Voting for the exit

In many ways Yahoo and China’s Sina Corp are similar companies. Both started out as internet portals – and in the dotcom era both ruled the roost in their business habitat. But both were then beaten at their own games by younger and savvier rivals.

The rise of Google (and its superior algorithms) savaged Yahoo’s search engine business. Shareholders weren’t happy and in 2008 the web pioneer had to settle a nasty proxy fight with activist investor Carl Icahn, who campaigned for the sale of Yahoo’s core business to Microsoft. A truce was only reached after Yahoo ceded three board seats to Icahn, while promising shareholders better returns by unlocking the value of its minority stake in Chinese e-commerce giant Alibaba.

Sina is three years younger than Yahoo, but it consciously set out to copy the American firm’s model – so much so that its founders even debated whether to add an exclamation mark to the company’s name (i.e. like Yahoo!).

Sina also found itself outdone by Baidu, China’s answer to Google. Attempts to diversify into other internet services such as online video games were unrewarding too, although it did manage to develop a killer app that – like Yahoo’s stake in Alibaba – served as its crown jewel: its Twitter-like service Weibo.

Again like Yahoo, Sina is now having to deal with complaints from activist investors, with New York-based hedge fund Aristeia Capital pushing for an overhaul of Sina’s board of directors and an unlocking of value from the stake in Sina Weibo. This type of proxy fight is new territory for Chinese firms and the unfolding drama might persuade Sina’s peers to think twice about listing in America.

What has happened?

In the corporate world a proxy war is waged when a group of investors join forces to win a vote at a shareholder meeting.

Sina’s headache began in June when it received a letter from William Techar, a partner at Aristeia Capital, regarding “among other things, the company’s current market valuation” and requesting a meeting with the firm’s chairman and CEO Charles Chao.

The hedge fund had acquired a 3.5% stake in Sina but Chao didn’t take the meeting. Instead he sent company CFO Bonnie Zhang to meet with Aristeia representatives as part of a regular investor briefing in July. Reportedly the meeting didn’t go well and a few days later Aristeia informed Sina that it would seek the support of other shareholders to add two directors to the board to push for corporate governance changes.

Representatives from the two sides then began to contact each other more frequently, leading to a meeting between Chao and Techar late last month in Hong Kong.

Aristeia has demanded that Sina take a number of “value-enhancing actions”, which include a more ambitious share buyback programme or the handing out of more shares in its separately listed social media unit Sina Weibo.

After private talks failed to heal the rift, the row was made public by Aristeia last week when it issued a press release calling for a public proxy contest. The battleground is Sina’s 2017 annual general meeting in November, at which Aristeia says it will campaign for other shareholders to support its call to expand Sina’s board with its two nominees.

There’s still time for the two sides to reach a truce, although the American firm has since upped the ante by calling for more drastic measures such as an outright sale of Sina, a reverse merger with Weibo, a repurchase of up to $1 billion of Sina shares, or a disposal of part of the more valuable Weibo unit.

Does Aristeia have a strong case?

It is not uncommon for Chinese firms listed in the US and Hong Kong to come under attack from short sellers over sluggish performance and poor corporate governance (see WiC370).

But Aristeia says it has no track record as a troublemaker, stressing that this is the first time it has ever engaged in a proxy contest. It also says that shareholders need more of a voice on Sina’s board, which currently comprises five people: Chao (with a permanent seat) and four independent directors, who all have tenure of more than 13 years at Sina.

“None of these directors are truly independent. Equally concerning is the fact that only one incumbent director stands for re-election each year,” the fund complains.

The hedge fund also claims that an “entrenched” and “insular” board has failed shareholders with a number of critical governance shortcomings over the years.

These mistakes include approving or taking part in “unnecessary share issuances to related parties”, including transactions in which Chao has used “borrowed funds to opportunistically purchase hundreds of millions of dollars of Sina stock”. Aristeia is referring to a controversial placement in November 2015, which saw Sina raise $456 million by selling new shares to Chao.

The sale reinforced his position as Sina’s biggest single shareholder with an enlarged 17.9% stake at the time.

The shares were priced at $41.49 apiece and Sina’s stock has since rebounded to more than $112 (as of this week).

But Aristeia believes the internet firm is still undervalued and that management is

“perpetually disregarding and overlooking an array of options available to unlock value”. Its position is that new directors are needed to remedy the situation

and it has launched a website (www.sinashareholdersaction.com) to present its case on “why change is needed at Sina”.

How has Sina reacted?

So far it has shown little sign of backing down in the face of Aristeia’s demands. “We urge our shareholders to discard any proxy materials sent to you by Aristeia and to vote ‘against’ the Aristeia nominees,” it has advised. “We believe that Aristeia’s proposed plan will not create sustainable shareholder value, but will instead consist of financial engineering manoeuvres that will introduce substantial risk to your company, including certain proposals that are simply not feasible.”

Although Aristeia is one of Sina’s top five shareholders, the social media firm described it as lacking long-term commitment, saying the fund had “traded in and out of Sina’s shares over the last few years”.

Moreover, Sina says that it would be inappropriate for a 3.5% shareholder to control nearly 30% of the board (should Aristeia succeed in grabbing two extra directors seats).

Concerning the share placement to Chao in 2015, Sina countered that its chairman was purchasing the shares at an above-market price at a time when the company’s stock was under pressure. “He did so in an effort to increase shareholders’ confidence,” the company explained in its investor communication (Caixin Weekly noted that back in 2015 Chao’s move stoked speculation that he was preparing to take Sina private and relist the internet firm in China’s A-share market).

Sina’s defence has hinged on what it perceives as Aristeia’s poor understanding of the Chinese market. “Aristeia and its two nominees lack the relevant skills, experience and understanding of Sina, the China market and public companies operating in the internet and media industries in China,” it said, adding that Aristeia’s plans could be potentially destructive by creating long-term risks, even if there was a short-term gain in the stock price.

“The board determined that the Aristeia nominees would not add any skills or experience not already well-represented on the current Sina board and believes the Aristeia nominees would seek to implement a risky, short-term interest-driven and potentially long-term value destructive process for Sina and its stake in Weibo,” the statement said.

Is Sina undervalued?

Yahoo bought a 40% stake in the then unlisted Alibaba in 2005 for $1 billion. The stake was later reduced to 15% following the internet titan’s record-breaking IPO in New York in 2014 but analysts have wondered what Yahoo is really worth without its Alibaba investment.

Sina faces a similar situation with Weibo. Rather like Yahoo’s investment in Alibaba, 21CN Business Herald says that the popular social media platform is one of the few things that Sina has done well for its shareholders recently. The market capitalisation of Sina stands at $8.1 billion as of this week after an 85% surge this year (in line with the rise in the share price of internet majors such as Alibaba and Tencent). However, Weibo, which went public in New York in 2014, is now worth more than $21 billion after climbing nearly 140% this year. So the 46% stake in Weibo owned by Sina is worth $9.6 billion. That is to say it is more valuable than the parent.

The discount in the share price is even more troublesome, Aristeia has suggested, because Sina has 72% voting control in Weibo thanks to a dual-class shareholding structure (similar to Alibaba’s listing structure). The hedge fund believes Sina’s net asset value (NAV) is no less than $14.1 billion but that its shares are now trading at a staggering 41% discount.

The problem is that Sina’s aging portal business hasn’t kept pace with the more vibrant Weibo. And over the longer term, Sina hasn’t matched some of China’s other internet firms in performance either. According to Aristeia, Sina’s shareholders have seen their investment nearly double over the past 10 years. But shareholder returns for Tencent during the same period were 4,027% or 1,464% at NetEase. “Sina has dramatically underperformed the companies it compares itself to in its public documents,” Aristeia complains.

What is next for Sina?

Strangely, the proxy fight in the US has solicited limited interest in China. On Zhihu, China’s answer to Quora, a question on why Aristeia has picked on Sina has resulted in only eight replies. “Sina is overvalued but not undervalued. The prospects for its core business would only dim further as years pass by,” one of the Zhihu commentators suggested. “A reverse takeover of Sina by Weibo? Who would go for such a bad deal? Jack Ma would be the first to say no,” another claims, referring to Alibaba’s 20% stake in Weibo.

The Public Opinion Centre for Listed Companies of China, a think tank focused on corporate governance, is one of the few local observers that has taken the case seriously. Indeed a researcher from the think tank predicts that more shareholder actions are anticipated at underperforming firms, especially those with a fragmented shareholding structure such as Sina.

Analysts have also been talking about an A-share return for Sina. However, a buyout of its New York-listed shares would require the unwinding of its so-called “variable interest entities” (VIEs) – the opaque shareholding structures that help companies to skirt the rules on foreign ownership in Chinese assets (see WiC197). VIEs are a particular favourite of internet players (technically foreign investors cannot own Chinese internet firms). In fact, they have been dubbed “the Sina model” because the company was a pioneer in using them when it went public in New York in 2000.

Since then these shareholding structures have emerged as “China’s strangest export”, the Economist wrote recently. Investors outside China have about $1 trillion invested in firms that use VIE vehicles to shift sensitive assets “such as operating licences into special legal entities that are owned by Chinese individuals, usually the firms’ bosses”, the magazine warns.

How does it work? The companies sign contracts with the VIEs to guarantee that the offshore listed entity is paid by the operating company in China. Critics of the structure say there is always a risk that the firms concerned won’t honour their obligations.

Worse, the Chinese government’s attitude is hard to fathom. It tolerates the existence of VIEs while making it plain in a Damocles Sword-like fashion that it could declare them void anytime it pleases. (That said, analysts reckon the authorities would be reluctant to do so, as the impact on foreign investor confidence would be huge – Alibaba and Tencent both use VIEs).

In fact, the VIEs make things a lot more complex for activist investors. Aristeia, like all foreign shareholders, doesn’t directly own equity in Sina’s operating company – it owns shares in the VIE, or service company.

Sina says that the VIE structure makes it harder to carry out some of the restructuring measures that Aristeia has proposed. What the firm hasn’t directly said is that Chao and his partners are in a position to prove disruptive should the proxy battle be lost. Why? Because they’re part of the entity holding key licences for the operating businesses.

However, if the experience of Yahoo is anything to go by, Chao might steer Sina towards an outright sale to another internet firm. After numerous proxy fights, Yahoo’s time as an independent company came to an end in June when Verizon completed its bid to acquire its core internet assets. Should Sina go down a similar route, the likely acquirer is Jack Ma’s Alibaba. At the right price, this might be an outcome that both Chao and Aristeia could live with. But for now, the dispute rumbles on…

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