Alphabet Inc. (NASDAQ:GOOG)(NASDAQ:GOOGL), parent of Google and YouTube, recently announced a patent licensing deal with China's tech giant Tencent Holdings (NASDAQOTH:TCEHY). The goal is another attempt at entering the most populous nation, where Google is all but irrelevant due to regulatory restrictions on the company's search engine and other services. Google has made similar agreements with companies in the past, but this is its first with a major Chinese business.
The problem with not being Chinese
The list of U.S. corporations that have failed in China is lengthy. Since the country opened up to foreign investment in the 1970s, the pull to set up shop there has been strong. China has nearly 1.4 billion people -- four times the U.S. -- and has a fast-growing middle class. That's a powerful combination businesses can't ignore, but a failure to understand the diversity of China's population, culture, and consumer preferences is a leading cause of failure.
And then there's the political and regulatory environment, a trait of the country that has been Google's thorn since its first venture in the early 2000s. The problem is the government's censorship requirements, which Google will not allow on its sites. That effectively amounts to a self-imposed exile from the country, and as a result, services like Google search, the app store, and Gmail are banned. So Chinese search engine Baidu (NASDAQ:BIDU) holds sway over the country.
A new strategy
Google still wants a slice of the pie, but this time a local ally is being enlisted. Thus the deal with Tencent, which is an agreement to share patents and intellectual property across a wide range of technologies. Details were sparse, but it's an initial step toward building new services and deeper collaboration between the two.
Though the agreement is an obscure one to decipher, what Tencent is (and what Google's owner Alphabet is) provide some hints about the objective. Tencent is the holding company for China's largest social media and mobile payment platform, WeChat. Other market-leading subsidiaries develop mobile games, video and entertainment, and cloud computing services. The company recently crossed the $500 billion valuation mark, putting it in a class with American tech giants like Alphabet.
Thus Tencent and Alphabet have a little, but not too much, overlap in what they do. Both companies are also growing but have mounting competition in the world of high tech. For Tencent, its Chinese rivals like Baidu, Alibaba, and NetEase.com. For Alphabet, the list includes Facebook, Amazon, and Apple. That competitive landscape was especially evident in Alphabet's latest earnings report, which showed the company still growing, but with growing headwinds.
The angle on this deal, then, looks like a way for Google to finally make some inroads in China. It's also a way for both businesses to bolster their defenses against their other technology platform competition. In the end, the new relationship between Google and Tencent sounds like a good one for investors.
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Nicholas Rossolillo owns shares of Alphabet (C shares), Apple, and Facebook. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Amazon, Apple, Baidu, Facebook, NetEase, and Tencent Holdings. The Motley Fool has the following options: long January 2020 $150 calls on Apple, short January 2020 $155 calls on Apple, short March 2018 $200 calls on Facebook, and long March 2018 $170 puts on Facebook. The Motley Fool has a disclosure policy.