China Buys Its Way Into Silicon Valley; Tencent’s Push for Stake in Snapchat Is Latest Effort to Gain Foothold in U.S.

China Buys Its Way Into Silicon Valley

Tencent’s Push for Stake in Snapchat Is Latest Effort to Gain Foothold in U.S.

EVELYN M. RUSLI and PAUL MOZUR 

Updated Nov. 4, 2013 7:31 p.m. ET

China’s homegrown Internet giants are buying their way into Silicon Valley. The Chinese firms, which have little consumer business outside their home market, are unloading small fortunes on startups as they strive to understand and eventually gain a foothold in the elusive U.S. market. This week, Tencent Holdings Ltd.0700.HK -1.37% , a social networking and gaming company, is vying to lead a fundraising round of $200 million in buzzy American messaging app Snapchat Inc., according to people briefed on the matter. Tencent’s investment will likely value the two-year-old company, which has no revenue, at $4 billion.Snapchat is just China’s latest target. Tencent, which has more than $5 billion in cash reserves from its massive social networking and online gaming business, this summer led a $150 million investment in Fab.com Inc., an American e-commerce company. Last month, Alibaba Group Holdings Ltd. took the lead on a $206 million investment in ShopRunner Inc., a rival to Amazon.com Inc. AMZN -0.07% Smaller mobile browser company UCWeb Inc. also says it is actively looking for investment opportunities in the U.S.

Long cloistered by a censorship regime that blocks international competitors, China’s 600-million user strong Internet market has helped companies like Tencent and Alibaba become some of the world’s largest. Tencent is worth more than $100 billion, while Alibaba is edging toward an IPO that could value it just as much. Growth, however, has slowed in recent years amid ferocious competition, and the largest firms have begun to look abroad for new opportunities.

To accomplish this, Chinese firms are tunneling into Silicon Valley’s tightknit network with more than just thick checkbooks.

To lead their efforts, they’ve tapped a small circle of connected bankers and executives. In October, Alibaba established a San Francisco-based U.S. investment group, headed by Michael Zeisser, formerly of Liberty Media Corp. LMCA -1.62% and McKinsey. The Chinese firms’ appetites are fueling lofty valuations in the frothy U.S. startup market, where founders who don’t even need the money are now entertaining aggressive bids.

“Obviously, China is not the pioneer in terms of global Internet,” Martin Lau, Tencent’s president, said at a conference at Stanford University last month.

The Chinese firms “will begin to impact the landscape,” said Rich Wong, a partner at venture-capital firm Accel Partners. “They have the market cap to put to work, and that market cap can help them go global.”

At the center of the activity is Tencent, which has sought for years to gain a toehold in the U.S., and lately grown into one of the Valley’s most aggressive players, according to interviews with startup executives, venture capitalists and former employees.

Tencent doesn’t have a splashy U.S. conference or startup incubator, but Palo Alto, Calif.-based senior executive David Wallerstein and his colleagues regularly visit the offices of venture capitalists and quietly work the rooms at investing and videogame industry events. One entrepreneur, who described him as “crazy, well-connected,” said Mr. Wallerstein can project a casual, goofy demeanor, even as he diligently grills founders for information about their startup.

Back in Shenzhen, where Tencent has its headquarters, two Goldman Sachs Group Inc.GS +0.68% alums call the shots. Company President Mr. Lau formerly worked at McKinsey and later ran Goldman’s telecom, media and technology group in Asia. Chief strategy officer James Mitchell, once led Goldman’s global Internet coverage in New York, and was lured to China by Tencent in 2011.

Tencent declined to make any of the executives available for interviews, and declined to comment on Snapchat. “We are interested to work with companies that share the same goals through partnerships, open platforms or equity investments,” said a spokesman.

Founded in 1998, Tencent first gained prominence with an instant-messaging system called QQ that targeted Chinese college students. The company used its dominance on chat—where it now claims more than 800 million monthly active users—to drive people to videogames and social-media sites where it made money by selling virtual products, charging gaming fees, and advertising. Less than 10% of Tencent’s revenue comes from ads; by comparison, Facebook Inc. FB -3.08% makes some 80% of its revenue from ads.

Early in its history, Tencent established a beachhead in America, where it now operates out of a former Christian Science church in Palo Alto. But for many years, it struggled to gain meaningful traction. The company built services, like games on Facebook, that never really took off. Tencent America, meanwhile, passed on several major opportunities to invest early in Zynga Inc. ZNGA +4.33% and YouTube.

Tencent shifted strategy in 2011 by loosening its purse strings. The company announced a $760 million fund for emerging companies. Later that year, it poached Mr. Mitchell, an Oxford graduate who had spent years at Goldman slicing through the financials of Internet companies like Google Inc. GOOG -0.09% and Tencent.

By 2012, the Tencent team was well on its way in establishing itself as a money player in Silicon Valley. The company made investments in venture-capital firms, such as Andreessen Horowitz and SV Angel, which helped the company get early peeks at rising startups. In 2012, Tencent acquired the bulk of game maker Riot Games for $231 million, and purchased about 40% of Epic Games for some $330 million. Its purchase of Riot Games has already yielded dividends: a former board member of Riot, Mitch Lasky, is also a partner at Benchmark and a current board member of Snapchat.

This summer, Tencent was also part of an investment group that spent $2.34 billion for an almost 25% stake in Activision Blizzard Inc.

The Activision deal showed how Tencent hoped to tie together investments and cooperation. Just before they announced the investment in July, Activision said it would exclusively partner with Tencent to release a China-geared version of its biggest franchise “Call of Duty.”

People familiar with Tencent’s strategy say the company entices startup founders with the prospect of guidance for an entry into the China market, while it uses investments to better understand the U.S. market. It also looks to invest in companies that can provide it with technology or content it can bring to market in China through licensing or partnerships.

Though Tencent is fond of partnerships, employees at some Western gaming companies have said they have had difficulties working with it. Intense competition between Tencent’s internal teams, which work on sometimes competing services, can mean partners don’t get the levels of promotion or cooperation they expect.

The trio of Tencent executives along with other members of the management team, regularly hold off-site meetings in China to discuss strategic investments.

For a large transaction like Fab.com, Mr. Mitchell will often handle the bulk of the process and the discussions, according to those familiar with the company’s deal making. Mr. Mitchell—who used to grill Mr. Lau on questions about margins as an analyst on earnings calls—is known for paying close attention to a company’s financials and projected revenue. Mr. Lau, who has a master’s degree in electrical engineering from Stanford University, is described by Tencent employees as mild-mannered.

Usually, Tencent has taken larger stakes of 30% or more in a companies—such as in the case of Riot Games or Epic Games. However, it has had less success pursuing such a strategy here, where founders are often more hesitant to give up a lot of equity.

In the case of Fab, Mr. Mitchell met with Fab’s CEO Jason Goldberg this summer, but soon fell quiet and didn’t return with an offer, until months later. Fab, which has ambitions of eventually expanding to Asia, accepted.

“There’s no obvious follow-up, but you know they are doing their research,” said one person familiar with the deal.

The play for a stake in Snapchat, which allows users to send messages that expire, may be connected to Tencent’s global ambitions for its own smartphone-based messaging application, WeChat. The app, which as of August had 236 million monthly active users, has taken China by storm, but is less popular elsewhere.

The company previously spoke to executives at U.S.-based rival WhatsApp Inc. about an acquisition, according to people familiar with the matter. “They are looking for scale, especially in the U.S., India and Europe,” said one venture capitalist who meets with Tencent executives frequently.

Even a small stake in Snapchat would give Tencent a foothold in a service that could be America’s next-big-thing. It would also give Tencent a better angle on Chinese rival Alibaba’s new chat application Laiwang, which also allows a sender of a message to delete it after the message is sent.

For Snapchat, a Tencent deal also offers more than a lump sum. Even outside of China, Tencent is considered a pioneer in figuring out how to make money on online services beyond advertising. While Snapchat has been able to fuel growth, it has yet to unveil a revenue model.