After Years of Waiting, Internet Consolidation Starts

Cash crunch drives China Internet consolidation

After years of inactivity, China’s Internet sector has seen a sudden flurry of M&A deals with potential to consolidate the fragmented space and create some truly world class companies that could one day compete with the likes of Amazon and Google. While commercial factors are mostly behind this sudden M&A spring, Beijing could also play a limited role by encouraging more consolidation, helping to lay the foundation for a vibrant and sustainable Internet sector that could become a global leader. The latest deal in this sudden new wave of M&A came late last week, when e-commerce leader Alibaba agreed to pay $294 million for 28 percent of AutoNavi, a provider of mapping services. (previous post) Just 2 weeks earlier, Alibaba also agreed to pay another $586 million for 18 percent of Sina Weibo, China’s leading microblogging service. Both deals will help Alibaba boost its mobile and social networking capabilities to complement its core e-commerce business.

Meantime, leading search engine Baidu (Nasdaq: BIDU) entered the M&A arena last week with announcement of its plan to purchase PPS, a leading online video site, for $370 million. (previous post) Baidu planned to combine PPS with its own iQiyi unit to create a solid number-two online video company to rival industry leader Youku Tudou (NYSE: YOKU).

Elsewhere on the Internet, reports also surfaced last week that veteran web portal Sohu (Nasdaq: SOHU) is looking to sell its own Sogou online search unit. Those reports said a number of buyers were interested, led by security software firm Qihoo 360 (NYSE: QIHU). Such a deal, which would also be valued in the hundreds of millions of dollars, would allow Qihoo to combine its own up-and-coming search service with Sogou to create the first serious rival in years to Baidu’s dominance in online search.

This kind of consolidation has been needed for years, but never happened for a number of reasons. One reason was personalities, since many Chinese Internet firms were dominated by their founders who were reluctant to cede control. At the same time, those founders didn’t need to worry about cash, since eager investors from both China and abroad were happy to provide piles of money for a chance to buy into the China Internet story.

But the abundant cash flow has suddenly turned off over the last two years, the result of a plunge in investor interest as many Chinese Internet companies failed to become profitable and a series of accounting scandals rocked the sector. That cash crunch has forced many company founders to do the once unthinkable and consider selling their firms or major equity stakes to more cash-rich sector leaders like Baidu, Alibaba and Tencent (HKEx: 700).

While commercial factors should dictate the broader pace of consolidation, Beijing could also take some small but important steps to ensure this much-needed new movement doesn’t lose momentum. Such steps could include providing some funding from state-run banks to help with merger finance, and also some regulatory assistance that might cut out some red tape that could slow down deals. That kind of quiet assistance would help to expedite this young but beneficial consolidation, as China’s Internet sector finally starts to mature.

Bottom line: A new wave of consolidation is sweeping China Internet landscape, fueled by an industry cash crunch.

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