LeEco Has Hit a Life-or-Death Moment. Is This the Start of a Chain of Bubbles Bursting?

How much bigger LeEco's bubble — and China's internet bubble with it — can be blown may come down to whether Jia Yueting can convince the market one more time today.

In the big conference room at LeTV Tower, Jia Yueting — in a black pullover and jeans — talked to a room full of institutional investors for more than 100 minutes and answered 26 questions.

They asked how LeEco would fix its cash shortage, how it would solve the production-capacity problems with its hardware, how its TVs would make money, how hardware could get it into overseas markets, and where the money for the car business would come from…

After the meeting was made public, LeTV's stock hit its daily limit up, adding more than 10 billion yuan to the company's market value. A company that had been short of cash since the day it went public had, once again, persuaded A-share investors to bankroll its push into new markets.

All of that happened on February 4, 2015.

At 10 a.m. today, in the LeEco Ecosystem Building — whose logo has since been changed to LeEco — Jia Yueting will face institutional investors again, hoping to replay what happened 21 months ago. After the plunge of the past week, the institutions that took part in the last four share placements are all underwater.

It isn't hard to guess what he plans to say; he has been warming it up for days. Last Sunday evening, a company-wide letter from Jia Yueting leaked. He then repeated its message in an interview he had lined up in advance with Tencent Tech: there isn't enough money for the phone and car businesses, and the company has hired a few too many people lately and has to deal with that.

Yesterday, LeEco announced that the planned deal to fold LeVision Pictures into LeTV for 9.8 billion yuan would not close within 2016, because the market had changed enough that it could significantly affect the basis for the performance guarantees and the valuation — and that "a downward revision of the transaction price in this major asset restructuring cannot be ruled out."

LeVision Pictures had been seen as one of the better performers among LeEco's unlisted businesses, and folding it into LeTV was expected to lift LeTV's stock price.

This round of LeEco's crisis broke out on November 2, the day LeEco formally launched LeEco Finance and declared its ecosystem complete across seven major sectors. That same day, word spread on social media that LeEco owed phone suppliers more than 10 billion yuan and had been cut off from supply.

Over the next five trading days, LeTV's stock fell more than 12%, wiping out more than 10 billion yuan in market value. Shares in Yinxi Technology, a supplier for LeEco phones, also plunged 8% starting November 2.

At first LeEco called the reports a rumor, but Jia Yueting's letter to all staff on Sunday admitted that the phone and car businesses did have funding trouble, and that the company had to "leave behind cash-burning expansion and focus on the ecosystem it already has". Coolpad, the phone maker controlled by LeEco Holding, then plunged 19% on the Hong Kong Stock Exchange.

LeEco has always been short of money — it was the same when it started making TVs. But until now it always talked about entering more markets and linking them together to set off a "chemical reaction" across the ecosystem. By that logic, the losses on TVs, phones and even cars would eventually come back as service fees.

Now Jia Yueting says in public that "rapid expansion has to pause here," which means the machine can no longer keep turning, and the company has to slow down.

For a normal, profitable company, slowing down isn't necessarily bad. Alibaba and Amazon — the second-most-valuable internet companies in China and the US — have both been through periods of contraction. But for LeEco, stopping could mean death.

There's nothing wrong with selling a story to raise money and grow faster. Plenty of successful companies do it

The A-share market is the biggest source of the money LeEco burns. Jia Yueting sold shares at the top to cash out 10 billion yuan and put it into the unlisted businesses; LeTV spent heavily on content rights. The reason he and LeEco keep holding press conferences to tell the same story is the same in both cases: keep the public market confident, lift the stock price, and secure the capital to keep burning.

There is nothing wrong with using a story to attract capital. Early-stage startups all raise money by selling equity on the strength of a story.

When listed companies move into new businesses and raise money through share placements, they too are pulling in capital on the strength of a story.

Amazon, the world's fourth most valuable company, is the most successful example. Its market value is 60% of Apple's. Its profit in the most recent quarter was 2% of Apple's.

For 20 years, Amazon has held on to astonishing growth with almost no profit, putting its money into its core business and into building the businesses of the future.

"Amazon has raised the cheapest capital in human history by telling a story," says Scott Galloway, a professor at New York University's Stern School of Business.

Amazon started by selling books, and before it had made any money it was already investing in full-category e-commerce and a logistics network. After it turned a small profit, it began investing in cloud computing. Then the money went into the Fire Phone, video streaming, music services, artificial intelligence…

This high-growth, zero-profit model has run into trouble before. The Fire Phone, which failed to sell in 2014, caused Amazon's biggest loss since 2003 in the third quarter of that year. Investors briefly lost confidence and the stock fell by a third.

Jia Yueting has taken a road somewhat like Jeff Bezos's. He too starts one business after another, with the company supporting several new businesses that make no money at all.

How LeEco became what it is today

2004

LeTV is founded

2010

LeTV lists on the ChiNext board

2011.12

LeVision Pictures is founded

2012.9

LeEco announces it will make TVs

2013.10

LeEco fully acquires Hua'er Film & TV

2014.12

The LeEco Super Car project is announced

2015.4

LeEco unveils the Super Phone in Silicon Valley

2015.10

LeEco invests US$700 million in Yidao, becoming its controlling shareholder

2015.12

LeEco plans to inject LeVision Pictures into LeTV

2016.10

LeEco holds a press conference announcing its entry into the US market

2016.11

LeEco Finance is announced

Even the way they talk sounds alike. At a recent event, Bezos said e-commerce lets him fight his rivals in video at lower cost: "Our TV series won a Golden Globe at Cannes, and that sells a few more pairs of shoes on the e-commerce platform."

Jia Yueting's version isn't nearly as plain. He hauls out a pile of strange terms — businesses that have a "chemical reaction" with one another, what he calls an "ecosystem chemical reaction."

But LeEco cannot stop

The difference is that if every one of Amazon's new businesses failed, the company would still run normally. Its market value would just shrink.

Amazon controls more than half of the US e-commerce market, and e-commerce keeps taking a larger share of US retail. It is also the world's biggest cloud-computing company, with double the share of its nearest rival, and its quarterly net profit keeps rising.

It went into e-commerce in 1995, cloud computing in 2004 and e-books in 2007. Each time, Amazon laid the groundwork four or five years before the market took off.

LeEco's position is different: it has no business that it got into early enough and that is also steady.

LeEco Finance, a new business started only two months ago, and the US market are both doubtful.

LeEco Finance does not have the licenses it needs. As for the US market, at the TechCrunch summit in Beijing on Tuesday, host Jon Russell had this exchange with Xu Changhong, senior vice president of LeEco's global mall:

Jon Russell: Didn't you launch a new phone in the US two weeks ago? Is it hard to sell? Xu Changhong: It sold out in four hours — just like LeTV, gone in 9 seconds, a flash sale. Jon Russell: So how many did you actually sell? Xu Changhong: It's not convenient to disclose that right now. Jon Russell: We're all here right now — isn't this a good time to disclose it?

The biggest problem right now is phones. In a recent interview, Jia Yueting admitted: "There is only one business making our cash so tight, and that is the phone business."

LeEco entered the phone market in 2015, just about the worst moment to start a phone business in China. It began pushing hard at the end of that year, and ran straight into the ceiling on China's phone market.

Never mind LeEco — even Xiaomi's sales have fallen. Using the industry estimate that LeEco loses 200 yuan on every phone, its shipments of 17 million units this year have already cost it 3.4 billion yuan. And everyone from budget player Xiaomi to Apple, which rules the high end, has already shown that paying for hardware with software-service revenue is not enough.

That LeEco's next move is layoffs, and cuts to what it spends on phones and cars, is beyond doubt.

But phones and cars both need enormous investment and both are brutally competitive. Tesla, with all the money it has raised, still cannot guarantee mass production of a cheap electric car. Xiaomi, without enough money to subsidize its sales channels, still lost to OPPO and vivo.

If LeEco can't raise more money to burn, neither business has a future. That would leave the video site and the TV business as its only big businesses — the future Jia Yueting described in his interview.

The trouble is that whether you buy content rights or make your own, video streaming is a market where everyone is burning cash. A good part of LeTV's recent profit comes from hardware subsidies — buy a LeEco membership, get a free phone or TV.

Jia Yueting has stressed that "our TV business loses money, but its cash flow is good." Even if TVs did make money, they could hardly cover what LeEco's other businesses need. Hisense, which sells more TVs than anyone in the market, posted net profit of just 1.496 billion yuan in 2015.

The unlisted businesses are further still from making money. LeSports, which has expanded fast, is another reason LeEco is short of cash. And LeEco Finance, which just launched five business lines at once, still doesn't hold all the licenses it needs.

If it can't convince the market and hold up its stock price, LeEco won't just be short of money for new businesses. It won't even keep the employees it holds with equity.

On November 1, 360 LeTV employees received 18.56 million stock options in total, with a strike price of 38.84 yuan. An executive entitled to 100,000 shares would have to pay 3.884 million yuan to exercise them.

At the closing price of 38.99 yuan on the 7th, those 100,000 shares he paid nearly 4 million yuan for would earn him 15,000 yuan.

If LeEco can't hold on, the damage won't stop at LeEco

Since going public in 2010, LeEco has ridden the hottest years of Chinese internet investment. Among founders as a group, Jia Yueting also works the capital markets in more ways than anyone.

Trading his own stock

By LeTV's own disclosures, Jia Yueting's stake in the company reached nearly 70% at its peak. During the A-share bull market of 2014, he announced that over the next six months he would sell 148 million shares, cash out 10 billion yuan and lend it to LeTV. He lent another 10 billion yuan to LeEco's unlisted businesses, putting it into the unlisted car business.

• Playing the timing gap

When LeEco moves into a new business, it almost always raises money on a promise first, then uses that money to start making the promise real.

LeEco announced it would make TVs in 2012, and the product went on sale more than a year later. The gap is longer for the Super Car: since the project was announced in 2015 there have been several press conferences, and at the most recent one, where a prototype was supposed to appear, the car happened to be in a crash. As for when the car business will produce anything, the latest word is that "there's still something to look forward to in 2017."

How long has LeEco taken to go from announcing a business to shipping a product?

2012.09

LeEco announces it is entering the TV business; the product goes on sale 10 months later.

2014.01

LeEco's cloud computing company is founded; its cloud service is fully built out 19 months later.

2014.03

LeSports is founded; the LeSports site, on its own domain, goes live 18 months later.

2014.12

Jia Yueting reveals the LeEco car project on Weibo; it still hasn't reached mass production.

2015.01

Jia Yueting announces on Weibo that LeEco will make phones; three LeEco phones launch four months later.

2015.04

LeEco announces a partnership with Flying Pigeon to make a Super Bike; the product launches six months later.

2015.08

Jia Yueting brings in a former deputy governor of the Bank of China to run the finance business; the product arrives 15 months later.

• Working the books

In its early years LeEco bought content rights in bulk. To make its financial statements look better in the year of purchase, it spread the cost over several later years, a method it calls "straight-line amortization." Buying the same volume of TV series as everyone else, LeTV's accounting made its first two years look a little better.

According to an analysis by Market Cap Storm of LeTV's 2015 annual report, operating profit for the year was only 69 million yuan, while after-tax net profit tripled — the result of a drop in income-tax expense caused by minority-shareholder gains and losses. Put simply, the profit was made out of shareholder subsidies.

What LeEco is better at is turning losses in its unlisted businesses into profit for the listed one. Membership with free hardware is the classic case.

LeSports, which has spent huge sums on content rights, doesn't count as LeTV spending, while the losses on phones and TVs are converted into membership services and booked as LeTV revenue.

The true state of LeTV's profits is probably known only to LeEco.

• Leveraged buyouts

On July 27 this year, LeEco said it would buy the US TV maker Vizio for US$2 billion, in a leveraged buyout. Most of the price is debt financing, and after the deal closes Vizio's Series A funding will repay the loans used for the acquisition — LeEco buying a company with the bank's money, needing as little as US$200 million of its own to finish the purchase.

On top of that, since LeTV's IPO in 2010, its total fundraising — the IPO, follow-on placements and bond issues included — has passed 33.4 billion yuan.

LeTV's disclosed fundraising and share placements since its IPO

2010.08

LeTV lists on the ChiNext board, raising 730 million yuan.

2010.12

LeTV uses 80 million yuan of oversubscribed funds to buy online rights to film and TV content.

2012.11

LeMall completes a Series A round worth tens of millions of yuan.

2013.04

LeMall completes a Series B round totaling 300 million yuan.

2013.08

LeVision Pictures completes a Series A round totaling 200 million yuan.

2013.09

LeTV issues an additional 1.598 billion yuan of shares.

2014.08

LeTV issues an additional 4.5 billion yuan of shares.

2014.09

LeVision Pictures completes a Series B round totaling 340 million yuan.

2015.05

LeSports completes an 800-million-yuan Series A round.

2015.11

LeEco's phone business completes a US$530 million round.

2016.03

LeSports completes an 8-billion-yuan Series B round.

2016.06

LeTV issues an additional 4.8 billion yuan of shares.

2016.07

LeTV's total self-funded investment reaches 1.32 billion yuan.

2016.09

LeEco's car business completes a Series A round of US$1.08 billion.

Admitting the shortfall in public probably means LeEco has run out of other ways to cover it.

There may really be no other company in China as inventive with its finances as LeEco. But internet companies losing money on LeEco's scale are still everywhere in the Chinese internet industry.

Among the world's 50 most highly valued unlisted companies, the Chinese ones are together worth US$195.8 billion. Of those, the only ones that may not be losing money are DJI, valued at US$8 billion, and ZhongAn Insurance, which is about to go public, plus Xiaomi, whose profits are thin. The rest — Didi, Meituan, Ele.me and others — are all still burning cash for growth, only to different degrees.

There is also Baofeng, a smaller A-share-listed company that ships products more slowly but behaves much the same way.

If LeEco can't hold on, founders of tech companies whose storytelling falls short of Jia Yueting's may find it much harder to convince the market that burning more cash will burn its way to a future.

Something like this happened on Nasdaq in 2000: once investors lost confidence, more than a hundred internet companies went under. Companies promising delivery to your door in an hour, pet e-commerce and fresh-food e-commerce were all among them.

Things may "look" a little better on the Chinese side, though — most of these companies haven't managed to go public yet.

Cover image from LeEco's US launch event.