Review on the Impact the Negative List of China (Shanghai) Pilot Free Trade Zone may have on Foreign Investment in China’s Value-added Telecommunication Services
By Hai Huang｜Wu Wang｜Jing Gao
In August 2012, the U.S. retail giant Wal-Mart Stores, Inc. (“Walmart”) was approved to acquire a controlling stake in Yihaodian, one of China's largest online supermarkets under the condition that it divest itself of Yihaodian’s third-party platform business in order to comply with anti-trust decisions made by the Ministry of Commerce of China (“MOFCOM”). However, it was recently reported that[Endnote 1] , since new policies promulgated by the China (Shanghai) Pilot Free Trade Zone (“Shanghai FTZ”) have allowed foreign investors to hold more than 50% equity interest in third-party platform businesses, Walmart therefore established a joint venture company in Shanghai FTZ in November 2013, and has achieved its initial target of engaging in Yihaodian’s third-party platform business.
Did Walmart actually acquire control of Yihaodian’s third-party platform business by taking advantage of such break-through provision that foreign investors are allowed to hold more than 50% equity interest in third-party platform businesses in the Shanghai FTZ? This article will take a look at this question.[Endnote 2]
Before looking into this question, let’s first take a look at an overview of the acquisition deal between Walmart and Yihaodian.
I. The Whole Story
Based on relevant materials[Endnote 3] , at the time of Walmart’s investment in Yihaodian, the corporate structure of Yihaodian might have been a VIE structure shown as below:
For the purpose of this article, the companies shown in the above structure and their businesses will be collectively referred to as “Yihaodian.” In the above structure: (1) Niuhai Holdings Limited (hereinafter referred to as “Niuhai Holdings”) is the offshore financing vehicle of Yihaodian, which was the one invested into by Walmart; (2) Shanghai Yishiduo E-Commerce Co., Ltd. (hereinafter referred to as “Shanghai Yishiduo”) is the domestic operation company of Yihaodian, which holds and operates the online platforms of Yihaodian; and (3) Niuhai Information Technology Co., Ltd. (hereinafter referred to as “Niuhai Shanghai”) is a wholly foreign owned enterprise, which actually controls Shanghai Yishiduo through VIE agreements.
Control. In November 2011, Walmart decided to increase its stake in Yihaodian from 17.7% to 51.3%, which triggered the antitrust review in China. At that time, Yihaodian mainly engaged in two categories of business through its online platform www.yihaodian.com: the first was direct engagement in sale of goods via its own online platform (i.e. direct sale business, which does not fall into value-added telecommunication services); and the second was to provide online services for other transaction parties via its own online platform (i.e. third-party platform business, which falls into value-added telecommunication services). After their antitrust review, MOFCOM approved Walmart’s acquisition, but imposed restrictive conditions from the perspectives of both anti-trust and foreign investment policies, and required that Yihaodian divest itself of the third-party platform business while also prohibiting Walmart from engaging in this third-party platform business though VIE structure.
Divesture. Thereafter, in order to comply with the above requirements made by MOFCOM, Yihaodian on the one hand transferred its original online platform www.yihaodian.com from Shanghai Yishiduo to Niuhai Shanghai. On the other hand, Yihaodian divested its third-party platform business and transferred this business from Shanghai Yishiduo to Shanghai Chuanji E-Commerce Co., Ltd. (hereinafter referred to as “Shanghai Chuanji”), and used Shanghai Chuanji’s online platform www.1mall.com to continue operating the third-party platform business. Presently, there is no public information indicating the shareholder structure of Shanghai Chuanji, so we cannot identify whether there are any connections between Shanghai Chuanji and Yihaodian. According to relevant media coverage, this divesture has caused certain adverse effects on Yihaodian’s business and operation.
Integration. Despite the above divesture, Walmart did not give up on Yihaodian’s third-party platform business. On November 14, 2013, through co-investment with Shanghai Chuanji, Walmart established a joint venture company named Niuhai E-Commerce (Shanghai) Co., Ltd. (hereinafter referred to as “Niuhai E-Commerce”) through Niuhai HK in the Shanghai FTZ, which eventually combined the online platform for the third-party platform business (www.1mall.com) and online platform for direct sale business (www.yihaodian.com) into a new online platform operated by Niuhai E-Commerce (www.yhd.com). Thus, Walmart completed the integration of Yihaodian’s third-party platform business and direct sale business under one online platform. After the integration, the chart below may illustrate the corporate structure of Yihaodian:
Shanghai FTZ’s New Policy. It was widely reported in the media that there may be some connections between Walmart’s recovery of Yihaodian’s third-party platform business and the “Negative List” issued by Shanghai FTZ for foreign investment policy on September 29, 2013, which provides that: “[t]he proportion for foreign investors investing in commercial E-commerce business shall not exceed 55%, the proportion for foreign investors investing in other online data and transaction processing service shall not exceed 50% (“Shanghai FTZ New Policy”).”
China’s Existing Policy. In China, the business of “investment in E-commerce” and “other online data and transaction processing service” as mentioned above belongs to value-added telecommunication services. But before China became a member of the WTO, the foreign investment in the value-added telecommunication business had always been prohibited, until the promulgation of Catalogue of Industries for Guiding Foreign Investment (2002), which provides that:“ the foreign investment in value-added telecommunication services will have been allowed as of December 11, 2001 and the proportion of foreign investors shall not exceed 30%; no later than December 11, 2002, the proportion will be allowed to no more than 49%; no later than December 11, 2003, the proportion will be allowed to reach 50%.” Since then and until the latest Catalogue of Industries for Guiding Foreign Investment (2011), the restriction on the proportion for foreign investment in value-added telecommunication services has not been altered to exceed 50%.
Media Report. Media outlets made the assumption that since the establishment of Niuhai E-Commerce, the new joint venture company, was within two months from the issuance date (September 29, 2013) of the Negative List of Shanghai FTZ (it was established on November 14, 2013), and since Niuhai E-Commerce was located in the Shanghai FTZ, then they were probably correct in reporting that Walmart took back Yihaodian’s third-party platform business due to the break-through that Shanghai FTZ has allowed foreign investment to control the E-commerce business.
Our Understanding. It’s indicated by relevant materials that the shareholding of Walmart in Niuhai E-Commerce is only 50%, which does not exceed the current 50% restriction; therefore, we are not necessarily convinced that one can reasonably conclude that Walmart’s recovery of Yihaodian’s third-party platform business has a direct relationship with Shanghai FTZ New Policy. Also, we are not sure about the reasons why Walmart’s equity ratio in the joint venture company is only 50% under circumstances that the Shanghai FTZ has already allowed more shareholding. Although we can only speculate here, it might be due to the antitrust concern (e.g., if Walmart holds more than 50%, an antitrust review may be triggered), or it might be due to other reasons.
III. Impact of the Negative List of Shanghai FTZ on Foreign Investment in Value-added Telecommunication Services
A. Impact on Foreign Strategic Investment in Domestic Enterprises Engaged in Value-added Telecommunication Services
Although, Shanghai FTZ has not entirely lifted the restriction limiting foreign investors to no more than 50% equity interest in the companies engaged in value-added telecommunication services, and the restrictions have only eased in certain parts of this industry (e.g., app stores business of information service, commercial E-commerce business of online data and transaction processing services[Endnote 4]); however, the media frenzy surrounding the event of Walmart’s acquisition of Yihaodian might give other foreign strategic investors who expect to invest and hold more than 50% equity interest in domestic enterprises engaged in value-added telecommunication services and idea about how to accomplish this goal (e.g., a foreign investor can establish a joint venture company with the target company in Shanghai FTZ and transfer the business conducted by the target company to the joint venture company, so that to achieve its strategic investment in the target company).
B. Impact on VIE Structure
For more than ten years, the VIE structure has always been a principal investment manner for the foreign investors to invest in China’s value-added telecommunication services, mainly for the following reasons: (i) foreign investors are not allowed to hold more than 50% equity interest in value-added telecommunication services; (2) in practice, foreign invested enterprises experience difficulties obtaining the required Value-added Telecommunications Business License; (3) companies engaged in value-added telecommunication services experience difficulties obtaining financing through domestic channels (e.g., loans/private equity/IPO).
Even though Shanghai FTZ has allowed foreign investors to hold more than 50% equity interest in third-party platform businesses or some other value-added telecommunication services, and it is said that the joint venture company established by Walmart in Shanghai FTZ has obtained the Value-added Telecommunications Business License (No. He Zi B1.B2-20130004)[Endnote 5] which was issued by the Ministry of Industry and Information Technology of the PRC (“MIIT”), the following issues must be carefully noted: (1) in practice, MIIT rarely issues the Value-added Telecommunications Business License to foreign invested companies, despite the fact that MIIT issued the License to Niuhai E-Commerce, and (2) the equity ratio of Walmart in Niuhai E-Commerce still does not break the cap of 50%, therefore, it cannot be assured that all of such qualified foreign invested enterprises can obtain the Value-added Telecommunications Business License from the MIIT in the future.
It now seems that the impact of the Negative List of Shanghai FTZ which partly liberalizes foreign investment in value-added telecommunication services is not sufficient to break the dominant position of VIE structure in value-added telecommunication services area—the structure used by Walmart in its investment in Yihaodian can be deemed as a “direct investment structure,” which, compared with VIE structure, is not yet good enough to meet value-added telecommunication enterprises’ demand to list on oversea markets to get financing.
MIIT and Shanghai Municipal People’s jointly promulgated Opinions about Further Open Value-added Telecommunication Services in the China (Shanghai) Pilot Free Trade Zone on January 6, 2014, confirm that value-added telecommunication services will be further opened in Shanghai FTZ. Meanwhile, the implementation of the Provisions on the Administration of Foreign-invested Telecom Enterprises will be suspended, and pilot administration rules will be made in their place. While it is true that Shanghai FTZ has made a step forward in the reform of foreign investment in the value-added telecommunication services area it is not yet clear how much impact this step will have on foreign investment in this area, so we will keep an eye on it.
Mr. Hai Huang is a Beijing-based partner with Global Law Office who specializes in advising both foreign and domestic clients on the cross-border mergers & acquisitions, foreign direct investment, venture capital/private equity investment and equity offering on overseas capital markets. (E-mail: email@example.com)
Mr. Wu Wang is a Beijing-based senior associate with Global Law Office who specializes in merger & acquisition, private equity investment, venture capital investment, foreign direct investment, corporate financing, and corporate public offering and listing. (E-mail: firstname.lastname@example.org)
Ms. Jing Gao is a Beijing-based associate with Global Law Office who specializes in advising both foreign and domestic clients on the cross-border mergers & acquisitions, foreign direct investment, venture capital/private equity investment and equity offering on overseas capital markets. (E-mail: email@example.com)
Endnote 1: Please refer to Yihaodian breaches divesture dilemma: recovering platform business through Shanghai FTZ reported by Sina.
Endnote 2: The basic information for this article is collected from websites and other public channels. We cannot predict the truth and reliability of such information. If there is any mistake of such information, the conclusion of this article might be different.
Endnote 3: Including Announcement No. 49  of the Ministry of Commerce –Announcement on the Decision of Conditional Approval of Wal-Mart Stores Inc.’s Acquisition of 33.6% Equity Interest in Niuhai Holdings upon Antitrust Review of the Concentration of Business Operators.
Endnote 4: Please refer to Special Administrative Measures (Negative List) on Foreign Investment Access to the China (Shanghai) Pilot Free Trade Zone (2013) promulgated by Shanghai Municipal People’s Government on September 29, 2013.
Endnote 5: Please refer to Notice of Receipt of Value-added Telecommunications Business Licenses of the PRC – No. 19 and 20 Batch released by Telecommunication and Information Service Center of Telecommunication Research Institute of Ministry of Industry and Information Technology.