37 Days, 10.8 Billion Yuan Gone: Only a Trading Halt Stopped LeEco's Slide. Time to Talk About a Way Out

LeEco grew big by painting a picture of the future. Now that no one believes in that future, it is fighting for its life.

LeEco's stock has finally stopped falling — but nothing has actually turned around.

On Wednesday, LeTV, the listed arm of LeEco, filed a trading halt announcement and suspended trading in its shares. LeEco said the stock had fallen sharply and the company needed to prepare an asset restructuring.

Since early November, when reports surfaced that its phone business was behind on payments to suppliers, LeTV's stock has fallen 19%, wiping out 10.8 billion yuan in market value.

Measured against its high in May last year, LeTV has shed 40 billion yuan in market value.

Since then LeEco has held a shareholders' meeting and announced a new round of financing. Neither changed how the market sees the company.

The market has no real reason to change its mind. Most of what LeEco has disclosed itself is bad news: it has admitted to running into cash problems, admitted that its phone and car businesses are burning money too fast, and hinted at layoffs.

What has leaked out is worse: LeEco falling behind on payments to its phone suppliers, Qualcomm and MediaTek halting chip supplies over unpaid bills, suppliers suspending shipments to the TV business, and the Nevada State Treasurer, a partner on the car project, calling the whole thing a Ponzi scheme.

The latest is the photo below, circulating online, said to show LeEco employees lining up to process their resignations.

LeEco says the line is for other kinds of paperwork.

But the layoffs are real. An employee who recently left LeTV told QDaily that people have indeed been cut, in waves, though internally the company calls it "optimization." One figure going around inside LeTV puts the share at 20%. LeTV is only one of LeEco's many companies. NetEase Finance reported that the whole LeEco Group is "optimizing," affecting 10% of staff.

None of this is what worries LeEco most. By LeTV's own announcement, the biggest factor was an article titled "LeEco's Terrifying Second: Jia Yueting's 64.81% Pledged Stake Briefly Broke the Liquidation Line." That article was listed as the main reason for the halt.

Why would one article matter so much? And once trading is halted, what can LeEco do?

The halt buys time, and keeps Jia Yueting from losing control

Pledging shares means a shareholder hands his stock to a financial institution as collateral in exchange for cash.

Between 2014 and 2015, when LeTV's stock was doing well, Jia Yueting pledged LeTV shares to third-party financial institutions 15 separate times, turning them into cash to invest in new businesses. To this day, 77.74% of his shares have not been redeemed.

The institutions do this to earn interest. To guard against losses, they agree with Jia on a share price at the time of the loan — the liquidation line. If LeTV's stock falls below it, the lender has the right to sell the pledged shares and recover its money.

Which means most of the stock in Jia's hands could end up bought by someone else, costing him effective control of the listed company.

The A-share market has seen this before. In February this year, the chairman of Coship Electronics lost control of his company for exactly this reason.

The article the announcement blamed came from Yema Finance, and can no longer be found on that outlet's own site. Versions reposted by Sina, Ifeng and others still turn up in search.

Citing data from East Money's iChoice, the author wrote that Jia had pledged 64.81% of his shares at 35.21 yuan apiece, and that on December 6th LeTV touched a low of 35.01 yuan.

But East Money's product staff and executives, answering questions about it, said the 35.21-yuan figure was an estimate based on industry averages, not a precise number.

An investment analyst who once worked at a U.S. bank told QDaily that the number is genuinely hard to estimate, because it moves with how the bank judges the borrower — usually 30% to 60% of the share price at the time. A share worth 100 yuan, for instance, might be pledged for 30 to 60 yuan in cash. For giant state-owned enterprises like Baosteel or Wuhan Iron and Steel, a ratio above 60% is not out of the question.

As a rule, once the stock falls to 140% of the principal lent, the lender starts thinking about selling. Above that price there is usually a warning line as well.

Take LeEco. Say Jia pledged shares then worth 10 billion yuan to Bank A at an agreed ratio of 30%, turning them into 3 billion yuan in cash.

If those shares fall to the warning price of 4.8 billion yuan (160% of the amount lent), Bank A tells Jia to top up the collateral. If they keep falling to 4.2 billion yuan (140% of the amount lent, the liquidation line), Bank A has the right to dump the LeEco stock to cut its losses.

"But financial institutions don't usually do that straight away. When they lend, they set aside 15-20% of the principal as a safety margin — the principal plus that margin is what people call the liquidation line," the analyst said. Just after the price first breaks the line, the bank's principal is still covered, so it won't necessarily sell.

If the stock keeps falling and eats into the principal itself, he added, the institution's risk-control department takes over and sells. Risk control has no interest in sentiment or prospects; it answers for the loss figures.

Asked why Jia halted trading now, the analyst's read was: "The way LeTV's stock is moving is bound to worry institutional risk-control departments. Some lenders may already have asked Jia, under the pledge contracts, to top up his collateral. That he rushed into a halt this time suggests he may not be able to come up with the extra money on short notice."

The Shanghai Securities News reported that some of the institutions that arranged pledge financing for Jia last year are already weighing the risk and looking for a way out.

As for the "major matter under planning" LeTV itself raised, some media reported it may involve Leshi Zhixin, the LeTV subsidiary that runs the TV business, with word that Leshi Zhixin is bringing in a new round of strategic investment and that a Shanghai investment firm has already started wiring funds.

"Jia Yueting was already thinking about borrowing from friends before this. Asking him to raise a large sum right now really is hard. Whether or not LeTV is truly planning something major, at a moment when the market has settled into a negative view of the company, halting trading to protect itself isn't a bad option," a private-equity fund manager in Shanghai told QDaily.

How much time can a halt buy?

Any A-share listed company can apply to the exchange for a halt by citing a major change, and can even ask for a temporary halt mid-session. The exchange then decides, based on the circumstances or on requirements from the CSRC, China's securities regulator.

When the Baoneng group was fighting for control of Vanke, Vanke halted trading for seven months, citing a share issuance, a major asset restructuring and an acquisition. LeTV itself announced a halt last year over plans to fold LeVision Pictures into the listed company, and did not resume trading for nearly six months.

LeTV trades on ChiNext, which comes under the Shenzhen Stock Exchange. The exchange's "Memorandum on Trading Suspension and Resumption for Listed Companies," issued this May, caps a halt for a major asset restructuring at three months; if the halt is expected to run longer, the company must put the question to a shareholders' meeting, which decides whether to keep the stock suspended while it works on the plan.

If the CSRC does not object, and neither the shareholders' meeting nor the board raises objections, LeTV can stay halted. That buys it more time to find money and rearrange its businesses.

None of the three has much reason to push LeEco back into trading before its problems are settled.

LeTV makes up 5% of the ChiNext index. A 10% fall in LeTV drags the index down 0.5% — roughly what Sinopec and PetroChina do to the Shanghai Composite.

When prices collapsed in 2015, the so-called national rescue funds bought heavyweights like Sinopec and PetroChina in bulk to keep the Shanghai Composite from falling further.

As of the third quarter this year, LeTV's ten largest shareholders included four LeEco executives, a Shenzhen government-backed fund, two public mutual funds and Central Huijin (the "national team" that steps in to prop up the market). Together they hold 47.98% of LeTV's freely tradable shares.

In the year since Central Huijin joined LeTV's top ten shareholders, it has not cut its stake once — not even through the crash of the past month. Its purpose in taking positions in LeTV and other listed companies is not to push their prices up but to keep them from falling too hard. Sometimes it sells and then buys back when the moment suits.

Major shareholders have the most direct stake in the company, which makes them the group least eager to see LeTV trade again.

The financial institutions that lent against the stock, meanwhile, have no say right now. With LeTV halted, the price frozen and the shares untradeable, all they can do for now is demand that Jia top up his collateral as the contracts require.

With everyone's interests tangled up this way, LeTV stands a good chance of staying halted for half a year, or longer.

What can a halt do? Borrowing is no longer easy

Sending LeTV executives out to borrow money wherever they can is what Jia Yueting is doing now.

It does not solve LeEco's problem.

On the evening of November 15th, Jia said on Weibo that he had borrowed $600 million from classmates at Cheung Kong Graduate School of Business.

Once the news was out, the listed companies those people work for all issued statements distancing themselves from LeEco, calling the loans personal acts by individual executives that used no company money.

That is what LeEco now faces in the market. From the moment the trouble broke into the open to the rush to disown any connection, everything shows how hard it has become for LeEco to borrow.

No one wants to lend it money, and that is exactly the market's verdict on the company.

LeEco got here because it never had a steady, money-making business, so it kept starting new ones.

After listing on ChiNext in 2010 on the strength of LeTV's online video business, LeEco moved into film and television production, TV sets, cloud services, sports, phones, ride-hailing, cars and finance.

Of all these, only LeTV and the TV business — whose numbers have never been audited — are said to have stopped losing money. The rest burn cash.

And much of the cash LeEco has burned came from loans its executives raised against their stock, not from the venture capital internet companies usually live on.

That money has to be paid back with interest.

Even the businesses that do make money aren't healthy. Whether they buy rights or produce their own shows, video sites all operate in a market where everyone is burning money. A good share of LeTV's recent profit comes from hardware subsidies — buy a LeEco membership, get a free phone or TV. Losses in the unlisted hardware business turn into profit on LeTV's books.

Jia Yueting likes to say, "our TVs lose money, but our cash flow is good." That doesn't help much in the TV market, because even a profitable TV business can barely cover what LeEco's other ventures need.

Hisense, the best-selling TV brand on the market, made net profit of just 1.496 billion yuan in 2015. By Jia's own account, the car business alone has burned more than 10 billion.

How LeEco Became Today's LeEco

2004

LeTV is founded

2010

LeTV lists on ChiNext

2011.12

LeVision Pictures is founded

2012.9

LeEco announces it will make TVs

2013.10

LeEco acquires Huaer Film and Television outright

2014.12

LeEco announces its Super Car program

2015.4

LeEco unveils its Super Phone in Silicon Valley

2015.10

LeEco invests $700 million in Yidao and becomes its controlling shareholder

2015.12

LeEco plans to fold LeVision Pictures into LeTV

2016.10

LeEco holds a press conference to announce its entry into the U.S. market

2016.11

LeEco Finance is announced

2016.12.7

LeEco announces a trading halt

For Jia Yueting, selling a big picture to raise money and speed up growth is no sin in itself; plenty of successful companies do it. Whether it was Jia personally selling down shares at the peak to cash out 10 billion yuan and pour it into the unlisted businesses, or LeTV spending heavily on content rights, the reason he and LeEco kept holding press conferences to tell the same story was to keep the public market confident, hold the share price up, and secure more capital to burn.

Now Jia has to borrow from individuals.

To prove it is a sustainable business, LeEco has to cut

Cut the cash-burning businesses, and persuade the capital markets to believe in a new structure, new cost control and real profit: that is LeEco's best hope.

The car will never be built.

LeEco says the car has cost 10 billion yuan of the company's own money, yet its factories at home and abroad show no sign of starting production, and a U.S. government official who partnered on the project has called it a Ponzi scheme. After foreign media exposed all this, LeEco's car unit has no chance of hiring the kind of people Qoros and FMC got when they poached BMW executives.

The overseas acquisitions can stop too.

On July 27th this year, LeEco announced it would buy the American TV maker Vizio for $2 billion in a leveraged buyout. Most of the price was to come from debt, and once the deal closed Vizio's own Series A round would repay the acquisition loan, so LeEco needed as little as $200 million of its own money. Even $200 million may be too much now.

The business that most needs cutting may be the phone.

LeEco phones went on sale in May 2015 and have shipped 17 million units to date. This is a low-margin trade that only turns a profit at scale, unless you make the phone a luxury object the way Vertu does.

Someone in the phone retail channel told QDaily that LeEco is widely believed to lose about 200 yuan on every handset it sells, chasing volume. At 17 million units, that is 3.4 billion yuan gone. LeEco no longer has the money to subsidize at that rate.

LeEco has said again and again that its car and phone businesses burn cash, which already hints at where both are headed.

The plan to enter the U.S. doesn't look promising either.

At the TechCrunch conference in Beijing in November, host Jon Russell had this exchange with Xu Changhong, senior vice president of LeEco Global Shopping:

Jon Russell: You launched a new phone in the US two weeks ago. Is it hard to sell? Xu Changhong: It sold out within four hours — just like Le-TV, sold out in nine seconds, that kind of flash sale. Jon Russell: So how many did you actually sell? Xu Changhong: I'm not able to disclose that right now. Jon Russell: We're all here — isn't this a good moment to announce it?

LeVision Pictures, which has stayed out of this round of trouble, did not look good in what it disclosed earlier either. In 2014 and 2015 it posted net profit attributable to the parent company's shareholders of -891 million yuan and -102 million yuan.

This year's figures remain to be seen, but the fact that LeVision Pictures was never folded into listed LeTV says enough.

Then there is LeEco Finance, which only launched formally last month.

It still has no more than an insurance license and a small-loan license. And even with licenses, no one should count on finance to make money. Even JD.com is spinning its finance business off right now, to keep the losses from dragging down the whole company.

Cutting businesses means large-scale layoffs. LeEco has said many times that it is overstaffed and needs to strictly cut the bottom 10% of performers.

That does not mean it can use the system to lay people off for free. Under Chinese labor law, even when an employee is dismissed for being unable to do the job, the company must give 30 days' notice and produce the grounds for it.

It can also sell down stakes in affiliated companies.

It is already doing that. Last week Coolpad Group, a company under LeEco Holding, announced it would sell an 80% stake in Coolpad Mobile for 272 million yuan. Coolpad Mobile was set up in 2014 with 1 billion yuan from two Coolpad Group executives and ivvi, mainly to run the ivvi phone brand. By a rough count, the investment has lost more than 50% of its value in two years.

By one media tally, LeTV also holds, through subsidiaries, a 20.09% stake in TCL worth 1.937 billion yuan, plus stakes in A-share companies including Beijing Youth Media, Dangdai Mingcheng and Zhilan Yushu, bringing the total to 2.059 billion yuan. All of it is an asset LeTV can turn into cash.

Riding with Yidao no longer earns you a LeEco membership, either. Yidao is also pushing users to top up their accounts at a discount, to bring in more cash. Which suggests LeEco has stopped funding that company.

If it can't become a sustainable business, what does LeEco have to sell?

Strip all of this away and it is still hard for outsiders to judge whether LeEco can go back to operating as a normal company.

None of the new businesses is listed, and none has disclosed its losses or its debts. Only LeEco's own executives know how much money it takes to fill the hole.

If the company can't recover, it won't hold on to its people either. Bringing in a new strategic investor at a discount, or selling assets, becomes the other way out.

State-backed BesTV spent $30 million in 2012 to buy the online video site Funshion. LeTV's tie-up with the CIBN internet-TV integration platform run by China Radio International has been approved, giving it an internet-TV license, so seeking state capital is not out of the question either.

Financial institutions could also sell the pledged shares to a private-equity firm willing to gamble. The Shanghai Securities News noted that some private-equity firms have already said they would "take over" LeTV's pledged stake, proposing to acquire it at a reasonable price through asset securitization (ABS). Some are even considering setting up industry M&A funds as a way into LeTV's equity.

That is no long-term fix. Private-equity funds are limited in size, and investing in LeEco is, in the end, about making money. If LeTV's stock resumes trading and keeps falling with no floor, they won't hold the shares forever.

If nothing turns around, LeTV's last option is to sell off pieces: Chongqing LeEco Microloan, which holds a small-loan license, say, or LeSports, which is already restructuring.

Since 2015 LeSports has spent $200 million on three years of exclusive Premier League broadcast rights in Hong Kong; $110 million for all-media rights in mainland China to every AFC competition from 2017 to 2020; 2.7 billion yuan for exclusive new-media rights to the Chinese Super League for the 2016 and 2017 seasons; and a reported $100 million-plus for NBA rights in Hong Kong and Macau for the 2016-2021 seasons. Those rights alone have eaten most of the 8.8 billion yuan LeSports raised in two rounds of financing.

How much bad debt sits inside all that, only LeSports knows. Last month the ATP came close to cutting off its broadcast feed for the Shanghai Masters, over rights fees it had not paid.

That leaves two better businesses: LeTV and the TV business.

Finally, there is still a shell

Listing on the A-share market is hard. Even a company that meets the profit requirements waits years in line.

As of December 1st, 693 companies were queuing on the Shanghai and Shenzhen exchanges.

At the CSRC's pace of approving 15 listings a month, it would take them at least 46 months to all get through.

Nearly four years is too long to wait. No one can promise nothing will go wrong in the meantime. If profits slip, or the company falls into losses and no longer clears the listing bar, it has to withdraw.

For companies with the means, taking control of an already-listed firm to skip the queue has become the shortcut.

The CSRC says it does not allow ChiNext companies to be used for reverse mergers. Since Liu Shiyu became its chairman, more than 40 reverse-merger applications have been rejected.

But LeEco could still end up as a shell.

The most recent case happened this week. Legend Holdings took control of the ChiNext-listed Wanfu Biotechnology, and its subsidiary Joyvio Group holds actual control of it. Joyvio went public through the shell.

Wanfu Biotechnology is ChiNext's most notorious fraud: it falsified its financial statements and inflated profits, and publicly admitted to overstating revenue by 740 million yuan. Its chairman has been handed to the judicial authorities, and its underwriter, Ping An Securities, faces heavy penalties.

As a shell for sale, LeTV's credentials are still better than Wanfu Biotechnology's. But at a market value of 70 billion yuan, it is far too expensive to be one.

In general, a reverse merger on the A-share market costs 8 to 10 billion yuan, and the shell is usually worth around 3 billion. SF Express's shell, Dingtai New Materials, was worth 3.2 billion yuan; YTO Express's shell, Dayang Trands, 4 billion.

If it really comes to that, LeEco will have nothing left to do with the LeEco Jia Yueting wanted.

Cover image: from the film Wall Street