A group of investors in Chinese internet company got a rough lesson in the risks of doing business in the unpredictable and politically influenced business environment there. On Thursday, a website called 56.com went down without explanation. 56.com, which was one of three websites seeking to become the "Youtube of China," had received funding from Sequoia Capital and Disney's Steamboat Ventures. It had recently entered into a partnership with the National Basketball Association.
Senior executives at the company have not commented on the site's outage. A message on the site mentions a "server upgrade" in Mandarin. Many believe that the Chinese government shut down the site.
Years ago, before we built DealBreaker, we worked for clients providing acquisition funding for the purchase by a Chinese company buying a part of a major US tech company. The funding was collateralized by assets in China. Everyone involved realized that the collateral was likely worthless because it was uncollectible. The odds were very long that a Chinese court would ever allow western banks and hedge funds to take possession of high-tech Chinese manufacturing assets from a company partially-owned by the Chinses government.
This provided only minimally influential, however. In part, those providing the funding just weren't too worked up about the collateral. The company seemed likely to be able to pay off its debts, in part because of the backing of the government. But even more important, funding Chinese acquisitions of western companies was seen as a way to make inroads into the Chinese markets and win favor with the government.
Perhaps equally important, the deal was struck while the buyout boom was running very strong and credit was loose and easily available. We got the distinct feeling that many of the banks who were funding the loans thought that rules about collateral were silly. The banks made money on the loan origination fees and viewed their real downside protection as being able to sell to vulture funds that invest in distressed debt. Collateral was just old fashioned, something that needed to be in place for accounting reasons.
Even with the news of 56.com getting shut down, investor appetite for Chinese companies has hardly batted an eye (to mix clichés and metaphors). As Alley Insider put it, "the potential upside is so great, there seem to be plenty still willing to roll the dice."
A Chinese YouTube Disappears, Along With Millions Of Western Dollars. Next? [Alley Insider]