U.S. markets open in 45 minutes

Baidu, Alibaba, and Tencent Are All Investing in This Hot IPO

Leo Sun, The Motley Fool

Baidu (NASDAQ: BIDU), Alibaba (NYSE: BABA), and Tencent (NASDAQOTH: TCEHY) are considered fierce rivals in China's tech market. Baidu owns the country's top search engine, Alibaba's owns its biggest e-commerce marketplace, while Tencent dominates the social media and video gaming markets.

That's why it was surprising when all three companies recently agreed to invest in Foxconn Industrial Internet's (FII) upcoming IPO. Let's take a closer look at what FII does, and why these three tech giants are interested.

Robotic arms on a factory assembly line.

Image source: Getty Images.

What is Foxconn Industrial Internet?

FII is a subsidiary of Taiwanese contract manufacturer Foxconn Technology Group. FII manufactures electronic devices, cloud service equipment, 5G networking equipment, and factory automation products for a long list of customers -- including Apple (NASDAQ: AAPL), Amazon, Cisco, and Dell.

Bloomberg Gadfly estimates that 20%-30% of FII's revenue comes from Apple, which relies on the company to produce its iPhone frames and casings. The IPO will split a large portion of Foxconn's higher-growth contract manufacturing business from its other divisions.

Baidu, Alibaba, and Tencent will each purchase 21,786,000 shares of FII at 13.77 RMB ($2.14) apiece -- which will give each company a 3.86% stake in the new company. Those stakes, at about 300 million RMB ($46.7 million) each, will be subject to a lock-in period of three years.

FII's IPO is expected to be China's biggest domestic offering in three years, and will raise 27.1 billion RMB ($4.2 billion) and give the company a $43 billion valuation upon its market debut. The IPO date hasn't been set as of this writing, but the offering was already nearly 300% oversubscribed as of May 24.

Why are Baidu, Alibaba, and Tencent investing in FII?

It might seem unusual for Baidu, Alibaba, and Tencent to invest in FII, since all three companies generate most of their revenue from advertising, transactions fees, or software instead of hardware. However, investors should remember that all three companies are also expanding their presence in cloud computing, data centers, and connected cars.

Therefore, FII could become a valuable supplier of networking equipment, 5G chips, or automotive components for all three companies. FII could also reduce its dependence on big customers like Apple and evolve into a first-party device maker -- just as Samsung did over the past few decades.

Servers in a data center.

Image source: Getty Images.

These investments are also likely politically motivated. Many of FII's other top investors are Chinese state-owned enterprises. Baidu, Alibaba, and Tencent are China's three biggest internet companies -- but none of them are listed on Chinese exchanges.

China recently started urging its tech companies to launch new listings at home, and FII's IPO is being promoted as a marquee listing to kick-start its domestic IPO market. That's probably why FII's filing was approved in just over a month, versus wait times of one to two years for typical IPOs.

That fast-track approval was also likely related to the fact that Foxconn is a Taiwanese company. A mainland IPO for Foxconn's high-growth manufacturing unit allows Chinese firms to own larger slices of the Taiwanese company -- which wasn't previously possible due to Taiwanese restrictions on Chinese investors owning large shares of Taipei-listed companies.

Lastly, Chinese tech companies are now pooling their resources as a hedge against the escalating trade tensions between the U.S. and China. Tencent CEO Pony Ma recently called the U.S. ban on sales of components to telecom equipment maker ZTE a "wake-up call" for Chinese tech companies, noting that "without the mobile (devices), the chips, and the operating system," Chinese companies couldn't compete.

If China's state-backed enterprises and top tech companies nurtured the growth of their domestic hardware companies, the country could gradually reduce their dependence on overseas tech -- a long-term goal that has been repeatedly touted by the Chinese government.

Will this affect Baidu, Alibaba, and Tencent?

FII's market debut will likely generate immediate paper gains for Baidu, Alibaba, and Tencent -- but they can't sell their shares anytime soon. Therefore, investors should see if their investments in FII will eventually help them expand into adjacent markets -- like data centers and cloud computing -- over the next few years.

More From The Motley Fool

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Leo Sun owns shares of Amazon, Apple, Baidu, and Tencent Holdings. The Motley Fool owns shares of and recommends Amazon, Apple, Baidu, and Tencent Holdings. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.