Tencent and Line Team Up to Counter Alibaba in Japan

Tencent (NASDAQOTH: TCEHY) is partnering with Line (NYSE: LN) to provide mobile payment services to Japanese retailers according to a recent Nikkei report. Line will lease out terminals that are compatible with Tencent's WeChat Pay platform to small to mid-sized restaurants and retailers that haven't adopted its Line Pay service yet.

Those terminals, which will start to be installed this month, will let shoppers use both Line Pay and WeChat Pay to make payments. Line will also waive its processing fees through 2021 to nurture faster adoption rates.

A brewing payments war in Japan

The move clearly targets Chinese tourists, since WeChat Pay and Alibaba (NYSE: BABA)-affiliated Alipay are the two most popular payment platforms in China. 7.35 million Chinese tourists visited Japan last year, representing a three-fold increase from three years earlier. The move could also help Japanese retailers pivot away from cash-only transactions ahead of the 2020 Summer Olympics in Tokyo.

Tencent and Line's team up counters a similar partnership between Alipay, Yahoo Japan (NASDAQOTH: YAHOY), Japanese telco SoftBank (NASDAQOTH: SFTBY), and Indian e-commerce services company Paytm. Through that partnership, shoppers could use PayPay -- a mobile wallet service created by Paytm, Yahoo Japan, and Softbank -- at participating retailers' terminals. Some of those PayPay terminals were also compatible with Alipay.

But that's not all: Sumitomo Mitsui Financial Group, one of the biggest banks in Japan, also plans to launch a single terminal for cashless payments (including cards and smartphones) next year. SoftBank's rival NTT Docomo also launched a QR code payments service in April, Apple Pay is also gaining ground with retailers that use NFC terminals, and e-commerce giants Amazon and Rakuten are also rolling out their own smartphone payment services.

Simply put, the Japanese mobile payments market remains a fragmented one without a clear leader. However, Tencent and Alibaba -- which already hold a duopoly on mobile payments in China -- could lift some payment platforms to the top.

Will this deal help Line?

Line struggled with two major issues in recent quarters. First, its monthly active user (MAU) growth across its four key markets -- Japan, Taiwan, Thailand, and Indonesia -- hit a brick wall. It finished the third quarter with 165 million MAUs in those countries, representing a sequential gain of just one million MAUs and a decline of three million MAUs from a year earlier.

Second, Line is trying to boost its revenue per user by expanding its ecosystem with a news feed, stickers, streaming music, comics, e-commerce services, and mobile payments via Line Pay. Unfortunately, developing, launching, and promoting those services caused Line's operating profit to plunge 72% annually last quarter, even as its revenues grew 25%. This caused Line to report a net loss of 7.69 billion yen ($68 million), compared to a net profit of 12.2 billion yen ($110 million) a year ago.

Therefore, Line is teaming up with Tencent to expand its ecosystem and lock in users. However, Line is still running most of its services at razor-thin margins or losses, and launching terminals with processing fees waived until 2021 sounds like another loss-leading strategy.

Nonetheless, Line Pay remains an important growth driver for the company's top line, and it's already available at about one million retail locations. Revenue from Line's "Strategic Businesses" unit -- which includes Line Pay and other services -- rose 65% annually last quarter and accounted for 13% of its top line.

Tencent might be getting a better deal

Tencent and Alibaba are both running out of room to grow in China. Tencent's WeChat is the top mobile messaging platform in the country with 1.08 billion MAUs, while Alibaba is its biggest e-commerce player. That's why both companies are aggressively expanding into adjacent markets -- like cloud services, AI tools, smart retail, and streaming media -- as well as other countries.

Tencent and Alibaba are both leveraging the growing spending power of Chinese travelers to expand their e-commerce and payment ecosystems. We've already seen this battle escalate in Southeast Asia, where Tencent-backed Sea and JD.com are trying to hold Alibaba's Lazada at bay.

Therefore, it isn't surprising to see Tencent and Alibaba turn their attention to Japan. Japan remains a popular destination for Chinese tourists thanks to its close proximity, the weaker yen, and an abundance of products (particularly cosmetics, healthcare items, apparel, and luxury goods) that can be purchased without big import taxes. Tencent and Alibaba's affiliate Alipay would be well-poised to profit from those purchases if they make their payment platforms ubiquitous across Japan.

The key takeaways

Line Pay could benefit from rising demand for WeChat Pay-compatible retailers in Japan, which would give it an valuable edge against its myriad challengers. But it's also a costly strategy that could exacerbate its widening losses.

There seems to be less downside in this deal for Tencent, which could boost its high-growth "other" revenues (mainly from its cloud and payment services) -- which rose 69% annually last quarter and accounted for a fourth of its top line. However, it's still unclear if Tencent can convince enough Chinese shoppers to use WeChat Pay instead of Alipay.

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Leo Sun owns shares of Apple, JD.com, Amazon.com, and Tencent Holdings. The Motley Fool owns shares of and recommends Apple, JD.com, 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.