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Autohome float a case of buyer beware

Telstra's US listing of its Chinese car sales site is not without risk, writes Peter Cai.

Telstra's US listing of its Chinese car sales site is not without risk, writes Peter Cai.

Telstra this week took steps to cash in on the boom time in technology floats, pushing ahead with a planned US sharemarket listing of China's Autohome, the largest car sales website in the world.

Analysts value the float at more than a $1 billion, which will represent a significant windfall for Telstra shareholders as the telco paid a little over $100 million after increasing its holding in the company to 71.5 per cent over several years.

The planned float comes as the sharemarket debut of Twitter saw the social network's value soar to more than $US27 billion.

Autohome is likely to attract investors who want to gain access to the Chinese car market, which recently replaced the US as the world's largest for passenger cars.

However, Telstra's "nice little property" as described by chief executive David Thodey has one significant risk, which it disclosed in its prospectus lodged with the US regulator, but buried it on page 24 as one of the many potential pitfalls.

Telstra warns of risks related to Autohome's corporate structure.

New shareholders have exposure to the business not through ownership of assets, but a contract which gives them a claim on the returns of of the business.

The agreement mentioned in the prospectus is a complex legal structure known as a variable interest entity - or VIE - which is designed to get around China's tough foreign ownership laws in areas such as finance, telecoms, internet services and education.

In essence, Telstra is not legally eligible to obtain a licence to run an internet business in China. So it has entered into a set of contractual agreements with Chinese nationals who hold the licences to reap economic benefits from its investment and exercise indirect control.

The Autohome prospectus notes that if the Chinese government finds that the contract operating services in China fails to comply with restrictions on foreign investment in internet businesses then Autohome "could be subject to severe penalties or be forced to relinquish our interests in those operations".

This has been a manageable risk so far as Beijing turns a blind eye to this practice. After all, there are more than 200 Chinese companies, including overseas-listed tech companies such as Sina, Alibaba and Tencent, that rely on such a structure.

However, there are worrying signs that the government is clamping down on this questionable legal structure, and especially after a recent ruling by Supreme People's Court. The court ruled that contracts used by non-Chinese citizens to gain access to sectors of the economy that are protected from foreign investment were invalid. "They (VIEs) almost certainly are not legal," said Steve Dickinson, a partner at Harris & Moure on his China Law Blog.

This assessment is echoed by Niranjan Arasaratnam, head of telecoms and media practice at Allens. He said the whole legal structure Telstra relied on could be "illegal".

Mr Arasaratnam said there was a worrying trend lately that Beijing was less willing to accommodate this practice.

"In a nutshell, we don't like them, don't trust them, and don't do them," Mr Dickinson said. "Quite frankly, our malpractice insurance just isn't high enough for the massive risks we see in these investment vehicles."

King & Wood Mallesons, a law company with extensive China practice also warns about the "great controversy regarding the legality of VIE structures". It says a recent leaked report from the China Securities Regulatory Commission recommends future overseas listings using a VIE structure should first obtain regulatory approval.

This has caused "grave concerns" for foreign and domestic investors relying on this structure, says the company in a note to clients. Telstra initially bought into the business in 2008 when former boss Sol Trujillo paid $76 million for a 55 per cent stake in Sequel Media, a technology start-up that owned the Autohome brand. Telstra then paid $37 million to lift its stake in Autohome by a further 11 per cent this year. This effectively values the business at about $330 million.

Autohome has grown strongly on the rapidly expanding car and internet industries in China. The number of new cars sold there is expected to increase from 14.2 million last year to 20.7 million by 2015, a year-on-year growth of 13.3 per cent.

Potential investors in Telstra's Autohome should realise that the telco relies on a questionable legal structure to control its investment. Its continuing success in China relies more on Beijing's goodwill than the black letters of these contracts.

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