AdChina filed for a potential $100 million IPO on Nasdaq on Friday.
Until recently, Chinese companies seeking to do an IPO in the U.S. were allowed to do “confidential filings” that were reviewed by the SEC staff but were not publicly available. That allowed companies to clean up the offering document based on SEC comments before a near final version became available for investors to read. That changed last year and now the initial filings are immediately available on the SEC website. I think the change is good, since the public may raise questions about these IPOs that the SEC staff might have otherwise overlooked, preventing the kind of last minute surprise that appeared to help doom the La Shou IPO last year.
The U.S. IPO market for Chinese companies has been dead since Tudou listed last August. An initial filing by AdChina Ltd was made last Friday, suggesting that the company hopes to soon break the logjam. Fredrik Oqvist pointed out this filing to me, and I dove into it because I am interested in the adjustments that companies are making to deal with the VIE controversy. AdChina uses a typical VIE structure.
There is an expanded discussion in this filing of the issues related to the use of proceeds. One of the difficulties these offerings face is whether they can move the proceeds raised in dollars into China for use as renminbi in the business. China heavily regulates foreign currency transactions, and the company indicates that while it can contribute the proceeds to the capital of its Chinese subsidiaries, they can only be used within the business scope of the WFOEs and cannot be used for equity investments. The company points out that the WFOEs could make loans to the VIEs, but these have to be approved by the government (and also be within the business scope of the VIE). There is no indication whether these approvals can actually be obtained or whether the loans would be within the business scope of the WFOE. The tendency in filings is to explain the rule, but to fail to explain whether the rule will actually cause problems for the company. The lawyers should opine whether the loan activity would be within the business scope of the WFOE, and the company should state whether it expects government approval to be probable. Since there appear to be existing loans to the VIEs, have these loans been properly approved?
The VIE risk disclosures have been expanded to discuss the purported CSRC memo on VIEs that leaked out in September 2011. The filing states that the authenticity of the memo cannot be determined. However, investors are warned that regulatory authorities would have broad discretion in dealing with any violations, including putting the company out of business.
The financial statements have improved VIE disclosures, which indicate the accountants are starting to pay attention to the new disclosure rules. AdChina’s disclosures go on for six pages. There are two statements that the SEC should challenge and demand be better supported.
There has been increasing concern about the ability of companies using the VIE structure to access the assets of the VIE. Because there is no ownership in the VIE, the only way to access the assets of the VIE is through the agreements. If there is a judgment against the company, it cannot be enforced against the VIE. AdChina addresses this issue. The financial statement footnotes say that the company “can freely have assets transferred out of the VIEs without any restrictions because of the series of contractual arrangements mentioned above”. The arrangements mentioned above are the standard VIE agreements, and only one of those provides for an asset transfer (the support service agreement). The payments under that agreement are based on a service fee based on a set formula. How do payments due for services under a set formula qualify as the right to freely have assets transferred out of the VIE? This is not a petty issue. AdChina’s VIEs hold 44% of the group’s assets.
Another concern over VIEs is the risk that the interests of the VIE shareholder and the public shareholders may not be aligned, providing an economic incentive to the VIE shareholder to ignore the agreements and take the VIE. Interestingly, this is addressed in the financial statement footnotes – a first I think. The company says “the shareholders of the consolidated VIEs are also shareholders of the Company and therefore have no current interest in seeking to act contrary to the contractual arrangements.” That statement is absurd on its face. The key VIE is 100% owned by the founder and his wife, yet they only control 18% of AdChina before the IPO. While the 18% shareholding is significant and mitigates the risk of the shareholders taking the VIE, it is quite an overreach to conclude they have no current economic interest in doing so.
Google Analytics tells me that the SEC is my most faithful reader. So, if you always wanted to try your hand at being an SEC reviewer, dive into this filing and post your findings below.