Chinese tech giants Tencent (NASDAQOTH:TCEHY) and Alibaba (NYSE:BABA) could acquire a minority stake in U.K. advertising giant WPP's (NYSE:WPP) Chinese unit, according to Sky News. Tencent and Alibaba, along with China Media Capital Holdings (CMC), are reportedly interesting in buying 20% of WPP China in a deal which would value the unit between $2 billion to $2.5 billion.

Under the terms of the deal, WPP would spin off its Chinese unit into a new holding company. WPP would retain a majority stake in the new company, while Tencent, Alibaba, and CMC would gain roughly equal shares. However, Sky News' anonymous source warned that the deal "could still fall apart" due to its complexity.

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Image source: Getty Images.

But if the deal closes, it would significantly strengthen Tencent and Alibaba's advertising businesses, while giving WPP a firmer foothold in the digital advertising market.

Why WPP wants to make a deal

WPP is the world's top advertising agency. But in recent years, WPP lost business to Alphabet's Google, Facebook, and other online challengers. CEO Martin Sorrell, who transformed WPP into an advertising behemoth over the past three decades, also recently resigned amid misconduct allegations.

WPP's sales growth was buoyed by acquisitions and a weak pound in recent years, but its core business continues to struggle. Its earnings were mainly supported by cost cuts and buybacks. Analysts expect its revenue to dip 2% this year as its earnings drop 3%.

WPP generated $1.7 billion in revenues in China last year, which accounted for about 7% of its top line. That makes China WPP's fourth largest market after the US, UK, and Spain, in that order. However, many of China's businesses are also flocking toward internet-based advertisers like Baidu (NASDAQ:BIDU), which owns the country's top search engine and a sprawling network of portals and cloud services.

Last May, GroupM estimated that Chinese companies would spend 57% of their ad budgets on internet ads in 2017, compared to just 19% in 2012. If WPP wants to stay relevant in this evolving market, it needs to strike a deal with tech giants like Tencent and Alibaba.

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Image source: Getty Images.

Why Tencent and Alibaba need WPP

Tencent owns WeChat, the most popular mobile messaging app in China with over a billion monthly active users, along with the older messaging app QQ and the social network Qzone, and its massive portfolio of video games makes it the world's top game publisher. It also owns the popular Tencent Video and Tencent Music streaming platforms.

Tencent sprinkles ads across that ecosystem, which generated 40.4 billion RMB ($5.9 billion) in advertising revenues in 2017, representing 50% growth from 2016. Tencent tethers many of its ads to services --like deliveries, e-commerce purchases, and ride hailing services -- within WeChat's app.

Alibaba is China's top e-commerce player and cloud platform provider. However, the company also serves up ads through its Youku Tudou video streaming platform, Xiami music streaming platform, its UC Browser, and Shenma mobile search engine. That's why Alibaba's digital media and entertainment revenues (which include its ad and subscription revenues) rose 33% to 19.6 billion RMB ($3.1 billion) last year.

Tencent and Alibaba's ad revenues look impressive relative to WPP's revenues in China. However, Baidu's advertising revenues rose 13% to 73.1 billion RMB ($11.2 billion) last year, more than Tencent and Alibaba's combined ad revenues for the year. By taking a stake in WPP China and integrating its clients' data with their own ecosystems, Tencent and Alibaba can strengthen their ad businesses against Baidu.

Is this a win-win deal?

An alliance between Tencent and Alibaba is rare, since the two tech giants compete against each other in cloud services, e-commerce, and mobile payments. However, teaming up to take a stake in WPP could be a smart way to hold Baidu at bay. The deal would also help WPP, which desperately needs firmer footholds in China's digital advertising market.

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Leo Sun owns shares of Baidu and Tencent Holdings. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Baidu, Facebook, and Tencent Holdings. The Motley Fool has a disclosure policy.