AdChina’s IPO Reveals Worries Of Foreign Investment In Chinese Internet Sector

AdChina Ltd., an Internet advertising company in China, has issued its draft prospectus for an eventual initial public offering of its Cayman Island entity on Nasdaq under the symbol ADCN.

The company claims in its Form F-1 filing that its online platform reached 486 million monthly unique visitors and 249 million monthly mobile unique visitors in December 2011. Those data come via a February 2012 report by DCCI, a China-based Internet data search agency.

While the company last year recorded over USD50 million in revenue, its net losses hit USD18.56 million. The company faces competition from better-financed search engine Baidu and dozens of other online advertising networks, but AdChina says its strength is in helping advertisers in the increasingly-fractured online media market and helping publishers with their under-monetized pageviews in China.

Chinese laws limit foreign ownership of advertising companies in China. Therefore, AdChina provides its services via a variable interest equity entity relationship with two of its Chinese companies — New E-Media and Yihong.

This VIE arrangement is a contractual relationship that can potentially be severed, leaving investors with limited ability to see the company directly generate revenue in China. New E-Media is 91% owned by AdChina’s founder, and 9% owned by the founder’s wife. Yihong is 95% owned by the founder, and 5% owned by the company’s chief technology officer. All three owners are, respectively, Chinese citizens.

Advertising companies until recently could only be majority-owned by Chinese citizens. However in 2008 this law was changed and foreign companies could thereafter create wholly-owned advertising businesses in China, but only if their offshore company has at least three years of direct operations in the advertising industry as their core business outside China. If a foreign company instead wants to create an advertising joint venture in China, they need only have operated their ex-China company for two years, but that entity still needs to have advertising as its core purpose.

In response to the above, AdChina states in its draft prospectus: “We are a Cayman Islands company and a foreign legal entity under PRC laws. We have not directly operated any advertising business outside of China and therefore, we currently do not qualify under PRC regulations to become the shareholder of a PRC subsidiary that engages in providing advertising services. Accordingly, our PRC subsidiary, Kendall, is currently ineligible to apply for the required licenses for providing advertising services in China. Our advertising business is operated in China by our consolidated affiliated entities, New E-Media and Yihong. They are both owned by individual shareholders, who are PRC citizens. They both hold the requisite licenses to provide advertising services in China. We do not have any equity interest in our consolidated affiliated entities but effectively control them, and receive the economic benefits from them, through various contractual arrangements.”

Goldman Sachs Asia and Credit Suisse Securities are listed as underwriters on the offering.