Why China O2O sector will see more consolidation

October 31, 2015 08:04
Ctrip and Qunar have agreed to merge amid intensifying competition in the Chinese online travel service industry. Photos: Bloomberg

Ctrip.com International Ltd., China's largest online travel company, has agreed to merge with its rival Qunar Cayman Islands Ltd. The deal will create a dominant online travel service company in the mainland with nearly 70 percent market share.

Ctrip and Qunar have seen their shares jump 22 percent and 8 percent respectively in the US market on Oct. 26 following the news.

Travel business has expanded rapidly in China in recent years. Chinese outbound travelers are expected to spend US$229 billion this year, up 23 percent from the year before, according to data from China Luxury Advisors and Fung Academy.

Meanwhile, the nation's outbound tourism expenditure is expected to nearly double to US$422 billion by 2020.

Why would Qunar accept the merger offer given the rosy market outlook?

Well, it appears that Qunar’s biggest shareholder, Baidu, played a key role. Under the share swap deal, Ctrip will have a 45 percent share in Qunar and Baidu will own 25 percent of Ctrip.

Four Ctrip executives, including Chairman Liang Jianzhang, have been appointed to Qunar’s board of directors. Baidu Chairman Li Hongyan and Vice President Tong Yip will also join Ctrip’s board. Baidu also posted a stock rise of almost 6 percent on Monday.

In fact, rumor of the merger surfaced in April last year. But Qunar rejected an unsolicited buyout offer from Ctrip at that time. Why has it changed its mind now?

China's internet firms have seen a spate of tie-ups in recent years. Ten years ago, Focus Media Holding Ltd., which operates the largest out-of-home advertising network in China, merged with Target Media. Chinese online video giants Youku and Tudou tied up in 2012. And Didi Dache and Kuaidi Dache, two of China's leading taxi-hailing apps, also merged in February this year.

We’ve already seen a trend for consolidation in the nation’s internet sector.

In fact, the market crash in A-shares has been the real trigger for the merger between Ctrip and Qunar. Local group buying services site Meituan announced in October it will combine with Dianping in order to reduce competition.

O2O, or online to offline, is a money-burning business model. In order to ramp up the number of users quickly, platforms have to offer huge discounts. It’s the same trick for group buying or tourism.

Ctrip reported just 140 million yuan profit for the second quarter of this year after posting a loss in the first three months.

Qunar, meanwhile, reported a loss of 810 million yuan for the second quarter, nearly double the loss suffered in same period of last year. The company lost almost 1.85 billion yuan last year. Sufficient capital support is key to success in China’s O2O market.

However, investors have become more cautious after the market meltdown. Against this backdrop, it's sensible for the start-up firms to tie up rather than battle with each other.

We can gauge the cooling of the capital market not just from lower valuations in stock market, but also the massive capital inflow into bond market.

A-shares hit a peak in mid-June and then slumped to a low of 2,400 points on the Shanghai benchmark index in late August. Meanwhile, the yield for 7-year corporate bonds with AA-rating fell to 5.4 percent in September from 5.8 percent in June.

China Vanke (02202.HK) issued 5-year debt at 3.5 percent, even lower than the 3.54 percent yield in 5-year government bond.

It's a sign that capital is flooding into the debt market as investors seek safe havens amid worries over the economic slowdown.

Given the overall situation in the economy and markets, it won't be surprising to see more tie-ups among Chinese internet firms.

This article appeared in the Hong Kong Economic Journal on Oct. 28.

Translation by Julie Zhu

[Chinese version中文版]

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Columnist at the Hong Kong Economic Journal