eHi IPO - On the Road, Off the Rails

(Editors Note: In early October, Huxiu ran a story on eHi's less than salient numbers breakdown and questionable car services sector. The following article reprises the findings of that story in light of eHi's impending IPO.)

1. The Inside Track

Today, Friday the 14th of November, Chinese car rental company eHi (一嗨) has its IPO. The offering is set to raise USD $100 million and is expected by some to reach as much as $200 million. Start line share prices range from $12.00 - $14.00.

Despite its public listing on the NYSE, questions and concerns about the legitimacy of eHi's business—which Huxiu covered here—remain.

Founded in 2006, eHi is China's 2nd largest car rental company and is intent on overtaking current market leader China Auto Rental, now CAR Inc. (神州租车). Last October, eHi submitted a prospectus to the Securities and Exchange Commission (SEC) in the United States in preparation for their IPO. eHi filed for USD $100 million with JP Morgan, Goldman Sachs and Deutsche Bank as underwriters.

By Q2 2014, eHi's rental fleet size was just over 15,400. 14,300 of these belonged to eHi's car rental sectors, and 1,149 went to providing a private chauffeur service. eHi did not disclose the book value of the fleet, though it is surely not greater than the carrying value of its 1.4 billion yuan of fixed assets. The prospectus also suggests eHi operates in 90 cities and directly manages 760 outlets.

2. Hogging the Road

eHi claims the rank of "No. 1 car services provider and No. 2 car rentals provider in China," and says it has "generally maintained a car rental fleet utilization rate of over 70%." However, alleged high occupancy rates and low revenues present contradictions, and greater controversy surrounds eHi's car services.

Based on assertions of a 70% occupancy rate of its vehicles—which it compares to CAR Inc.'s 60% occupancy rate—eHi purports higher operational efficiencies over its competitor. However, revenue data does not support this conclusion. In the first half of 2014, CAR Inc. reported short term rental (Note: rentals 90 days in length or less are defined as short term) operating revenues of 1.38 billion yuan, with an average of 38,800 yuan per vehicle, given a fleet of 35,602. eHi's revenues over the same period were 268 million yuan. With 14,300 cars, and an average of 18,800 yuan per car, this only amounts to a 48.5% occupancy rate.

A 12.5% statistical nudge is one error, but unlawful business practice is quite another.

As China's premier car service provider, car services are integral to eHi's ability to turn a profit. But what exactly do 'car services' entail? eHi itself describes these as "chauffeured car services [provided] primarily to corporate clients, which consist of corporations of all sizes and government agencies. [...] Our car services include routine services such as airport pickup and drop-off, inter-office transfers and other business transportation needs, as well as event-driven activities such as conventions, promotional tours and special events."

The brief goes on to explain that in 2013, eHi derived an estimated 33.4% of its net revenues from its car services business.

This is a key stat. The revenue generated between car rental and car services is basically split 70-30. In 2013, that 33.4% amounted to RMB 566 million; in the first half of 2014, eHi's revenues reached RMB 384 million, with car services (chauffeuring) again accounting for about a third, 30.4%.

Though the numbers could be solid, discerning investors will pay attention to the cracks in eHi's model.

It is unclear if the eHi employees that facilitate car rentals are doubly the drivers chauffeuring services. This may not sound an unreasonable extension of labour, but in fact both a) providing a car rental employee as a chauffeur service driver and, more significantly, b) simultaneously operating a car rental and car service business within the same company is illegal in some of the cities of eHi's operation.

3. Licence and Registration, Please.

In China, strict regulations stipulate all businesses involved in operating vehicles (and drivers of those vehicles) must possess the licences to do so. For example, to apply to establish a taxi service in Beijing in accordance with municipal regulations, the Administrative Department for Industry and Commerce must first sign a pre-approval and register all business units and individuals involved in the outfit. Then, a written application must be forwarded to the Municipal Traffic Administrative Department with relevant supplemental documents that require authentication. Within 30 days of the application's receipt, the Municipal Traffic Administrative Department will issue an approval or rejection—qualifying applicants will receive a business licence.

In addition to business licences, taxi drivers (and similar professionals, such as chauffeurs) must obtain certificates to work as such. A sample of the many conditions would-be Beijing taxi drivers have to meet includes being in good health, having held a driver's licence for more than 3 years, complying with laws and regulations, and obtaining official certification vis-à-vis an examination held by the Municipal Traffic Administrative Department.

While the above regulations apply specifically to Beijing, different provinces and municipalities may enforce different rules. In response to this varying terrain, eHi acknowledges that it works in some zones without all necessary licences—in a word, illegally. eHi conducts operations without official licences, and employs drivers who drive without certification.

eHi concedes in its prospectus it is subject to obtain certain permits, licences, filings and other regulatory requirements. It states that the car rental and car service industry in China is still maturing, and cites a lack of national laws or regulations pertaining directly to this industry, minus a few official notices issued by the Ministry of Transport.

eHi notes that permits and licences are explicitly required for road transportation and taxi businesses, yet argues that regulatory boundaries between car rental, car service, road transportation and taxi businesses are blurred. Contending that it is neither a taxi or road transportation business, eHi refutes the need to obtain licences for either.

Succinctly put, potential investors (who read the prospectus) are warned, "Primarily as a result of the inconsistency in local rules and practices as described above, we have not met all of the qualifications and regulatory requirements in all of the provinces and cities where we currently operate our car rental businesses."

(Ed: It is a bewildering logical disjunction to hold that rules do not apply to you while simultaneously admitting your business runs in violation of the law...)

4. Jumping on the Bandwagon

Feasibly, eHi takes on these risks, skirting ambiguous legal conditions as it does so, in pursuit of perceived opportunities for growth in the market. According to industry consultant Frost & Sullivan, China's car rental market grew in terms of revenues from RMB 9.4 billion in 2009 to RMB 26.7 billion in 2013 (amounting to annual growth of 29.8%). Frost & Sullivan project further growth through 2017 to RMB 51.0 billion (annual growth, 17.6%).

Likewise, the car services market has grown from revenues of RMB 1.3 billion in 2009 to RMB 3.0 billion in 2013, and is expected to grow to RMB 5.2 billion by 2017.

The demand for car rentals and car services is legitimate. Whether the business providing these is legitimate too, that is another matter. In a country with strict government oversight, especially of corporations, the CCP's tacitness on eHi is somewhat surprising. Presumably, the Party Machine has a clear view of eHi's offenses—albeit for the moment it appears the CCP upholds the pretense of the company's credibility.

Though currently free from government interference, if eHi does have knowledge of risks that might befall its enterprise—say, if the government decides to move against its unlicensed drivers or freewheeling service outlets—it is obliged to report those risks to potential investors.

In the extensive Risk section of its prospectus—strung out in practiced legalese—admission of eHi's violation of the law is scant, but nevertheless present. eHi posits that "the PRC legal system is based in part on government policies and internal rules (some of which are not published on a timely basis or at all) that may have a retroactive effect. As a result, we may not be aware of our violation of these policies and rules until sometime after the violation." A wink and a nod, perhaps, but nothing concrete.

eHi put these risks in slightly more explicit terms under the heading:

Failure in obtaining all of the requisite permits, licenses or making all of the requisite filings or registrations or meeting other regulatory requirements for operating car rentals and car services business in China by us or any third-party service provider who cooperates with us may subject us to fines or other administrative actions.

Naturally, eHi does not forthrightly say it conducts its business outside of the law. The same rationale of "the inconsistency in local rules" is used along with the fact of eHi's rapid expansion to explain that "we have not obtained, made or timely renewed all of the requisite permits, licenses, filings or registrations for our business operations or fully complied with all other regulatory requirements applicable in the cities in which we currently operate our car rentals and car services business," and "We cannot assure you that we will obtain or successfully renew all of the requisite permits and/or licenses, make all of the requisite filings or registrations or set up all necessary branches in a timely manner, or comply with all other regulatory requirements in the future."

Penalties for any business caught operating without a licence can reach RMB 100,000. Failures to obtain proper permits, licences and filings can also be hit with an RMB 100,000 fine, or up to ten times the amount of illegal income per violation.

With an IPO projected for between USD $100 - $200 million, such punitive measures pose little more disincentive than slaps on the wrist. For the time being, eHi is set to ramp up business, though under the hood risks abound from illicit component parts. Investors are ultimately cautioned against being taken for a ride.