Jan 11, 2021 07:02 AM

In Depth: China Applies Closer Scrutiny to Sprawling Tech Acquisitions

A Tencent Holdings Ltd.'s QQ penguin mascot stands in Shenzhen

As Chinese regulators ramp up their fight against unfair competition, the rapid expansion of tech giants through mergers and acquisitions is coming under stricter scrutiny.

The toughening regulatory posture against anticompetitive practices may throw into question the proposed multibillion dollar acquisition of game-streaming site DouYu International Holdings Ltd. by rival Huya Inc. The combination could create a Chinese game livestreaming leader akin to Amazon.com Inc.’s Twitch Interactive Inc.

The State Administration for Market Regulation (SAMR), the country’s antitrust watchdog, said last month it is reviewing the deal, which was engineered by China’s game and social media giant Tencent Holdings.

The merger of Huya and Douyu, both backed by Tencent, would give Tencent a 67.5% stake in the new company, according to an agreement announced in October. This would further consolidate Tencent’s dominant status in China’s 30 billion yuan ($4.6 billion) gaming market, the world’s biggest.

Tencent built up its command of the Chinese gaming industry through massive acquisitions of small rivals. Backed by its popular messaging apps WeChat and QQ, the company controls a large share of game distribution in the country.

“Sixty percent of Chinese people are playing games that Tencent wants them to play,” a game industry source said. “Game developers without Tencent’s investment or partnership won’t survive.”

Now, regulators are studying what the merger of Huya and Douyu would mean for Tencent and other market players. However, experts said it will be tough to define the deal’s impact on market competition under the current antitrust law, which was launched in 2008 and designed for traditional industries. The law is undergoing its first revision to better adapt to changes wrought by the internet economy.

It is also a challenge for regulators to determine whether the livestreaming business of DouYu and Huya is relevant to the gaming market, experts said.

Antitrust review of the Huya-Douyu deal will show how tech giants’ unbounded expansion could challenge regulatory supervision. Unlike traditional businesses, which mostly grow by acquiring rivals in similar and relevant businesses, internet giants often expand into completely new territories to obtain new resources and consolidate their market status, said Chen Hongmin, an economics professor at Shanghai Jiaotong University.

“They could skirt regulations to enter industries such as financial services, health care and education by acquisition, posing challenges to regulatory oversight,” said Chen, who compares internet companies’ cross-market expansion with connected-party transactions that can create room for violations because of lax oversight.

Experts said Tencent’s extensive business network is like the Amazon rainforest spreading around its two main social media platforms.

Archrival Alibaba controls an equivalently sprawling business chain that links a vast range of services with its e-commerce and payment platforms.

Tencent and Alibaba built up their business empires through massive acquisitions. According to business record database Tianyancha, Tencent reported 785 investment deals over the past 12 years while Alibaba recorded 440, covering almost every corner of social life.

Inspired by the two giants, smaller internet majors like ride-hailing provider Didi Chuxing and food delivery company Meituan also followed the path of acquisition-fueled expansion, buying up rivals or squeezing out smaller players with cash-burning price wars. But as markets become increasingly consolidated by the major players, consumers’ complaints of monopolistic practices also grow.

Clearing uncertainty over VIEs

While putting ongoing deals under closer scrutiny, the antitrust watchdog is also trying to clarify lingering regulatory uncertainties by issuing rulings on previous controversial acquisitions.

The SAMR last month fined Alibaba 500,000 yuan ($76,500) for failing to seek approval before increasing its stake in department store chain Intime Retail Group Co. Ltd. to about three-quarters in 2017. It also fined China Literature Ltd., the e-books business spun off by Tencent, and logistics giant SF Express for violations in previous purchases.

The decisions for the first time made clear that all companies must apply for antitrust clearance when making acquisitions that cross a certain threshold set by the regulator. It also removed a lingering uncertainty over whether variable interest entities (VIEs), the legal structure many Chinese tech companies use, are within the purview of China’s Anti-Monopoly Law.

VIEs, typically based in low-tax jurisdictions like the Cayman Islands, were traditionally used by Chinese businesses like Alibaba and Tencent to allow them to raise funds in the U.S. and skirt Chinese laws that prevent foreigners from owning assets in certain sectors.
In the past, most internet companies with the VIE structures didn’t declare potential transactions because of the obscurity of the law, Jiang Huikuang, co-partner of Zhong Lun law firm, told Caixin.

The latest rulings against the three companies signal that companies with VIE structures may no longer be spared anti-monopoly probes, legal experts said.

Companies may also face heftier penalties for failing to declare potential transactions for antitrust review. A draft amendment to the Anti-Monopoly Law published in January would dramatically increase the fine’s upper limit from 500,000 yuan to 10% of the operators’ sales in the previous year. That could lead to astronomical fines for internet giants, Jiang said.

Flynn Murphy and Anniek Bao contributed to this story.

Contact reporter Han Wei (weihan@caixin.com) and editor Bob Simison (bobsimison@caixin.com).

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