Tencent aims to boost holding in Sogou, by acquiring the Chinese Search Engine for $2.1B, at a $3.3B valuation.
By Zaid Dudhniwala, BSc Economics @LSE
OVERVIEW OF THE ACQUISITION:
- Acquirer: Tencent Holdings Ltd (HKG: 0700)
- Target: Sogou, Inc. (NASDAQ: SOGO)
- Estimated value: $2.1B transaction, at $9 per share with a $3.31B valuation
- Financing: All-stock transaction — Cash Buyout
- Announcement Date: 27/07/2020
- Acquirer Financial Advisors: Goldman Sachs (Asia) L.L.C.
- Acquirer Legal Counsel: Davis Polk & Wardwell LLP
- Target Financial Advisors: Not yet selected
- Target Legal Counsel: Not yet selected
Chinese Tech Giant Tencent Holdings Ltd (HKG: 0700) is looking to acquire the American-listed Chinese Search Engine Sogou, Inc. (NASDAQ: SOGO) through the purchase of any outstanding shares it does not currently own. A proposed takeover, which may easily become hostile if there are disagreements from Sogou equity holders, has been offered to current Sogou shareholders, at $9/share. If this transaction were to go through, this would cost Tencent over $3.3B, at a respectable premium of around 56.5% to the $5.75 closing price of Sogou’s American Deposited Shares on July 24, the week before the deal was announced.
Since Tencent already has 39.2% of the total issued and outstanding shares and 52.3% of the total voting power of Sogou, this seems like a relatively easy transaction that will occur. This high probability has caused Sogou’s share price to soar by 50.2% to $8.64, as investors look to gain the big payoff when this transaction goes through. This seems a very predictable move for the Chinese Giant Tencent, which further looks to bolster and integrate Sogou as part of it’s online services to it’s ever-growing market of over a billion monthly active users, across all it’s different platforms. The rationale behind this approach is clear, and can be seen as a way in which Tencent flex their strong balance sheet on their major competitors, Baidu & Alibaba, through this multi-billion dollar transaction.
COMPANY DETAILS — Tencent Holdings Ltd (HKG: 0700):
Tencent Holdings Ltd is a Chinese technological powerhouse, driving the tech addiction infusing people in the masses in the fast-growing middle-class population in China and neighbouring countries. Founded as a messenger app at the start of the dot com boom, Tencent went on to revolutionise the tech space in Chinese markets, firstly through mobile gaming and their cellular services. Then later on, the rise of Weixin (renamed now to WeChat), as the core social media app presented to the market by the company, has really defined the firm as a key player in the global tech space. Boasting over 1 billion active monthly users, the company shows no signs of faltering as the technology industry drives growth both in markets and economies worldwide.
Tencent’s strength is visible in their recent boom in share price, which has increased by 62% in the past year, despite the market impact of Covid-19. Their product line is also becoming more and more diversified, as they now also provide services ranging from Maps and Food Delivery, Cloud storage and B2B solutions all the way to E-Commerce and their own cashless payments system, all under the famous “We” brand. They have strong ambitions with the Belt & Road Initiative to expand further.
- Founded in: 1998
- Headquartered in: Shenzhen, China
- CEO: Ma Huateng (Pony Ma)
- Number of Employees: 64,238
- Market Cap: $686.3B
- EV: $699.7B
- LTM Revenue: $57.4B
- LTM EBITDA: $20.5B
- EV/ LTM Revenue: 12.2x
- EV/ LTM EBITDA: 34.1x
COMPANY DETAILS — Sogou, Inc. (NASDAQ: SOGO):
Sogou, Inc., a subsidiary of the tech conglomerate Soho, inc, is a Chinese search Engine, listed on American markets. The company was founded independently as a spin-off from Soho around 2012, initially made as a search engine by top talent from the heralded Tsinghua University. Despite early investments by Alibaba through Jack Ma, the company has stayed relatively independent, and succeeded as so too. That was until Pony Ma stepped in from Tencent, merging the website SoSo.com to create the default search engine for the second most popular website in China, QQ.com, owned by Tencent. Sogou became profitable shortly after, raising nearly $600M through their IPO in the States soon after. The close links with Tencent brought more consumers through WeChat, especially since Sogou has a specific function through which WeChat public accounts can be searched for.
Their strong alliance with Tencent has brought them a lot of success, causing mutually beneficial growth for both. Sogou now accounts for around 20% of the crowded mobile search market in China, showing their dominance in the services they provide. The company has a strong foothold in the market, but more competitors, especially in house alternatives from Alibaba and market-leader Baidu, pose a serious threat to the company going forward.
- Founded in: 2005
- Headquartered in: Beijing, China
- CEO: Wang Xiaochuan
- Number of Employees: 2,738
- Market Cap: $3.4B
- EV: $2.3B
- LTM Revenue: $1.2B
- LTM EBITDA: $0.1B
- EV/ LTM Revenue: 1.9x
- EV/ LTM EBITDA: 23.0
STRATEGIC RATIONALE:
This deal makes perfect sense from Tencent’s side. As the largest sole shareholder in Sogou from all the way back in 2013, there is little reason for there to be any misfits, whether that be operational or cultural. Sogou’s operations come under a subset of what Tencent provides, so for Tencent, this acquisition is just a method for further streamlining of their systems and processes, especially since Sogou was already assisting WeChat & QQ usage.
The hefty premium at hand also provides a strong financial push for Sogou to accept the transaction. There will be very few worries of lay-offs too, as the transaction will be a matter of holistic integration, rather than a pure synergy merger. The synergies are already there, which will make the sale easier from Sogou’s side too. This can also help boost Sogou’s coverage to get anywhere near that of Baidu, the current king of Chinese search engines.
RISKS AND UNCERTAINTIES:
Despite the strong relationship both firms already have, there may be some risk and uncertainty going forward with this transaction. Even though the synergies are evident, the payout may be too high for Tencent. Although Sogou is predicted to grow strongly, there are many concerns from analysts and speculators that Sogou may just end up being the Chinese “Bing or Yahoo Search”, that will forever be in Baidu’s shadow. This acquisition will not boost Sogou’s market share that much more to take on Baidu, and so could be deemed as too expensive, especially at that premium, for Tencent.
Sogou may also want to keep their independence and presence on the buoyant NASDAQ, rejecting a delisting, even though Tencent has the majority power when it comes to votes. Sohu, the parent company of Sogou, said its board of directors has “not yet had an opportunity to review and evaluate the Proposal in detail, or to make any determination as to how to respond to the Proposal or as to whether or not the proposed acquisition of Sogou would be in the best interests of Sohu, in its capacity as Sogou’s controlling shareholder, to approve or reject the Proposal.” If there is conflict to erupt from the deal, it could tarnish the services both parties currently enjoy from providing through their strategic alliance.
OUR VIEW:
With the booming technology industry paving way for the economic recovery into the third decade of this century, this acquisition makes perfect sense for Tencent to solidify their market position, letting Alibaba and Baidu know that they are in the Search Engine battle too, and will not just settle at running the “We” line of services. The synergies will be instant, with not much restructuring required. The only concern will be that Baidu’s dominance will be hard to eradicate, and maybe this acquisition will not reap huge rewards for Tencent, especially when the extortionate premium paid is considered. Yet still, it is a step in the right direction if Tencent wants to seek maximum market share in this buzzing tech space.
