The planned merger of Huya (NYSE:HUYA) with Douyu International (NASDAQ:DOYU), its main rival in China's video game streaming industry, is expected to close by the first half of 2021. It will create one titanic, dominant player.

While Huya will remain listed, Douyu's shares will be delisted from the U.S. stock market. Tencent Holdings (OTC: TCEHY), which backs both Huya and Douyu, will own almost 68% of the combined entity.

Investors are set to gain from the merger, which will likely deliver enormous synergistic benefits.

Four young men playing a video game

Image source: Getty Images.

The bigger, the better

The merger will create a single dominant player with more than 300 million users, making it China's biggest video game streaming platform. It will also own 80% of the emerging esports market. Such a scale confers many advantages.

First, the union should help the new company attract and retain top streamers as well as more users thanks to the network effect. Top hosts prefer to be where the audiences are, while audiences will follow their favorite hosts, which would result in a self-reinforcing cycle of more users and hosts.

Moreover, instead of competing for users, as they did in the past, Huya and Douyu can now focus on bigger threats looming on the horizon, such as Douyin, ByteDance's Chinese version of TikTok, which has 600 million users. Like other rivals, Douyin offers live-streams alongside short videos and subscription video on demand. And as the industry's billion-dollar battle for eyeballs heats up, all three companies are making forays into game streaming. The combined entity should be better positioned to defend its lucrative game streaming business against these challengers.

As of the second quarter of 2020, Huya's and Douyu's ad businesses generated less than 5% and 8% of total income, respectively, leaving plenty of room for growth following the merger.

Tencent will play an important role in Huya's future

Tencent is the world's largest game publisher by revenue, and its portfolio spans PC megahits like Fortnite and League of Legends and leading mobile titles like Clash of Clans. There's potential to tightly integrate Huya streaming features within Tencent's ever-expanding game catalog.

As of Q2 2020, several Tencent titles included built-in streaming features linked to the Huya platform. With the click of a button, gamers can instantly start live-streaming from within the game itself. This effectively turns Tencent's gamers into Huya's hosts.

Not only that, Tencent has more than a billion users of its popular apps WeChat and QQ, which Huya can tap into to grow its user base. Tencent could also provide management know-how and leverage its extensive resources to help Huya deepen its competitive advantage in areas including esports content acquisition, user acquisition, and technology investment.

All said, I think Huya will be strategically in a better position to grow over the long term as Tencent will be more involved in the merged company.

Potential benefits and downsides

On the financial front, a larger scale will improve Huya's bargaining power with streamers, saving content acquisition costs. On top of that, the two platforms could share fixed costs, leading to lower costs, thicker margins, and improved profits.

Still, we do not know for sure whether the company will maintain two separate platforms or merge them. Doing the former would somewhat reduce the potential for cost savings. Also, we know that Douyu CEO Shaojie Chen will be co-CEO of the new entity alongside current Huya CEO Rongjie Dong. After the merger, any culture clash or strategic conflict could be negative for Huya's future.

Luckily, Tencent looks to be the kingmaker here. According to the South China Morning Post, between 2000 and 2019, Tencent invested in about 700 companies, including 63 that went public and 122 private firms now worth more than a billion dollars. In other words, it knows how to make these kinds of situations work. Specifically, Tencent's experience in consolidating the online literature and music industry -- the former via China Literature and the latter through Tencent Music Entertainment -- will come in handy to make this merger a success.

A way to play esports

Huya gives investors a front-row seat to the fast-growing game streaming industry in China, which is projected to grow at a compound annual growth rate of 34% between 2017 and 2022 to hit $4.9 billion.

The stock dropped on the merger news, so investors looking to ride China's esports boom could get a better price now than they could last month.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.