HONG KONG Almost a decade ago, Xie Guomin set out to create a music streaming business for China. He spent eight years painstakingly obtaining the licenses for thousands of songs, eventually building a giant library that helped give his music app the largest share of the domestic market.
Last year, however, Xie made an unusual decision for a chief executive with a dominant position in a market: He signed off on a 50-50 merger of equals with a far smaller and less successful rival. His company, China Music, had twice the revenues and active users of its new partner, QQ Music.
But Xie and his private equity partner, Shan Weijian, chairman and CEO of Hong Kong-based investment company PAG, felt they had little choice. After all, QQ Music was owned by Tencent Holdings, the Chinese internet giant. Xie knew that at some point the copyrights China Music had so carefully assembled would come up for renewal, and Tencent could easily outbid his team for those rights when the time came.
"We have more users today than Tencent," Xie said at the time of the deal. "But if they chose to fight, and if they don't care about the money, they can change their market share very quickly. They can pay 10 times more than we can for content."
Very few people can say no to Tencent or its great rival, Alibaba Group Holding, these days. The two Chinese tech groups have access to cheaper capital and deeper reservoirs of cash than any other player on the mainland, thanks to their soaring share prices and market capitalizations of around $400 billion each -- and counting.
While the two companies once operated in separate spheres -- with Tencent dominating social media and games, and Alibaba ruling e-commerce -- they are increasingly bidding against each other for investment opportunities. The result is a frenzied competition between two of the world's richest and fastest-growing companies for dominance of businesses spanning from artificial intelligence to Hollywood content, food delivery to fintech, and genomic research to voice recognition. In effect, they are transforming themselves from tech businesses into massive investment companies.
Both companies have spent billions on splashy acquisitions in recent years, with Alibaba paying $4.7 billion for Chinese browser company UCWeb in 2014 and Tencent spending $8.6 billion on Supercell, the Finnish producer of video games such as "Clash of Clans," last year. Behind these headline transactions, both companies are making smaller deals almost constantly. Alibaba has spent in excess of $1.72 billion buying at least 50 startups and small businesses since 2013, according to Dealogic data. Tencent has spent at least $780 million over the same period. (The data represents only the smallest 50 deals made by each company since 2013, so it provides only a snapshot of their acquisition activity.)
Sometimes Tencent and Alibaba invest in the same deals. But far more often, they are bitter rivals. And as they compete across the entire business landscape, they are shaping innovation in China -- often determining who will succeed and who will not.
That market power and the winner-take-all culture of the tech investment scene in China may be good for shareholders of Alibaba and Tencent, but it is bad news for other investment companies. Perhaps the only investment company outside the mainland that comes remotely close to the firepower of the Chinese titans is Tokyo-based SoftBank, which leads the $100 billion Vision Fund. But even SoftBank doesn't have the capital, market power and "halo effect" that the two most powerful investors in China have.
There may be much broader consequences of the Alibaba-Tencent dominance, however. Critics say their monopoly power ultimately harms innovation and competition in China. "Their dominance has become a huge constraint. It isn't healthy," said Kai Fang, a managing director at Beijing-based China Renaissance, a merchant bank that specializes in technology deals.
On a macro level, these two behemoths -- along with Baidu, the search giant that forms the third leg of China's internet trinity known collectively as "BAT" -- have changed hundreds of millions of lives in China. They have created hundreds of thousands of jobs, reduced the gap between rich and poor and shrunk the disparities between urban and rural China. When Jack Ma Yun, the charismatic founder of Alibaba, talks about the percentage of world gross domestic product that Alibaba will account for in coming years (comparable to Germany, he says) it is not just empty boasting.
Moreover, both Alibaba's Ma and Tencent founder Pony Ma Huateng have a grip on China's soft power that is stronger than government-controlled media such as the People's Daily or China Central Television. Arguably, only Beijing itself is more powerful than Alibaba and Tencent.
"PRINCELINGS" PUSHED ASIDE Twenty years ago, U.S. private equity firms were among the most powerful investors on the mainland, providing finance to Chinese companies such as China Pacific Insurance and Shenzhen Development Bank, and later selling out after pocketing many times their original money. Then it was the turn of the so-called princelings, who capitalized on their connections with Premier Wen Jiabao or President Jiang Zemin to gain access to profitable deals that no other companies got to see. For example, one of the senior executives at Boyu Capital is Alvin Zhang, the grandson of the former president. Several years ago, Boyu was able to take a big stake in a chain of duty-free shops at Chinese airports in a transaction that none of its rivals was offered.
More recently, though, the princelings themselves have also been eclipsed. In the past few years, the biggest returns have accrued to the venture capital firms. Neil Shen, founder of Sequoia Capital China, has made so much money for Silicon Valley-based Sequoia that he has status equal to that of his partners in California and may well be the successor to the heads of the company when they retire. Shen is one of the most widely respected investors in China. As an early stage investor, when companies are still in their infancy, his instincts are uncanny.
Not surprisingly, in the past, Shen's chief leverage with entrepreneurs was the legitimacy the name Sequoia conferred on recipients of his money. Today though, his leverage resides in the fact that he tries to stay neutral in the war between Tencent and Alibaba.
"If you take money from one of them, the other will kill you," said the founder of an artificial intelligence startup in Beijing, referring to Alibaba and Tencent. This founder took his seed capital from Shen, adding that he would still prefer to have Sequoia's money even if the valuation is far lower. Had he taken money from Alibaba, this entrepreneur added, he could never have won business from China's banks, since they regard Alibaba as their direct competitor. Ant Financial, its online payment system, is venturing further into the banks' territory in areas such as payments and fund management.
Similarly, when one Shanghai-born entrepreneur set up a media platform with money from some Chinese investors, including Tencent -- which has the most powerful online content distribution vehicle in China through WeChat -- he was told he made a fatal error.
"You don't have money from Alibaba," one international venture capitalist with a big China presence told him. "That means that now Alibaba will surely try to kill you." The entrepreneur thought a moment, then noted ruefully that the company could still try to kill him even if he did take its money. It is common for Alibaba and Tencent to invest in several competing companies and then kill off the weaker ones.
Although it is tempting to liken the tech investment scene in China to that in Silicon Valley, the similarities are superficial. For one thing, the concentration of power and the intensity of the rivalry between the two mainland giants is more extreme. The culture in China may be loosely described as winner take all but it is actually more akin to winner kill all. "If JD.com (a rival to Alibaba in e-commerce) did not have the backing of Tencent, Alibaba would have killed it a long time ago," said Fang.
CONCENTRATION OF POWER To get an idea of how much of a blood sport investing in Chinese startups has become, consider the country's online food-delivery business. Not long ago, Meituan, Dianping and Ele.me had distinct backers and business lines. Originally, Meituan and its founder, Xing Wang, were clearly in the Alibaba camp, while Tencent backed Dianping.
But over time, their business models converged and all went into the business of delivering food ordered online. Meituan merged with Dianping in late 2015. But Alibaba was bitterly opposed to the marriage of Meituan with a company backed by Tencent. It dumped its Meituan shares at a valuation below the level that the combined entity was seeking in a subsequent round of financing, putting downward pressure on the company and its investors -- including Tencent, according to numerous people familiar with the matter.
Such vicious battles are made possible in part because there are few legal or regulatory constraints on these powerhouses. China doesn't yet have a culture in which conflicts of interest are a problem or fiduciary duty an obligation.
To be sure, in Silicon Valley there is consolidation of power and blurring of the lines between the core businesses and investments among the so-called FAANGs -- Facebook, Amazon, Apple, Netflix and Google. But it is nowhere close to what exists on the other side of the Pacific. Last year, the FAANGs accounted for only 5% of all venture investments, while Alibaba, Baidu and Tencent accounted for somewhere between 40% and 50% of all such investment in mainland China.
The only comparison is the market power that Microsoft and its Windows operating system had in the 1990s. But even then, Microsoft's monopolistic tendencies were repeatedly challenged in the courts.
In the U.S., there are limits and challenges to the power of even the wealthiest tech companies because of antitrust regulations embodied in rules such as the Clayton Act. For example, if a business gets a certain amount of revenue from one company, it is barred from relationships with direct competitors to that one company. Corporations make sure that their outside directors protect information from rivals, and also bar them from investing in their rivals.
And while China has antitrust laws, it has nothing comparable to the Sherman Antitrust Act, which was used to challenge the old AT&T at the height of its power before it was broken up -- and which many analysts say should be used against the FAANGs today.
China has made progress in many areas, such as the protection of intellectual property. But without enforcement of competition regulations, even more concentration seems inevitable.
"Tencent and Alibaba have become so monopolistic -- they are Microsoft times 10," said one investor. "It is because regulators don't understand the winner-take-all culture."