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Why Uber Raised a White Flag in China -- and How It Still Comes Out a Winner

By Daniel Miller – Aug 13, 2016 at 9:00AM

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Sure, Uber may be backing down in China, but it seems like a big win to me.

Image source: Uber.

Uber is arguably the most recent rags-to-riches story the business world has to offer. Seemingly overnight, the young ride-hailing company went from a small-time phone app to a household name. Surging onto the scene like that does wonders for a company's valuation, and Uber's has been cited numerous times as being over $60 billion. For context, Detroit's second-largest automaker, Ford, currently has a market cap under $50 billion.

However, at a time when many companies are battling one another to get a foothold in the Chinese market, Uber is raising a white flag and withdrawing from its operations in China. But despite backing down, did it really lose?

Why China is a different market

Despite China's massive economic potential for many global companies, it remains one of the most difficult markets in the world to crack. Between government regulations that often force foreign companies to pair up with local companies to enter the market, a litigation system that is confusing and often biased, and wildly different consumer preferences and culture compared to the Western world, even the most dominant businesses have said "No, thanks" -- even Alphabet ducked out for the time being.

Those issues played a lesser role with Uber; the major issue was that the company has been in a heavyweight bout with local ride-hailing champion Didi Chuxing in China, and it was essentially using its profits from other parts of the world to help fund this battle -- more on why this matters later. But the straw that may have broken the camel's back was a major investment from Apple.

Didi announced it had rounded up $7.3 billion in a funding round this summer from investors including China Life Insurance, Ant Financial, Apple, and others. While Uber has had zero issues raising capital with investors, this presented a unique challenge since the company had previously won markets by outspending its competition.

Let's make a deal

Rather than continue the unprofitable war for China's ride-hailing business, which had no end in sight and had Uber reportedly spending about $1 billion per year for a 20% market share, Uber thought outside the box to create an interesting deal. While the details aren't yet public, according to The New York Times, the new company's estimated value is a combination of Didi's $28 billion valuation and Uber China's $7 billion, and Uber shareholders would receive a 20% stake in the new company. Meanwhile, Didi would agree to make a $1 billion investment in Uber's global operations.

Honestly, it seems like a brilliant move. Uber wiggles its way out of a bleak scenario in China, and owns part of the company best positioned to benefit from a market with less competition, while receiving $1 billion in cash to help fund its attack on other markets.

What's next for Uber?

This move could mean a number of things for Uber -- and its investors. If Uber is planning to go public, the drag China was creating on its bottom line would have been a problem, and the company's investors were likely thrilled about the decision to back away from the region. This move gives the company a way to juice its bottom line and create a better growth story.

Speaking of growth story, now with even more cash, Uber can focus on other markets. One such market will almost certainly be India, which many consider to be the next battleground. It's the norm for local companies to win in China, but that is far from the case in India, where the massive market is much friendlier to foreign players wishing to operate in the country.

As a bonus, this deal could actually complicate a partnership created to take on Uber. Late last year, four of Uber's major rivals in the U.S. and Asia -- Lyft, Didi, Ola (the major player in India), and Grab -- entered into an alliance of sorts that allowed users to book rides from one another's apps in all of the regions they operate in. Now that Uber and Didi have their new setup, it'll make for an awkward situation for the alliance -- despite being in an alliance to thwart Uber globally, it's now in Didi's interest that Uber's global business does well. Furthermore, Ola, which is in the alliance with Didi, basically gets to watch the latter help fund Uber's attack to take market share in India.

If you can't beat 'em...

"As an entrepreneur, I've learned that being successful is about listening to your head as well as following your heart," Uber CEO Travis Kalanick wrote in a blog post obtained by Bloomberg. "I have no doubt that Uber China and Didi Chuxing will be stronger together."

While some will see Uber's surrender in China as an embarrassment, it seems the opposite to me. This was a wise strategy to stop the bleeding in China -- a market where many tech companies struggle to overtake the local competition -- to boost its cash position, to narrow its focus on a friendlier massive market, and to open the doors to an IPO in the near term. It sounds like a win-win for Uber.

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Daniel Miller owns shares of Ford. The Motley Fool owns shares of and recommends Alphabet (A and C shares), Apple, and Ford. The Motley Fool has the following options: long January 2018 $90 calls on Apple and short January 2018 $95 calls on Apple.

We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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