Xunlei backs out of IPO due to market volatility

The company had set a price range of $14-16 per share, but announced in a regulatory filing that Thursday that it would not proceed with the offering, citing volatile market conditions.

Xunlei recorded a net profit of $25.7 million in 2010, with revenues primarily driven by online advertising and cloud-based subscription services. Yet the company is best known for its download software that allows users to manage and share digital content. The proliferation of illegal file-sharing and copyright infringement led to it being sued in 2008 by six Hollywood studios and CCTV, China's state broadcaster.

The principal shareholder is Vantage Point Global, a company owned by Xunlei founder Sean Zou, with 27.5%. Morningside, IDG and Ceyuan hold 24.6%, 12.2% and 11.3%, respectively. Minor shareholders include Google, with 2.8%, and, reportedly, Rupert and Wendi Murdoch.

According to Reuters, investors may also have been put off by two aspects of Xunlei's listing, both of which are outlined in the IPO prospectus. First, the company admits to a material weakness in its accounting resources and ability to comply with US GAAP and US Securities and Exchange Commission reporting requirements. Second, the Cayman-incorporated company that is Xunlei's listing vehicle controls the China-based assets through Shenzhen Xunlei, a variable interest entity (VIE).

Neither of these issues is unusual and they haven't prevented IPOs in the past. However, accounting deficiencies have come under the spotlight in the last year or so as a number of US-listed Chinese firms that went public through reverse takeovers have been exposed as frauds. This has had a detrimental effect on all firms, including those whose financial statements haven't been questioned.

Companies such as Xunlei use a VIE because direct foreign ownership is not permitted in China's internet industry. The Cayman company controls a wholly foreign-owned enterprise (WFOE) that runs the Chinese business and receives profits from it as dividend payments. The VIE is a parallel company owned by Chinese nationals and holds the business licenses - and the WFOE's economic interest is secured through five legal agreements.

VIEs have been in question ever since they were outlawed from the third-party payment space. Last month, it was reported that the China Securities Regulatory Commission (CSRC) had called on the State Council to take action against the structures.

The government is unlikely to invalidate existing VIEs and investors tell AVCJ that, while they are following developments, they are not unduly concerned by them. For some months now, lawyers have been exploring alternative structures - that either coexist with VIEs or backing them up - that are intended to operate independently of the regulators and lock in investors' economic position.

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