Caixin
Nov 01, 2017 10:16 AM
DOING BUSINESS IN CHINA

LeEco Offers Lessons in Dangers of Driving With Turbo-Charged CEOs

What a difference a year makes. That may sound cliché in many cases, especially here in China where things change so quickly that a year can sometimes seem like an eternity. But nowhere is it truer than at the corporate basket case known as LeEco, the former online video superstar that this week is officially “celebrating” the one-year anniversary of its spectacular fall from grace.

In honor of that occasion, I thought I would explore some of the lessons learned from this case, arguably the biggest and fastest downfall ever of a major private high-tech company here in China. When the dust finally settles, I have little doubt that LeEco will become fodder for numerous business textbooks as a case study of how not to do things in China, or anywhere else for that matter.

As a longtime follower of such companies, I’ve always marveled at how they operate and seem able to do anything they want with little resistence from investors or business partners until things go wrong. That said, let’s focus on some of the many red flags that LeEco, also known as LeTV in an earlier life, was sending out before it headed into its downward spiral a year ago. It was at this time last year that charismatic founder Jia Yueting first admitted he may have bitten off just a little more than he could chew, and things went steadily downward from there.

For anyone less familiar with the story, LeEco was one of the first Chinese companies to make a serious play at online video, which has successfully challenged the older establishment of state-run broadcasters. The company was doing just fine when about three years ago Jia suddenly went into a major expansion drive that took his company into new energy cars, smartphones and sports entertainment, among many other things.

That drive included major capital-raising and a few acquisitions along the way, which investors were more than happy to fund as Jia pledged his own shares as collateral to help the breakneck growth. Not surprisingly, the debt burden quickly became too heavy and a spectacular downfall ensued, ultimately ending in Jia’s ouster in July by a new investor who is now trying to salvage the company.

In talking with a few business strategy consultants, the biggest lesson from this mess is to be wary of companies that expand too quickly into unfamiliar areas. That was certainly the case with LeEco, and it’s also quite common with Chinese private companies in general. There’s often a bandwagon effect here in China where everyone rushes into new product areas, even when they have little or no relevant experience. One of my contacts once described this as people being bitten by the Chinese bug that says “There’s money to be made, and not a moment to be wasted”. It seems that Western concepts of things like strategic planning and market research are for foolish and indecisive in this climate.

Beyond this bigger lesson, there are also a number of other warning signs that investors and business partners can watch out for when working with this kind of company. Many of the easiest simply require a little research to find out whether the company’s top ranks are filled with independent thinkers, or simply people there to feed the ego of a charismatic and often headstrong founder.

Two of my contacts pointed out that a company CFO is one of the best places to start. Most often the CFO is brought into a company a year or so before going public, and thus is more a seasoned financial professional than a founder who may lack such monetary sense. But in some cases such CFOs are brought in mostly as window dressing, and it’s quite obvious such people basically do whatever the founder tells them to get a desired effect in the balance sheet and financial statements.

That said, there are some company founders who really do understand the importance of surrounding themselves with smart people who are independent and not afraid to speak their mind. Those are often the safest choices for both investors and business partners. Clearly that wasn’t the case with LeEco, where Jia was apparently viewed as a god within his own company.

Who’s in the Boardroom?

Along similar lines, another warning sign can often be found when a company’s boardroom becomes filled with people whose life mission is to nod their heads to the chief’s will. One such case is now taking place with stalwart web portal Sina Corp., which is fighting a proxy battle with a dissident shareholder trying to get one of its own independent nominees onto the company’s board.

Another red flag to watch for is when a public company starts using its funds to invest in areas unrelated to its core business, for example, when the founder of an e-commerce firm suddenly finds an appetite for sports teams or real estate. In such instances, investors can insist on a “ringed fence” approach that forces the founder to make such investments using other vehicles. LeEco is a classic case that lacked such a ringed-fence, since there’s not much evidence that the finances of its listed company were kept separate from its many other newer endeavors that got it into trouble.

At the end of the day, one of my contacts summed it up quite nicely when he said: “Could investors have protected themselves? I am not sure they wanted to, understood, or cared.” That quite succinctly describes what happened in LeEco’s case and with lots of similar ones in China, namely that investors and business partners let greed get the better of them and simply put their heads in the sand to avoid seeing the obvious warning signs.

Such an approach may work for a while, especially for those who know when to pocket their gains while things are still going well. But for the big majority of us who aren’t so good at such timing, the better approach is to look for the warning signs early, and simply avoid such companies.

Doug Young has lived in Greater China for two decades, including a 10-year stint at Reuters, where he led China corporate news coverage. Send your questions or comments to DougYoung@caixin.com.


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