Buying a Chinese Internet Stock? You Might Want To Read the Fine Print Very Carefully

So, you thought perhaps the Chinese achieved their economic miracle through naivete? There is a perception in investment circles that buying Chinese securities is a way to get in on the Asian boom. Those who are actually familiar with Chinese government policy and cultural norms will tell you that they dont like giving up much influence to outsiders, of whom you are most likely one, let alone actual control.

Research is starting to show that the chances are investors are not buying equity in an operating company domiciled in China, as they would in a US or European company.

Joe Weisenthal reports in Business Insider:

"The current crisis facing Yahoo -- which just saw one of its prize Chinese assets slip through its fingers -- should make all investors in Chinese equity sit up straight.

We said yesterday that everyone should be asking themselves: What do you really own, when you buy stock in these companies?

So to start, you're not buying a Chinese company. You're getting a Cayman Islands company, which through a series of subsidiaries is connected to companies in Beijing that actually operate and run the business. But at least your Cayman Islands company owns those companies, right? Not really.

The F-1 explains:

We do not have an equity interest in 1Verge Information or Jiaheyi. However, as a result of these contractual arrangements, we are considered the primary beneficiary of 1Verge Information and Jiaheyi, and we treat them as our consolidated affiliated entities under the generally accepted accounting principles in the United States, or U.S. GAAP. We have consolidated the financial results of these companies in our consolidated financial statements in accordance with U.S. GAAP.

So your Cayman Islands company doesn't own the equity. It's just connected through contractual relationships, which in an ideal world would be a perfect analogue for equity (hence treating them as consolidated entities). The full post at StoneStreetAdvisors delves further into the contractual relationships, which is murky stuff that the average investor thinking they're buying the "YouTube of China" or the "Facebook of China" is never going to appreciate. But again, if even Yahoo can lose out -- and they own a stake directly in an actual Chinese company -- everyone's guards should be higher.