Do Most Chinese Internet Firms Have A Technically Illegal Corporate Structure?
- Posted by bbishop
- on September 2nd, 2011
The Financial Times reports today on a potentially problematic development for many Internet in China. In Foreign internet presence in China to face scrutiny, Kathrin Hille writes that:
Changes to China’s mergers and acquisitions rules that took effect on Thursday mean internet companies in the country are set to face greater scrutiny of the vehicles they have been using for more than a decade to circumvent foreign ownership restrictions in the sector…
Under the practice, a domestic company, a so-called variable interest entity (VIE), holds the license necessary for operating a business such as running an internet search engine or an e-commerce platform in China, and the foreign-invested company secures control of that domestic business through a set of contracts instead of share ownership.
The scheme is being used by foreign internet companies such as Google ($GOOG), but also Chinese internet groups that introduced foreign shareholders through overseas listings. These include as Baidu ($BIDU), the country’s largest online search engine by revenues, Sina ($SINA), the operator of China’s leading microblog, Youku ($YOKU), the biggest online video company by revenues and Renren ($RENN), the biggest Facebook clone by revenues.
“As of April 2011, 42 per cent of Chinese companies listed in the US have used the VIE structure and thousands of unlisted companies continue to operate through the use of the VIE structure,” said Cadwallader, the law firm, in a note to clients.
VIEs were in the news a few months ago when Jack Ma expropriated Alipay from the Alibaba Group on the grounds that for national security reasons the government would not allow foreign-backed firms, including those with a VIE, to obtain an online payments license. Ma eventually agreed to compensate Yahoo ($YHOO) and Softbank, but few believe he is paying them 100 cents on the dollar for an asset they once partly owned.
It is unlikely that the Chinese government intends a wholesale investigation or restructuring of the Internet industry, but investors should not be blind to this risk, nor should they believe arguments that the government would not dare because too many jobs would be lost. Jack Ma proved that you can you restructure the foreigners out without any job losses, and to the advantage of Chinese investors.
Foreign participation in the Internet, perhaps the last major industry in China that is not state-dominated, has come under increasing scrutiny, not just during the Alipay scandal but also in a recent article in Study Times, a publication of China’s Communist Party School, that decried the amount of foreign ownership in China’s Internet firms.
If there are any investigations of foreign ownership of Internet companies on national security grounds, one might be forgiven for thinking that search (Baidu) and Weibo (Sina and Tencent) are at least as important to national security as online payments are. Given that much of the foreign ownership in Chinese Internet firms is actually Chinese money offshore, and frequently very connected Chinese money, I would expect that in the unlikely event of any major restructurings there would some mechanism to take care of the important investors.
For those who want a deep dive into VIEs, I have embedded an excellent primer on the subject from the Cadwalader law firm. You can also follow this link to China Law Blog for several good articles and podcasts on the topic.
[UPDATE: I started a thread on Quora about this topic and there are already some very knowledgeable comments--Do most Chinese Internet firms have a corporate structure that is technically illegal? - Quora. END UPDATE]
Full disclosure, at the time of posting I own shares of Yahoo.
The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.blog comments powered by Disqus
Bill Bishop is an American living in Beijing. He is bilingual and has experience working in both US and China. In 1997 he co-founded CBS MarketWatch and stayed until the sale in 2004 to Dow Jones. He was never a journalist, and instead worked in several business roles over the years, the last as head of the MarketWatch consumer Internet business. More »
- Sinocism China Newsletter For 08.30.12
- The Sinocism China Newsletter
- Today’s China Readings July 18, 2012
- Sina Sell-Side Still Searching For Muppets
- China Daily Readings
- Sina Admits It Has Not Complied With Weibo Real Name Registration Rules
- Groupon’s China Firesale
- Apologies For The Hiatus
- Tweeting The Sina Q4 2011 Earnings Call
- Quick Thoughts Ahead Of Sina Earnings
- August 2012
- July 2012
- May 2012
- April 2012
- February 2012
- January 2012
- December 2011
- November 2011
- October 2011
- September 2011
- August 2011
- July 2011
- June 2011
- May 2011
- April 2011
- March 2011
- February 2011
- January 2011
- December 2010
- November 2010
- October 2010
- September 2010
- August 2010
- July 2010
- June 2010
- May 2010
- April 2010
- March 2010
- February 2010
- January 2010
- Inside Sina Weibo
- Reuters: China VIE Company Structure Under Threat
- Authorities Removing Apple iPads From Chinese Store Shelves? (Updated)
- China's Internet: The Invisible Birdcage
- Is Tencent The Wrong Partner For Groupon In China?
- If Sina Is Cooking Its Books I'll Eat This Blog
- Jack Ma Talks To China Entrepreneur Magazine About The Alipay Case (UPDATED)
- Do You Know Where Your China Stock CFO Lives?
- New Report On China's Online Game Industry-$3.6B in 2009 Revenue, $9.2B By 2014
- China's MIIT Declares Most VoIP Services, Including Skype, Illegal
TagsAdvertising Alibaba Apple Baidu Beijing cctv Censorship china China Mobile Corruption Cyberwar DangDang eCommerce Facebook Fraud Gaming GFW Google Group Buying groupon Internet Investing IPO Media Mobile Music Netease PerfectWorld Piracy Policy Readings Regulations Search Shanda Sina SNS Social Games Tencent Twitter US-China Virtual Items Web Video Weibo WoW WVAS
- Group Buying
- Internet Security
- Listed Firms
- Online Games
- Online Memes
- Online Payments
- Online Trends
- Perfect World
- Public Relations
- Renewable Energy
- Social Gaming
- Traditional Chinese Medicine TCM
- Web Advertising
- Web Video
- World of Warcraft
StockTwits - All Updates