Financial Pressures Shaped Didi-Uber Deal in China

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Uber and Didi have been fierce competitors, but China’s internet is increasingly a game of giants.  Photo: Andy Wong/Associated Press

When Jenny Zeng invested in Uber Technologies Inc. last summer, and, as part of the deal, took a small stake in its China operation, she thought it likely that UberChina would end up merging with Didi Chuxing Technology Co.

“The two companies should have known it, too,” said Ms. Zeng, managing partner of Magic Stone Alternative Investments, a Beijing-based firm that she founded in 2011. “It’s inevitable as part of the consolidation trend in the Chinese internet industry.”

This isn’t hindsight. Ms. Zeng told me this not after learning the news on Monday that Didi is buying UberChina in exchange for about 20% of the enlarged company, but in mid-June. She was one of several investors with skin in the game who told me then that a merger, which seemed improbable to some, might be in the cards.

Their thinking sheds light on some of the forces that shaped Monday’s deal. For one, China’s internet is increasingly a game of giants. There are the big three that dominate the industry— Alibaba Group Holding Ltd. BABA 2.26 % , Tencent Holdings Ltd. TCEHY -1.20 % , and Baidu Inc. BIDU 2.27 % —but there also have been a string of mergers recently forming new big players. For instance, Meituan.com, China’s version of Groupon.com, and restaurant-review app Dianping Holdings Ltd., merged in October to provide offline services for online users. And Didi itself was born out of a merger early last year between former rivals Didi and Kuaidi.

Ms. Zeng said that when she invested, she thought UberChina had good momentum, but also that the huge amount of cash needed to battle Didi would lead the rivals into each other’s arms. She figured that would provide a good exit path delivering good returns. She declined to say what her investment is valued at now.

Also driving a tie-up: cash isn’t flowing as freely into China’s tech sector as it was last year. Early-stage angels in China made 818 investments in the first half of 2016, 30% lower than the same period of last year, according to Beijing-based Zero2IPO Group. The number of venture investments also was down 30%, while the total value of disclosed deals was down 10% from the same period of last year, according to Zero2IPO.

UberChina gained significant market share after launching its ride-hailing service in Shanghai in early 2014, but at sizable cost. It has had a tough time raising new funding from Chinese investors recently and had to rely on its parent company to fund its loss-making operation, according to people familiar with the matter. Didi also has spent heavily, dating from the days when Didi and Kuaidi battled for market share before their merger in February 2015.

Though Didi and UberChina claimed that they were getting closer to profitability, it was hard to see how that was possible, especially for the much smaller UberChina. According to Beijing-based research firm Analysys International, Didi had 43.1 million active users in May while UberChina had 10.1 million. New regulations governing the sector, issued just last week, would make it even harder to try to gain market share by barring companies from operating below cost.

For example, an Uber ride I took last Wednesday from the Beijing airport to a hotel in the city cost 52 yuan ($7.82), or 20 yuan cheaper than my return trip on Sunday on a taxi, even though the Uber ride experienced worse traffic. As I was writing this column, I got a message from UberChina, offering a carpooling ride within the distance of five kilometers (3.1 miles) for five yuan (75 cents) only.

While I was in Beijing, I used Didi to call a taxi but didn’t use its ride-hailing service because it was more expensive than Uber. I used Didi more when they gave me coupons. Most Chinese consumers are like me—there is no brand loyalty to speak of.

Investors know this means endless, costly battles, and were increasingly reluctant to throw in additional cash for the companies to burn, said an investor whose fund invested in Didi. In addition, the need to fund those battles meant that earlier Didi investors were seeing their stakes diluted. Didi raised $7.3 billion in its latest funding round that valued the company at $28 billion. After Monday’s deal, Didi will have a valuation of around $36 billion when combined with UberChina’s business that was valued at around $8 billion. “We didn’t make money in this merger or last funding round,” said the Didi investor.

Since few Chinese funds are big enough to feel comfortable investing in startups as big as Didi, some early Didi investors also worried that the company would have a tough time finding future investors if it kept losing money.

For Uber, the Didi deal is a sort of retreat, but certainly doesn’t mean its foray into China is a failure. UberChina’s 20% stake in Didi already is being compared with Yahoo YHOO 1.60 % ’s early investment in Alibaba, which turned out to be the most valuable asset for Yahoo.

Deteriorating exit options for Chinese startups also could be another factor for UberChina’s sale to Didi. An initial public offering for UberChina in China is increasingly unlikely as the securities regulator tightened rules in initial public offerings. The wait time for an IPO, if approved, could be two to three years.

Chinese regulators require companies to win government approval before they can list, and also require that companies be profitable before listing.

So some investors are very happy about the sale. “The essence of business is making money,” said Ms. Zeng, the Uber investor. “It’s about creating value for shareholders, employees and customers.”

Li Yuan at li.yuan@wsj.com and LI YUAN at li.yuan@wsj.com





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