(Chinese Version)

China will only have two kinds of Internet companies in the future: BAT-leveled or cash-flow companies.

In October, fragrans blossom in the city of Shanghai, with the enchanting scent spreading thought the air. Without a doubt, to be able to walk on the streets of Shanghai during this period would be an exciting and comfortable experience. October is a month of harvesting, and it’s also the start of harvesting season for the Chinese Internet sector. In this very month, we witnessed many game-changing events taking place in specific sectors of the Internet industry, which might have to power to influence the Internet industry as a whole. Now let’s go back in time and see what exactly happened:

On October 8th, Meituan merged with Dianping, once again putting Tencent and Alibaba on the same boat in the O2O sector (last time it was the merger of Didi and Kuandi). Now the new company the merger has formed values at 17 billion dollars. The 12-year-old Dianping decided to merge with Meituan, a company that only has a history of five years, to stop the price war since both companies have been losing money.

On October 12th, Tencent bought 58 To Home then sold its shares to Alibaba at three hundred million dollars. At present, 58 To Home is valued at one billion.

On October 15th, ShenZhou Private Car cooperated with EDaijia officially and now they are sharing their brands and products in hopes of competing with Didi who’s also losing huge sum of money.

On October 16th, Alibaba acquired Youku-Tudou at 4.5 billion dollars in cash.

On October 17th, Tencent teamed up with JD to launch brand-commerce platform, a move for JD who just lost 800 million dollars to approach Tencent. It’s fair to say that Tencent had once again successfully penetrated JD.

In the first half of this year numerous mergers have taken place in the Internet sector as well. Alibaba invested 590 million dollars in Meizu. The merger of Didi and Kuaidi also happened, pulling Tencent and Alibaba together in the cab-hailing area. Last year, 58.com that had lost 79.3 million dollars in the first half of this year acquired Ganji. What’s more, the only profiting company in the OTA industry, Ctrip, had acquired eLong, who had been facing constant loss for a long time.

All these acquisitions took place in different line of business and are of different scale, but there are actually two similarities here:

1. It was always the profiting companies that acquired the ones that were facing constant loss. Additionally, companies that had a higher market valuation made the acquisition.

It’s commonly accepting by industry insiders that companies that have a higher market valuation, or let’s say, market share, acquire companies with a relatively lower valuation and market share. Since enterprises with a higher valuation obviously have better potential to develop, and therefore venture capital organizations are happy to give these companies a hand in order to gain a larger share and avoid price war. Profiting companies acquiring those that are not is also a development tendency. Internet companies have been convinced by VC organizations that they can lose money in exchange of the market and use low-pricing strategies to attract users. That’s why most Internet companies are not making money at all in the field. Companies that lose money in exchange of market share are no matches to those that are currently making profits and already are giants in their respective industry. In this case, many profiting companies eliminate rivals through acquisition or investing in building new teams to get fresh blood. Some prefer to conquer specific sectors and gain market share in a fast way.

2. Baidu, Alibaba, and Tencent have become another major force in acquisition besides VC organizations

BAT, short for Baidu, Alibaba, and Tencent, are all over the Chinese market this year. In 2015, BAT have made many major investment moves in the market: Alibaba’s involved with over ten investments of over four billion dollars recently; in the second quarter alone Tencent had participated in over 10 investments as well, ranging from the entertainment industry, local life services, medical care industry and automobiles; Baidu had also been extremely active. It appeared that all of a sudden these dominating three Internet companies in China had entered a competition of acquisitions. They had invested in diversified sectors and to be honest it was quite overwhelming. It’s fair to say that they are another pouring capital pool other than the VC community in China.

China will only have two kinds of Internet companies in the future

Starting from the second half of this year, the market has been going straight down. The most obvious indicator is that Baidu, Alibaba, and Tencent have all stopped recruiting. In fact, nobody is entering the company and people are being laid off. The secondary market is on a bumpy road while Chinese stocks are having a difficult time in American stock markets. The closing down of the listing entry brings panic to the primary market, causing people to think that a capital winter has come. As a matter of fact, a capital winter does sweep through the whole VC community, and the very Internet industry suffers the most from it.

According to statistics from China Venture, the total investment in the second quarter this year is only half of quarter one’s. Meanwhile, startup funds’ raising volume also appears to be having a downfall. Statistics from Zero2IPO Research show that in July this year overseas and domestic investments for startups and private equity investment organizations had raised a capital volume of 3.886 billion dollars. Compared to June’s scale, which was 7.996 billion dollars, it fell by 51.4%. It’s a 17.4% decrease when compared to the same period in 2014, in which the total volume was 4.705 dollars. The capital winter has come, and the layout of the Internet industry is destined to encounter great changes.

The future belongs to cash-flow companies

Cash-flow companies have to ability to regenerate and self develop, which means they would have more opportunities.

1. Profit is what really matters. Cash-flow companies are the ones that have the potential to conquer the market

In the eyes of Internet industry insiders, people that enter the industry from brick and motor industry share a common problem, which is that they are generally too conservative. Over focusing on the cash flow will limit the development of enterprises. Companies that are willing to burn money to win over consumers and conquer the market with their advantage in pricing can no doubt attract capital more easily. And of course, if they can terminate their rivals in the mean time it would totally be a plus. But the harsh reality is sacrificing profits in exchange of market is not a long-term strategy and it would do great harm to companies and eventually burn lots of money in the long run. Venture capital is just like marijuana. It keeps companies high. Just recently Yongche.com ran out of money and had no choice but announced the company had been injected with an investment of seven hundred million dollars from LeTV.

Only companies that are able to self-regenerate can get through the capital winter. Capital flow naturally to appealing places. In this case, no one should expect the capital would just come out of nowhere. In this harsh capital winter when everything seems lost, companies have no one to turn to and they have to rely on themselves to make it through. And in generally only three kinds of companies can survive the capital winter:

a. Companies that have the ability to regenerate and achieve growth. For instance, the three portals that discovered SP mode after the crash of NASDAQ in 2000. Companies that died during that period were countless.

b. Companies that have already stored a certain amount of resources before the capital winter in order to get through the harsh cold wind. For instance, 58Daojia, and Alibaba who used the 1.7 billion dollars fund raised from the listing on Hong Kong Exchanges to get through the financial crisis in 2008.

c. Companies that are willing to lower their valuation also have the potential to make it through the winter. JD, for example, had a extremely difficult time finding investment when LEHMAN went out of business in 2008, and the company’s valuation went down from 160 million dollars to 60 million dollars after announcing the start of the series B round of financing, eventually causing great panic among lenders who had made bridge loans for JD. LeTao’s valuation in 2010 was only 80 million dollars during its forth round of financing while in 2010 the company’s valuation hit 250 million dollars.

Without a doubt, the first kind of companies is on a healthy developmental path while the third kind is pretty much running on luck with most companies failing to survive. Take the O2O sector which burnt the most money for example, in 2014 about 846 companies successfully made their series A round of financing but when it comes to the series B round the number plunged to 225, let alone the series C round. The series C round of financing is like a dangerous cliff for companies to climb through, during which process most fall to the abyss and die. Companies that lose their capital chain will eventually use up all the resources and starve to death. Only companies with cash flow have the chance of surviving.

2. Profitability really matters

Under the same circumstances, companies with higher profitability are more easily to win over capital. Profitability is an important indicator to measure a company’s value. It’s something that can be built by burning money. Similarly, in today’s business outlook in China, which requires to burn money in exchange of the market, companies with higher profitability and better profit record are more favorable in the eyes of capital organizations. Investors want their money to mean something and make something, not just burning mindlessly. When companies lose all their capital, they will be shrinking at a fast speed and eventually die. That being said, VC organizations don’t want companies that only know how to burn money, but companies that know how to profit more effectively by burning money.

3. Profitability gives enterprises more space to explore

Only when material life is improved to an advance level, will people seek further development both mentally and physically. We can’t expect people that are still busy working and trying to make ends meet to have a huge developmental space. The same thing applies to enterprises. Once the capital source is out, companies will have to fight for their own survival instead of finding ways to make further improvements. The perfect case here will be Dangdang.com. Except for the year of 2014, the company had been losing money ever since the listing. In the first half of 2015 the company even lost 81.4 million RMB. And due to the limitations brought by the lack of fund, the 16-year-old Dangdang is hiding in its comfort zone, the book sector. Even in quarter one its attempt in expanding new businesses in the book sector was packaged as compromising profit for expansion by the company’s PR. But the inconvenient truth is that JD, which Guoqing has always looked down on, now it’s 67 times higher than Dangdang in terms of the valuation.

But of course, if you have investors that are willing to support you at all cost, for instance, Tencent Paipai, Weibo, Baidu’s YouA, Baifa etc., you will still need to be careful. Sometimes they could be even colder than VC organization if the situation is too harsh for them. But if you do get lucky and find investors that support you, for example, Lei Jun for Vancl, then you basically won’t be able to lose at all. We have more cases like that, such as JD who has Xu Xin behind its back, Nuomi that’s backed by Baidu with over 20 billion. But if you know deep down in your heart that you won’t be this lucky, then you must consider whether burning money is the best strategy for your company to develop in the market.

4. The very nature of VC organizations goes against enterprises

The fund provided by VC organizations actually has a time limit. Long ones are usually 8 to 10 years while short ones can be 3 to five years. In the end, fund settlement will proceed, which is the main way for VC organizations to make money. This profiting mechanism of VC decides that their investment would not be long term. Therefore, VC organizations prefer fast-growing companies that can find new investors in a short time. In certain periods VC organizations can help nurture and improve enterprises. However, there are also possibilities that some VC organizations only fund companies in order to make profits after they are out of business.

But in general entrepreneurs all want their projects to work and last, maybe even becoming a traditional giant with a history. They want to make their companies big. That’s why VC organizations’ very nature goes against enterprises’ needs. VC organizations want to make money quick and they have all kinds of means to do so, such as the valuation adjustment mechanism.

Valuation adjustment mechanism is generally considered an investment agreement between investors and the financing side on future changes to the financial position of the invested enterprise. Both sides bargain on the basis of the current performance of the proposed invested enterprise to fix investment conditions, that is, specific performance indicators shall be deemed as the terms of the agreement based on the performance growth recognized by both sides. If the conditions stipulated in the agreement are satisfied, the investors may exercise the right to adjust the valuation. It’s a mean adopted by investment organizations that use KPI to forcefully establish a mid or short-term incentive mechanism with entrepreneurs. VAM naturally encourages entrepreneurs to focus more on the profit growth within the betting period instead of the future development on the long run. That being said, such mechanism will blind entrepreneurs from future opportunities, forcing them to jump to chances to make profits at a fast speed. From the perspective of enterprises, this is definitely a bad thing. That why my friend Chu Feng, CEO of SELF, preferred capital from actual companies that are doing businesses in Hong Kong over those from prestigious VC organizations, while offers from VCs were much higher.

Although many companies also profited a lot from VAM, for example Mengniu’s performance was much better than the agreed profit goal and therefore it won a 550% return rate of investment, most of time it would turn out to be a failure for companies. For instance, ChinaHR lost on the betting with Monster and had no choice but sold the company at a low price as Xu Xin withdrew entirely. The famous international catering company South Beauty also lost control over its own in gambling with CDH Fund. Such cases are numerous, Yong Le also lost control in betting with Morgan Stanley and CDH Fund and later was acquired by Gome.

Meanwhile, compared to foreign capitals, Chinese capitals are more speculative, which causes them to be less patient to nurturing the market and industries. Generally foreign capitals are available to invested companies for 7 to 10 years while Chinese Internet funds will only be there for 3 to 5 years. That’s why Chinese VC organizations are usually more aggressive on the field.

The future belongs to BAT, while companies that do not profit will eventually die out in the competition

Tencent and Alibaba both have a market valuation of 180 billion dollars while Baidu is valued at 50 billion. The annual revenue of these companies are 23.8 billion, 23.4 billion, and 13.1 billion respectively, which confirms the truth that they are indeed super gigantic cash-flow companies. As the Internet companies that have the highest valuation in China, BAT do have more potential and more space and resourece to explore the market. However, there are some questions that have been haunting entrepreneurs all along: what if BAT decide to copy my product? what if BAT are not willing to invest in my company even if they won’t copy my product? which side should I choose in BAT? For sure, the concept of BAT I am talking about here is not merely just referring to Baidu, Alibaba, and Tencent, but also other cash-flow and healthy companies with high market valuation.

1. The matthew effect makes BAT more competitive

BAT are way ahead of their rivals, and thanks to the capital and resources they have accumulated through years of operation, they are without a doubt more advanced when it comes to dealing with consumers, information, products. The Internet industry itself is a highly monopolized industry, meaning that second best companies will encounter challenges of life and death in the future. In comparison with startups, BAT possess more possibilities. They have more and better resources and bigger talent pools, which also contributes greatly to this tendency. The matthew effect is extremely common in the Internet sector since this very industry develops at a way-too fast speed. The Internet only started to become popular in China in 1997 and it has only been 20 years from then, but the whole Internet industry has undergone five transformations, or some people might say, revolutions. This is something that has never occurred in traditional industries before. The TV sector took off 40 years ago and today it’s pretty much the same. And when you think about the first personal computer back then and compare it to the ones offered in computer stores today, they can also be considered as predictable. Traditional companies such as BMW, Coco Cola, and IBM get to survive and thrive, and the Internet sector had also fostered giants like BAT. Startups that have the potential to become the next BAT are also growing and gaining traction.

Before 2015, the main indicator to measure success in the Internet sector was the traffic. Internet companies that had attracted enough traffic were considered commercially successful in the past. The three major web portals were crowned according to that, as well as the top online games and BAT. No matter what form the Internet is going to become next, BAT sill own the most traffic across the country. Whether it’s the products they have or the user base, BAT are dominant. In this case, new products from BAT have better access to reach abundant users. This is the advantage that no other company in China has. That’s also why even though BAT replicate a lot of products, they are still the winners for most of the time. Under these circumstances, Bona Film’s president Yu Dongcai believes that film companies will all work for BAT in the future.

2．BAT need to further boost its current advantages through acquisitions

As the concept of Internet+ and Internet thinking become popular and mature, services and specifying consumers have become more important than ever. Questions about how to provide users with better services (for instance intellectual communities were born from that, and the very example in this area, Logic Show, is now valued at 1.32 billion RMB) and how to specify target audience (VIP.com and Xiaohongshu.com both enjoy great success for example) attribute greatly to development on the long run. The Internet sector is just developing too fast and the products in this sector also continue to transform with every passing day. One company doesn’t have the resources to cover all aspects of this industry. And simply ripping off others’ products doesn’t really work for companies anymore. Therefore, BAT have chosen to get into different fields and penetrate different companies through acquisition and investment.

In the past few years, BAT have entered the financial, entertainment, traveling, medical care, education, local life service, and O2O sectors. Statistics show that 80% of successful startups that haven’t got listed in the top 30 startup chart is involved with BAT. But BAT’s capital didn’t just stop from there. Instead, BAT have invested 30 listed companies and hundred of other companies that haven’t got listed. In some way it shows that BAT’s layout is very widespread.

3. Compared to VC organizations, BAT are more easily to be on the same boat with enterprises instead of just merely using them

BAT started as startups as well, and it allows them to better relate to other enterprises and startups. This is the biggest difference between BAT and VC organizations. BAT’s investments can be categorized into four groups: complementarities to BAT’s current businesses, new business layout, financial investment, and innovation killers which are supposed to eliminate competition.

The failure of Paipai, YouA, and Laiwang makes BAT realize that no matter how hard they try and how much money and time they are willing to spend, there’re always things that they can not achieve. In this case entrepreneurs don’t have worry about that BAT might steal your products. All you have to do is make your products great enough. Additionally, no matter the investment goal, BAT don't intervene enterprises’ development as much as VC organizations do. BAT don’t require the invested sides to reach a certain goal in a certain period and they usually are not interested in making purely financial investment but rather complementary investment. In other words, BAT prefer long-term investment. However both investors provide entrepreneurs a new direction of exiting and development.

4. BAT are the best supports

For entrepreneurs, if they are not going to get VCs’ further financial support, then no matter how well they have already developed, they would probably drop die during the series C round of financing. VCs’ exiting channels are just too limited, and one of the most methods to deal with such issues is find another organization to take over. It doesn’t matter this newcomer is a new investor or a acquirer, this method works the most. However, acquisition deals are not easy to reach. The well-known recent cases for example, such as Youku and Tudou, Didiand and Kuaidi, Meitua and Dianping etc., are all cases where both sides shared the same VCs who were the main contributors that made the merger or acquisition to happen. The lack of co-investors would make everything more complicated for them, and they were fortunate enough. Another method is get the IPO. But since IPO is deeply affected by policies, things could be unpredictable and sometimes out of control.

But things are different for BAT since BAT themselves are also enterprises. With that, entrepreneurs are given another alternative. They can get investment from BAT as well as be acquired by them if BAT find their products can be complementary to theirs, which literally means another fresh start for entrepreneurs. For instance, on January 24th this year, Baidu announced to have acquired all the shares of Nuomi that Renren was holding and invested another 20 billion in Nuomi. On February 10th, Alibaba bought 72% of AMap’s shares in cash at the price of 1.1 billion dollars and further invested in AMap’s map service business. Later on 19th, Tencent finally seized the deal with Dianping and bought 20% of its shares, obviously a move to upgrade the company’s local life services. From this investments, it’s apparent that BAT are deploying their layout in the O2O sector to infiltrate this very sector in the near future.

5. BAT have the resources that startups need

The best support that BAT can offer to enterprise is funding, but professional talents and other resources. BAT all have their own strength in different fields and their resources also vary. Tencent has WeChat and QQ while Alibaba has big data collected from Taobao and Baidu has big data from its search engine. BAT have the most traffic in China and are the biggest entry points of data flow. If startups can have some help from BAT on traffic, the effect would be immense. For example, JD was integrated into WeChat, Weibo uses the shopping data from Alibaba, and Qunar now is a part of Baidu’s future blueprint. All these cases turn out to be successful so far.

The matthew effect also exists in the Internet sector. That why it’s essential to have advantages in the first place. BAT’s resources prove to be great boosts to the development of startup companies.

As the big data technology develops, big data are becoming more important since data are the foundation whenever such technology is needed. BAT are huge data sources themselves, and they would ultimately make their data available to business partners. Therefore, becoming a part of BAT’s system by being invested could be a promising start.

The capital winter is full of risks, but with that opportunities also come along. The lack of funding forces companies to find ways to spend the right money on the right places and reduce their cost and loss, which might help them achieve the goal of profiting in the end.

The business world is cruel, and when the funding is cut off, it’s really the time for true tests. But no matter what, companies that keep losing money will not be the survivors: Yu Gang left YHD.com since the company kept losing money; Yongche.com lost control under Zhou Hang’s leadership due to being profitless; the 12-year-old Dianping sold itself to Meituan who had much more money.

Getting listed on the stock market is a common goal for entrepreneurs, but when the company is losing money, a listing won't do much good: Youku, led by Gu Yongqiang, had no choice but turn to Alibaba in the end; the largest online book store Dangdang that suffers from constant loss is still struggling to survive. Such cases are not uncommon. And when you compare them to companies like BAT, NetEase, and Momo and look at their market valuation, you will find that the gap is enormous.

But of course, don’t use the example of Amazon, who has a higher valuation, to convince yourself into some make-believe. Amazon the one of the rare exceptions on NASDAQ that have a high valuation and still are losing money. But we have to know that Amazon is the dominating company in the retailing sector and basically has no matching rivals in that area, thus Amazon faces less challenges and can compromise current profit for future market. Such model is not for everyone.

“Internet companies are either large or small. There’s no in-between,” Xu Xin from Capital Today said. But from my perspective, there are only two kinds of Internet companies, which are BAT-level companies and cash-flow companies. Non-profit companies will either be destroyed or acquired by BAT-level companies, or they will just die during the fierce competition.

[The article is published and edited with authorization from the author @Michael, please note source and hyperlink when reproduce.]

Translated by Garrett Lee (Senior Translator at ECHO), working for TMTpost.