In Depth: China Applies Nearer Scrutiny to Sprawling Tech Acquisitions

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

The tightening of regulatory stance on anti-competitive practices could lead to the proposed acquisition of the game streaming site DouYu International Holdings Ltd. by rival Huya Inc. in the billions. The combination could create a Chinese livestream game leader similar 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 examining the deal drawn up by Chinese gaming 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 cement Tencent’s dominant status in China’s 30 billion yuan game market ($ 4.6 billion), the largest in the world.

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

“Sixty percent of the Chinese play games that Tencent wants to play,” said a game industry source. “Game developers without Tencent’s investment or partnership will not survive.”

Regulators are now investigating what the Huya and Douyu merger would mean for Tencent and other market players. However, experts said it was difficult to define the deal’s impact on market competition under the current antitrust law, which was introduced in 2008 and designed for traditional industries. The law is being revised for the first time to better adapt to changes in the internet economy.

According to experts, it is also a challenge for regulators to determine whether DouYu and Huya’s live streaming business is relevant to the gaming market.

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The anti-trust review of the Huya-Douyu deal will reveal how the tech giants’ unlimited expansion could call regulatory oversight into question. Unlike traditional companies, which grow mainly by acquiring competitors in similar and relevant companies, Internet giants are often expanding into entirely new territories to gain new resources and consolidate their market status, said Chen Hongmin, an economics professor at Shanghai Jiaotong University.

“They could bypass the rules for entering industries like financial services, healthcare and education through acquisitions and challenge regulatory oversight,” said Chen, who compares internet company expansion across markets to related party transactions that leave room for breach can manage because of lax supervision.

According to experts, Tencent’s extensive business network is like the Amazon rainforest spreading across its two main social media platforms.

Archrival Alibaba controls an equally sprawling chain of businesses that combine a wide range of services with their e-commerce and payment platforms.

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

Inspired by the two giants, smaller Internet majors such as the hailstorm provider Didi Chuxing and the grocery shipping company Meituan also pursued the path of acquisition-driven expansion, bought up rivals or displaced smaller players with price wars that were about burning money. However, as markets increasingly consolidate away from the major players, so do consumer complaints about monopoly practices.

Eliminate uncertainty about VIEs

As the antitrust watchdog takes a closer look at ongoing business, it also seeks to clear up the ongoing regulatory uncertainties by making decisions about previous controversial acquisitions.

The SAMR fined Alibaba 500,000 yuan ($ 76,500) last month for failing to obtain approval prior to closing its stake in Intime Retail Group Co. Ltd. Increased to around three quarters in 2017. It also imposed an e-book against China Literature Ltd. The book business was spun off from Tencent and logistics giant SF Express for violating previous purchases.

The decisions made it clear for the first time that all companies must apply for antitrust approval for acquisitions that exceed a certain threshold set by the regulatory authority. It also removed the ongoing uncertainty about whether Variable Interest Entities (VIEs), the legal structure used by many Chinese tech companies, fall within the scope of China’s Antimonopoly Law.

VIEs, typically located in low-tax areas like the Cayman Islands, have traditionally been used by Chinese companies like Alibaba and Tencent to raise funds in the US and circumvent Chinese laws that prevent foreigners from owning assets in certain sectors.
In the past, most Internet companies with the VIE structures have failed to declare potential transactions due to the ambiguity of the law, Jiang Huikuang, co-partner of the Zhong Lun law firm, told Caixin.

Recent judgments against the three companies suggest companies with VIE structures may no longer be spared antimonopoly probes, legal experts said.

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Companies can also face higher 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 from 500,000 yuan to 10% of the operators’ sales last year. That could lead to 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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