Wal-Mart M&A: Yihaodian Restructures its VIE. I Still Have Questions.

October 11, 2012

You may recall that back in August, Wal-Mart increased its shareholding in a Chinese e-commerce company called Yihaodian. This was not only a big move in the retail sector, but it also caught the attention of China law geeks like myself because the deal was subject to review by the Ministry of Commerce (MOFCOM).

MOFCOM approved the deal with conditions, which is quickly becoming standard operating procedure for China when greenlighting foreign-related acquisitions under Anti-monopoly Law rules. One of those conditions in particular raised a lot of eyebrows in that it specifically forbade Wal-Mart from getting into the e-commerce business via the use of a variable interest entity (our old friend the VIE). I wrote about the deal twice (once on the foreign investment angle, and again on the VIE aspects of the MOFCOM decision).

Basically, MOFCOM told Wal-Mart that it was kosher for it to use the Yihaodian online platform to sell its own stuff, but that it could not be involved in third-party transactions. As I noted at the time, this makes perfect sense as foreign companies are generally free to distribute their products online these days, but facilitating third-party transactions remains a tightly regulated Internet business partially closed to foreign investment.

The specific language of the MOFCOM decision was vague and generated quite a few questions, including speculation over post-deal restructuring by Yihaodian. If Wal-Mart couldn’t use the online platform, what would become of it?

Here’s the answer:

Yihaodian, a leading business-to-consumer company in China, recently received financial backing from one of its major shareholders — US retail giant Walmart. The company now plans to spin off its e-commerce channels for third-party transactions and integrate them into an independent e-commerce website called 1mall.com, the Shanghai-based First Financial Daily reports.

Before you say “Problem solved, let’s move on,” we should ask a further question or two about this restructuring. Specifically, I’d like to know what is being spun off, which corporate entities are involved, and what the post-restructuring will look like.

Sorry to do this again, but we have to revisit the somewhat complicated shareholding structure of Yihaodian that I outlined back in August:

1. Wal-Mart was a minority shareholder of a company called Niuhai, which has a Hong Kong offshore structure as well as one or more onshore subsidiaries. Niuhai is the entity in which Wal-Mart increased its shareholding.

2. Yishiduo is a Chinese company HQ’d in Shanghai that is the holder of the necessary VATS license required to operate the Yihaodian e-commerce platform. This is the VIE.

3. Presumably, Niuhai’s onshore company and Yishiduo have several contractual arrangements we all know and love, the basis of the VIE structure.

This is a classic VIE situation involving three entities: Wal-Mart (foreign investor); Niuhai (holding company); and Yishiduo (the VIE). Nothing new here.

Presumably, the proposed spin off primarily involves Yishiduo, which is the license holder. However, that entity may also have assets that Yihaodian/Wal-Mart will be using in the future, so that transaction might prove a bit more complicated that it appears from afar.

Here’s one complication: Yishiduo is a VIE, not a subsidiary of Niuhai. That means that the assets of Yishiduo are owned by one or more Chinese individuals or entities. These folks were no doubt part of the overall investment deal.

When we usually talk about a company being “spun off,” it means that a subsidiary or some of its assets are being reorganized into an independent entity, or at least independent from the current owner. But with Yishiduo, what we think of as the owner, Niuhai, actually doesn’t have any ownership stake whatsoever, just a series of contractual rights.

So how exactly is this spinning off supposed to happen?

If this were a “normal” deal, I would break this into two pieces. First, some of Yishiduo’s assets might be transferred (i.e., sold) prior to, or as part of, the spin off. If so, I would guess that they would go to one or more of Niuhai’s foreign-invested enterprises in China. I’ll call these the “Niuhai Assets.”

Regardless of whether there are Niuhai Assets to be transferred, the sensitive telecom/Internet licenses will remain with Yishiduo. Let’s call these the “Restricted Assets.”

Because the Niuhai Assets are not restricted with respect to foreign investment, there is no problem transferring them to one or more foreign-invested enterprises owned by Niuhai (and ultimately controlled by Wal-Mart).

Still with me? There are many different ways to do this (the above is merely one possibility), but if my speculation has any basis in reality, then the question remains: how to move these two classes of assets from the current VIE structure?

With respect to the Niuhai Assets, these are currently owned by Yishiduo and will be transferred to one or more Niuhai entities. As the ownership will change, this has to be done via asset purchase. The details and terms of this asset purchase might have been discussed when Wal-Mart upped its stake in Niuhai (also known as Yihaodian), or perhaps this was only decided in light of the MOFCOM decision. Either way, between Wal-Mart, Niuhai, and Yishiduo, the terms of that transfer would have to be worked out. Sounds messy to me, but if Wal-Mart wants to use the online platform, it seems like it needs to pull some stuff out of that existing entity.

As to the Restricted Assets, this may actually be easier than you think. The current structure is a VIE, which just means a Chinese company that has signed a bunch of contracts. How do you make a VIE independent? Well, the obvious method is to simply terminate those agreements. Contractual obligations go away, and the company is now on its own.

Sounds easy, but I have two questions. First, an accounting issue. If Yishiduo was a real VIE, that means Niuhai, insofar as its financial statements were concerned, was treating it like a subsidiary. When Wal-Mart upped its stake in Niuhai, therefore, the value of the VIE was factored into the purchase of that stake. So if all or part of the VIE will be spun off, that value needs to be recaptured. I’ve personally never come across something like that in an M&A deal, so I’d be curious to see what that ultimately looks like.

By the way, if you’re heading into an M&A deal that could trigger MOFCOM review, particularly when VIEs or foreign investment restrictions apply, you better make sure that your share purchase agreement plans ahead for this sort of thing. Fixing it later sucks balls, if you’ll pardon the legalese.

OK, second question to wrap this up. What relationship does Wal-Mart/Niuhai want to maintain with Yishiduo post-spin off, and do they need to worry about MOFCOM scrutiny? Yes, according to MOFCOM, Wal-Mart shouldn’t use that VIE to get into the e-commerce business, so the spin off needs to happen. However, how independent does that entity need to be?

If I’m Wal-Mart, I certainly don’t want Yishiduo competing against me. Even better would be some sort of mutually beneficial business relationship. Sounds fine as long as that relationship is kept at arms’ length. The closer any sort of contractual arrangement between Niuhai and Yishiduo becomes, though, the greater the risk that MOFCOM could step in and say, “Uh, guys, didn’t I tell you to cut out that VIE shit? You’re not fooling anyone, you know.” Something to think about moving forward.

Had enough? I’ll let you go. Too much legal jibber-jabber can fry the brain.

One thought on “Wal-Mart M&A: Yihaodian Restructures its VIE. I Still Have Questions.

  1. Aden Chen

    Be careful, Wal-Mart! Don’t ruin the VIE.
    It seems that MOFCOM is taking a second look at VIE, and like 东施 with 西施‘s makeups, she cannot afford a second look.
    Save the VIE!