SMARTPHONES: Qihoo’s Coolpad Divorce: Real or Bargaining Move?

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Bottom line: Qihoo’s latest move forcing Coolpad to buy-out their joint venture could be a bargaining tactic to pressure Coolpad into ditching a separate tie-up with LeTV, and could spark a bidding war for Coolpad by Qihoo and LeTV.

Bidding war brewing for Coolpad?

Smartphone maker Coolpad (HKEx: 2369) has become a bit of a hot potato lately, though it’s not clear if the company is hot property or a pariah these days. The company was one of China’s earliest smartphone makers, and quickly built up share as a leading name in its fledgling home market. But rampant competition as others piled into the market hurt its prospects, prompting it to form a major equity tie-up with security software maker Qihoo (NYSE: QIHU) last December, and then with online video firm LeTV (Shenzhen: 300104) last month.

The LeTV tie-up surprised many, and led Qihoo feeling betrayed. Now Qihoo, whose equity tie-up came in the form of a joint venture, appears to be seeking revenge for that betrayal. In its latest move to express its outrage, Qihoo has just announced it will exercise a non-compete option in their agreement that will force Coolpad to buy out their joint venture at double the current market value.

Qihoo estimates the move will cost $1.5 billion, which looks quite steep for a company like Coolpad that’s already struggling due to the stiff competition in China. The timing of this move also looks a bit odd, since Qihoo just launched the joint venture’s first smartphones 2 weeks ago, with ambitious plans to quickly build up share in the China and India markets. (previous post)

All that leads me to believe that Qihoo’s latest move with the exercising of its “put call” is just a bargaining tactic, aimed at forcing Coolpad to dump its newer alliance with LeTV. Such a tactic could ultimately force Coolpad into divorcing LeTV, which formed its own tie-up by purchasing 18 percent of Coolpad last month for $280 million. (previous post)

All of this may be quite a bit confusing for readers unfamiliar with the situation, so let’s step back and take a closer look at the latest announcement from Qihoo in this brewing battle for Coolpad. According to its announcement, Qihoo has decided to exercise its put option forcing Coolpad to buy out Qihoo’s stake in their joint venture announced last December. (company announcement)

Expensive Price Tag

Qihoo now holds 49.5 percent of that joint venture, and paid $420 million the stake when it was set up. It set up the venture as part of its own bid to enter the crowded smartphone market to promote its own online products, including its popular security software and search engine. Coolpad’s motivation was more practical, as it needed the cash and a wealthy backer like Qihoo due to the intense competition.

In its latest announcement, Qihoo says the put option in their agreement requires Coolpad to buy out the joint venture for twice the fair market value of Qihoo’s stake. By its own estimates, that stake has grown sharply in value and is now worth $742.5 million, meaning Coolpad would have to pay $1.5 billion to buy out the venture.

Qihoo was also careful to add that there’s no guarantee that Coolpad won’t dispute the value of the joint venture, or try to dispute Qihoo’s move in court. All that returns us to my earlier conjecture that all of this is just a bargaining tactic to force Coolpad to dump LeTV and consider selling some or all of Coolpad to Qihoo.

Previous reports had indicated that Qihoo’s controversial founder Zhou Hongyi was actually considering such a move, after being surprised by LeTV’s investment last month. Another report last month said Qihoo was also considering abandoning an unrelated separate recent bid to privatize the company, meaning it might be planning to use its cash resources instead to make a counter-bid for Coolpad. (previous post)

We’ll have to wait to see how Coolpad and also LeTV respond to this move by Qihoo. As I’ve said above, Coolpad can hardly afford the $1.5 billion price tag that Qihoo says the buyout would require. But the cash-rich LeTV could probably afford that amount, and its quite possible LeTV’s equally feisty chief Jia Yueting could decide to spark a bidding war for ultimate control of Coolpad.

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