-sharing company, Bluegogo, collapsed late last year.
Another wild card is the regulatory environment in Beijing. The advances of Chinese tech giants were long a point of a national pride. And while China’s leaders still encourage innovation, they have tightened the grip on many of the country’s biggest players, including Tencent Holdings Ltd. and Alibaba Group Holding Ltd. —even shutting down or blocking products they don’t like.
In June, China’s official People’s Daily newspaper warned investors against a rush of capital into tech startups that could turn investing into a “gamble.” Smartphone maker Xiaomi Corp. had to scale back ambitious listing plans, eventually going public in July at a valuation of $54 billion, about half of what it initially hoped.
Still, money keeps flowing in. In September, Chinese investment firm Hillhouse Capital Group unveiled a new $10.6 billion fund—the largest-ever capital raise by a private-equity firm in Asia, topping a $9.3 billion fund set up by KKR & Co. last year. The fund was “heavily oversubscribed,” it said.
Days earlier, food-delivery giant Meituan Dianping , which has lost at least $8.5 billion since 2015, went public in Hong Kong at a market capitalization of around $53 billion.
One company that has seen its valuation skyrocket is Manbang Group, the truck-hailing firm whose apps let Chinese truckers contract with shippers for cargo.
The company approached investors this year looking for around $300 million in funding. By April, so many had expressed interest that Manbang raised nearly $2 billion, added plans for a fleet of electric-powered, self-driving trucks, and was valued at around $6 billion.
Manbang has more than six million users and has deployed around 3,000 young staffers across China to sign up more.
One recent Sunday, two of those marketers hit up a dusty parking lot on the outskirts of Beijing, offering baskets with shampoo and toothpaste to get truckers to download the apps. Truckers say they see teams every day.
“I’m almost bothered to death by you guys,” one driver said.
But most of Manbang’s users aren’t paying. It has gotten around 200,000 shippers to fork over around $250 a year in membership fees and is aiming to break even next year, said a person familiar with the matter. But it isn’t yet charging truckers, and many are already complaining that the apps are pushing down shipping prices.
Recently, Manbang has started looking for an additional $1 billion at a valuation of $10 billion. This time investors are skeptical, people familiar with its plans say. Manbang didn’t respond to requests for comment.
Other major startups are slugging it out with as many as a hundred or more competitors. Some are going to extremes.
Every day during the height of China’s bike-share frenzy last year, says Ben Cavender, an analyst at China Market Research Group in Shanghai, workers from Ofo would rearrange bikes near his office so they completely surrounded those of rival Mobike. Ofo says it has never instructed its bike marshals to block competitors’ bikes.
Luckin Coffee, the startup that surpassed $1 billion in value seven months after launching in January, has been spending furiously to open 2,000-plus outlets and subsidize giveaways like half-priced snacks. As Starbucks Corp. responds with its own delivery service, Luckin is again raising funds.
Its co-founder said Luckin is still losing money, but the market potential is great.
Then there are companies like Didi Chuxing, which raised about $24 billion over the past six years in large part to help it defeat rivals. Even after coming out on top in a battle with Uber two years ago, it has yet to turn a profit. It now finds itself fighting a fresh batch of competitors, including Meituan, which expanded into ride-hailing last year.
In March, Meituan started offering short rides in Shanghai for less than a U.S. cent, resulting in a surge in users taking cars for distances they’d normally walk. Didi responded with its own subsidies.
Stephen Zhu, Didi’s chief strategy officer, says competition in China is fiercer, partly because its markets are less developed. In the U.S., services like ride-hailing are “more like dessert,” he says, while in China, where car ownership is still relatively low, “it’s your main course.”
Lately, Didi has moved into food delivery—the main source of revenue for Meituan, as well as for Ele.me, a company Alibaba bought in May.
In April, Didi flooded streets in the central Chinese city of Wuxi with scooter-riding delivery staff, offering them monthly salaries and bonuses sometimes more than double Wuxi’s average wage, and gave restaurants bonuses for filling orders on its app.
It also subsidized meals, including a one-time coupon for 25 yuan ($3.67) to anyone ordering on its app. Meituan and Ele.me fired back with their own big discounts. Delighted diners posted screenshots of meal receipts on social media.
“It’s a pity you’re not in Wuxi, hahahahahaha,” wrote one user on China’s Twitter counterpart Weibo, attaching a screenshot of an order via Meituan for fried chicken, orange juice and milk tea that after discounts cost 0.01 yuan—about a 10th of a U.S. cent.
Song Yunyi, the boss of a box-lunch kitchen called Mr. Bento, says Meituan marketing staff warned him not to work with Didi. After he listed on Didi anyway, he says, Meituan’s app started describing his shop as closed. Other restaurateurs have complained to Wuxi’s government Meituan blocked them on its app after they listed with Didi. Meituan declined to comment.
After the government ordered the companies to stop the craziness, things calmed down—for a while.
Since then, Didi has pushed food-delivery services into at least three more cities, and is plowing funds into bike-sharing and automated driving. It lost more than $580 million in the first half of this year.
Didi is looking for more money and next year hopes to go public at a valuation of as much as $80 billion, people familiar with Didi’s plans say.
Meanwhile, Meituan is pushing into bike-sharing and grocery delivery. “You need to jump-start the market” with spending on inducements sometimes, says Chief Executive Wang Xing.
Ele.me’s parent, Alibaba, is merging the company with an affiliate and has raised $3 billion for the combined business at a possible valuation of $25 billion, partly from investors like Japan’s SoftBank Group Corp. This summer, Ele.me spent $440 million—the bulk of its previous quarter’s revenue—on discounts and other enticements.
“At the start, yes, you are virtually treating consumers to free meals,” says Wang Lei, chief executive of Ele.me. But, he says, at some point, spending “often will get more logical.” When? “It’s really hard to say.”
Backers of China’s tech boom say the risks are worth it.
“For many outsiders, they think Chinese companies are raising money too fast, and the valuations are very high,” says Richard Peng, a former executive at Tencent whose fund, Genesis Capital, invested in the latest round of Manbang Group, the truck-hailing firm compared to Uber.
“But No. 1: The potential is huge. And No. 2: The Chinese companies’ growth is much faster than their peers out of China.”
The gold standard is Alibaba, whose 2014 initial public offering was the biggest in history, making a mint for investors like U.S. venture-capital firm GGV Capital. When GGV invested in Alibaba in 2003, it was valued at around $180 million, says managing partner Hans Tung. Since then, Alibaba’s value has increased more than 2,000-fold.
“Alibaba was expensive in every single round,” he says. “But it’s become a half-trillion-dollar company and it’ll get to a trillion very soon.”
Alibaba said its e-commerce business continues to charge ahead with sales up 61% in the latest quarter, despite worries about a Chinese economic slowdown. But the company warned its profit will be pressured by continued heavy spending on new businesses.
There is now so much money chasing companies that it’s sometimes becoming hard to justify valuations by traditional measures. Some startups are calculating potential revenue from markets that haven’t yet developed, bankers say.
A dearth of investment options in China’s still-restricted financial markets likely channels money to startups that in a more open economy may have had other destinations.
And Beijing’s recent actions to tighten control over champions like Alibaba and Tencent show that tech companies’ business prospects can change quickly, depending on how their technology aligns with broader government ambitions, whether in leading the world in cutting-edge technologies like artificial intelligence or in building a web of digital surveillance at home. Tencent’s social-messaging app WeChat, for example, has been used to police speech and monitor crowds.
Analysts estimate that Tencent lost $1.5 billion in sales in the second quarter after regulators delayed approvals of some of its videogames. Before that, authorities forced Alibaba affiliate Ant Financial to sideline a potentially lucrative credit-scoring business in favor of a government-backed system.
Bytedance Ltd., a $30 billion unicorn backed by Sequoia Capital and others, has recently found itself in regulators’ crosshairs. Authorities ordered the demise of its joke app Neihan Duanzi over what they said was too much vulgarity and temporarily removed Bytedance’s best-known product—news aggregator Jinri Toutiao, with 120 million daily users—from app stores because it didn’t like the content.
Nonetheless, Bytedance is in talks to raise $3 billion from investors like Japan’s SoftBank and U.S. private-equity firm KKR at a valuation of as much as $75 billion, people familiar with the matter say, which would rank it above both Uber and Chinese ride-hailing powerhouse Didi Chuxing Technology Co. as one of the world’s most valuable tech firms.


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