Article / 01 April 2015 at 3:56 GMT

Five Chinese startups every investor should know

China Watcher / Shanghai
China
  • China’s startup scene is booming
  • Best known are Xiaomi and the merged entity of Kuaidi Dache and Didi Dache
  • Lesser knowns include Meituan, Meizu, Koudai Gouwu, Uxin Pai and Dianping

By Neil Flynn

China has previously been seen as an imitator rather than an innovator, but over the past few years, we have seen this change. China’s startup scene is booming on the back of huge funding opportunities from the nation’s tech giants as well as overseas investment firms. As a result, China is transforming itself into a tech innovator, and this is seeing Western firms taking a closer interest.

Although Western startups are relatively well known around the world, China’s startups are predominantly China focused, and as such can be difficult for Western investors to understand. Nevertheless, some companies have gained international recognition, including the two most well funded startups, Xiaomi and the merged entity between the two taxi-hailing apps Kuaidi Dache and Didi Dache. As I have previously written about these two firms, I have omitted them from this report, and have instead focused on five startups that are more likely to be unknown to Western investors.

Meituan

Meituan is a voucher and discount firm similar to Groupon that has emerged as the market leader. It was one of the earliest group buying sites in China, and even after competition grew quickly and resulted in two years of industry consolidation, Meituan has retained its status, with 20m daily mobile users in more than 1,000 cities, and is one of the few profitable firms in the industry, after breaking even in 2013. The firm has since expanded from its group buying business into a services directory for businesses such as restaurants and hotels, similar to Dianping, which I have discussed later on in the report.

Meituan has capitalised on the popularity of location based O2O, as service providers effectively need to have an online presence on service directory apps in order to remain competitive. By focusing on group buying and discounts, Meituan has been capturing market share by appealing to users casually looking for services, by allowing discounts and promotions to sway a user's decision.

Meituan's Hotel Reservation Page
Meituan has expanded from group deals to services like hotel reservations. Source: Meituan

After its Series D funding round, Meituan has amassed $1.02bn in funding from investors such as Sequoia Capital, Northern Light Venture Capital, and perhaps most importantly Alibaba. The Alibaba investment is key because we have seen rivals Baidu and Tencent enter the group buying market, with their investments in Nuomi and Dianping respectively. With Alibaba’s backing and potential for collaboration, Meituan should be able to leverage its services in order to maintain its market leading status. Alibaba has its own group buying service called Juhuasuan, but I would expect that Alibaba’s management would seek to build on the success of Meituan.

It is also becoming apparent in China that smaller firms simply can't remain competitive without the backing of one of China's BAT tech trio: Baidu, Alibaba and Tencent. Not only is financial support available if needed, but the startup is integrated into the backer's mobile ecosystem and introduced to the huge user base. Therefore Meituan should be able to maintain its market leading status as it looks towards a US IPO in the coming years. 

Meizu

Whilst overseas investors are familiar with domestic smartphone manufacturer Xiaomi, rival Meizu is relatively unknown. However, with the backing of Alibaba, we should see the smartphone manufacturer build its presence both in China and overseas over the coming 12 months. Meizu has grown rapidly in China over the past few years as the firm has catered to the demand for cheap Android smartphones, but as domestic smartphone growth slows, Meizu will need to look to overseas markets in order to expand its customer base. Xiaomi has already entered the Indian market, and I would expect Meizu to do the same.

Meizu Phones
Smartphone manufacturer Meizu will look offshore to expand its customer base. Source: Meizu 

I have discussed how China’s tech giants are partnering with domestic smartphone manufacturers in order to preload phones with their own apps. This will reduce the need for users to download rival apps, and hence increase the mobile user base and increase the amount of data that firms collect from each user, which can be monetised. Alibaba has partnered with Meizu not only to preload its shopping and entertainment apps onto the smartphones, but also to use its proprietary operating system YunOS. This is an important move, because Alibaba’s management will focus on the growing smart home industry during 2015, and its current offerings all use its YunOS operating system. This will allow Meizu to become an integral part of Alibaba’s smart home strategy, and leverage within the Alibaba ecosystem will only help to boost its presence and user base.

Koudai Gouwu

Koudai Gouwu (lit. Pocket Shopping) allows firms to set up a store within WeChat so that users can make purchases without having to leave the app. As merchants can have direct access to WeChat users, Koudai earns revenue from lead generation fees and sales commissions. Because of the ecommerce business within WeChat, Tencent invested $145m into the firm as part of its Series C funding round, which took Koudai’s total investment up to $362m.

Users access Koudai Gouwu by following its public page. Selecting the Shopping button opens the Koudai homepage within WeChat, and from there, users can get access to all of the stores that have been opened on the platform. With Tencent’s investment, a clear strategy going forward is for stores to have their own public pages via Koudai in which users can follow. Therefore, as each store adds new products or has discounts, users will be immediately notified. In addition, with Tencent’s knowledge of user behaviour, shopping and product recommendations will be more targeted, and hence transactions on WeChat will increase. Tencent has recently begun to monetise WeChat by placing advertisements in the social networking Moments page. As ecommerce via Koudai grows, WeChat will be able to gain a stronger understanding of each user's behaviour, and will therefore be able to offer more targeted advertisements. 

Koudai Gouwu's WeChat entry page
Users gain access by following Koudai’s public page (L) on WeChat and the Shopping (逛逛街) button opens Koudai’s homepage (R). Source: WeChat  

Tencent’s WeChat is unrivaled in China’s instant messaging market, despite Alibaba’s continued attempts. Tencent has used this app as the key entry point into its mobile ecosystem, which has allowed the firm to expand into a whole range of services from mobile games to shopping. In 2014, Tencent invested in online retail giant JD.com, meaning that both Tencent and JD.com can actively compete with Alibaba in the online retail market. The investment in Koudai is a further example of Tencent using its most important asset, WeChat, to take on Alibaba in the online retail market.  

Koudai Gouwu
Tencent’s WeChat is unrivaled in China’s instant messaging market. Source: Tech Crunch 

Uxin Pai

Uxin Pai is China’s largest online used car auction company, and is improving the clarity and efficiency of this rapidly growing market. The firm has over 1,000 specialists in 50 cities who inspect the vehicles on sale via Uxin’s platforms, and this allows the firm to offer a full guarantee to buyers and a 15-day refund if there are any undisclosed issues with the vehicle.

Uxin Pai
Uxin’s B2C platform. Source: Uxin Pai

The concept of buying a used car or second hand property has been looked down upon in China, and hence has always seen cars and property sell at a significant discount. However, this stigma is slowly eroding in the used car industry, as the high cost of new vehicles, particularly foreign brands, are forcing consumers to look for cheaper alternatives. The used car industry has benefitted from government investment in infrastructure throughout China, because the poor quality of roads outside major eastern cities caused enough damage to cars after a few years that they became virtually impossible to sell. As road conditions have improved, this is becoming less of a problem, and buying a used car has become much more feasible.

After its series C funding stage, Uxin Pai has attained a total of $460m in funding, from Tencent, Legend Capital, and last month’s investment from Baidu. Prior to this funding round, Uxin Pai focused on B2B used car transactions, but will use the $170m from the Series C round to expand into the B2C used car market. Baidu has been active in the used car business by expanding into new verticals with collaborations with both BitAuto and Autohome. In addition, in August 2014, BitAuto formed a joint venture with Uxin in order to expand its inventory of used cars and to improve the O2O strategy for both firms in the used car market.

The used car market is incredibly fragmented, as even the largest firms in the industry tend to focus on a few regions within China. Uxin Pai will be looking to leverage itself through partnerships with BitAuto and Baidu to grow its presence in this rapidly growing industry.

Dianping

Dianping is an essential app for anybody living in or visiting China, because it allows users to search for a whole range of services, from restaurants and hotels to furniture stores and zoos. In addition, Dianping is essential for service providers, because it is becoming the most common method for users to find local services. In fact, so important is this app to restaurants that it’s not unusual for customers to get a discount on their bill if they write a positive review on Dianping. Restaurants actively encourage users to post photos of their food onto the app so that prospective customers can view their full menu, as well as choose dishes that others have recommended. Dianping users also benefit from being active on the app, because as you write more reviews and receive more likes, your user rating improves, and you receive more discounts for restaurants and services.

We have seen over the past 12 months that China’s tech firms are focusing heavily on their O2O strategies, which connect online users to offline services. Baidu has launched its Baidu Connect search feature and Qihoo has launched Merchant Connect, but both cannot currently compete with Dianping. In February 2014, social networking giant Tencent invested around $400m in Dianping for a 20% stake. Prior to the investment, Dianping had just 10.7% of WeChat’s monthly active users, and this has since increased. This is because collaboration between the two firms has created strong synergies. Dianping benefits from access to Tencent’s huge mobile user base, while Tencent expands its presence in the O2O business through the market-leading app.  

Dianping's Direct Access Through Tencent's WeChat
Dianping (L) is a directory for nearby services, and its investor Tencent (R) has a direct link to Dianping on its WeChat services page. Source: Dianping & WeChat  

Dianping has received total funding of $162m after its Series E funding round, and it is rumoured that its proposed Series F funding round would see total funding reach $850m. Dianping is well developed in Tier 1 and Tier 2 cities, but it needs to expand its presence in the smaller Tier 3 and 4 cities. Mobile usage in these smaller cities is much lower than in cities such as Shanghai and Beijing, and further funding should help Dianping to expand its O2O land grab strategy. 

As Meituan has expanded into service directories, it has become Dianping’s biggest rival. The industry is growing rapidly and both firms are posting profits, which have led to rumours regarding both firms holding a US IPO in 2015. Dianping filed for an IPO in mid 2014, but has yet to update prospective investors on its plans, which suggests that further delays are to be expected as a result of the Tencent investment. This wouldn’t be the first time that IPO plans have been delayed, as the firm shelved its proposed 2011 IPO in order to allow management to post earnings without public shareholder pressure. However, with the amount of funding that both firms have received, they may find that there is pressure from backers to generate return on their capital sooner rather than later.


--Edited by Susan McDonald


Neil Flynn is a portfolio manager at Alcuin Asset Management. Follow Neil or post your comment below to engage with Saxo Bank's social trading platform.

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