Didi Chuxing: a bumpy ride after Uber deal

China's homegrown ride-hailing app appeared to have pulled off a coup when it bought Uber's business in the country. Since that deal, its troubles have only mounted.

"Dear driver, hope you are well. Didi is still trying the best to communicate with relevant [government] departments on details of the new online taxi-booking regulation. Please do not worry and take orders as usual.”

That was the text message drivers of Didi Chuxing received from the ride-hailing mobile services operator on the evening of October 30. Less than 48 hours later, new rules on the online booking of taxi services in China took effect — and it did not appear to be business as usual.

The new rules were unveiled less than three months after Didi pulled off what appeared a startling success: winning a price war with US rival Uber. UberChina agreed to exit China, merging its operations into Didi in exchange for a 17.7% stake for the US parent and 2.3% for investors in its China operation. Didi also invested $1 billion in Uber’s global business.

After the acquisition of its long-time rival in August, Didi Chuxing pushed up its market-share in the ride-hailing sector to more than 90% from the earlier 85.3%. That dominant position appeared to offer Didi eye-catching growth, at least judging from the success Uber has had in its domestic market.

But some investors who have worked on Didi financings in the past, or who have weighed up potential investments, told FinanceAsia the move had not turned out to be the coup some hoped it would be. After winning its fight with Uber, Didi now appears to be in a pitched battle amid a policy dispute between local and central government departments. Uber, they argue, may have got out at the right time.

New rules, new trouble

When China’s Ministry of Transport rolled out provisional rules on July 28 to legalise online car-hailing services, Didi and Uber must both have celebrated the end of the grey area they’ve been operating in. In welcoming the regulator’s effort to recognise ride-sharing platforms, Didi Chuxing’s founder and chief executive Cheng Wei referred to the rules as “the world’s first nationwide online ride-booking regulations”.

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The government told the firms that, under the provisional rules, drivers must have at least three years of driving experience to work on a ride-hailing platform, that the cars they use cannot have more than seven seats and that the cars must not be in service after reaching 600,000 kilometres. The ministry then ordered provincial and municipal bureaus to implement this guidance in accordance with local stances and by-laws, starting in November.

This is where things got tricky.

Local governments, rather than just rubber-stamping the provisional guidelines of the central government, got to work on their own rules. On October 8, local transport departments in major Chinese cities including Beijing, Shanghai, Guangzhou and Shenzhen released their city-level draft rules, followed by Hangzhou, Chongqing and Tianjin the day after.

These rules were “much harsher than I imagined,” Zhou Hang, CEO of Yidao Yongche, a local rival to Didi Chuxing, told QQtech, an internet and technology portal run by Tencent.

All seven cities said cars used for ride-hailing services needed to have local registration plates, in one fell swoop excluding many potential drivers who might have bought second-hand cars elsewhere. Some cities are also trying to limit the types of cars that can get on the road, with wheelbase requirements that would disqualify some of the most popular models in China.

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But the toughest requirement is on drivers themselves.

In Beijing, Shanghai and Tianjin, transport officials have demanded that drivers have a local hukou, a Chinese household registration document that determines where a citizen can live. Given most drivers are migrants to these big cities, this requirement would put a virtual chop to the supply of drivers — severely limiting the potential growth of online-booking apps.

Clamping down

Responding to those unusually stringent proposals, Didi Chuxing on October 8 said that millions of drivers would lose their jobs and paycheques, and that millions of families might therefore lose a major income source.

According to Didi Chuxing, among the more than 410,000 drivers in Shanghai using its platform, fewer than 10,000 have a local hukou. And less than 20% of its fleet in the city can pass the proposed wheelbase by-law.

Beijing-based research house BIAOZHUN in its October report put the proportion of non-local drivers on online ride-hailing platforms including Didi at 79%, and said that more than 40% of the cars registered on these platforms lacked a local plate.

Didi, which emerged out of the union of China’s two largest taxi-hailing applications Didi Dache and Kuaidi Dache in February last year, clearly has the most to lose from these changes.

Its spokesman said: “Didi is in constructive consultations with local authorities, and we are inspired to see substantial improvements across the board. The new regulatory context will help facilitate rather than hinder our strategy to design more diversified and higher-quality mobility solutions to China’s fast-rising middle-class populations.”

Some, however, think differently.

“The impact of the rules would be definitely negative on Didi,” said a person who previously led a Chinese financial institution’s investment into Didi.

“Didi can work on government relations, but so far, it doesn’t seem to be working,” he told FinanceAsia, questioning why such strict local by-laws would be laid out anyway.

There are rumours the nation-level provisions would have been harsher – for example, requiring that cars be scrapped after eight years — had Didi not lobbied hard for leeway.

At the local level however, especially in Beijing and Shanghai, regulators have made it clear that they want to strictly control the growing population and traffic.

These roadblocks will potentially stall Didi’s growth — and more importantly, its profitability and readiness to go public.

Too big to hail

China’s National Information Centre estimated the size of the country’s sharing economy at Rmb1.95 trillion at the end of 2015 and projected it could grow by 40% per year to 10% of GDP by 2020. Given such eye-catching numbers, it is no surprise investors have tried to come along for the ride.

Didi Chuxing attracted internet giants and state-owned funds as investors, including Alibaba, Tencent, China Investment Corporation, China Life Insurance and Ping An. UberChina had Baidu, China Life Insurance, China Minsheng Bank, CITIC Securities and HNA Group as backers.

But a lot of investors are too “optimistic” and tend to “follow the tail” without thinking from the long-term issues, said a Shanghai-based director at an international financial institution that runs a private equity arm in Asia. He reviewed potential investment opportunity of Didi but decided to walk away.

“It is easy to fall into the ‘too big to fail’ trap,” he said, referring to the dominance of Didi Chuxing in the market and the fact that so many renowned investors have made a commitment to this sector.

Taxi markets in most Chinese cities are dominated by the likes of Qiang Sheng, Dazhong and Jinjiang, typically state-owned enterprises under local government administration.

These companies — which are struggling to make a profit according to their public filings — collect a 50% franchise fee from their drivers while providing cars and insurance to the employees. Didi, on the other hand, charges a 20% fee on ride income from drivers, many of whom use private licensed cars.

Didi does have a competitive edge over state-owned companies given its greater operation efficiency, but to some degree that can be offset by the cost-saving these companies can get from buying cars in bulk. In this environment, the chances are slim that Didi can break even, the director said.

This analysis ignores the additional burden of the extra regulations. The city-level proposals could fundamentally change Didi’s cost base by adding the costs of car purchase and maintenance, which it doesn’t have any advantage in, he said. That means Didi risks becoming reliant on its greater efficiency, something that may not prove a lasting advantage. Another Shanghai-based executive director covering consumer services sector at a global investment fund, echoed the view, saying:  “We don’t think the company can make money”.

But Didi expects to achieve overall profitability “very soon”, according to senior director of international strategy Li Zijian. Li told June’s Converge, a technology conference, the company was profitable in more than half of the 400 cities it operates in.

“Now we have the ability [in some cities] to precisely predict 15 minutes in advance of the supply and demand mismatch [of car-hailing] in a certain area,” he said, referring to how the company deploys data to minimise cost and drive efficiency.

The company is valued at about $35 billion, based on Didi’s most recent valuation of $28 billion and $7 billion, that of UberChina. Didi sealed a $7.3 billion fundraising in mid-June that included $4.5 billion in equity and $2.8 billion in debt, weeks after Uber received $3.5 billion from Saudi Arabia’s Public Investment Fund.

The end of the war

Before the landmark deal in August, both Didi and Uber had been blamed for a subsidy war that resulted from their desire to win market share, leading to billions of dollars spent on subsidies to both drivers and customers.

One of Didi’s earliest institutional investors, Allen Zhu from GSR Ventures, compared the pair’s fundraising to the First Gulf War in a June interview with the Wall Street Journal.

“They can’t fight on like this. It’s got to stop before reaching $30 billion,” Zhu said, at a time when Didi Chuxing and Uber had collected about $20 billion from investors.

Allen Penn, head of Asian operations at Uber, told a conference in June spending had been pushed to “irrational levels”.

But now the threat of Uber is out of the market, investors are once again taking stock. Didi can finally enjoy its dominant role in China, which it had been offering subsidies of up to $200 million each month to maintain. But what else did Didi buy?

Not much, it turns out.

On the technology front, although UberChina was made a standalone entity last year as co-founder Travis Kalanick wanted to make it “authentically Chinese”, the global entity supplied technical support to the China unit.

“All we got in China is marketing and operation … technical stuff, including product design and development, back-end maintenance and IT engineering, is based in the US and out of their reach,” a former UberChina employee now with Uber in Singapore told FinanceAsia on the condition of anonymity.

More than 40% of UberChina’s top management — city general managers and above — have left the industry or joined Uber global, according to a calculation by FinanceAsia. That includes former head of UberChina Liu Zhen, who resigned to join a news aggregator.

Maggie Wu, who headed strategy and planning for Uber in Shanghai before leaving for another venture, said the new city-level proposals hinted Uber exited at the highest point of valuation. The US unicorn spent around $2 billion over the last two years in China, but walked away with $7 billion worth of equity, Wu wrote in a book published in December.

Uber also walked away from headaches in dealing with Chinese bureaus, though of course as a shareholder it retains an interest in Didi’s success.

The prospects

It is not all bad news for Didi. Criticism around the city-level proposals has been mounting among Chinese academia.

According to Chinese media outlet CBN, some legal experts are questioning whether local governments have the power to legalise online ride-hailing as per their proposals. It is hard to determine what bracket online ride-booking falls under, and therefore which authorities can regulate it, according to CBN.

On October 12, Tencent’s Pony Ma told a conference he wished the government would not “kill” the online car hailing industry and would allow for some “buffer time” for some new rules to phase in. Primier Li Keqiang responded “basic principles of the rules were clear” and that he would ask “relevant cities” to conduct more research and study.

On December 21, Beijing, Shanghai and Guangzhou set down the final version of their local rules, with lower requirements on the type of cars allowed for hailing services. But they've insisted that a driver has a local hukou (or a local residence permit, in Guangzhou's case) and uses a car that has a local registration plate. Beijing allowed a five-month buffer period, while Shanghai and Guangdong didn't.

As of mid-January, some other cities are developing their local by-laws. Some rules may not achieve final approval, whether down to Didi’s lobbying or to public and academic pressure.

But for investors who hoped Uber’s exit would herald the end of Didi’s troubles, things have not turned out so far. The company has pushed out a capable local rival, but now faces a still more
terrifying threat — the spectre of  Chinese regulation.

¬ Haymarket Media Limited. All rights reserved.
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