Looking at LeTV from the National Financial Work Conference
Published: 2017-07-29
For finance- and tech-innovation-focused media over the past month, there has been no shortage of varied topics and hot issues. In mid-month the once-every-five-years National Financial Work Conference was held in Beijing; the conference’s high profile and strong declaration of policy reform made it the undisputed focus of recent financial news. At the same time, micro-level entities such as LeEco, Wanda, and Sunac China appeared in the press frequently, repeatedly occupying major headlines. Any one of these hot topics will yield dozens or hundreds of articles if you search, and especially along the path of LeEco’s problems fermenting, countless viewpoints have emerged. Now that facts and mainstream views have largely stabilized, I want to analyze the seemingly unrelated but concurrent Financial Work Conference and the LeEco case together.
The necessity of regulation
Let’s start with the macro background surrounding this Financial Work Conference.
External environment. From the RMB depreciation against the dollar that began spreading late last year to the ongoing reality of repeated U.S. rate hikes this year, pressure for capital outflows has steadily increased. What followed was a period of relativelystrict foreign exchange controls.
Domestic environment. The domestic financial system and economic conditions are not encouraging. Off-balance-sheet business of commercial banks exceeds 50%, shadow banking accounts for 87% of GDP, and banks’ entrusted investments have heavily purchased stocks and private placements, significantly exceeding the traditional scope of banking operations. In the securities market, universal insurance-like products represented by entities such as Qianhai and Anbang have been stirring up the capital markets with ambitious moves. Overall social leverage has also been climbing; although household leverage is not very high, elevated local and corporate debt keep aggregate leverage at a high level.The economy lacks internal momentum, while finance, leverage, and the capital markets are overshadowing the real economy.
In the face of internal and external crises,the central bank must on one hand respond to external pressures such as U.S. rate hikes and balance-sheet reduction, and on the other hand control domestic capital outflows. At the very moment when authorities were already under great strain, some companies showed little regard for the country’s difficulties; instead of helping to stabilize things, they pursued aggressive acquisitions abroad, which irritated the central bank. That led to a series of chain reactions in which large overseas investments by the likes of Wanda, Fosun, and HNA were halted and domestic high liabilities were forcibly repaid.
Among them, Wanda was the most conspicuous. Due to historical institutional limitations, China has long had a dual-track factor market pricing system: state-owned enterprises enjoy very low financing costs, especially in indirect financing markets. As a result, some inefficient SOEs would borrow cheap bank funds and lend them to cash-strapped private firms, turning losses into profits in strange ways. Wanda is a special case: because of its high-quality assets, considerable influence, and favorable politico-business ties, Wanda could obtain bank loans in amounts and at costs far beyond most private firms’ reach. Leveraging its domestic credit, Wanda used low-cost bank funds through internal guarantees and external lending to carry out large overseas acquisitions, enjoying exceptional acclaim. This fueled a wave of Chinese outbound M&A that eventually provoked regulators and market backlash, culminating in a painful dual hit to its stock and bonds, and the billionaire’s tearful distress sale of 13 cultural-tourism projects to Sunac and 77 five-star hotels to R&F.
Jeff Immelt, the former CEO of General Electric, made one of his major reforms a significant reduction of the company’s financial business to return the firm to high-end manufacturing and industrial intelligence. For nonfinancial traditional enterprises, as they grow to a certain scale financial activities seem to follow a cycle of emerging and then being scaled back. Chinese companies now appear to be in the earlier phase: take any large traditional firm and it seems embarrassed if it lacks some lending or leasing businesses—Evergrande Financial, Gome Finance, Wanda Financial—mushrooming like bamboo shoots after rain, all eager to carve out a piece of a pie that looks larger than the real economy itself,This is a trend occurring among traditional enterprises.
and another trend is happening in the venture capital market. At an internet venture-sharing conference, a vendor selling flatbreads and a noodle seller sat on stage boasting about their startup gospel, how they would disrupt the catering industry and change people’s lifestyles. A traditional restaurant owner, making more than a million yuan annually but feeling trapped in chaotic times, sat anxiously in the audience, afraid of being left behind by the era and eager to learn transformation wisdom from these youths. When he asked about revenue and profit metrics, the yet-unprofitable young founders corrected him: “If you want to transform, don’t think about traditional metrics; everyone talks about monthly active users and traffic now.” They then spoke grandly about dreams and industry disruption. The traditional businessman could only nod silently, bewildered and at a loss, asking himself whether he really had been made obsolete by the times.
This half-true, half-fictitious story is abstracted from real reports with slight exaggeration for effect; the point I want to make is the element of “illusion.”Some funds may appear to flow directly into the real economy rather than into the securities market, real estate, or local financing platforms, but in fact they flow into narratives—into dreams—that eventually circulate in the capital markets, just as some capital flowed into ecosystems like LeEco’s.
The inevitability of LeEco
I once admired LeEco and Jia Yueting. Whenever I spoke of Jia, a trace of Shanxi pride would surface. But now abundant evidence has confirmed the indisputable fact that the Jia family shifted funds and cashed out through share reductions, guarantees, and private placements, which is regrettable. Below is an excerpt from a Tencent Tech article“The Tragedy of LeEco: Jia Yueting’s Loyalty and Departure”—an analysis of LeEco.
LeEco’s ecosystem model contains three core components:
Selling TVs, phones, and other hardware at low prices or even at a loss to rapidly scale product sales and expand revenue size;
Using content revenue to subsidize hardware losses, with a membership pay model based on hardware and platform value-added services;
New ecosystem businesses are incubated via capital operations, folded into the listed-company structure, with losses shifted to non-listed entities through related-party transactions to drive sharp increases in the listed company’s results and stock price; then financing through private placements and similar methods feeds back into business growth, and business synergies raise overall profits, ultimately closing the loop of the LeEco ecosystem model.
To supplement, LeEco’s ecosystem entities also have a three-part structure: the listed-company system mentioned in the third step—the listed LeTV (LeEco) network—as the first part; the second part is the non-listed company system centered on LeEco Holdings, including LeEco Mobile, LeSports, LeVision Pictures, etc.; the third part is LeEco Auto.
According to Tencent Tech’s analysis of LeEco,the origin of LeEco’s crisis also stems from a shift in regulatory direction. Beginning in 2016, the China Securities Regulatory Commission’s tightened supervision of capital operations by listed companies such as LeTV made the planned injection of LeVision Pictures into the listed LeTV company fail, and subsequent attempts kept stalling.As is well known, LeEco lacked stable profitable cash flow. Heavy investment across TVs, phones, sports, and automobiles incurred large losses; without delivering on listing promises and establishing capital exit channels, continuous external financing was difficult to secure. Thus the entire LeEco ecosystem relied on capital lifelines from the listed LeTV company.Repeated obstruction of asset injections, private placements, and other capital operations related to LeTV prevented the third step of Jia Yueting’s “three-step strategy” from taking shape, amplifying a series of hidden risks within the LeEco ecosystem. That precipitated LeEco’s subsequent debt crisis and the vicious collapse in stock valuation, leading to an overall breakdown of its credit.
LeEco Auto, as a relatively independent segment, effectively represented Jia Yueting’s personal positive equity and was largely separated from the indebted, troubled LeEco Holdings. The large overseas investments later associated with LeEco now appear to have been measures Jia took to shift assets abroad, but under tightening foreign exchange controls those transactions were suppressed.
Returning to this Financial Work Conference,its core summary is economic deleveraging, stronger financial regulation, and guiding funds back to the real economy. The newly established State Council Financial Stability and Development Committee also expanded regulatory boundaries to include financial activities and transactions conducted by nonfinancial institutions, safeguarding the stability of the social economic order.LeEco’s past behavior ran counter to the intentions of regulators. Every event has its contingencies and inevitabilities; LeEco’s crisis and the emergence of the Financial Work Conference had long been gestating. Coincidentally, in what was historically the hottest July,they were simply the concentrated outbreak of a phase of contention between regulators and the regulated..
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