Until recently, the three giants had been mostly content to expand on their own turf: Alibaba Group Holding in e-commerce, Baidu BIDU -0.23% in search and Tencent Holdings TCEHY +3.53% in games and messaging. Now, a flurry of deal making—five significant acquisitions this month alone—has the trio stomping all over each other's turf and beyond China. Alibaba's planned $15 billion initial public offering in New York has heightened investor attention.
Tencent has taken the fight to Alibaba with an investment in JD.com, a direct rival in online retail. Tencent's investment in second-place search engine Sogou, owned by Sohu.com, S is a direct attack on Baidu. Alibaba's stake in Sina's Twitter -like Weibo is aimed at Tencent's messaging prowess.
The battle has spilled abroad, with Alibaba and Tencent both investing in U.S.-based chat startups, and Tencent investing in a Korean gaming company. Tencent's WeChat also is working to develop an audience overseas to challenge Facebook's WhatsApp and others.
Foreign players such as Facebook and Twitter are boxed out by Beijing. And Google withdrew in 2010. This has created a hothouse in which the largest domestic players hold even more sway. The small guys have little choice but to choose sides.
Since the start of 2013, Baidu has spent more than $2.4 billion on acquisitions, Alibaba over $1.9 billion and Tencent at least $1.3 billion, not counting the value of two businesses it traded to JD.
The deals aren't huge yet, especially relative to the size of the acquirers. But as the frenzy continues and competition intensifies, heavy spending on marketing and promotions is eroding profitability.
Operating margin at Tencent fell to 28% in the fourth quarter of 2013 from 39% two years earlier. Baidu's margin fell to 28% from 51% over the same period, and the company warned investors not to expect any profit growth this year despite rapidly rising revenue.
In this environment, potential acquisition targets may prove better investments. A few publicly listed companies are now conspicuous for their lack of affiliation with any of the major players.
Following Tencent's investment in Leju, the online unit of Chinese real-estate broker E-House (China) Holdings, it wouldn't be surprising to see a rivals take an interest in much larger Internet real-estate site Soufun Holdings, which has dominant market share in online-property advertising.
Each of the big three now competes in online video, and Alibaba this month acquired a controlling stake in ChinaVision Media Group, a film studio that can help provide content. Stand-alone site Youku Tudou is wrestling with Baidu's video for the top spot by monthly users. Youku is money-losing due to the high cost of content, but its video library could be a valuable resource for one of the big three.
Travel is another hot spot. Baidu has a majority interest in bookings site Qunar Cayman Islands, while Tencent holds a minority stake in rival eLong. But Ctrip.com International, the largest travel site by revenue, is independent.
These companies range from market values of $4.5 billion for Youku to $6.1 billion for Ctrip, so deals for minority stakes would likely be in the same range as recent ones.
The biggest stand-alone player, with a market value of $11.4 billion, is Qihoo 360 Technology. It provides security software and operates China's third-largest search engine behind Baidu and Sogou, now part-owned by Tencent. A strategic alliance with a bigger player is possible, perhaps cemented by the sale of a stake in one of its units.
The big three are well positioned to capture users and traffic on China's Internet. But as they compete to scoop up minnows, investors might want to look beyond the hunters to the prey.
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