INTERNET: Tencent Solves Excess Cash Problem with Supercell Buy

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Bottom line: Tencent’s Supercell purchase looks like a relatively smart use of its big cash pile, and will give it access to leading-edge games and let it focus on the more important task of developing an ecosystem of products and services around WeChat and QQ.

Tencent gets $8.6 bln charge from Supercell

Internet giant Tencent (HKEx: 700) has been a victim of its own success, accumulating one of China’s largest cash pots even as it remained quite conservative as an acquirer. But now the company has taken some pressure off of itself to invest that cash, with the announcement of its purchase of a controlling stake in Finnish game maker Supercell for a hefty $8.6 billion. I haven’t done any detailed research on the purchase, but this does appear to be the largest acquisition of all time by a Chinese Internet company, and is probably worth as much as or even more than all of Tencent’s other acquisitions to date combined.

There are quite a few things to say about this mega-deal, including not only its significance for Tencent but also for Internet rivals Alibaba (NYSE: BABA) and NetEase (Nasdaq: NTES). Alibaba watchers will be relieved to see that Tencent is buying the stake from Japan’s Softbank, which also sold off a big chunk of Alibaba holdings last month worth even more than this Supercell deal. Meantime, the deal also has interesting implications for NetEase, which is the only company in China that seriously challenges Tencent in online games.

All that said, let’s begin with the deal itself and what it means for Tencent. Under the agreement, Tencent will pay the $8.6 billion for the 84.3 percent of Supercell held by Softbank, valuing the Finnish game maker at $10.2 billion. (company announcement; Chinese article) Despite buying such a large stake, Tencent insists that Supercell will remain independent. That’s quite consistent with its usual M&A strategy, where it usually takes smaller stakes in strategic partners and looks for synergies while leaving the partner company’s management intact.

This particular deal was reported earlier when talks were still ongoing (previous post). But I have to admit I was still a bit surprised, since I thought that Tencent might make a bid for US game giant Activision Blizzard (Nasdaq: ATVI), maker of the popular “World of Warcraft” series that is the source of a huge hit movie now playing in Chinese theaters. Tencent already owns a stake in Activision Blizzard, but it appears the US company’s management probably wasn’t interested in selling more to its Chinese investor.

Smart, But Expensive

From a strategic perspective, these gaming tie-ups do look like a smart but somewhat expensive way to give Tencent preferred access to the hottest titles to maintain its position as China’s leading online game company. That might sound like a threat to NetEase, China’s second biggest developer. But in this case it’s noteworthy that NetEase has earned a reputation for developing its own games rather than licensing titles from third-party developers. Thus NetEase probably won’t feel too big an impact from this new deal.

Then there’s Alibaba, whose stock has been under heavy pressure since longtime investor Softbank sold off a major chunk of its shares in the company to ultimately raise about $10 billion earlier this month. (previous post) Some fretted that the sale represented a loss of confidence in Alibaba, and perhaps that’s partly true. But this new sale of Softcell will reassure some Alibaba investors, since it shows that Softbank is liquidating other major assets in a broader bid to raise cash to boost its balance sheet.

In terms of longer-term prospects, the Softcell purchase should take some pressure off Tencent to make more acquisitions, which is a good thing even if it paid a rich premium for the asset. That will allow Tencent to focus on the more important task of developing its WeChat  and QQ instant messaging services into diversified platforms at the base of an ecosystem for everything from communicating to shopping and investing. At the end of the day, Tencent’s biggest strength has always been its in-house product development, and acquisitions are really only a very secondary contributor to its business.

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