Didi Acquires Uber China, Why Uber China Was Doomed, Was Uber China Worth It?

Good morning,

It is good to be back! I was originally regretting taking earnings week off — I made the same mistake back in February — and I plan on covering most of the bigger companies this week, but big news from China just yesterday has validated my timing.

Didi Acquires Uber China

From Bloomberg:

Didi Chuxing, the dominant ride-hailing service in China, said it will acquire Uber Technologies Inc.’s operations in the country, ending a battle that has cost the two companies billions as they competed for customers and drivers.

Didi will buy Uber’s brand, business and data in the country, the Chinese company said in a statement. Uber Technologies will receive 5.89 percent of the combined company with preferred equity interest equal to 17.7 percent of the economic benefits. Uber China’s other shareholders, including search giant Baidu Inc., will get 2.3 percent of the economic interest in Didi Chuxing. Didi founder Cheng Wei and Uber Chief Executive Officer Travis Kalanick will join each other’s boards.

The truce brings to an end a bruising battle between the two companies for leadership in China’s fast-growing ride-hailing market. Uber has been spending at least $1 billion a year to gain ground in China, while Didi has been offering its own subsidies to drivers and riders to build its business…

This news was certainly shocking, but I suspect for Stratechery readers it was not surprising. As I’ve noted repeatedly the China ride-sharing market has the potential to be the most lucrative in the world; most obviously, the addressable market is not only massive on a numerical basis but also situated in massive cities with a level of density unimaginable to most Americans.

Just as important, though, is the question of infrastructure: on one hand, China’s urban infrastructure, including roads, is well-developed, and smartphone penetration is very high, particularly amongst the emerging middle class. On the other hand, a huge number of people in China still don’t have cars: the biggest obstacle for any ride-sharing service is the car you already own, and the fewer of those there are the greater the likelihood transportation can “leapfrog” to a service-based model that makes far more sense than the ownership model more typical in the West.

Small wonder that two massive players were willing to spend billions to secure the market; I’m talking, of course, about Alibaba and Tencent and their respective investments in Didi Dache and Kuaidi Dache. It was only 18 months ago that the taxi-based ride-hailing services had fought each other to a standstill. As I noted at the time:

Instead of losing money to gain share, both companies were basically losing money to hold on to what they had, and there was no reason to expect the situation to change given Alibaba and Tencent’s deep pockets.

What instead happened was that the two companies merged in a move I called a triumph of Chinese pragmatism: despite the fact Alibaba and Tencent were locked in an ongoing war for Internet and mobile dominance generally and wallet dominance in particular, both agreed that sharing the lucrative market profitably was better than endlessly losing money in a fight that could be neither won nor abandoned. Indeed, both the Didi and Kuaidi apps still exist; the latter is barely used now, but that’s ok for Alibaba as both apps now offer Alipay and WeChat Payment as options.

I added one final paragraph to my post on the merger:

Hilariously, several tech blogs framed this merger as being about taking on Uber, which couldn’t be further from the truth. Uber is basically a non-entity in China, even with Baidu’s recent investment in the ride-sharing company, and if anything this deal might help Uber: as long as Didi Dache and Kuaidi Dache were fighting via promotional pricing and other special offers there was a lot of incentives for customers to take advantage. Perhaps now Uber – which in China is going for more of a premium experience, anyways – can start to edge up in mindshare (but probably not).

That paragraph was correct at the time I wrote it, but within just a few months it looked ridiculous as Uber started racking up hundreds of thousands of rides a day. I wrote about the company’s surprising success in June 2015, noting that the company had, to a far greater extent than other Western tech companies (but inline with Uber’s overall philosophy), adopted local business practices, not just in terms of balancing competing government interests against each other, but more critically in being willing to incinerate capital (mostly on driver subsidies) in an all-out pursuit of marketshare (everything in China is unfathomably bigger, including burn rates!).

And so, just months after ending the strategic competition between Alipay and Tencent, Didi was right back into the cash-burning competition, but this time the ending would be much different.

Why Uber China Was Doomed

From the very beginning I have been consistently skeptical of Uber’s efforts in China, even as the market became the company’s biggest on a number-of-rides basis. There were three problems:

  • First, and most importantly, Uber was a foreign company, and while the national government in particular was content to let Uber effectively subsidize transportation for millions of Chinese for a time, as I noted in May, there was “no way that the government [would] tolerate foreign ownership of something as foundational as transportation infrastructure.” Moreover, whatever relationships Uber had managed to build with relevant government entities, they couldn’t compete with the influence of Didi and its powerful parents

  • Second, Uber was starting from behind, and while the company had an initial advantage in its ride-sharing model (Didi and Kuaidi were about hailing taxis), the new Didi quickly built a ride-sharing model of its own (ride-sharing is a separate mode, a la UberX versus Uber Black). Despite Uber’s growth Didi kept its lead and had a dominant share of the market (exact numbers are almost impossible to get, but likely around 80%), a big problem given ride-sharing’s winner-take-all effects.

  • Third, Uber’s stakes were lower than Didi’s. For the U.S. company China was upside on top of their already successful business; for Didi China was life or death. That was compounded by the fact Alibaba and Tencent had already given up the strategic fight for ride-sharing to focus on making money: there’s no way either would compound said loss by losing the market completely.

The ending was clear when Apple invested in Didi: I said at the time that “I suspect this deal is the beginning of the end” and “I wouldn’t be surprised if the U.S. ride-sharing company withdraws sooner rather than later.” And here we are.

Was Uber China Worth It?

All that said, to their huge credit Uber China was Chinese to the end: this ending is quite pragmatic and a far better outcome than I expected. In the long run, the expected return from owning a share of the monopoly ride-sharing provider in the most lucrative market in the world is without question vastly greater than the expected return from being said provider; the odds were, as I noted, quite close to zero.

It will be interesting to see the rate at which Didi becomes profitable and eventually IPOs: on the one hand, Didi finally has the monopoly position it has been angling for ever since the Kuaidi-Didi merger, but the company likely doesn’t want to forgo future growth by raising prices too quickly. Prices will rise though: a point missed in most Western media reports about last week’s approval of nationwide ride-sharing regulations is that the Chinese government will sharply limit excessive discounting. The timing — and reality of the Chinese market — certainly suggest that the new regulations and this tie-up are interconnected.

So that leaves one final question: was Uber’s China investment worth it?

In February Uber said it was losing $1 billion a year in China; even if they lost double that it’s still significantly less than their $6.2 billion share of Didi. If only we could all lose so profitably!

Still, there was an opportunity cost: the Financial Times separately reported yesterday:

Uber is preparing to pour $500m into an ambitious global mapping project as it seeks to wean itself off dependence on Google Maps and pave the way for driverless cars.

The San Francisco-based transportation company has mapping vehicles crisscrossing the US and Mexico to record the surroundings and gather images for maps. Uber says it will start driving mapping vehicles in other countries soon…

By developing its own maps Uber could eventually reduce its reliance on Google Maps, which currently power the Uber app in most of the world. Although Google was an earlier investor in Uber, the two companies have avoided working closely together and are now developing rival technologies for driverless cars.

Suppose Uber had not started spending in China in 2015, and had instead IPO’d on the back of its many profitable markets: the company would have had its own stock as a likely unbeatable currency when Nokia put HERE maps up for sale in April 2015 (I wrote about this missed opportunity here and here). Not only would the company have a much bigger head start when it came to building out what will be critical technology for the future of transportation-as-a-service, they would have gotten started on the problem in a much more serious way a year earlier.

It’s all but impossible to evaluate how much the HERE miss and year delay will ultimately cost the company; I still think Uber is the best-placed when it comes to Cars and the Future, but the company’s most mortal threat remains someone else (Google, Tesla, etc.) copying their business model but with driverless cars. Starting further behind in mapping a year later than necessary increases the chances of that unfortunate outcome coming to pass.

That said, in the end, at least from an investor perspective, the question isn’t close. This is a home run for Uber and its shareholders, as a 17.7% percent stake in Didi at the cost of ~$2 billion in capital is absolutely in the same ballpark as Yahoo’s Alibaba investment.

Again, the opportunity of the China market cannot be overestimated. The population is bigger, the cities are better suited (and have more need) for ride-sharing, and there is not the car in the garage to compete with. Didi has a very good chance of becoming the biggest Internet company of them all (Tencent, Alibaba, and Baidu are the traditional big three). Uber now has 20% of that, and it is not out of the question that a significant driver of their IPO will be the opportunity to invest indirectly in Didi. Indeed, this likely means an Uber IPO will come sooner-rather-than-later: if Uber lists before Didi they will enjoy a significant updraft from investors eager to get into the Chinese company, a la Yahoo and Alibaba.

In short, Kalanick did it: no, Uber won’t own the market in China, and the country remains spectacularly inhospitable to Western tech companies, but Uber is absolutely an overall winner because of the company’s impressive execution and unparalleled aggressiveness combined with a hitherto unseen ability to be pragmatic and settle for gains in hand. The first two qualities have characterized Uber from the beginning; if the third becomes habit this Didi investment will be an even bigger deal than its already impressive impact on the bottom line.

Note: This is a re-write of the original post that originally had a different conclusion due to a misinterpretation of Uber’s ownership stake

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