CELLPHONES: Alibaba Buys Into Smartphones With Meizu

Bottom line: Alibaba’s Meizu investment is likely to spark a round of similar buying by major Chinese Internet firms, but could jeopardize Meizu’s access to the latest Android technology from Google.

Alibaba invests in Meizu

E-commerce giant Alibaba (NYSE: BABA) is finally making a smart acquisition to revive its flailing smartphone initiative, with word that it’s investing a hefty amount in the well-respected second-tier player Meizu. This particular investment comes just 2 months after another similar deal that saw security software specialist Qihoo 360 (NYSE: QIHU) form another tie-up with smartphone maker Coolpad (HKEx: 2369), and could auger a new wave of similar investments by Baidu (Nasdaq: BIDU), Tencent (HKEx: 700) and perhaps one or two other cash-rich Internet companies.

The news could provide some new breathing room for companies like Meizu and Coolpad, since they and many of their domestic peers are probably losing big money due to intense competition in China’s overcrowded smartphone space. But this new buying spree could also mean that competition is unlikely to abate anytime soon, since wealthy companies like Alibaba and Qihoo are unlikely to give up easily on their new smartphone initiatives.

This new Alibaba purchase actually has quite a bit of history, but first let’s review the latest headlines that say the e-commerce titan will purchase a minority stake in Meizu for $590 million. (company announcement). The investment looks quite big for a company of Meizu’s size, and I suspect Alibaba is getting quite a large piece of the company — perhaps up to 30 percent. The pair will collaborate in a number of areas, in a bid to popularize Alibaba’s mobile e-commerce products.

I’ve never used a Meizu phone before and don’t know anyone who has, but the brand does seem reasonably well respected in China. That said, Meizu is also one of many domestic names with such a reputation, reflecting the overcrowded state of an industry where homegrown names like Oppo, OnePlus, Coolpad, and Xiaomi all have similar images. That’s in part because all use variants of the free Android operating system (OS) developed by Google (Nasdaq: GOOG), and all use similar product designs.

That’s where the Alibaba history starts to become relevant. Alibaba developed its own Android-based OS, called YunOS, and was working with Taiwan PC giant Acer (Taipei: 2353) to develop a phone with the system to promote its e-commerce services in 2012. But Google objected to Alibaba’s Android variant, and ultimately pressured Acer to abandon its plans to produce the phones.

Since then, no major manufacturer has dared to defy Google and make phones using the YunOS, forcing Alibaba to partner with a handful of small domestic companies with little or no reputation and poor sales channels. So this tie-up with Meizu looks like a clear effort by Alibaba to buy a larger smartphone maker that will soon be forced to sell at least some models loaded with the YunOS.

If Meizu takes such a path, it could soon discover itself in the same difficult position that previously dogged Acer. Put simply, a maker of Android-based phones can hardly afford to alienate Google, since support from the US Internet giant is critical to developing and maintaining cutting-edge phones using the latest Android technology. It’s unclear how Meizu would react to such pressure, since its current phones use Android-based systems. But Alibaba would almost certainly insist on installation of its OS in future Meizu phones, which could put the company at a serious competitive disadvantage.

Returning to the original issue of consolidation, this Meizu investment shows that China’s Internet companies increasingly see smartphones as a critical element of their future business. Both Baidu and Tencent have made huge investments in mobile services, and each is almost certain to see Alibaba’s investment as a challenge that they will feel pressure to follow. For that reason, look for more M&A in space during the rest of the year, with 2 or 3 of the major mid-tier players likely to find major new backers over the next few months.

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