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Business deals

Behind the scenes of the $27bn Yahoo-Line merger

Deal driven by desire to defend Japan and grow in Asia -- and SoftBank's deep pockets

TOKYO/BANGKOK -- It was two months ago that Yahoo Japan and Line got serious about merging their two companies in a $27 billion union that would create an internet platform serving over 100 million people and could be big enough to fend off U.S. tech giants like Facebook from Japan.

After several years of on-and-off talks, negotiations about a possible partnership kicked into high gear over the summer. Soon, though, the conversation between Takeshi Idezawa, president of Line, and Kentaro Kawabe, president of Yahoo Japan, shifted toward a full-blown merger, people familiar with the matter told Nikkei.

Both sides recognized something had to be done. Yahoo Japan had fallen behind in the race to provide smartphone services. Line was struggling to grow its customer base in Japan.

Both companies were also worried by the growing penetration of U.S. tech companies in their home market of Japan, rising pressure throughout Asia from Chinese "super app" operators such as Tencent, and stagnant growth throughout their businesses.

A deal could provide a way forward. In essence, it involved the creation of a Japanese super app.

Line would contribute the 82 million Japanese users of its messaging app. Crucially its significant presence in Thailand held out the potential of a deal that would be more than a defensive Japanese merger: it could provide a platform for growth through East Asia, especially as Z Holdings, as Yahoo Japan is now known officially, is not allowed to use the Yahoo brand name outside of Japan.

Yahoo Japan would meanwhile contribute its popular news portal and an e-commerce business, bolstered by this month's $3.6 billion acquisition of maverick Japanese fashion brand Zozo. That held out the promise of cross-selling products and services that entwined themselves into every aspect of users' lives.

Most important of all, Z Holdings would bring the financial firepower of its parent SoftBank and, with that, the money needed to fund the combined venture's expansion.

Idezema and Kawabe took the plan to their parent companies in September. Masayoshi Son, the deal-making chairman and CEO of SoftBank whose $97 billion Vision Fund has poured money into tech investments around the world, swiftly gave his blessing.

"SoftBank Group will back the new platform that will be created by the merger," he said.

Naver, the South Korean parent of Line, also agreed. Son had courted Naver for several years, hoping to tap the chat app's client base through a capital partnership. Those advances had been rebuffed, but times were different now.

Line is on track for a second year of losses as it has rolled out an e-payments system. Moreover, Naver has so far successfully defended its dominance in internet search on its home turf in South Korea from Google. But pressure was rising -- and not just from Google but also from Apple, Facebook and Amazon, the so-called GAFA quartet of U.S. tech giants.

Similar fears of GAFA's dominance exist in Europe. But it has no homegrown platforms that can compete. In East Asia, however, the union of Yahoo Japan and Line could create a GAFA rival.

On Wednesday, news of the deal leaked to Japanese media. Investors immediately cheered the prospect, bidding up Yahoo Japan's share price by as much as 16% and Line by 9%.

Bankers and analysts agree that the main purpose of the deal is defensive. However, it may not be entirely so and the reasons for that revolve around a number, $58 billion, and a country, Thailand.

The number, $58 billion, is the amount GAFA spent on research and development in 2018 alone, according to Statista. By contrast, Z Holdings and Line together spend $185 million annually at most.

This discrepancy has left them outgunned, out-researched, and out-developed by the products that GAFA provides its users -- as illustrated by the fact Line has been unable to expand its core messaging app in South Korea, even though that is the home of its parent company. Sotbank's deep pockets might be able to change that.

Meanwhile the country, Thailand, could provide a platform for fresh growth as Line has established a dominant presence there.

Of its 164 million users globally, 44 million are in Thailand. The app was first introduced in 2011 and now has more users than Facebook Messenger, Skype or WeChat.

Moreover, Line has also diversified its business lines there, turning itself into a "semi-super app." Line Man is a kind of virtual assistant that can arrange package deliveries or make a restaurant booking. Rabbit Line Pay and Rabbit Cards allow for e-payments.

The merger could see Yahoo Japan build out Line's capabilities and turn it into a genuine super app, akin to Indonesia's Gojek or Singapore's Grab.

Using Thailand as a training ground could also provide lessons on how Line might expand into neighboring Asian nations, where services such as WhatsApp or Facebook Messenger are more popular, and Chinese giants Alibaba and Tencent have also invested heavily.

The two sides aim to complete the merger by the end of 2020, sources told Nikkei, but multiple details have to be sorted out first.

One is the new venture's structure. As currently conceived, Kawabe and Idezawa will become co-CEOs of the new Z Holdings, which will serve as the parent of Line and Yahoo. Each side likely will appoint three directors, with another four coming from outside.

A second issue is regulatory approval, especially as Japan and South Korea have frayed political ties. Representatives from Z Holdings and Line are believed to have met with government officials to lay the groundwork for the merger. Still, some concern exists about a union of two companies with large troves of personal data.

A third concern may be financial, as it is unclear whether the venture would involve buying out minority shareholders of Z Holdings and Line.

Z Holdings, which has a market capitalization of $17 billion, has a freefloat of around 54% while Line, which has a market capitalization of $10 billion, has a freefloat of 22%, according to FactSet.

If these shareholders need to be bought out, that could add some $11 billion to the final bill -- a daunting figure even for SoftBank's Son given that he is still digesting $9 billion of investment losses at the Vision Fund from failed bets on technology companies such as WeWork.

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