China Breaks the Global Model of VC Investing
(Bloomberg Opinion) -- When you find a unicorn, you invest in it — no matter where on earth it is. From Silicon Valley to Bangalore, the world’s biggest venture capital funds have been writing million-dollar checks to back these most promising of startups, which are valued at $1 billion or more. But distance sometimes imposes a lack of clarity. Now, China’s crackdown on its ride-hailing giant Didi Global Inc. raises an uncomfortable question for the VCs: Does their globe-trotting model work?
The funds have been super-aggressive this year. SoftBank Group Corp.’s second Vision Fund is adding on average one new startup target per day. But New York-based Tiger Global Management LLC is even more keen, involved in funding rounds worth more than $20 billion, beating out SoftBank’s $17.8 billion, according to CB Insights.
Finding fresh unicorns is hard work, so VCs inevitably look for leverage and synergies. One strategy, deployed by SoftBank and Tiger Global, is geographical extension. If a new online service concept takes off in one region, chances are it will work in another too; and it may be time to put money in a similar startup in another country.
As a result, the big funds have stakes in a lot of foreign unicorns. Tiger Global, which tops the global rankings in terms of the number of unicorns it has stakes in, has one-third of its portfolio in foreign start-ups. Coatue Management LLC, also New York-based, has 22% of its unicorn portfolio in China and 20% in other foreign countries, data provided by CB Insights show.
At its peak, SoftBank took this global concept one step further, using its first Vision Fund’s $100 billion war chest to invest in rivals in the same sector — and forcing them into arranged marriages. One example is ride-hailing. In late 2014, SoftBank, a major investor in Uber Technologies Inc., poured $250 million into Uber’s archrival in Southeast Asia, GrabTaxi Holdings Pte. A month later, it led a $600 million financing round that benefitted Hangzhou Kuaidi Technology Co., Uber’s competitor in China. Didi Global is the product of a merger between Didi Taxi, backed by Tencent Holdings Ltd., and Kuaidi in 2015 — and the acquisition of Uber China in 2016. (Thus, San Francisco-based Uber has an 11.9% stake in the just-listed Didi.)
If this investing philosophy feels too simple to be profitable, it is. China is turning the globe-trotting dream into a nightmare.
Here is the sad narrative: For a number of years, the big venture capital funds had plowed billions of dollars into Didi but they were getting impatient. Feeling the pressure, the aging unicorn pushed ahead with a blockbuster $4.4 billion initial public offering in New York to provide a profitable exit for its investors. It did so even as Beijing was quietly suggesting that Didi delay the IPO to conduct a thorough examination of its data network security. Irked at being ignored, China flexed its muscles, announced an investigation and sent Didi shares plunging.
Foreigners are feeling the pain. Over the years, SoftBank invested nearly $11 billion into Didi. As of Tuesday’s close, its stake was worth just around $12 billion, making Didi an unprofitable trade if one accounts for the time value of money. Tiger Global and Coatue were early investors too. Meanwhile, China simply doesn’t care if Didi’s investors need to exit, or whether they are doing so with handsome returns.
And Beijing is not done. Wary of data sovereignty and national security implications, the government said on Tuesday it would tighten rules for companies listed overseas or seeking to sell shares abroad. This is a direct blow to the VC funds. Their most common exit option has been a public listing in New York, which has the world’s most liquid stock market.
Other unicorns they’ve backed — from TikTok owner ByteDance Ltd. to logistics and delivery start-up Lalamove — have frolicked in territory that Beijing is starting to feel sensitive about: consumer and infrastructure data. As such, ByteDance, financed by SoftBank and Tiger Global, may have to delay its IPO or even see its valuation cut. Lalamove, funded by Tiger Global, filed confidentially for a $1 billion U.S. IPO last month. Its roadshow will be interesting to watch.
China is by no means an exception. Governments around the world are increasingly concerned with data security and consumer rights. South Korea’s e-commerce Coupang Inc, which counts SoftBank as its largest shareholder, is being probed over alleged manipulation of search algorithms.
Burned by the Didi debacle, U.S. stock investors may start to put a risk premium on foreign unicorns. If so, it will be harder for the big funds to break even.
A venture capital fund’s mandate is fairly simple. It finds a unicorn, and looks for fruitful exit after a few years, or when the IPO market is frothy. However, things can get hairy when geopolitics is involved. Exporting a concept from one region to another may have seemed to be a profitable equation, but local politics and parochial concerns are now inserting themselves as risk factors. China is proof of that.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Shuli Ren is a Bloomberg Opinion columnist covering Asian markets. She previously wrote on markets for Barron's, following a career as an investment banker, and is a CFA charterholder.
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