(Chinese Version)

It seems that everyone knew it all along it’s just a matter of time that LeEco would eventually run of cash. Leshi, the so-called Chinese Netflix, has changed its brand name to LeEco to mark its ambition. The company has been burning great amount of cash and over expanding to build an ecosystem, acting like a mad man going straight for his goal without giving much thought about anything else. Nobody really understands LeEco’s strategy. LeEco is now the most controversial Internet company in China while being the top one share on the second-board market.

Jia Yueting’s recent internal letter to employees has erupted a major earthquake in the business world. TMTpost has reported this earlier in the story Jia Yueting Admitted LeEco’s Overexpansion And Said To Cut His Salary To One Yuan To Save Money For The Company. It seems Jia Yueting still had a lot to say, and did reveal more in a later interview.

I have concluded Jia Yueting’s words and the core information can be paraphrased into six short aspects:

The company is going to lay off some staff and adjust the organizational structure.

LeEco is going to comfort suppliers whom the company still owes money to, telling them that the company is thankful for their support and hoping that they will continue to support LeEco.

The company will take all means to stabilize the share price as it influences the cash flow, which is LeEco’s backbone since the priority is to uphold the interests of the listed company(Le.com).

Jia Yueting’s own money, cashed from the share market through multiple ways, has run out, and that the company has spent over ten billion already.

LeEco, who was planning to be listed in the U.S and swore to achieve an evaluation of 100 billion in 2016 and 170 billion in 2922, had failed in finding financing.

LeEco falls short of financing while LeEco’s sub ecosystems like its automobile business have trouble finding financing from major organizations, and therefore has to rely on its own cash flow to operate.

What really intrigues us is how come LeEco, the rapidly expanding company that just gave a big press conference in the U.S., is reflecting on itself now. LeEco has always been short of cash, but why does it reflect on these issues now?

To find the answer, we can look back at the three major events that took place last week first:

1. LeEco is failing to pay its suppliers. Rumor has it that the amount we are talking about here is as much as ten billion. Although on November 3rd, LeEco had made a statement that this is all rumor, denying all the allegations. But the internal letter by Jia Yueting tells a different story. What the letter suggests is the situation is actually very serious now. LeEco’s stateoment on the 3rd this month already emits a sense of panic. The company even threatened to undergo penal process to clear its name, which is not something a big company body like LeEco would speak of, as if handling the justice system is like playing in its own backyard.

2. LeEco’s official page on Weibo posted a politically incorrect post.

3. The most serious event is the slump of LeEco’s share price. The closing price of LeEco last Friday slumped to ￥40, making its valuation shrink to the ten billion scale. On November 7th, one day after Jia Yueting sent out his internal letter, the share price kept falling since the opening. Within just half an hour since the opening, its share price had fallen by 5%.

LeEco had never given so much thought about the A-shares in the recent two years after the company initiated its ecosystem project until today. On November 9th 10:00 am, LeEco even had a meeting with investors from the A-shares.

“This is a grand game that would fall like domino in the very beginning. Eventually it entered its last but also most interesting phase,” Yuan Jian wrote in On Chinese Securities Market, commenting on D'Long’s peak time.

A-shares is the the core cash source for LeEco

LeEco’s internal financial model that generates money with money is the core business model of LeEco.

Many of my friends would ask me when discussing about LeEco if I think LeEco is actually a Ponzi scheme, a question reflected in a trending article recently. In my opinion, what sets LeEco from Ponzi scheme is whether LeEco will deliver what it has promised, such as its sports, automobile and smartphone project. If LeEco could really keep its promises, then it’s not a Ponzi scheme since it does in fact deliver what it has promised. But if it fails to do so, then it’s another story. But there can’t be a conclusion yet since everything is still ongoing. Anyhow, I want to compare LeEco to D'Long instead.

D'Long was the LeEco, or even more glorious compared with LeEco, on the second-board A-shares market at that time. D'Long built a closed-loop game that generated cash with cash within its own system through financial planning, acquiring corporate shares, and industrial integration. But D'Long turned out to be a big failure for its unstable ecosystem as one part of the structure shook the whole tumbled. The higher D'Long climbed, the harder it fell. Unless it can bring about a grander capital game that fights poison with poison.

Speaking of A-shares, everyone might be impressed by Jia Yueting’s classic cash-in methods in the recent years.

According to incomplete statistics on Jia Yueting’s cash-in record on the A-shares market, Jia cashed in ￥5.7 billion in total in 2015. On June 3rd 2015, Jia cashed in by ￥2.5 billion while getting ￥3.2 billion on October 30th. That’s how Jia Yueting got his ￥10 billion personal fund.

Besides the crazy moves on the ecosystem layout and all those press conferences, people rarely saw the issues that have shown from the company’s operation in this year. It wasn’t until the coming out of this internal letter that the industry goes crazy about the issues behind. Almost half of the letter was talking about non-listed companies serving listed company, which is quite astounding to many people. But still it appears to everybody that LeEco’s survival is reliant on the money from A-shares investors.

LeEco is just like D’Long, using money to generate money within its closed-loop ecosystem. If we were to say D’Long didn’t have good looking figures on the primary market, then it’s even worse for D’Long on the secondary market. It went off the track and chased after hot money. D’Long utilized the connection between the mid-process of issuing and circulation and the secondary market to achieve a leveraging loop. LeEco, on the other hand, made use of the secondary and primary market.

This is how the loop works: Selling listed companies’ share at high price to cash in—SPO—factoring—cash in——>lending the cash to listed companies—investing in other subsidiaries within the ecosystem—bringing up subsidiaries’ financing——> subsidiaries inject the revenue into the listed companies to bring up the share price through doing ecosystem relevant businesses, while transferring losses to subsidiaries——>after bringing up the share price, continue SPO—cash in—financing through factoring——>lending to listed companies—investing in other subsidiaries—bringing up the financing of subsidiaries. That’s LeEco’s cash-in loop.

That’s the financial model that generates money with money, and the core business model of LeEco. This loop lets every subsidiary of LeEco achieve a positive cash flow loop and profit independently without needing listed companies to loan for new fuel. This is LeEco’s model.

Therefore, it’s all about when LeEco’s subsidiaries can achieve that model, when the A-shares listed company would end its high growth and when the cash flow of the A-shares listed company’s core businesses would tumble.

But jut like what Jia Yueting has stated in the open letter after doing an interview with Tencent, LeEco didn’t realize that subsidiaries would achieve positive cash flow so fast.

What caused it to happen earlier than expected? The big slash of the A-shares and the capital chain of listed companies’ core businesses took place earlier than Jia Yueting’s expectation.

What I couldn’t figure out before was why LeEco chose the automobile sector as its entry point into the global market. If LeEco was really aiming for going global, then it should have undergone what LeTV had gone through before——start with buying American contents’ copyrights. LeEco’s successful models in China are all based on content.

Still, LeEco does have actual products in China that are related to its content business and TV business. If we were to say LeEco’s ecosystem is a game of filling holes while digging more holes, then the company’s content and smart TV business are the filled ones. However, LeEco still needs to fill out other holes it has dug since it can’t really walk with giant holes on the ground.

The reality is LeEco didn’t choose to do so, but instead put its most expensive project, the automobile project, in the U.S and started its globalization there, continuing to dig more holes. A little known fact is although LeEco has bought many copyrights internationally, but most of them are copyright purchase for the Chinese market, not the American market. International copyright sellers have strict restrictions over regions. Without enough capital, personnel, resources, and accumulation on automobile core technology patents, it’s quite odd for LeEco to choose the automobile sector as the starting point.

I would sometimes ask my friends at LeEco about the company’s globalization plan, but none of them really gave me a satisfactory answer.

It was actually Jia Yueting’s open letter and transcript on his interview with Tencent that kinds of clear out the mist for me: This is a typical method that companies use to transfer the capital out.

On November 18th 2015, LeEco sent out an internal letter to its staff, saying that the company would give out 50% of LeEco Global’s shares to the staff.

Zhang Zhiwei stated when launching the Lepad Project in early 2015 that professional organizations had estimated that the valuation of LeEco Global would hit over ￥100 billion in 2016, and that the subsidiaries were undergoing financing. The letter also said that the valuation of the subsidiaries would reach ￥108 billion in 2016, ￥200 billion in 2017, ￥350 billion in 2018, ￥570 billion in 2019, ￥950 billion in 2020, ￥1300 billion in 2021, and ￥1700 billion in 2022.

Their original plan was to set up LeEco Global and find financing and listing opportunity in the U.S.

But apparently, Jia Yueting has spent all of the 10 billion fund within one year, and now the company is bleeding cash while failing to gain recognition from international capital. It’s evident that no American investor is willing to take over this hot potato. An apparent result is that Jia Yueting’s capital in the country has been transferred through pledging, loan, and cashing in through A-shares etc. in China.

But of course, it remains unknown what are the reasons for Jia Yueting’s capital transfer besides LeEco’s internationalization.

What we do know now is Jia Yueting is changing his lines when speaking of relevant matter. In July this year, Jia Yueting acquired American TV maker Vizio, on which he commented that LeEco’s capital structure is divided into two parts——the listed one, Le.com and the private one, LeEco Global. The latter would be in charge of LeEco’s global businesses and the businesses of local private companies in China. This acquisition was completed by the private company LeEco Global.

However, in recent interview with Tencent, he told the journalist a different structure: “LeEco’s capital structure consists of three parts, the listed one, whose core businesses are video content, cloud and TV businesses. And then it’s the LeEco Global, which is the company’s private system. Then we have the automobile part, which is an independent sector.”

Le.com is problematic already

The amount of direct and indirect financing has already hit over one hundred billion RMB for the company, which is definitely not the having-trouble-finding-financing case.

To keep LeEco’s ecosystem stable, the core lies in keeping the cash source safe and sound. What Jia Yueting worries the most right now is not finding money to pay suppliers, or the fact that the subsidiaries haven’t achieved positive earnings yet, but all the problems hidden inside the listed company Le.com.

Jia Yueting claims that Le.com lacks capability to find financing, but the truth is the industry sees it as a financing-driven company, quite the contrary of what Jia claims to be. So who’s opinion is more accurate?

Let’s take a look at four sets of data first, collected and sorted by TMTpost:

1. Le.com’s secondary market direct financing record(including issued shares, SPO, and issued bonds)

Direct SPO record: The total amount of SPO so far is ￥6.03 billion. The total amount of SPO planned by the board is ￥11.82 billion.

Bond issue record: ￥200 million in May 2012; ￥200 million in July 2012; ￥200 million in September 2013; ￥1 billion in August 2015; ￥930 million in November 2015; less than ￥3 billion in 2016. The total amount of issued bonds would surpass ￥5 billion.

IPO record: the very first IPO in 2010 raised around ￥700 million. Le.com has raised a financing of over ten billion in total with another 11.8 billion planned.

2. Jia Yueting’s private equity pledge record

Private equity can be categorized into two usages: First, it provides financing for the subsidiaries on the primary market, serving as a guaranty for financing and VAM; as security guaranty when subsidiaries of Le.com are borrowing from financial organizations. In some way, it can be described as indirect financing.

3. The primary market financing record of LeEco’s subsidiaries(most of which are still under development)

The following is record collected and edited by TMTpost:

These are the incomplete data TMTpost attainted on the primary market financing situation of LeEco’s subsidiaries. The total amount is around ￥20 billion.

4. Detailed guaranty record of Jia Yueting and Le.com’s

The record shows most guaranties have expired in 2016 or are about to be expired, with very few, one or two of them will be expired by the end of 2017. The rest of guaranties must be paid in the first half of 2017. The amount TMTpost has added into the incomplete statistics is about ￥40 billion.

5. Record on subsidiaries’ factoring

LeSports:

LeCloud:

The five records mentioned above show the direct and indirect financing the listed company has raised is around ￥100 billion. It’s not convincing at all to say LeEco is not good at financing at financing and capital operation looking from these statistics. Of course, LeEco has made guaranty, pledge, as VAMs, and therefore indirect risk from the debts is very high.

If we don’t count all these financings as direct liability, then we could look at just how much direct liability Le.com has.

All the numbers on Le.com’s Q3 fiscal report this year look stunning, stating that Le.com has achieved a revenue of ￥6.732 billion, a year-on-year growth of 71.99%. The report also says a net profit around ￥209 million go to the shareholders, an increase of 70.55%. In the earlier three quarters this year, Le.com made a revenue of ￥16.796 billion, a year-on-year growth of 100.54%. Le.com attainted a revenue of ￥493 million that belong to the company, which is a 30.75% jump compared with last year. The report claims the roaring revenue growth is contributed by the hot sales of smart TVs, income from member subscription, and advertising.

Despite the good-looking figures, greater risks are also just lurking around.

1. The asset-liability ratio is too high. In the earlier three quarters in 2016, investors have been providing interest-free loan for Le.com and the company has raised part of its funding. The fiscal report shows that the company’s asset-liability ratio surges skyhigh due to the factors mentioned above and the influence of bank loans and its business credit. By September 30th 2016, the company already had a loan of nearly ￥19 billion, among which ￥2,986,486,000 were short-tem loan and ￥2,248,802,700. The company also has a one-year non-current loan of ￥60,368,100, with an asset-liability ratio of 65.72%. While the company’s loan and asset-liability ratio are looming large, the company still has to deal with the interests that come along.

2. The inventory risk on Le.com’s supply chain is also problematic. The inventory volume of the company in 2015 and by the end of September in 2016, had been ￥1,138,787,400 and ￥1,847,968,200. The inventory has been on the rise as the inventory by the end of September in 2016 grew by 62.28% compared with that in late 2015. If it continues to grow at this speed, the inventory growth by the end of 2016 would be around 100%. Le.com claims that the inventory is mostly terminal products and the growth could be attributed to the terminal sales and the continuous expansion of the online store business. The sales model has transformed from pre-order+spot-goods to spot good centric. “If the market is going to have a big shift in the future, that might bring about losses from the falling price.”

3. What I was talking about above are only tangible assets. That said, while the inventory of hardware terminals would only continue to surge, the intangible assets also determine the cash flow of Le.com.

By September 30th 2016, the amount of Le.com’s intangible assets hit about ￥6.1 billion, accounting for 21.26% of the total asset, which is quite high. This is mainly caused by an increase of purchased copyrights. “If the copyrights Le.com purchased could not cash in in time, the company’s intangible asset would probably suffer losses as more new TV shows emerge. That will affect the company’s operating cash flow,” read Le.com’s Q3 fiscal report.

The decline of intangible assets could be a great threat to Le.com in accordance with Le.com’s principle on income.

Even income that is accumulated through over one year is counted as one year’s income. That’s why we are seeing absurd subscription models like 50-year membership.

Different from real estate companies that focus on asset, Le.com’s direct asset-liability ratio of 65.72% is incredibly high. The cash flow might also go down due to the inventory and the decline of intangible asset. Other risks include due guaranty and the pledge of shares from direct financing. The harsh reality is that Jia Yueting’s cash-in business(Le.com) is losing its capital chain.

The demise of D'Long

D’Long also had similar expansion plans in order to “fight fire with fire”.

2014 is a crucial year for LeTV’s rapid expansion. Although LeTV fell into a huge financial and credit crisis after it admitted its involvement in a corruption case, it miraculously survived the crisis nevertheless. However, instead of becoming more prudent and conscious, LeTV changed completely and began to expand even more crazily.

I learn that Jia did attempt to negotiate with some major investors when he was hiding overseas, but they all declined to invest in in LeTV, whether because its valuation was too high, or due to various other reasons. However, under such circumstances, Jia not only didn’t let others take over, but instead initiated even bolder expansion plans even when the cash flow was tight. Within the past two years, LeTV managed to build a comprehensive ecosystem, covering seven major fields.

When we look back on D’Long’s original capital accumulation model, we might find it quite simple to understand: buying and reselling legal persons’ shares in the primary and secondary market. However, by the end of 1996, the stock market underwent catastrophic change and stock price plummeted. At that time, Tang Wanxin was forced to post additional margin, otherwise he would be held in a close position.

Worse still, it was at that time the central government began to rectify financial order, comb out financial leasing companies’ capital business in all major stock exchanges, and required financial leasing companies whose license had expired to re-apply for license. According to Wang Hong(D’Long’s senior executive)’s court statement, D’Long’s insolvency reached 100 million RMB (over $14.7 million), its total debt reached 420 million (over $61.8 million) by the end of 1996, while its total asset was merely around 300 million ($44.1 million).

In other words, Tang Wanxin’s D’Long was on the verge of bankruptcy. However, in order to survive the crisis, he chose to “fight fire with fire”, as he later admitted in court. At the Dayuan Meeting held in 1997, also referred to as “Zunyi Meeting for D’Long”, they made an even bolder decision and started doing capital acquisition business for state-owned asset. By a series of tricks (capital embezzlement, bond, bond insurance, etc.), Tang managed to raise 5 to 7 million yuan within only nine months. Indeed, D’Long survived the 1996 crisis, though with even greater hidden dangers.

Tang’s ability to maneuver capital as well as his courage were quite stunning even when we look back. By 1998, D’Long had already controlled a huge bunch of state-owned asset. By the end of 2003, D’Long had become dominant shareholders of over 177 companies. Its annual revenue reached over 40 billion yuan (around $5.9 billion), while its annual tax reached nearly 2 billion yuan (over $290 million). It even owned traditional assets such as farms and mines.

D’Long’s maneuver was already quite stunning at the turn of the century in China, though venture capital was still less-known then and D’Long integrated the industry merely through the secondary market.

However, by the end of 2002, the bankruptcy of D’Long’s China Tech became the first Domino to usher in D’Long’s ultimate demise. Although it managed to survive for another two years, D’Long finally met its demise and became part of the history after failing to overcome all kinds of crisis and meet the needs of all its clients along the supply chain.

It is our most sincere wish and LeTV won’t meet its demise and become part of the history now. Perhaps, there’s still opportunities out there.

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[The article is published and edited with authorization from the author @Zhao Hejuan, please note source and hyperlink when reproduce.]

Translated by Garrett Lee (Senior Translator at PAGE TO PAGE), working for TMTpost.