A battle royale in online food delivery is underway across China.
Mobile apps are vying for the attention of China’s burgeoning middle classes who are increasingly partial to ordering take-out meals via their smartphones due to their busy lifestyles and the country’s traffic congestion.
The nimble startups are spending money lavishly, heavily subsidising menus to gain market share at the same time as paying fleets of bikers to deliver piping-hot food to customers within 30 minutes.
Decisive factors in the looming showdown will be how strong your allies are and the start-ups' capital-raising prowess. Accordingly, some of the world’s largest investors and internet players are getting ready to rumble by lining up behind their respective champions: Ele.me, in the case of SoftBank and Alibaba, and Beijing-based Meituan Dianping on the side of Tencent.
Ele.me’s latest private funding round values the firm at a lofty $30 billion after the fresh capital has been added to its balance sheet, according to a person involved in the deal. Investors value Meituan Dianping's outstanding shares at $28 billion following its September initial public offering on the Hong Kong bourse.
The puppeteers behind these fast-growing startups have tantalised and frustrated other investors in turn. What is crystal clear is that their influence cannot be ignored.
SoftBank’s chief executive Masayoshi Son has become a kingmaker among entrepreneurs. Backing from his group’s near-$100 billion Vision Fund can propel a startup like Ele.me beyond the reach of its nearest competitor.
Son describes the Vision Fund’s strategy as betting on the leading horse at the last turn before the finish line. Some call it race fixing, given the amount of capital the Vision Fund injects into its chosen startups.
“We believe winner takes all,” Ashkay Naheta, a managing director of strategic finance at SoftBank.
China’s internet giants, Baidu, Alibaba, Tencent and JD.com, known collectively as BATJ, have also created their own investment teams to scout the globe for startups.
Some have set up dedicated funds, similar if smaller than the Vision Fund, while others invest straight off their balance sheet. Alibaba has birthed a series of such funds, known in the industry as corporate venture funds or general partners (GPs), including AliBaba Entrepreneurs Fund, AliBaba Innovation Ventures and AliBaba Capital Partners. Baidu has sprouted Baidu Ventures.
Forest Lin, managing partner of Tencent Investment, said in answer to a question from FinanceAsia that his team invests primarily from Tencent’s balance sheet. The Shenzhen-headquartered company makes about $10 billion to $15 billion worth of investments a year in startups around the world.
Public and private Investors looking to piggy-back on the value that SoftBank and BATJ are creating at startups are buying their stocks, co-investing alongside them or trying to predict where they will invest next, hoping to be bought out.
“We’ll see a new breed of GPs emerge, which will include technology companies’ captive tech platforms, such as Softbank, Alibaba, JD and Tencent. [They will] utilise their deep knowledge in technology and their vast network in the new economy to source and value-add,” said Canada Pension Plan Investment Board’s Suuyi Kim. CPPIB has invested in Alibaba and its payments affiliate Ant Financial.
GROWING CLOUT
In a sign of their growing clout as investors, BATJ and SoftBank have captured a bigger proportion of the deal volume across the Asia-Pacific region from other investors.
In the third quarter of 2018, corporate funds accounted for 35% of deals with venture capital-backed companies in Asia, up from 29% in the fourth quarter of 2016, according to data provider CB Insights. Elsewhere, US corporate funds made up 29% and European corporate funds captured 28% of deals.
Tencent's investment portfolio generated net other gains of Rmb8.76 billion in the third quarter ended September, roughly a third of its operating profit, while Alibaba's investment portfolio netted Rmb6.64 billion in interest and investment income over the same period, a third of its net income.
As a result of the internet giants’ deep pockets, IT sector experience and network effects, they attract the entrepreneurs most likely to succeed, said Olivia Ouyang, a director in the private capital department of Ontario Teachers’ Pension Plan, which has about C$30 billion ($22.4 billion) invested in private equity globally.
BATJ and SoftBank are creating internet ecosystems that contain multiple services and are tailored to customers’ needs based on their vast troves of data.
That is particularly true of entrepreneurs locked in a vicious battle with competitors for market share, where capital is a decisive factor as in the case of Ele.me and Meituan-Dianping.
Some entrepreneurs try to stay independent longer to avoid the rivalry between Alibaba and Tencent, as picking a side can limit their business opportunities. They also fear that their company could become subjugated within the wider group to the needs of the larger business.
For example, major shareholders can view food delivery as a way to engender loyalty to the group’s brand as a whole, by driving huge transaction volumes and adding vast amounts of customer data, according to one early investor in Ele.me who declined to be named.
“People are very happy to get money from strategics but at the same time they have to be very careful; strategics have their own agenda,” said Helen Wong, a partner at China-based venture capital firm Qiming Ventures’ Wong, an early investor in Alibaba. “Startups have to be careful that they don’t become a pawn in this bigger game.”
To be sure, powerful conglomerates such as those controlled by the Keirutsu in Japan, tycoons in Hong Kong, South-East Asia and India and the chaebols in Korea, as well as Chinese state-owned enterprises, have long muscled other investors out of deals across Asia.
Even so, the advent of whole internet ecosystems with their own corporate funds is particularly crushing because they focus on the technology sector at a time of enormous value creation. With good reason, people call it another industrial revolution.
Overall returns to investors from this sector have significantly outperformed the average private equity returns over the 10 years to December 2016, according to alternatives data provider Preqin.
THE SOFTBANK FACTOR
Internally managed corporate funds have evolved and grown dramatically in recent years. In the past, a typical corporate fund was the investment arm of a manufacturing company, such as German conglomerate Siemens, which set up Siemens Venture Capital in 1999. They were created to acquire innovative products as well as profitably deploy free cash flow.
“Corporate funds were once a side-show in venture, though that is no longer the case in this cycle,” Juan Delgado-Moreira, head of Asia at Hamilton Lane, told FinanceAsia.
In many investors’ eyes, the transformative moment came when SoftBank’s Son launched the Vision Fund in October 2016 in partnership with Saudi Arabia’s sovereign wealth fund to invest in internet and emerging technology businesses.
“We want to go and fund the leader, maybe even over-fund it, and scare the heck out of the competition,” Softbank’s Naheta said. When asked by FinanceAsia if this tactic could destroy value if a startup didn’t need the capital, Naheta said: “They think they need X amount and we say you should scale now, think bigger.”
The emergence of powerful corporate funds impacts other investors in numerous ways. Most broadly, their cutting-edge technology is changing customers’ consumption habits and boosting economic growth, particularly in areas such as payments and mobility.
However, their size and accumulation of data on customers have created formidable network effects that are hard for competitors to match.
Sometimes the internet giants impose their rivalry onto their own investors. When Alibaba’s payments affiliate Ant Financial raised $14 billion in June it inserted a clause in the deal contract that barred its investors from backing rivals including Tencent.
One of the few private equity fund managers that have managed to navigate the rivalry between Tencent and Alibaba is Neil Shen, head of Sequoia Capital China. He has backed companies in Tencent’s corner including Meituan Dianping and JD.com, as well as in Alibaba.
A chink in the armour of these internet giants is investment talent. Generally speaking, the compensation they offer professionals is lower than at private equity firms. They often include company shares as incentives rather than offer profit sharing, known as carried interest at other general partners.
“By and large, they have not become a magnet for talent so far,” said Delgado-Moreira. “The best set of economics, for the most part, remains in third-party money.”
A few investment professionals are even spinning out from BATJ. Richard Peng has founded Genesis Capital after heading up investment for Tencent between 2008 and 2015. JD.com’s international president Winston Cheng is looking to return to finance, potentially setting up his own fund with partners after leading the ecommerce giant’s investment in luxury brand retailer Farfetch, which created a gain for JD.com of over $500 million in its third-quarter results.
“They carry the stamp of approval from the corporates and have that insider angle; then they go out and fight the Goliath,” said Delgado-Moreira.
PIGGY-BACKING
Public investors have thronged to the stocks of the world’s technology giants.
Long positions in FAANG (Facebook, Amazon, Apple, Netflix, Google) plus BAT were the most crowded trade for a tenth straight month in November, according to BofA Merrill Lynch’s monthly survey of fund managers. The same survey three months earlier showed FAANG plus BAT to be the most crowded trade outright since investors went long the US dollar en masse in December 2015.
Of course, the shine has come off these stocks somewhat in recent months due to rising concerns about stiffer regulations and excessive valuations, as stock markets generally have tumbled. But longer-term the investment case for these titans, including SoftBank, remains intact.
US hedge fund Tiger Global has gone large on backing these internet ecosystems. The fund, founded by Charles (Chase) Coleman III, had built a stake worth over $1 billion in SoftBank as of July. On November 14, Tiger Global Management raised its stake in Alibaba by 45.5% to 6.5 million American depositary shares. The fund has also invested in numerous Alibaba affiliates such as Paytm Mall as well as backed Tencent portfolio companies such as Flipkart.
But one problem investors faced when investing in these high-profile public stocks is a lack of transparency and the overweening influence of their founders, such as SoftBank’s Son, who still owns a 21% stake in the firm he founded.
BATJ and SoftBank are so flush with cash that they don’t need investment partners, making so-called co-investments are rare.
Corporate funds do not tend to accept capital from third-party investors, SoftBank’s Vision Fund being a prominent exception. According to a filing with the US Securities and Exchange Commission earlier in December, it had collected $98.58 billion from 14 investors.
Other notable corporate funds include Ping An Ventures, the China investment arm of the world’s largest insurer Ping An Insurance (Group) Company of China, which has been raising capital from institutional investors this year for a couple of healthcare funds. A Ping An spokesperson declined to provide details on the current status of the fundraising effort.
Meanwhile, Baidu set up Baidu Ventures in 2016, which manages about $500 million across three funds. Baidu is invested in the funds but also opened the gates for other financial institutions and corporations.
But investors in these sorts of funds should question whether the interests of a fund’s sponsor could ever conflict with their own.
As Kevin Jacques, head of corporate fund Visa Ventures, put it at the Milken Asia Summit in September: “Sometimes the strategic return, and let’s say enhanced distribution for the card network, can completely outweigh in terms of return potential the dollars we are putting at risk.”
NIO Capital, an affiliate of smart electric vehicle manufacturer NIO, has tried to draw boundaries with its parent company to allay any such fears from third-party investors in funds, also known as limited partners (LPs).
“We strategically didn’t take NIO’s money. Our ultimate responsibility is to our LPs. And our team is incentivised by the performance of the fund,” Ian Zhu, managing partner of NIO Capital, told FinanceAsia. “We are an independent, financially-driven firm,” he added.
According to Zhu, NIO Capital is backed by an unnamed Asian sovereign wealth fund, insurance companies from Asia and Europe, as well as several independent corporations such as a $10 million contribution from the corporate venture fund of oil major BP.
NIO is only a minority owner in the fund’s general partnership, so while the unicorn takes a slice of the fund’s profits, Zhu said it can’t unduly sway investment decisions.
Another issue for third-party investors in these corporate funds is tracking returns.
A manager at one of the BATJ funds told FinanceAsia, on condition of anonymity, that it is even hard for people internally at the funds to track value creation given the synergies with the overall group. He said when the portfolio company performs well, different parts of the group claim credit, when it tanks, no one wants to own the problem.
A few investors have tried to invest alongside BATJ and SoftBank in every funding round of a startup; some copy their investment decisions while others try to predict their moves and hope to be bought out.
“As [venture capitalists] we want to follow the Alibabas and Tencents of this world. We do also think they could be our exit strategy as well,” said Qiming Ventures’ Wong. Qiming Ventures has about $4 billion under management including investments in Chinese electronics company Xiaomi and bike-sharing firm Mobike, as well as in Indonesia’s Akulaku.
However, smaller funds struggle to gain entry to the hottest startups. And if they do manage to get in, many have to fold as the size of the investment rounds increases.
To deal with that, some GPs have devised ways to sell the bulk of their pro-rata investment rights in later-stage funding rounds to larger investors by creating a new side-vehicle, which allows the original investors to garner a percentage of profits on their smaller, diluted holding. The practice has resulted in a hodgepodge of fee structures and convoluted capital structures for pre-IPO companies in China.
STAR GAZING
In China, the influence of BATJ and SoftBank has reached a point where other investors fear all they have to do to kill a company is ignore it or copy it. So studying their strategies has become a major factor in investment decisions.
“In many sectors, you need to know which way the current is flowing in order to avoid being at risk of drowning,” Delgado-Moreira said.
They can act to stop price wars. Hence, SoftBank, as a major shareholder in several ride-hailing apps including Uber and China’s Didi Chuxing as well as Singapore’s Grab, was able to suggest to Uber’s management to become a shareholder in Didi and Grab rather than compete tooth-and-nail for market share, according to an executive at one of the ride-hailing apps.
And in other cases, they can stoke them by investing in several companies, even fierce rivals. For instance, Tencent invested in both Ofo and Mobike, rival bike-sharing brands in China. They do this in order to widen their ecosystem’s footprint, particularly in payments, and to gain more customer data.
Similarly, China’s internet giants view food delivery as a way to bring more merchants – in this case restaurants – into their ecosystems. The business boosts their other services such as payments and logistics too.
“The tendency of using the food-delivery services is high, which can drive online traffic and transaction volume for our platforms,” Lei Wang, Ele.me’s chief executive, told FinanceAsia.
The investor in Ele.me quoted earlier expects the subsidy war to weigh on all combatants next year – until, that is, Ele.me reaches its target of a 50% market share. As of September 30, Ele.me had a market share of 29.1% while Meituan-Dianping had 60.1%, according to Beijing-based consultancy TrustData.
Meituan Dianping executives, locked in competition with Ele.me, filmed themselves shouting “Fight until death!”, according to multiple Chinese-language reports.
There are also personal factors at play. Son was a very early investor in Alibaba and sits on the ecommerce giant’s board of directors, so SoftBank repeatedly backs Alibaba in its proxy wars with arch-rival Tencent. One person who sat down to lunch with Son said he talks as if it was him that created Alibaba, explaining his partisan behaviour.
Son, who founded Softbank as a computer parts store in 1981, also plans his investments in terms of decades, even centuries, so a few years of losses is a blip.
If so, the war will be one of attrition for shareholders as well as for the companies.
With assistance from Molly Jackson
SoftBank's growing empire across Asia
