The Motley Fool

Can Tencent Win in This Huge Market With Baidu’s Help?

It’s becoming clearer by the day that China’s BAT tech acronym is outdated.

Although it is still a leading tech giant, Baidu (NASDAQ: BIDU) simply can’t keep up with Alibaba Group Holding Ltd (NYSE: BABA) (SEHK: 9988) or Tencent Holdings Ltd (SEHK: 700).

In terms of market cap, Alibaba and Tencent are far bigger. As of late July, Alibaba and Tencent both have market caps of over US$600 billion.

Meanwhile, Baidu is a relative minnow as it has a market cap of around US$40 billion.

Some of the spending outlays that Alibaba and Tencent have announced for the future are huge.

Earlier this year, Alibaba announced plans to spend around US$28 billion in the cloud over the next three years.

Shortly after Alibaba’s announcement, Tencent announced plans to spend US$70 billion in “new infrastructure” over the next five years, much of which will be used on cloud spending.

While Baidu has a lot of cash, cash equivalents, and short-term investments on its balance sheet, it can’t afford to spend the same amount in the long run.

Cloud growth

Given Alibaba and Tencent’s announcements, it’s becoming clear that the two tech giants are willing to spend a huge amount of money in the cloud to gain market share.

Alibaba and Tencent will very likely price cloud resources competitively and the two will spend a lot of money to upgrade their infrastructure.

If trade relations improve between the US and China, and if China opens up its cloud sector further, Amazon and Microsoft will become bigger competitors.

While Baidu’s cloud division is growing rapidly, it doesn’t have the same scale that Tencent or Alibaba does.

According to Canalys, Baidu had 8.8% of China’s cloud infrastructure services market in the fourth quarter of 2019. Alibaba had 46.4% and Tencent had 18%.

Because Baidu doesn’t have the same scale or resources, it will be difficult for Baidu to compete if Alibaba or Tencent really wanted to lower the price of cloud resources.

Cloud value

Although this is just hypothetical, I think Baidu considering selling its cloud division to Tencent could be a good idea.

Tencent has a lot of money, and the company wants to gain market share in the cloud.

If Tencent were to acquire Baidu’s market share, it would have more scale and be a stronger second in China’s cloud infrastructure services market.

Although it is hard to integrate different cloud infrastructures, the benefits would outweigh the challenges if management executes.

China’s cloud market will be worth a lot in the future as technologies such as 5G, industrial internet, autonomous driving, and AI drive up cloud demand.

Paying a premium now and gaining market share could be more than worth it given the future potential.

Baidu would also win. Because Baidu’s cloud operations are very likely not profitable yet, its margins could look better and its profits would be higher.

By selling its cloud division, Baidu could also help finance a take-private from its New York listing if management were to decide on that course (or perhaps a listing in Hong Kong).

Selling the cloud division is a question of short-term gain or long-term potential for Baidu management.

Baidu’s cloud could be worth a lot more in the future if management decides to hold on to it and executes. Executing won’t be easy, however, given the competition.

Foolish takeaway

Although it’s a hypothetical, I think Tencent and Baidu cloud M&A is something that is within the realm of possibility.

It’s also another reason to be bullish on Baidu and Tencent. Both companies could win.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Hong Kong contributor Jay Yao doesn’t own shares in any companies mentioned.