Article / 23 September 2015 at 1:32 GMT

Qihoo's call on Coolpad leaves shareholders on hold

China Watcher / Shanghai
China
  • Qihoo has boosted its share of the Coolpad joint venture from 49.5% to 75%
  • The US-listed Chinese software firm is acting like a private company
  • The company's ongoing privatisation bid remains up in the air
  • Qihoo needs to properly communicate its intentions to shareholders

By Neil Flynn

The issue of corporate governance among US-listed Chinese firms has reared its ugly head again, after Qihoo signalled its intention to cash out of its smartphone joint venture amid corporate disagreement, only to increase its holding from 49.5% to 75% shortly afterwards.

In December, Qihoo entered into a joint venture agreement with domestic smartphone manufacturer Coolpad in order to produce a range of smartphones called Dazen. The concept was sound, because the hardware would be built by Coolpad and the software would be developed by Qihoo, offering customers a 'best of both worlds' product. 

However, shortly after the release of several Dazen smartphones, Qihoo announced that it had activated a put option in the JV agreement that allowed the firm to sell its 49.5% stake to Coolpad. The timing of the announcement was unusual, given that the first range of phones had just been released and Qihoo had been discussing their potential in its second quarter earnings release.

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Qihoo's joint venture deal with smartphone maker Coolpad was a sound concept, but ran into difficulty when online video company LeTV gained a share in the venture. Photo: iStock

Concerns about the sustainability of the joint venture arose when LeTV acquired a stake in Coolpad. LeTV is an online video platform that has since moved into smartphones, smart TVs and is currently developing an electric supercar. 

This caused a problem for Qihoo, because it has been using its proprietary technology to develop the Coolpad Dazen smartphones, which will in turn indirectly influence the development of other Coolpad smartphones that are not part of the joint venture. LeTV would not only earn a profit from this, as a shareholder, but would also likely use the technology to develop its own-branded smartphones. This is in addition to LeTV being renowned for causing rifts with other technology firms (Xiaomi and Apple, among others).

Power play

Qihoo's activated clause would have required Coolpad to buyout Qihoo’s 49.5% stake for approximately $500 million, which never looked feasible, given that Coolpad’s market capitalisation is only $700mln. It became clear that it was just a power play, with Qihoo wanting nothing more than to gain further control of the joint venture and to marginalise LeTV’s involvement in Coolpad. 

Inevitably, the rift between Qihoo and Coolpad was resolved with Qihoo now holding a 75% stake in the joint venture, leaving it ripe for an eventually takeover by Qihoo should it prove successful.

With Qihoo now holding a dominant share in the joint venture, and presumably a form of Chinese wall to make sure that LeTV can’t use any of its technology, where does this leave Coolpad and LeTV? 

Coolpad’s future growth will likely be stunted because of the joint venture with Qihoo, which will almost certainly be bought out as soon as it becomes a viable long-term business, leaving Coolpad with a sub-standard smartphone range. LeTV likely won’t be able to reap the benefits to its own smartphone range that it expected to get when it acquired a stake in Coolpad in June, and investors will now be considering whether Coolpad is a viable long-term option for LeTV any more.

Corporate governance


On a wider view, it raises concerns of the levels of corporate governance that US-listed Chinese firms have in regards to shareholder clarity. I have been forthright in my criticism of Qihoo for failing to hold an earnings conference call after the release of its second-quarter earnings, the first since the announcement of the privatization bid. 

The lack of disclosure and lack of commentary other than the generic ‘the bid is still being evaluated’ is disappointing, particularly because no investor believes that the current bid will be completed, given that the premium stands at 62.6% as of last night’s close.

With the Coolpad concerns seemingly over, it has added to my concerns about Qihoo, on top of management’s lack of clarity towards the outstanding buyout bid, which is all but dead in the water. It is, in a sense, acting like a private company, which is all well and good given that the company is clearly moving in that direction. 

But while Qihoo is still a public company, more clarity should be given to shareholders. An inability to properly communicate intentions to the shareholders will see trust evaporate, and I expect that this will have a lasting effect on the firm, at least until it is inevitably privatised. 

It would be best for all parties if management completed the privatisation bid, although this would actually mean that the firm would have to provide clarity to shareholders.

– Edited by Robert Ryan

Neil Flynn is a China watcher based in Shanghai. Follow Neil or post your comment below to engage with Saxo Bank's social trading platform.

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