Indian startups wake up to a post-China world

Photo: REUTERS

Last week, after India abruptly announced a ban on 59 Chinese apps, TikTok’s CEO Kevin Mayer called for a virtual town hall with his India employees.

Over the past two years, ByteDance, which owns TikTok and Helo (also included in the list of the banned apps), had established a large presence in India. Despite the border conflict between India and China that led to the death of 20 Indian soldiers and the anti-China rhetoric that had been bubbling up here as the pandemic spread, the Beijing-headquartered ByteDance had no inkling that a ban was coming.

Mayer, who had joined TikTok as its global CEO only in May from the American entertainment firm The Walt Disney Company, sought to allay the concerns of the India employees. Mayer, 58, told the ByteDance employees that he was known to look after his employees as if they were family and that he would fight for his team. TikTok would continue to pay salaries and avoid cutting jobs for now, he added.

But Mayer’s address, which lasted a few minutes, failed to provide much comfort to TikTok employees, two company executives said.

“His town hall was really brief and there were no details on what the company can do to deal with this. No one was convinced … While we’re still hoping that the ban will be reversed, I wouldn’t say anyone expects it. Many have already started looking out for other jobs,” one of the executives said.

The government’s move, however, was cheered by local entrepreneurs and venture capitalists who expect startups in social networking, media and other spaces to benefit from the forced withdrawal of TikTok, Helo, SHAREit, NewsDog and others. Indian startups have faced existential threats mostly from American and Chinese companies that use their technology prowess and limitless capital to overpower local rivals. If the ban on Chinese companies stays, it’ll provide respite to local startups by permanently removing one set of competitors whom they believe were engaged in the unfair practice of “capital dumping.”

The ban was the second time in months that India had moved to put restrictions on Chinese companies and investors. In April, direct investments by Chinese investors into Indian companies without regulatory approval were prohibited. In that case, the impact on Indian startups was decidedly negative—Chinese investors have poured over $8 billion into startups directly or indirectly over the past decade, and in recent years, they had become the most important source of capital for small and large internet firms alike.

Put together, the two policy measures will lead to an immediate freeze on Chinese capital in India’s startup ecosystem that is likely to last until a political resolution of the latest border dispute. It will leave a huge funding gap for internet firms that are already struggling to cope with the slump caused by the pandemic. This blow easily outweighs the potential benefits to a handful of social networking startups.

There is a small possibility that if the two governments reach a compromise, both venture capitalists and the banned companies from China will return. Hence, the long-term impact of the moves remain unclear. ByteDance is pleading its case with the government and has offered to set up an engineering office and data centres in India, among other steps.

It is clear that India’s startup ecosystem has become a key geo-political battleground notwithstanding its small size—imports in sectors like smartphones and pharmaceuticals from China dwarf startup activity involving the two countries. But as foreign policy experts have pointed out, India has few viable options to undertake substantial retaliatory actions against China. In this context, banning apps and placing investment restrictions are seen as low-risk manoeuvres that could help the government save face.

One thing is certain: the startup ecosystem, whose development in the past decade had come largely in—and many say, because of—a policy vacuum, is now increasingly being shaped by the whims of the government. While it has benefitted from moves like demonetization and the Chinese app ban, the lack of consistency and stability in policymaking could easily swing the other way and hurt investor outlook over the coming years.

Social revival

For years, entrepreneurs and investors have talked big about “building for Bharat,” but it was the Chinese firms that had led the way in creating products for the Indian masses. From 2016, the availability of fast, cheap internet connections together with the proliferation of low-cost smartphones (most of them Chinese) brought hundreds of millions of Indians in semi-urban and rural areas online.

Dozens of Chinese firms, which had seen a similar internet boom in their country, rapidly launched internet browsers, video apps, messaging services and other products specifically designed for this audience. By mid-2017, apps like Bigo Live, UC Browser, SHAREit and UC News had already become hugely popular among Indians in smaller cities and towns.

Looking at the success of the Chinese firms, investors started hunting for local startups in social networking, video and news content with a focus on vernacular language offerings. For a short period, companies like ShareChat, Clip and Dailyhunt became investor darlings.

However, the expansion of TikTok with its endless stream of addictive entertainment in 2018 nearly destroyed content startups. In 2018, ByteDance also launched Helo to crush ShareChat, from which Helo was copied, and outspent its stunned rival many times over to attract users. As a result, ShareChat’s growth slowed, Clip was forced to sell itself for a pittance and investors deserted content startups.

After establishing a large user base, ByteDance began to sell ads on TikTok and Helo in 2019. TikTok was expected to become the fastest-growing digital ads platform this year and emerge as a serious rival to Facebook and YouTube, an achievement that no company has achieved in nearly a decade.

The ban has put the brakes on this transformation of India’s social networking and online advertising spaces. One big beneficiary so far has been ShareChat. Its app base has risen by more than 50 million in the week after the ban. The company plans to raise a large new round of capital that will lift it into the unicorn club from its present valuation of about $600-650 million. ShareChat, incidentally, has at least four Chinese investors.

Short-video platform Roposo (owned by ad tech firm InMobi) followed by other TikTok clones like Chingari and Mitron have all registered a spike in app downloads since the ban. “If the ban continues, it’ll be a defining moment for social networking startups,” said Anand Lunia, partner at venture capital firm India Quotient, which was one of the earliest backers of ShareChat, Clip, Roposo and other social networking startups.

Despite the optimism, it is unclear how many social networking startups will thrive at a large scale. Social networking tends to be a winner-take-most business, meaning that even if the Chinese apps are banned for good, only a very small number of local startups could end up extracting any meaningful value.

And while the banned Chinese apps served hundreds of millions, their actual business—through advertising revenue and in-app purchases—was relatively meagre, reflecting the low spending power of their users. One internet analyst estimated the overall business on these apps (excluding Club Factory and Shein, which are e-commerce marketplaces) to be easily less than $1 billion annually.

In addition, investors expect Google and Facebook to corner the largest chunk of ad revenues given up by the Chinese companies. “It is very likely that much of the ad spending that would have gone to TikTok or NewsDog will now be moved to YouTube (owned by Google), Facebook and Instagram (owned by Facebook),” an executive at a content startup said. “These apps are considered safe advertising options and their reach is unrivalled by any local startup.”

Huge blow

The purpose of India’s curbs on Chinese investments in April was to prevent Chinese firms from buying local companies on the cheap during the pandemic.

But as a blanket measure that covered even minority Chinese investments, it was criticized as misguided by VCs and entrepreneurs who pointed out that Chinese firms had anyway never sought to buy Indian internet companies. Though Chinese firms and funds have invested in startups across sizes and sectors, from Series A companies to unicorns and from e-commerce, mobility, logistics to financial services, healthcare and education, they are only minority shareholders.

After the restrictions were announced, law firms raced to complete funding deals in the small window before the rule took effect. Even afterwards, lawyers urged their Chinese clients to continue investing albeit in smaller volumes. The advice was: lie low and this will pass. At least two funding deals involving Chinese investors were signed in May and early June and sent to Indian regulators for approval (which hasn’t been granted yet). Some startups trying to raise funds from Chinese funds had even discussed the possibility of shifting their holding company to Singapore to get around the new rule.

But the lethal clash between the two countries over the Galwan Valley dashed any hopes of a speedy return to normalcy for Chinese investors. Many of them are now actively looking to exit from portfolio companies, especially those that they believe are underperforming, people familiar with the matter said. They are willing to sell their shares in secondary share sales at significant discounts to these companies’ present valuations, the people said. In portfolio companies that are thriving, Chinese investors are holding on for now.

The unravelling of Chinese holdings in Indian startups will be a long, painful process that will hurt both parties. In future, Chinese firms could invoke shareholder rights that make it bothersome for their portfolio firms to raise fresh capital without the former’s participation. The more likely consequence of the India-China stand-off on startups, however, is that they will struggle to find replacements for Tencent’s large cheques, or the deal volumes supplied by Shunwei Capital, especially in the current environment.

From late 2019, startup funding had started to slow in India and globally in the wake of the failed WeWork public offering. The pandemic then devastated many internet firms and forced VCs to freeze new investments, triggering a funding crisis. The loss of Chinese capital will exacerbate the funding downturn and could lead to a higher number of startup failures and distress sales over the next two years.

In the crosshairs

Apart from losing access to Chinese capital, three large Indian internet companies in particular—InMobi, Oyo and Paytm—could be hurt by the stand-off between the countries.

Unlike most Indian startups, which have avoided venturing into China, InMobi and Oyo have large operations there and count the country as one of their top two markets. InMobi has said that it generates about a fourth of its revenues from China, while Oyo has invested hundreds of millions of dollars on expanding in Asia’s largest economy.

Any retaliatory action by China will cause significant damage to the two firms. Oyo seems especially vulnerable, as its business has collapsed globally; China, whose economy has reopened after it successfully controlled the pandemic, was one of the few markets where a strong recovery was possible for Oyo this year.

Paytm, India’s most valuable startup, has close ties with China’s Alibaba Group, which in turn is known to be close to China’s ruling party. Alibaba’s sister firm Ant Financial is the biggest investor in One97 Communications, Paytm’s parent firm, while Alibaba is the biggest shareholder in Paytm E-commerce.

The Alibaba Group controls nearly 40% in Paytm and Paytm E-commerce. Alibaba and Paytm run a joint venture in online gaming Paytm First Games. Paytm has also said in the past that it uses Aliyun, Alibaba’s cloud computing service. Given that financial services is considered a sensitive sector by India, Paytm’s ties with Alibaba are likely to be scrutinized by regulators.

Paytm said that none of its “investors or other stakeholders” have access to its customer data. “All of the data across all our ventures are stored in India,” a Paytm spokesperson said.

This article was first published on livemint.com.

Singapore Reporter/s

In Singapore, we are looking to double our reporting team by this year-end to comprehensively cover the fast-moving world of funded startups and VC, PE & M&A deals. We want reporters who can tell our readers what is really happening in these sectors and why it matters to markets, companies and consumers. The ability to write precisely and urgently is crucial for these roles. Ideal candidates must have to ability to work in a collaborative, dynamic, and fast-changing environment. We want our new hires to be digitally savvy and ready to experiment with new forms of storytelling. Most importantly, we are looking for hard-hitting reporters who work well in a team. Collaboration and collegiality are a must.

Following vacancies can be applied for (only in Singapore).

Following vacancies can be applied for (only in Singapore).   

  • A reporter to track companies/startups that have raised private capital, and have the potential to become unicorns. SEA currently has over 40 companies with a valuation of over $100 million and under $1 billion.
  • A reporter who can get behind the scenes and reveal how funding rounds are put together, or why they’ve failed to materialise. She/he in this role will largely focus on long-format stories. 
  • A journalist to track special situations funds, distressed debt and private credit (from the PE angle) across Asia.

Singapore Reporter/s

In Singapore, we are looking to double our reporting team by this year-end to comprehensively cover the fast-moving world of funded startups and VC, PE & M&A deals. We want reporters who can tell our readers what is really happening in these sectors and why it matters to markets, companies and consumers. The ability to write precisely and urgently is crucial for these roles. Ideal candidates must have to ability to work in a collaborative, dynamic, and fast-changing environment. We want our new hires to be digitally savvy and ready to experiment with new forms of storytelling. Most importantly, we are looking for hard-hitting reporters who work well in a team. Collaboration and collegiality are a must.

Following vacancies can be applied for (only in Singapore).

Following vacancies can be applied for (only in Singapore).   

  • A reporter to track companies/startups that have raised private capital, and have the potential to become unicorns. SEA currently has over 40 companies with a valuation of over $100 million and under $1 billion.
  • A reporter who can get behind the scenes and reveal how funding rounds are put together, or why they’ve failed to materialise. She/he in this role will largely focus on long-format stories. 
  • A journalist to track special situations funds, distressed debt and private credit (from the PE angle) across Asia.