Qihoo 360 is one of the most notable internet companies in the world and is currently embroiled in a global legal controversy, but chances are, you haven’t even heard of it.
December 31, 2019 /MarketersMedia/ —
Beijing’s bustling, yet posh, Chaoyang District is home to foreign embassies, a hip bar street and the 2008 Olympic park. But unknown to most, its growing business district is also home to China’s third largest internet company, Qihoo 360. From their Beijing office, Qihoo manages over 4,200 employees who develop anything from an antivirus software to browsers and apps, and even a new smartphone. Qihoo’s client base is roughly that of the entire population of Europe; over 600 million users in a country which just might be the largest economy in the world.
And this is no humble beginnings story, either. Qihoo was founded by Chinese tech-veteran Zhou Hongyi (nicknamed “Red Cannon” or “The Tiger”) and his longtime partner Qi Xiangdong. Hongyi seems unstoppable; valued at US$4.7 billion, he is among China’s first internet pioneers. In 1998, he founded company 3721 which helped convert Chinese-language words into Roman-alphabet for domain names. When 3721 was sold to Yahoo, he became CEO of Yahoo China and later, in the early 2000’s, he started several successful startups; Thunder Networking Technologies, Kugou, and Discuz.
In 2006, Hongyi founded Qihoo 360. Just 5 years later, it was listed on the New York Stock Exchange. Qihoo quickly became the third largest internet company in China after tech giants Tencent and Baidu, with an annual $22.2 million net profit and revenue.
But something odd happened in July 2016. As Yahoo Finance reported it, the company announced a privatization that valued shares held by U.S. investors at $77, reflecting a valuation of $9.3 billion. Qihoo and co-investors CITIC Guoan Group, Golden Brick Silk Road Capital, Sequoia Capital China and others led a move to merge Qihoo with “New Summit Limited”, an anonymous Hong Kong entity. U.S minority owners had no say in the matter; by the power of majority, big investors forced minority share owners to agree to the $77 valuation they set themselves in a vote and all shares were cancelled.
Then, in 2018, just two years later, Qihoo was relisted on the Shanghai Stock Exchange for a $62 billion valuation, a return of more than 550%. This irked the NYSE investors, who, since August 2016, are demanding compensation for what they consider an unfair process of liquidation and privatization.
A lawsuit on the matter is still ongoing in the Cayman Islands, where Maso Capital Partners LTD – a Hong Kong hedge fund which held $16.9 million worth of Qihoo 360 shares before the privatization, demand justice. The hedge fund managers lost $75 million (according to the Shanghai relisting) and they are not going to give up easily. Maso Capital is currently seeking $92 million in the Cayman Islands court, which were already put into escrow by Qihoo 360 per the court’s order. Fund managers say $92 million is but a conservative estimate of the shares’ true worth; a robust expert valuation could yield an even higher share price for Maso.
The privatization-and-relisting scheme is no new trick; financial experts dubbed this antic “The Chinese Loophole”. It essentially means listing a company on the NYSE, privatizing at a low valuation then relisting in China for a much-increased value shortly after. This is made possible through a simple process; through a public listing, a Chinese company taps into U.S. capital. Then, majority owners take the company private at a significantly cheaper valuation, squeezing minority investors out at a named price thanks to the power of majority in a vote. Shortly after, the company relists back home in China, at a much higher valuation but without adding real value in the form of products or assets, leaving executives with a big windfall.
Surprisingly, it’s not illegal. While the companies are listed in the U.S, they are classified as Foreign Private Insurers (FPIs), subject to regulation by their home country’s exchange and not by the SEC. FPIs are also exempt from corporate governance practices by which most publicly listed domestic firms must comply, including a requirement to host annual shareholder meetings. That said, if investors could prove in court that they were cheated out of their true shareholding, consequences for said companies could be catastrophic.
This is exactly why this move by Qihoo 360 and its investors is already causing Hongyi a major headache. The Cayman Islands lawsuit by Maso Capital has already created problems for Qihoo by forcing it to constantly navigate between the desire to keep IP and confidential information from the public eye, to avoid risking its tech and business, and complying with the court.
In one occasion, a request for discovery of documents by Maso Capital’s lawyers caused Qihoo to send its employees a WeChat message in Chinese, asking them to destroy documents. In another case, Qihoo 360’s lawyers told the court that “multi-billionaire chairman, Mr. Zhou, did not have a computer or any electronic device issued to, used by or available to him, and that he has never used a computer since setting up the Company in 2006”.
This does not bode well for Qihoo and management. The company is expected to continue growing in 2019-2020, with share price finally stable after major losses since February 2018, but between the court’s concerns for lack of transparency (the Cayman Islands judge deemed the company’s approach to the discovery process “somewhat careless and cavalier, resulting in incomplete and ineffective discovery. There are areas where the company has given inconsistent responses to requests”) and the company’s attempts to protect proprietary information and technology, investors could start pulling out.
It's your classic princess and the pea story, and this pea could prove quite burdensome.
Legal experts who are well-versed in the issue had one word in mind when talking to us about the issue – mediation. Maso Capital is seeking $92 million from Qihoo and Zhou Hongyi, a number which could rise significantly in court after full discovery and in-depth analysis. Mediation could be a good way for Qihoo to control what that number comes down to.
Many also wonder why management has allowed the case to go on for so long, embarrassing the company and its corporate co-investors at a time when investor trust is paramount for Qihoo. “Risks Outweigh Growth” announced Seeking Alpha about Qihoo 360’s financial future in May 2019, as huge investments in new tech have yet to be returned.
This is not a time to be gambling on the investors’ patience. Some analysts predict stock markets’ crashes in the foreseeable future due to collapsing interest rates in international economies. Some urge investors to invest in bonds, gold and Bitcoin. In this climate, stability is not to be trifled with.
A quick and effective mediation, if taken seriously by both parties, could allow Qihoo 360 to focus on what it does best – provide security solutions for its clients as a forerunner of the industry.
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