(The author is a Reuters Breakingviews columnist. The opinions expressed are her own.)

HONG KONG - Baidu is getting some useful M&A advice from an unlikely source. Days after the Chinese search-engine operator agreed to buy a short-video-streaming app for $3.6 billion, short-seller Muddy Waters has accused its owner Joyy of fraud. It's a blessing in disguise.

The one-time web powerhouse has been under pressure to find new sources of growth. Advertising revenue from its main business was flat in the third quarter at $2.7 billion from a year earlier, according to results released this week alongside the transaction announcement. Boss Robin Li's track record has been mixed. Forays into online services such as movie-ticketing and food delivery were disastrous, while the company's Netflix-like subsidiary, iQiyi, has shown promise.

His latest deal, for YY Live, looks like another dud. Parent Joyy doesn't break out net profit for the Chinese business, but analysts at Morningstar estimate that Baidu is paying about 12 times estimated earnings for this year, roughly in line with New York-listed peer Momo. The trouble is that YY has fallen far behind in an increasingly cutthroat market dominated by giants including TikTok-owner ByteDance. Paying users at YY slipped by some 5%, to 4.1 million, in the latest quarter from the same period in 2019.

The reality could be even worse. Muddy Waters alleges that YY Live is "about 90% fraudulent" and that the parent company inflated revenue and user metrics, among other misdeeds. Joyy has not responded. Its shares tumbled by more than a quarter, erasing some $2 billion in market value.

It is the second time this year $39 billion Baidu has been linked to fraud charges. Another short seller in April targeted iQiyi, claiming that its reported figures were inflated. The company said last month that an internal probe found the attack had no merit, but it prompted the U.S. Securities and Exchange Commission to investigate.

Baidu has other things to consider, too. Its bets on artificial intelligence, such as cloud computing and autonomous driving, require heavy upfront investment. Spending roughly a third of its net cash pile on a video laggard looks foolish. All things considered, Baidu would be wise to use the pressure on Joyy to renegotiate or rethink its deal.

 

CONTEXT NEWS

- U.S. short seller Muddy Waters accused Chinese social media company Joyy, which owns video-streaming app YY, of fraud in a report dated Nov. 18. Joyy shares closed down 26.5% at $73.66 on Nov. 18.

- "We conclude that YY's component businesses are a fraction of the size it reports, and that the company's reported user metrics, revenues, and cash balances are predominantly fraudulent," Muddy Waters said.

- Joyy did not immediately respond to a request for comment.

- Chinese search engine operator Baidu said on Nov. 16 it would acquire Joyy’s YY Live, which includes a mobile app and website, for $3.6 billion in cash. It said the deal was expected to close in the first half of 2021, subject to certain conditions.

- Baidu shares closed down 1.3% to $142.07 on Nov. 18.

 

(The author is a Reuters Breakingviews columnist. The opinions expressed are her own.)

(Editing by Jeffrey Goldfarb and Katrina Hamlin) ((robyn.mak@thomsonreuters.com; Reuters Messaging: robyn.mak.thomsonreuters.com@reuters.net))