Autohome float a case of buyer beware
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.
Frequently Asked Questions about this Article…
Telstra's US listing of Autohome is significant because it allows the company to capitalize on the booming technology market. Autohome is the largest car sales website in the world, and the listing is valued at over $1 billion, representing a substantial windfall for Telstra shareholders.
Telstra's US listing of Autohome is significant because it allows the company to capitalize on the booming technology market. Autohome is the largest car sales website in the world, and its listing is valued at over $1 billion, representing a substantial windfall for Telstra shareholders.
Autohome's corporate structure is risky because it uses a variable interest entity (VIE) to circumvent China's strict foreign ownership laws. This means investors have exposure through contracts rather than direct ownership, which could be problematic if the Chinese government decides to enforce these laws more strictly.
Investors are interested in Autohome because it provides access to the Chinese car market, which has recently become the largest in the world for passenger cars. This makes Autohome an attractive investment opportunity for those looking to tap into China's growing automotive industry.
The VIE structure impacts foreign investment by allowing companies to bypass China's foreign ownership restrictions in sectors like internet services. However, this structure is controversial and potentially illegal, posing risks if the Chinese government decides to crack down on such arrangements.
Investing in Autohome carries risks related to its corporate structure. The company uses a variable interest entity (VIE) structure to navigate China's foreign ownership laws, which could be deemed illegal by the Chinese government, potentially leading to severe penalties or loss of business interests.
If the Chinese government enforces foreign investment restrictions, companies like Autohome could face severe penalties or be forced to relinquish their interests in operations. This would significantly impact investors relying on the VIE structure for returns.
A variable interest entity (VIE) structure is a complex legal arrangement used to circumvent China's strict foreign ownership laws in sectors like finance, telecoms, and internet services. It allows foreign investors to gain economic benefits and indirect control without owning the assets directly.
Investors might be attracted to Autohome because it provides access to the rapidly growing Chinese car market, which is now the largest in the world for passenger cars. The potential for high returns in this expanding market can outweigh the perceived risks for some investors.
The Chinese government's stance is crucial because if it decides to enforce restrictions on VIE structures, companies like Autohome could face legal challenges. Recent rulings suggest a tightening of regulations, which could impact the legality and viability of such structures.
Recent developments, such as a ruling by the Supreme People's Court and recommendations from the China Securities Regulatory Commission, suggest that China may be less willing to accommodate VIE structures. These changes indicate a potential crackdown on this legal workaround.
If Autohome's VIE structure is deemed illegal, the company could face severe penalties or be forced to relinquish its interests in its operations. This would significantly impact investors who rely on the VIE structure for their returns.
Telstra has benefited from its investment in Autohome by significantly increasing the value of its stake. Initially investing $76 million for a 55% stake, Telstra's holding is now valued at over $1 billion, providing a substantial return on investment.
Autohome has experienced strong growth due to the rapidly expanding car and internet industries in China. The number of new cars sold in China is expected to grow significantly, contributing to Autohome's success and attractiveness as an investment.
Potential investors should consider the legal risks associated with the VIE structure, the reliance on the Chinese government's goodwill, and the potential for regulatory changes that could impact the investment. Understanding these factors is crucial for making an informed decision.
Potential investors in Autohome should be aware of the risks associated with its VIE structure and the reliance on the Chinese government's goodwill. While the company has grown strongly, its legal structure poses potential challenges that could affect its future success.
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