In the investment world, it is not uncommon for the same model, product and strategy to produce totally different results in different markets. The most pivotal driving force here is the competitive landscape, though market dynamics also count for a lot. Endless fierce competition narrows moats and erodes away returns sooner than normal, and a fast-growing industry forces participants to constantly re-build their economic advantages.
In this regard, China’s Internet sector is a perfect example of competition decreasing shareholder value. It is famous for being intensely competitive, highly disruptive and rapidly moving. Thanks to these traits, it has become one of the least favored investable spaces for us at Urbem.
Take a look at Meituan-Dianping (HKSE:03690), which owns the No. 1 local-life service review platform in China. The company has not made an annual profit yet throughout its history, as the Chinese market is fragmented, resulting in too much information attracting little attention in an undoubtedly huge market. By contrast, Meituan-Dianping’s American counterpart, Yelp (YELP), has managed to break even in its moderately competitive markets. Meanwhile, Japanese Internet conglomerate Kakaku.com Inc. (TSE:2371) has performed superbly by delivering consistently high returns on assets (see below), facing relatively mild competition in the Japanese market.
We see a similar phenomenon in the online travel space between Trip.com Group (TCOM), which has achieved a monopoly-like status among Chinese travelers, and Booking Holdings (BKNG), which has more globally-diversified coverage. China is going to soon surpass the U.S. and become the largest online travel market, growing at a high-single-digit rate according to Statista. Nonetheless, a lucrative industry easily attracts competition, and Chinese consumers are well-known for lower brand loyalty. Per the chart below, Booking Holdings delivered more stable and higher returns on assets than Trip.com Group for the last decade.
A challenging competitive landscape in a fast-changing industry often pushes management to touch new domains to diversify the business. More often than not, companies would have to step out of their circle of competence, ending up with poor capital allocation and a diminishing moat. Baidu (BIDU) is a prominent example of this; China’s dominant search engine surprisingly entered the Groupon and delivery businesses a few years ago. At the same time, its core business faced increasingly fierce competition from other technology giants, such as Tencent (HKSE:00700) and Microsoft (MSFT). The end result was “diworsification” and value destruction. As you can see below, over the last ten years, the return on assets gradually deteriorated at Baidu, while the performance at its Western peer, Google (GOOG) (GOOGL), remained steady.
Disclosure: The mention of any stock in this article does not constitute an investment recommendation. Investors should always conduct careful analysis themselves or consult with their investment advisors before acting in the stock market. We own shares of Kakaku.com Inc.
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