Are Chinese tech startups overvalued?

When Uber was valued at $41 billion in December, it sparked demand for Chinese car-hailing app Didi Dache. Photo: Zuma Press

Technology startups in China are raising cash at a record pace from private investors, prompting concerns about potential overvaluation.

The latest hot deal is an $800 million-plus round for Shanghai-based Dianping, an online-review site similar to Yelp Inc. Late demand from new investors increased the fundraising, pushing Dianping’s valuation to around $4 billion, according to people familiar with the situation. That is twice what it was a year ago and more than publicly traded Yelp’s $3.4 billion market capitalization. The deal comes on the heels of Dianping’s chief rival, Meituan.com, raising $700 million in January.

Skeptics point out that Chinese technology companies are getting hefty price tags when they haven’t figured out how to generate revenue consistently, let alone make a profit. Investors and Internet entrepreneurs are using metrics such as user numbers and gross merchandise volume—a common yardstick for e-commerce transactions—rather than revenue and profit.

Some venture investors say they are slowing investments into private Chinese tech companies this year because they are getting too expensive.

“One factor driving private company valuations [in China’s tech sector] is the fear of missing out,” says Tony Hsu, chief investment officer at OTS Capital Management, a Hong Kong-based hedge fund. “Many investors are hellbent on associating themselves with the higher profile companies, irrespective of the price they have to pay.”

Chinese tech companies raised $5 billion in private deals in the second half of last year, compared with $700 million over the same period in 2013, according to Hong Kong-based Centre for Asia Private Equity Research Ltd. The largest was a $1.1 billion round by Xiaomi Corp. in December that valued the Beijing-based smartphone maker at $46 billion, making it the world’s most valuable tech startup. That is more than four times the $10 billion price tag hung on Xiaomi in August 2013.

Questions about whether China’s tech sector is overhyped mirrors similar concerns for U.S. tech startups and publicly traded tech stocks. Snapchat Inc. is now valued at $15 billion after Chinese e-commerce giant Alibaba Group Holding Ltd. invested $200 million in the U.S. messaging company.

“I wouldn’t say U.S. and China tech sectors are identical twins, but they are deeply intertwined,” said Hurst Lin, co-founder of venture-capital firm DCM China.

Investors often compare companies in the two markets, sometimes inflating values. Ride-hailing app Uber Technologies Inc. was valued at $41 billion in December, sparking demand for China’s two largest car-hailing apps, Didi Dache and Kuaidi Dache. The Chinese firms raised $1.3 billion in their latest funding rounds, then agreed to merge in a $6 billion-plus share swap. Under the deal, which hasn’t been completed yet, the two services would continue as separate operations. Existing investors say they are already being approached by potential buyers willing to pay prices that equate to a roughly $10 billion valuation.

Boosting interest is the entry of wealthy individuals and hedge funds into deals. These investors take smaller stakes with less influence.

Wealthy Chinese want access to private tech deals as real-estate investments look less like a sure bet. Xiaomi’s biggest investor in its latest round, All-Stars Investment Ltd., collects its funds mainly from wealthy Chinese.

Venture deals in China offer some protection. Investors often get a so-called ratchet clause, which lets them buy shares at a cheaper price or gives them a bigger stake if the company goes public below its earlier valuation.

Investors are counting on a big payday if the companies go public—a scenario highlighted by Alibaba’s record $25 billion initial public offering in the U.S. last year. Rival JD.com Inc. also went public last year, rising more than 50% since.

In some cases, private market valuations are outstripping what public markets would offer. Dianping hired banks to look into an IPO, but held off as private investors offered richer values and faster execution, people familiar with the situation said.

Chinese tech firms’ main attraction is their fast user growth. App developers are finding niches to serve China’s more than 500 million smartphone users. Dianping has more than 190 million monthly active users, with 85% of its page views last quarter coming from mobile users. Yelp had 136 million unique visitors last quarter.

Still, a challenge for Chinese tech startups is translating users to revenue and profit. Most, including Dianping, don’t disclose financial details. Xiaomi founder Lei Jun said this month its sales more than doubled last year to 74.3 billion yuan (US$11.9 billion), and it expects over 100 billion yuan in sales this year. Xiaomi hasn’t disclosed its profitability.

Xiaomi investors are betting the smartphone maker can generate additional revenue with its app store and selling services like games.

“The key risk for investors is whether Chinese consumers are willing to pay for online services. That’s still a big question mark,” said Forrester Research analyst Bryan Wang.


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