China O2O-Buy it online

45 Pages·2015·2.19 MB·English

by  Cai , Alice


Telecoms, Media & Technology
China Internet

China O2O
 RMB10trn market with just 4% online
penetration rate
 Competition is tough now, but profit
Buy it online, ‘fulfil’ it in the real world
should come with maturity
 Baidu and Tencent are better placed
than Alibaba (all rated Buy)
China’s Internet companies are committing billions of dollars in
order to tap into the burgeoning market of online-to-offline
(O2O). In this report, we answer: 1) what is O2O; 2) what are
the opportunities; 3) what are the long-term prospects; 4) how is
O2O in China different from the US; and 5) who can win.
O2O centres on connecting people with local services. This
includes bringing customers to retail outlets. It also involves
bringing services to the customers. For local services, O2O is a
marketing channel to reach and convert customers. For
consumers, it represents convenience. Internet companies can
act as a gateway for discovery, closing the loop from query to
fulfilment, capturing a potentially huge market. We estimate the
total addressable market is RMB10trn with online penetration at
less than 5%. The online portion of O2O revenues surged 80%
y-o-y to RMB300bn in 1H15.
Today, O2O in China is not profitable, as players are using
subsidies to capture market share. We believe this is a natural
13 November 2015 stage in nascent markets. But profits should emerge as the
market matures, market shares stabilize, players adjust their
Alice Cai*
monetization models, local services and customers get hooked
Associate Analyst
on these services, and as the small players run out of capital.
The Hongkong and Shanghai Banking Corporation Limited
[phone] [email protected] We are already seeing signs of rationalization and
consolidation in China and we expect this to continue. In the
Chi Tsang*, CFA
West, delivery earns close to a 20% operating margin. In our
Head of Internet Research, Asia Pacific
The Hongkong and Shanghai Banking Corporation Limited base case, we believe the profit pie could be RMB26bn
[phone] [email protected] assuming a 25% OPM in five years.
Qin Wang* We have developed a scorecard and Tencent (700 HK, Buy, TP
Associate HKD183) scores highest on traffic, while Alibaba (BABA US,
The Hongkong and Shanghai Banking Corporation Limited
Buy, TP USD111) scores highest on capital and Baidu (BIDU
[phone] [email protected]
US, Buy, TP USD230) scores highest on technology. Their
strategies in O2O are consistent with their strengths. Baidu has
taken a high-risk, high-return approach in owning and operating
View HSBC Global Research at: http://www.research.hsbc.com Baidu Nuomi. We believe Tencent’s platform approach,
*Employed by a non-US affiliate of HSBC Securities (USA) Inc, investing in best-of-breed players, is the lowest risk. Alibaba is
and is not registered/qualified pursuant to FINRA regulations
behind its peers in terms of O2O strategy, despite its Koubei JV
Issuer of report: The Hongkong and Shanghai Banking
(50% owned) with sister company Ant Financial. We expect the
Corporation Limited
newly announced combination of Meituan and Dianping (both
Disclaimer & Disclosures
unlisted) to continue to lead nationally in O2O in terms of
This report must be read with the
overall market share, but Baidu Nuomi should be a winner in
disclosures and the analyst certifications
30 cities and sub-categories due to its concentrated approach.
in the Disclosure appendix, and with the
Disclaimer, which forms part of it
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Investment summary
 RMB10trn market with only 4% online penetration
 There are no profits currently, but that should change
 We believe Baidu and Tencent are well placed in O2O;
Alibaba trailing behind

Some call it the “lazy consumer” business. Not that the consumers doing it are lazy; in fact they’re often
working hard. And that’s the point. They have less time to arrange their retail and leisure activities and
need quick, efficient help doing so. For many, O2O – online-to-offline – is the answer. It’s how the service
side of shopping gets done on your mobile device before you then go out and enjoy it in the real word.
It isn’t new. We’ve all heard of Groupon (GRPN US, not rated), Uber (not listed) and Airbnb (not listed),
even if outside China, the names Meituan and Dianping (both not listed) are less familiar. But O2O is
beginning to take off in a big way in China, where the size of the population and its willingness to
innovate are beckoning the titans of the internet to invest big in this burgeoning business.
The tools of the O2O business are usually promotions, discounts and pre-ordering. Goods and services are
bought and booked online and ‘fulfilled’ offline. It’s e-commerce with the emphasis on service rather
than goods. There are two basic models: (1) the so-called ‘omni-channel’ strategy in which brands or
retailers sell via their own websites and customers pick up the goods in offline stores (see our consumer
team’s report on 5 Nov 2014: Multi-line and specialty retailers); and (2) a market place or ‘gateway’
website that hosts third-party goods and services. This is the bigger part of O2O, and it is what we focus
on in this report.
We are a good four to six years into O2O in western countries where urban professionals work long hours
and regard leisure time as rare and precious. The online world makes everything so much more accessible
and efficient. Just Eat (JE LN NR) and GrubHub (GRUB US NR) that have listed and are making money
as operating margins start entering the teens. Most focus on catering, housing and lifestyle services.
In China, O2O only really got under way in 2014 with a surge of start-ups in restaurants, local services
and transportation, many of them copies of Western ones. But in China, two things account for better
opportunities and market potential: (1) the structure of the country’s retail sector is more fragmented; and
(2) China’s consumer behaviour is characterised by what might be called higher consumption frequency.
We estimate the O2O market in China is close to RMB10trn and online penetration is just c4%. According
to iReseach and Mofcom (Ministry of Commerce of the People’s Republic of China), the online portion of
O2O was RMB305bn in 1H 2015, up 80% y-o-y. The top three categories in terms of market size are travel
(RMB3.3trn, 9.5% penetration rate), followed by restaurants (RMB2.8trn, 3.5%), and home services and
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housekeeping (RMB1.2bn). These are followed by local entertainment, hotels, education and kids, beauty,
wedding planning services, all about RMB2.5trn, with a penetration rate of about 5.8%. We estimate the
total market could grow at 8-9% per year and penetration reach 12% by 2018e.
But here’s the big drawback: Chinese consumers don’t have a mind-set that is happy about paying for service.
So O2O companies are making heavy losses as, at this nascent stage, as (1) they charge low ‘take rates’ (less
than 5%) to attract merchants, and (2) subsidise users in the hope of increasing market share. We expect this to
change as the sector matures and Chinese consumers become more willing to pay for convenience, choice and
service and a take rate of 10-15%, comparable to global rates, is attainable. Subsidies would be phased out once
market share stabilises and more revenue should come from ads, subscription fees and merchandise sales.
There are already signs of rationalization involving attrition and consolidation. We estimate the annual profit
pool of China’s O2O market could be over RMB40bn in the long term.
The O2O businesses that we believe will come out on top as this maturing goes on are those with (1) large
online traffic, (2) a strong offline sales team to sign up and keep merchants, and (3) deep pockets. For
example, Baidu, China’s dominant search giant, will invest RMB20bn in Nuomi (wholly owned by Baidu),
currently China’s No. 3 local lifestyle service and ‘group buy’ platform, over the next three years. We
believe this is a high-risk investment strategy with high potential returns and is a natural extension of
Baidu’s search business. Baidu’s share price has already declined from over USD200 before 2Q results to
USD150 before 3Q results, which we believe factors in this risk and Nuomi’s impact on its earnings. We
reiterate our Buy rating on Baidu with a TP of USD230.
Tencent is building its O2O portfolio around its social networks, WeChat and QQ. It is a minority
investment with very limited impact on its income statement and EPS, and in future, should benefit its P&L
indirectly. The investment logic behind this is that Tencent has few sales forces. Tencent’s two biggest
investments are Dianping (not listed), the No. 2 player in ‘group buy’ and local lifestyle service, and Wuba
(WUBA US, Not Rated), the so-called ‘Craigslist of China’, which has been building a ‘to-home’ service
O2O business called 58.com. Dianping has level 2 access to WeChat and announced a merger with its
biggest competitor Meituan (not listed) on 8 October, while Wuba has access to QQ and merged with its
biggest rival Ganji (not listed) in April.
We think the newco of Meituan and Dianping is not necessarily 1+1>2. This is because there is a large
overlap of merchants and they will not be able to stop subsidising users as quickly as Didi and Kuaidi
(both not listed), the two biggest taxi hailing apps, were able to do, as they still need to compete with
Nuomi. That said, the merged Meituan and Dianping would be the lead player in O2O in terms of market
share and the newco should be able to enjoy all three of the criteria we listed above. Baidu Nuomi could
be the top player in some specific categories, such as movie tickets, and in the 30 cities where it has
5,000 sales staff.

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China O2O primer
 O2O is a potentially huge market, but is still at a nascent stage
 We are optimistic about China’s O2O business in the long term
and think it will become profitable as it matures
 Newco of Dianping and Meituan a major player nationwide; Baidu
Nuomi could be a top player in some categories and cities

Online-to-offline is about busy urban professionals who want their shopping, leisure and pleasure to be
arranged through a great service provided in the palm of their hand. But exactly what is it, and can you
make any money from it? In this chapter, we answer eight questions investors are asking about O2O:
1. Isn’t it just e-commerce by a cooler name?
2. Why is it so ‘hot’ now?
3. What sort of business can be best done through O2O?
4. Is it different in China?
5. Can it be profitable in China?
6. What are the big internet companies doing with it?
7. Who is well positioned to do well from it?
8. How big can it get? (We address this question in appendix section)
How is it different from good old-fashioned e-commerce?
E-commerce is ‘doing business on the internet’. In that sense, O2O is part of e-commerce. But for a long
time, we thought of e-commerce mostly like we thought of ordering books from Amazon: you go onto a
website to see what you would like, click ‘buy’ and wait for it to be delivered to your front door. O2O is
different in that it concentrates on helping you find what you want and then directs you to where you can
enjoy it in the real world. In short, you search and book online and ‘fulfil’ offline.
Thus, O2O is especially suitable for goods or service the consumption of which must be completed
offline. Obvious examples include restaurants and coffee parlours, cinemas and entertainment centres and
beauty and fitness salons. Others are taxi, travel and accommodation services. We view fresh food and
grocery delivery as part of O2O as well, as they have high offline delivery service requirements, with
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delivery usually needing to take place within a couple of hours of ordering, similar to food take-out
delivery. In this sense, we view fast logistics as an offline service.
In sum, we believe O2O is an extension of e-commerce that is different from conventional e-commerce in
that (1) O2O orders need be fulfilled offline and (2) O2O focuses on service rather than goods.
Why is O2O so hot now?
(1) Big market, huge opportunities: According to Baidu’s 2Q conference call, the market is
cRMB10trn, which is same as our estimates, even though the online penetration rate is less than 5%.
The market is to double in four to five years.
(2) At this early stage, even the small guy has a big chance: The year 2014 is seen as the beginning of
O2O in China. There are as yet no dominating players and no fixed competition landscape. It is still
possible to dream of becoming the next ‘BAT’ (short for Baidu, Alibaba, Tencent – the three big
internet players).
(3) Easing the conflict between internet and traditional players: O2O goes some way towards
resolving the rivalry between traditional and internet businesses. The ‘brick and mortar’ players are
given a lifeline to halt the decline in revenues, even provide incremental revenue by helping increase
the number of customers that come to them. Internet companies, on the other hand, are able to enjoy
further expansion of their appeal.
(4) Supportive government policy: The Chinese government is very supportive of O2O business
development. The State Council, the country’s executive, released a draft plan on 29 September 2015
to accelerate the innovation, transformation, development and advancement of O2O businesses.
(5) High smartphone penetration: According to the China Internet Network Information Centre, there
are 594m mobile internet users in China. This approaches the tipping point for consumption of
location-based services, which involve location-enabled and portable navigation applications that
play a large part in O2O services.
What businesses are suitable?
(1) High consumption frequency services, including taxi rides, private car hire, restaurants, takeout
delivery, etc.
(2) Low utilisation rate of facilities, such as local entertainment, including cinemas, karaoke bars (known
in China as KTV), health and beauty, gyms, home services, etc.
What is common to these two criteria is an imbalance between supply and demand. High-frequency
products and services often run into supply bottlenecks because there are so many people who want them.
For example, China only has about a million taxis that are able to meet just 60-70% of demand. Even in
Beijing, the city with the highest taxi number per thousand people, the ratio is just 4.2. This is gold-dust
for taxi-hailing apps such as Didi and Kuaidi. Industries with low facility utilisation stand to gain from
O2O’s efficiency effect.
O2O businesses can be divided into ‘to-store’ and ‘to-home’ delivery. In the former, consumers go online to
find what they want and then to the bricks-and-mortar outlet to fulfil their order. Parts of Meituan, Dianping
and Nuomi are aimed at solving this problem of under-used capacity. To-home delivery businesses can be
further divided into logistic-to-home (food and grocery deliveries) and people-to-home (home cleaners,
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appliance repairs, beauty services, etc). 58.com is the biggest player in this area. We think to-store O2O
businesses are relatively easier and have lower entry barriers than to-home businesses which could become
involved in bureaucratic issues and because they are more difficult to manage than stores.
How does O2O in China differ from elsewhere?
We think it is useful to compare what’s going on in China now with what has happened elsewhere. We
see two key similarities:
(1) Urbanisation: Longer hours devoted to demanding and stressful careers leave many people with little
time to properly plan and carry out many non-work functions, from shopping to entertainment and
holidaying. O2O offers help in the form of the “lazy consumer business”.
(2) Higher concentration in catering industry: Appendix tables 1 and 2 show that most start-ups are in
the catering industries, as it is the ‘vertical’ that offers the best opportunities for profit.
There are also some important ways in which China differs from the rest of the world:
(1) Retail structure: The retail industry is still immature in China; the market is highly fragmented in
China compared with elsewhere, such as the US where the top 50 chains (including McDonald’s, Yum!
Brands, Darden Restaurants Inc.) account for 30% of the market. In China, the top 10 restaurant players
account for just 5% of the market and the top 100 retail chain operators for just 8.6% of total retail sales.
Intensifying competition, together with rising rents and labour costs have taken a toll on the sector, which
should benefit from more online activity.
(2) Cultural differences: In Western countries especially, there seems to be a willingness to pay for good
service. This is not yet the case in China.
(3) Purchasing behaviour: In some cases, so-called ‘user frequency’ is lower in richer countries. For
example, annual average orders per user at Just East is about 6-7 times, implying each quarter 1-2 orders,
compared to average 2-3 orders per week for most Chinese users. The total orders for Just East in 1H15 is
41.9m or 0.2m per day, while Ele.me, the No.2 food take-out delivery players in China, handles 2m
orders per day, or 60m orders per month, which is higher than half-year orders of Just East.
Could O2O be profitable in China?
O2O in China started out with a ‘group buy’ business model, which involves offering discounted services
or products in order to attract large numbers of buyers. This model has proven very hard to sustain as:
(1) merchants need to sell at very low prices to attract customers, often at a loss; (2) some are forced to
lower their standards to match the price, resulting in a bad customer experience; and (3) a relentless
search for lower prices coupled with such bad product or service experiences do not result in much
customer loyalty.
Outside of China, Groupon is still struggling in making money – seven years after starting up – with an
OPM of -10% as of 3Q15. The stock has not traded above the USD31 high it made on its first day of
trading on 4 Nov 2011, and has fallen to just USD3 currently, underperforming the NASDAQ by 92%
over the period. Investors worry that Chinese O2O companies will struggle for profitability in the same
way that Groupon has, but we argue that they do not face the same obstacles as the US firm.
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Firstly, Groupon’s goods business line derives the majority of its revenue from a direct sales model
(accounting c20% of Groupon’s total GMV), which generates only a 10% GPM, compared with around
an 85% GPM for its market place model (which had an average take rate of as high as 27% in 2014). In
addition, the direct sales model incurs inventory risk. Chinese O2O firms, by contrast, operate a pure
market place model, avoiding such challenges.
Secondly, Groupon’s SG&A costs are equal to 40.5% of its revenue – high by any standard – due to sales
commissions for sales representatives, and expenses relating to technology, telecommunications and
travel. Chinese O2O companies’ losses, on the other hand, relate more to user subsidies and a low take
rate than high SG&A. It is reported Meituan is burning RMB600m per month, according to Sina news
dated 21 August.
In 2011, there were around 5,000 group buy companies in China. Today we estimate there are just dozens
and the top five – Meituan, Dianping, Nuomi, Lashou (not listed) and WoWo (WOWO US, Not Rated) –
have a market share of more than 90%. They – and the other smaller ones – are all shifting their business
models; whereas before they focused on the sale of ‘hot’ products, they are now focusing more about
merchant appeals and building member loyalty. They are trying to become the so called “local life service
platforms”. However, progress towards profitability remains slow. Commissions (‘take’) are still very low
because of fierce competition, no more than 5% in most cases, and deep discounting and subsidies for
users continue. According to venture capital firm Gobi Partners, about 30-40% of Chinese O2O start-ups
have closed in the past few months, having run out of cash. Other bigger companies have merged, such as
Didi and Kuaidi (now called Didi Kuaidi), Wuba and Ganji, and Meituan and Dianping.
However, we are optimistic on the long-term outlook.
First, let’s look at what happens if the discounts stop? The taxi hailing services Didi and Kuaidi should
provide some reason for optimism. Together, they enjoyed a market share of around 90%, according to
company, and, in a battle for dominance in 2014, they began a subsidy war. Yet, when they ended it and
raised fees, user numbers did not decline significantly. While Didi and Kuaidi are not yet profitable, at
least they are not burning cash as fast as they once did.
Didi and Kuaidi MAU Didi and Kuaidi DAU
mn mn
40
6 Stop subsidywar on 17 May
35 Stop subsidywar on 17 May
5
30
25 4
20 3
15
2
10
5 Start subsidywar on 10 Jan 1 Start subsidywar on 10 Jan
0 0
2014-01 2014-03 2014-05 2014-07 2014-09 2014-11 2014-01 2014-04 2014-07 2014-10
Didi MAU Kuaidi MAU Didi DAU Kuaidi DAU
Source: iResearch, HSBC Source: iResearch, HSBC

Second, we also expect that as disposable income rises and users become better educated, they will be
more willing to pay for good services. This is already happening in video where more and more users
appear to be willing to pay for subscription membership. iQiyi membership reached 10m in 3Q15.
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Third, to recall, Alibaba’s online marketplace, Taobao, which in its early days did not charge merchants,
now does and remains the most profitable China online shopping destination. It is a good example to
prove when companies gain enough market share, they can have better bargaining power and can charge
fees and make money. O2O companies as an extension of e-commerce are likely to follow the path.
Fourth, not all O2O companies in the developed world have struggled like Groupon. Some – such as Just
Eat, GrubHub Seamless – are profitable, with operating margins of as high as 12-18% and rising, according
to the companies’ reports. Below are the margin trends and revenue trends of the overseas companies.
O2O companies in developed countries - revenue trends O2O companies in developed countries - margin trends
3,U50S0D m 3,192 2300%% 16% 11% 14% 18%
23,,500000 2,334 2,574 -11000%%% -1% -40%% 0%4% 7%3%0% 130%1%%
2,000 1,610 1,570 -20% -15% -15%
-30%
1,500 1,238
960 1,073 -40%
1,000 800 -50%
500 99 313 546 1 140 95 821 62 15113 179 0 2592 54 --7600%% -69%
0 -80%
2010 2011 2012 2013 2014 2010 2011 2012 2013 2014
Just Eat GrubHub Seamless OpenTable Ocado Groupon Just Eat GrubHub Seamless Ocado Groupon

Source: Company data, HSBC Source: Company data, HSBC

Last but not least, one Chinese O2O company that is making money is Daojia (not listed), a food delivery
platform that has partnerships with thousands of restaurants, similar to GrubHub. Daojia charges a 15%
take rate from the restaurants as well as delivery fees from users and according to our channel check, the
company is already breaking even.
Thus, although near-term visibility on the profitability of many O2O companies remains low, we are
optimistic on their long-term outlook. We see several ways in which O2O can be monetized:
(a) Advertising fees. When merchants want more traffic, they could be encouraged to bid for key words,
a similar model to the one Alibaba uses for Tmall and Taobao.
(b) Higher take rates. Chinese O2O businesses can aim in the longer term for the global rate of 10-15%.
Daojia is making headway with this. At the moment, the take rate of the overall O2O industry is
relatively low, as we have discussed. Meituan’s nominal take rate from merchants is about 5-10%; but
because of the subsidies given to users aimed at gaining market share, we think its actual net take rate
is lower than 5%. Nuomi’s rate for movie tickets is in the low single-digits, and for dining, it varies
among different regions and under different circumstances, with an average of about 2-3%.
(c) Membership fees. These could come with more value-added services, such as providing ‘big data’
analytics to merchants that would help them target customers more precisely. In the case of cinemas,
they could help them arrange show times of different films according to popularity.
(d) Sales revenue from merchandise. This would involve cross-sales of curated products related to the
services on offer.
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What follows is a very simple scenario calculation for the revenue and profit of the O2O market. In the
worst-case scenario (scenario 1), with a low penetration rate and low operating profit margin, simulated
profits could still be around RMB17bn. This is more than half of Tencent’s RMB30.5bn operating profit
in 2014, slightly lower than Alibaba’s FY2015 operating profit of RMB23bn and above Baidu’s 2014
operating profit. Under the best-case scenario (scenario 3), even assuming no growth in current O2O total
addressable market (TAM) (ex-travel), the market’s annual profits could be as high as RMB53bn, higher
than the annual profit from BAT. We think the most likely scenario in five years is scenario 2 with a
TAM (ex-travel) profit of RMB26bn. Why this is the most likely scenario? First, based on both
iResearch and our forecast, online penetration rate should be 12% in 2018e. Thus, it could reach 14% in
2020e. Second, based on our forecast of Ctrip, the giant of online travel industry, its operating margin
should recover to 20% next year, and should back to 30% within three years. We believe other
submarkets will follow the trends after recent consolidation and rationalization of the industry. We think
overall 25% OPM margin in 2020e is doable.
O2O market revenue and profit scenario calculation
____________ Scenario 1 ____________ ___________ Scenario 2 _____________ ____________ Scenario 3 ____________
Unit: RMB bn TAM in Take Penetration Revenue OPM Operating Penetration Revenue OPM Operating Penetration Revenue OPMOperating
2014 rate rate profit rate profit rate profit
Restaurant (ex take out) 2,625 10% 10% 26 15% 4 18% 47 25% 12 25% 66 35% 23
Take-out delivery 161 10% 10% 2 5% 0 18% 3 15% 0 25% 4 25% 1
Travel 3,250 10% 15% 49 15% 7 18% 59 25% 15 25% 81 35% 28
Home services & 1,152 15% 7% 12 15% 2 10% 17 25% 4 15% 26 35% 9
housekeeping
KTV 480 15% 7% 5 15% 1 10% 7 25% 2 15% 11 35% 4
Taxi 310 5% 10% 2 15% 0 20% 3 25% 1 27% 4 35% 1
SPA & Hot Spring etc 300 15% 7% 3 15% 0 10% 4 25% 1 15% 7 35% 2
Beauty 297 15% 7% 3 15% 0 10% 4 25% 1 15% 7 35% 2
Wedding plan service 129 15% 7% 1 15% 0 10% 2 25% 0 15% 3 35% 1
Photographic 247 15% 7% 3 15% 0 10% 4 25% 1 15% 6 35% 2
Appliance repairing 98 15% 7% 1 15% 0 10% 1 25% 0 15% 2 35% 1
Entertainment ticket 45 5% 30% 1 15% 0 50% 1 25% 0 60% 1 35% 0
Laundry market 27 10% 7% 0 10% 0 10% 0 20% 0 15% 0 30% 0
Others 82 15% 7% 1 15% 0 10% 1 25% 0 15% 2 35% 1
Fresh food 241 10% 7% 2 5% 0 10% 2 15% 0 15% 4 25% 1
Education and kids 556 15% 7% 6 15% 1 10% 8 25% 2 15% 13 35% 4
Gym 28 15% 7% 0 15% 0 10% 0 25% 0 15% 1 35% 0
Total 10,028 12% 10.6% 116 14.7% 17 15.3% 166 24.7% 41 21.6% 236 34.7% 82
Total ex travel 6,778 12% 8.5% 67 14.5% 10 14.0% 108 24.5% 26 20.0% 155 34.5% 53
Source: Mofcom, iResearch, HSBC estimates

What is BAT doing with O2O?
Baidu
Baidu’s O2O strategy is focused on local services, online travel and transportation. This is intended to (1)
take advantage of its 643m mobile search users and 326m map users, but at the same time improve
mobile search ‘stickiness’ and secure its dominance of mobile search; (2) gain share in ad bidding
revenue at the city- and near-distant levels; and (3) promote use of its wallet. The chart below shows
Baidu’s O2O investments over the last three years.
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Baidu’s O2O investments
Baidu
Life style
Real Department
service Catering Transportation Travel Logistic Movie Healthcare Laundry Car Education
Estate store
platform
Nuomi Baidu food Uber Ctrip oTMS Stellar Yihuwang edaixi Anjuke Youxinpai Wanda Wanxue
take-out
delivery
Baidu 51 yche Qunar
connect
Meishisong
TTyongche
Baixing
Keruyun
Note: Baidu is the majority shareholder of the red entities and minority of the blue entities
Source: Company, HSBC

Among these investments, the three biggest are Qunar (QUNR US, USD39.88, Buy), Nuomi and Baidu
takeout delivery. As the majority shareholder, Baidu had to fully consolidate them in its income statement
and balance sheet, which directly impacts its margins and earnings. On 26 October, Baidu announced that
it had completed a share exchange transaction with Ctrip (CTRP US, USD99.58, Buy). After the
exchange, Baidu will own 25% of Ctrip and still has a 2% share of Qunar, while Ctrip will own about
48% of Qunar’s equity shares and 45% of voting power. Baidu will deconsolidate Qunar from
26 October, which had a 4ppt impact on its margin in 3Q15. For more details, refer our reports: Ctrip: A
giant is born, 27 Oct and China online travel: a second look at Ctrip-Qunar deal, 28 Oct.
Qunar has successfully shifted its hotel business from a pure-meta search business to an online travel
agency (OTA) business model, and its total revenue growth rate has been over 100% in the past five
consecutively quarters at the expense of heavily losses. We believe Qunar’s product team has
demonstrated remarkable execution ability, building the hotel OTA business from zero. It is now the No.
2 player in the OTA industry and we expect Nuomi will copy its strategy.
Before Nuomi, Baidu launched another O2O product called Baidu Connect in 2014, which has had only
limited success. A year after its launch, it had 760,000 merchants. But a survey by Sina Tech found that
Baidu Connect’s penetration rate was just 8%. We think Baidu Connect’s problems are to do with the fact
that it is more of a ‘pull’ O2O model, in which users need to have a preferred restaurant or movie theatre
associated with specific merchants before they go on to the site. We believe that at the current early stage
of O2O development, most people still do not have loyalty or a strong preference for specific merchants.
Nuomi, on the other hand, is a ‘push’ O2O model, displaying all the merchants, which means users can
easily compare, rank and choose as they like. The same survey by Sina Tech found the penetration rate of
users of Nuomi to be as high as 92%.
As this report has already noted, Baidu has announced it will invest over RMB20bn in Nuomi over the
next three years to subsidise both merchants and users in order to win more market share. Nuomi covers
restaurants, movie tickets, hotels, KTV, travel, laundry, leisure and entertainment. In the case of cinema
tickets on Chinese Valentine’s Day, for example, Nuomi’s market share was 25%. We think this
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