China's LeEco set out to change the world. Its failure has changed China

Key Points
  • Jia Yueting, founder of Chinese tech company LeEco, had sought to build a company that would become a global leader in electric cars, digital streaming, and smart devices
  • Plagued by cash shortages and questioned about accounting practices, LeEco took on emergency funding and handed over the reins to a new management team
  • Now, Chinese regulators are cracking down on companies that share attributes with LeEco, including the promotion of the "sharing ecosystem" — a once-popular term in China
Jia Yueting, LeEco founder, gestures as he unveils an all-electric battery "concept" car called LeSEE during a ceremony in Beijing, China April 20, 2016.
Damir Sagol | Reuters

Jia Yueting, the 44-year-old founder of Chinese tech company LeEco, once envisioned building a Chinese empire that would rival U.S. tech giants Netflix, Tesla and Apple all together.

With that vision, Jia quickly expanded his company from a video streaming portal to a multinational conglomerate, or a "sharing ecosystem" as he called, selling products from televisions to cloud computing; from smartphones to electric vehicles. In January 2016, the company rebranded itself from LeTV to LeEco — short for Le Ecosystem — in order to reflect the founder's global ambition.

It hasn't worked, and instead it turned into a multibillion-dollar quagmire that has rippled through the halls of Chinese power.

Fall from grace

In fact, it was Jia's grand ambition — what he and others called a "sharing ecosystem" that is "way far ahead" — that finally triggered the fall of the the once flamboyant tech icon, former employees and outside experts told CNBC.

The high-flying company was brought down to earth both domestically and internationally, largely because of its heavy reliance on debt to fund an ever-increasing stable of projects, which mostly failed to pan out.

One former LeEco employee, who asked to remain anonymous so as not to damage their reputation, pointed to that gamble when reflecting on the company's struggles.

"Jia's strategies for the company have always been extremely advanced, but those require extreme executions," the woman, who previously worked in LeEco's U.S. office, told CNBC.

"It's rare for ordinary companies or employees to execute strategies perfectly, not to mention that the company was experiencing such a rapid expansion," she said.

Other companies were all laughing at us.
A former LeEco employee

By the end of 2016, the rapidly expanding firm had become a force of nature with a highly sophisticated structure. Aiming to build a totally integrated ecosystem — that could see proprietary content playing on LeEco apps hosted on a unique digital platform and played through the company's own hardware (ranging from phones to smart cars) — LeEco quickly developed 15 subsidiaries and 68 affiliated parties.

Additionally, while LeEco was still largely unknown to American customers and its services were not widely available until December, 2016, that didn't stop the company from building a stateside presence.

In June, 2016, the company bought 49 acres in Santa Clara from Yahoo and claimed plans to hire 12,000 local employees, aiming at building its global headquarters in Silicon Valley. For comparison, Facebook only houses just over 9,000 employees at its Menlo Park headquarters, while Google employs roughly 20,000 people in the Bay Area, according to reports from earlier this year.

"It's okay to be optimistic, but you can't exaggerate too much," said another former LeEco employee, who worked at the company's Hong Kong office last year.

"Other companies were all laughing at us," the former employee told CNBC in a phone interview, also requesting anonymity. "How do you jump from 200 jobs to more than 10,000 jobs by 2018? That's bigger than Facebook!"

LeEco moves its headquarters closer to Apple
LeEco moves its headquarters closer to Apple

The source said he quit his job last year after feeling disappointed at the company and disheartened about LeEco's future.

"LeEco is a very hierarchical company but the person on top doesn't understand the market besides China. He [Jia] is doing too much but his knowledge set is not that strong," said the former Hong Kong-based employee. "Plus, the talents hired are not strong and not necessarily talented. What can money do? Money does not solve strategy and money can't buy talent."

But even money slowly became a problem.

While local media outlets in Silicon Valley scrambled to report on the newcomer's aggressive expansion plan in the region, investors back home started to worry about LeEco's financial health.

Red flags

Beginning in 2016, domestic Chinese media outlets, along with social media posts on Sina's Weibo and Tencent's WeChat started to point out red flags in the earnings report of LeEco's Shenzhen-listed unit.

That division, Leshi Internet Information & Technology, said in its full-year 2016 report that it had accounts receivable — money owed for goods and services already provided — of 8.68 billion yuan ($1.28 billion), an increase of 5.32 billion yuan ($783.79 million) from the prior year.

That same year saw revenues jump only 8.93 billion yuan ($1.31 billion), so the increase in accounts receivables made up nearly 60 percent of Leshi's total top-line growth.

Meanwhile, the listed unit was running a negative operating cash flow for 2016 of 1.07 billion yuan ($157.64 million), which was 221.97 percent worse than the prior year's, the company said.

So with surging accounts receivables and plummeting cash flows, LeEco was running out of cash.

I heard people were ringing the bell in the India office. There were ad agencies coming to ask for payment but we didn't have money to pay them.
A former LeEco employee

Beyond that, the soaring value of transactions with parties connected to LeEco also resulted in wide suspicion that Leshi may have been using accounting tricks to report exaggerated sales figures.

In 2016, Leshi reported that sales to affiliated parties reached 11.78 billion yuan ($1.77 billion), representing a 655 percent increase from the prior year while counting for more than half of the company's total revenue.

Fearing the risks of LeEco's cash problems, investors started to flinch by selling off Leshi's stock. By the end of 2016, the company's share prices plummeted by as much as 55 percent from a 2015 record high, and fell an additional 14.3 percent in 2017 before the company requested to halt trading.

"I knew the company might face cash flow problems around July last year [2016]," recalled the former employee of LeEco's Hong Kong office. "I heard people were ringing the bell in the India office. There were ad agencies coming to ask for payment but we didn't have money to pay them."

Reached for comment, a LeEco spokeswoman declined to comment on the claims of mismanagement, suspect accounting and a cash crunch.

A domino effect

In late 2016, Jia admitted that the company was facing acute financial troubles. Soon after that, things grew worse for LeEco, leading to a domino effect: The company stopped its electric car manufacturing plant in Nevada; revealed its plan to sell the company's Silicon Valley headquarters and cut hundreds of jobs; and cancelled its purchase of U.S. TV maker Vizio, resulting in the latter filing a $100 million lawsuit over a buyer-termination fee.

Amid mounting negative news about suppliers suing LeEco for nonperforming debts, a Shanghai court ruled on July 3 to freeze 1.24 billion yuan ($182 million) of assets held by the tech conglomerate and Jia due to defaulted payments on a loan to China Merchants Bank.

A few days later, Jia resigned from all his posts, including as the chairman of Leshi, and said he would instead focus on building LeEco's car unit — Faraday Future, a would-be Tesla competitor.

Among headline-making lawsuits and a damaged reputation, Leshi was handed over to an entirely new management team, with Sun Hongbin, the chairman of Chinese property developer Sunac, named the new chairman.

Sunac — highly indebted itself — had invested $2.4 billion in emergency funding to LeEco earlier this year in exchange for shares in the core television and film business.

The downfall of LeEco served as a lesson to Chinese regulators, who recently started to watch closely for the so-called "sharing ecosystem" and crack down on suspicious affiliated-party transactions.

Beijing steps in

In early October, Chinese newspaper 21st Century Business Herald cited industry sources in Beijing saying that the China Securities Regulatory Commission (CSRC) had begun to request that listed companies disclose more information and reduce affiliated-party transactions.

According to the newspaper, one source mentioned that CSRC has started to tighten regulation toward tech companies with complicated corporate structures or numerous affiliated parties.

"The risk that LeEco exposed has taught the entire market a lesson, and regulators have already started to look into affiliated-party transactions in the name of the so-called sharing ecosystem," the source told 21st Century Business Herald.

Such a trend can be seen from the latest bans ordered by the CSRC, which barred five insurers in early October, including the powerful HNA Group's Bohai Life Insurance, from conducting financial transactions to their parent companies.

Jia Yueting, LeEco founder, poses for a photo in front of a logo of his company in Beijing.
Jason Lee | Reuters

The CSRC has also tightened the process for approving initial public offerings, requiring stricter accounting standards, capital requirements, and disclosure rules. Data published by the CSRC showed that the IPO approval rate stood at 80.99 percent by the end of the third quarter this year, which was down nearly 10 percentage points year-on-year from 90.96 percent in 2016.

CSRC appears to have even stricter standards in the fourth quarter of the year: The IPO approval rate declined to merely 56 percent since new members of China's Issuance Appraisal Committee took office at the end of September. On Nov. 7, the committee gave the nod to only one out of six IPO applications, setting the lowest daily pass rate since 2015, according to Reuters.

"Regulations over compliance audit have become much stricter recently," a source working for a securities brokerage firm in Beijing told CNBC.

"The overall IPO approval rate has fallen to a nearly 10-year low," he added, requesting anonymity for professional reasons.

LeEco's future

Now, with LeEco still trapped at the center of the storm,

Jia is said to have stayed in the U.S. since his resignation and he has remained relatively silent, leaving debt-holders and LeEco employees back in China wondering where he is and when he will return.

Last month, a Chinese tech news outlet reported that Jia intends to file for bankruptcy for Faraday Future in the U.S. and then sell it to American investors.

LeEco's spokeswoman denied any Faraday Future bankruptcy.

But no matter whether Jia continues to lay low, or he eventually makes a comeback with Faraday Future, one thing is clear: The term "sharing ecosystem," once an emblem for China's global expansion and multinational conglomerates, is now a red flag for Beijing.