Why Tencent’s Golden Share Arrangements Could Be Worse for Investors Than Alibaba’s

While Alibaba's golden share arrangement was relatively limited, the same is unlikely to be true for Tencent. The company's corporate structure is likely to expose it to a more meaningful intervention

Tencent are reportedly in talks with regulators about its golden share arrangements. The company is likely to have a harder time than fellow internet behemoth Alibaba in limiting the influence of the arrangement, to the detriment of shareholders.

Golden shares are a way for the Chinese government to exert more control over the country’s internet firms, and look likely to be a permanent part of the operating landscape. They give Beijing board seats and certain veto rights, but importantly only in the actual units where the stakes are held. That means the impact of the golden shares varies depending on where they are placed and what they cover.

How much control Beijing takes from their stake varies based on the industry and corporate structure the company has employed. For a company like Weibo that operates almost exclusively in social media with a relatively simple VIE structure the stake is in their main VIE, and thus impacts the entire business. Alibaba on the other hand has managed to get their two golden shares in smaller units with a much smaller impact on the company’s core business.

While there is still a lot we don’t know about how the government thinks about these golden shares, they seem to follow something of a pattern. In general they favour taking one stake instead of many, but they want to make sure they cover all of the relevant online services. We see this in the government making sure they cover the ICP licenses needed to run these services in the stakes they take.

The government does seem to show some restraint in how they take their golden shares, adopting more of a scalpel than a hammer when possible. We see this in Bytedance, for example.

While the easiest solution for the government would have been to take a stake in the company’s top-level VIE (Douyin Co., Ltd.), making sure they exert control over the entire business, the golden share is actually in a subsidiary (Beijing Douyin Information Service Co., Ltd.). This is still a higher level entity, and seems to cover all the necessary ICP licenses and operations, but it’s not strictly speaking the entire business.

But while a scalpel treatment of sorts is possible, Tencent might be in a structural position that means they have to get the hammer nonetheless.

Firstly, the company’s VIE utilisation (how much business is in and runs through their VIEs) is much higher than Alibaba’s. Tencent’s VIEs account for around 47% of total revenue as opposed to 13% for Alibaba, according to the annual reports. It would be possible to do a significantly more detailed comparison if both filed under US standards, or if HK starts requiring the same levels of disclosure. But alas.

The nature of the company’s business also means the government is likely to want a say in a larger part of the core businesses, but the biggest issue is likely structural. While many internet company’s have a more distributed model, with licenses held in specific business units, Tencent seems to have adopted a more centralised approach.

According to records for their online service licenses it seems almost all core assets are held in their main VIE (Tencent computer), which means that, unless there is some restructuring, this is likely where the government would have to take its golden share, if it follows the same general method as before.

This is not great for shareholders. At the best of times VIEs already concentrate power in the hands of company insiders, and are therefore bad for minority shareholders in the listco. This is part of the reason why you want to structure the business away from VIEs and into the equity owned subsidiaries. Adding a government stake with veto rights in the main part of the business isn’t ideal from a corporate governance perspective, and should be avoided if at all possible.

The good news is that there does seem to be some leeway from the government to control or limit where the golden shares are taken. The bad news is that this likely has to happen before the arrangement is solidified, and companies are unlikely to be prepared for this. Investors should push companies to take action on this early, to make sure any changes take minority interests into account.

I’ve long argued that we should be working with VIE structures and risk limitation from a corporate governance perspective on the board level. The golden share arrangements now risk exacerbating the downside risks associated with poorly managed VIE structures, but perhaps it’s the type of key event needed to start taking the issue seriously.