Rising From The Ashes

Retailer Rebounds From A Devastating Fire

Forty-Year-Old Business Targets 50-Year-Old Women

Welcome to Porter & Co. Distressed Investing, edited by Wall Street’s Dean of High Yield, Martin Fridson.  To learn how distressed investments like this one help us take advantage of “The Greatest Legal Transfer of Wealth in History,” see the complete Guide to Distressed Investing on our Reports page. In addition to hosting Distressed Investing on our website, we also make it available as a downloadable PDF on the Issues & Updates page here.

The tabloids called it the “Graceland of Graft.”

From the outside, it didn’t look especially exotic – it could have been any seven-story, red-brick building in the southern port city of Xiamen, China. Inside, though, the Red Mansion – the secret lair of China’s most-wanted man in the 1990s, international smuggler Lai Changxing – was a pleasure palace straight out of old Hollywood.

Room 404 boasted a private 30-seat movie theater. Room 305 featured a state-of-the-art gym with massage tables. And Room 601… well, that was the Presidential Suite, where honored guests could sneak through a private entrance and spend quality time with any girl they liked… the ladies were all 5’6” or taller, and all answered to “Miss Temporary.”

The amenities at Lai’s $17 million den of iniquity weren’t limited to sex, drugs, and rock ‘n’ roll. Lai Changxing could get Red Mansion visitors anything they wanted: luxury cars, seed money to start a small business, a huge sack of gold jewelry, or (for one hard-to-bribe dignitary) thousands of dollars’ worth of calligraphy artwork. 

In return for this smorgasbord of favors, Lai expected his vast network of contacts – over 300 highly-placed authorities and port officials – to look the other way as he smuggled alcohol, weapons, oil, and cars through Xiamen customs without paying any import fees. His preferred method was to label the shipping containers as a non-luxury item like “wood pulp.” Between 1995 and 1999, he smuggled in goods worth 27.4 billion yuan ($4.35 billion) while not paying the duties of 13.99 billion yuan that he owed.

For a while, it worked… until one of Lai’s many contacts flipped on him and took a 74-page packet of evidence to Premier Zhu Rongji, a hard-line Communist Party official who’d made it his mission to crack down on corruption.

Lai didn’t kowtow without a fight. He fled China on a speedboat in August 1999, evaded capture in Canada for 12 years, and was eventually extradited back to China and thrown in prison for life. (14 of his high-ranking buddies weren’t so lucky – they received a death sentence for participating in “a criminal ring engaged in smuggling and bribery.”)

According to Lai, though – who today is behind bars somewhere in Fujian Province – he never did anything wrong. He’d just worked the system. The guanxi system, to be exact.

News stories at the time described Lai’s network as “the biggest test of the guanxi system’s reach.” Guanxi (pronounced “Gwonk-see”) is hard to define – it’s so woven into Chinese culture that it’s almost invisible to the naked eye. It’s a web of close, warm interpersonal relationships based on an exchange of mutual benefits – but it’s less formal than the Western concept of “networking.” As one Chinese businessman put it, “’You [Westerners] spend money on lawyers. We spend money on restaurants.”

Like yin and yang, guanxi has both a light and a dark side. It can metastasize into a tangle of complex corruption… or it can create life-giving, naturally profitable relationships. (Lai Changxing and law enforcement had a slight difference of opinion on where that line fell.)

The seeds of guanxi are found in ancient Confucian thought, in the fifth-century B.C. Book of Rites: “What the rules of propriety value is that of reciprocity. If I give a gift and nothing comes in return, that is contrary to propriety… All sources and roots of disaster and disorder come from failure in returning grace.” Guanxi is a system far older than the Chinese Communist Party – communism has tried, unsuccessfully, to replace the intimate “friend” with the more businesslike “comrade.” It’s also tried to regulate the practice of guanxi with levels of favors deemed “appropriate” and “inappropriate.” (Hiring “Miss Temporary” falls in the “inappropriate” column.)

Though officials like Premier Zhu Rongji may try to drive guanxi underground, it never truly goes away. Guanxi remains the nurturing lifeblood sustaining much of Chinese commerce.

And not just commerce behind the Bamboo Curtain…

Today, thanks to an innovative tech company called Taobao, guanxi (in its positive form) is spilling over into the Western world, too. It arrives just in time to save several industries from a glut of impersonal sales pitches and artificial-intelligence (“AI”) chatbots.  

Personal Business 

Taobao was steeped in guanxi from the start. A tiny spinoff of Chinese e-commerce site Alibaba – run by maverick billionaire Jack Ma – the fledgling online auction site, founded in 2003, focused on facilitating communication between buyers and sellers, rather than on capturing a quick buck. That ethos paid off when Taobao drove bigger Western rival eBay out of China with its tail between its legs.

At first glance, eBay held all the cards. After snapping up China’s biggest auction site, EachNet, for $180 million in 2003, eBay – already a $77 billion juggernaut with 95 million users worldwide – launched a full online presence in China in 2004, with a streamlined user experience and a sleek (for 2004, anyway) website. Tiny Taobao – operated by a handful of tech nerds in a rental apartment – didn’t stack up impressively, at first glance. (eBay’s CEO Meg Whitman referred to it dismissively as one of many “small competitors nipping at our heels.”)

Trouble was, eBay didn’t understand guanxi… and Taobao did.

Following its established business model, eBay kept tight control of its platform in China, insisting that buyers and sellers communicate anonymously through the paid eBay storefront. Taobao, however, opened up a laid-back forum and encouraged users to share email addresses and get into direct contact with each other. eBay also operated under a Western definition of “user-friendly” that wasn’t intuitive for Chinese audiences. eBay’s “clean” site model required that users type in complex Chinese characters to search for products – while Taobao’s “cluttered” site – designed to mimic the layout of a Chinese department store –  allowed customers to click on pictures and save time. 

Crucially, while eBay operated under a pay-to-play model, Taobao offered the first three years of its services for free. By doing their audience a big favor upfront, they figured – correctly, as it turned out –that they’d create a sense of obligation down the road. (The mutual back-scratching of the Red Mansion comes to mind.) 

Two years into the eBay-Taobao race, eBay’s user satisfaction level, at 62%, had dipped below Taobao’s at 77%, and Taobao had captured 67% of market share of users while eBay’s slice fell to 29%. The bottom line was even more dire: eBay had now sunk $300 million into an operation that was unprofitable year to year. In 2006, Meg Whitman pulled eBay out of the region and acknowledged this was one auction she wouldn’t win.

Taobao stayed put. After vanquishing eBay, the plucky upstart launched a network of sister sales and advertising sites and before long was raking in $200 million per year in ad revenue. By 2009, Taobao had cornered 80% of China’s e-commerce market, and sales on its site had surpassed sales on Amazon’s.

Next, Taobao stepped up its game by pioneering the concept of “swift guanxi.”

Stream On

Traditional guanxi often involves playing the long game (as with Taobao’s three-years-for-free strategy). Swift guanxi is, well, quicker. According to a 2014 research study in MIS Quarterly that takes a deep dive into Taobao’s use of guanxi, “Buyers’ effective use of [online communication] tools enable swift guanxi and trust by enhancing the buyers’ perceptions of interactivity and presence. In turn, swift guanxi and trust predict buyers’ repurchase intentions and their actual repurchases from sellers.”

In other words, it’s possible for sellers to fast-track meaningful relationships… but they have to figure out the perfect medium.

For Taobao, that perfect vehicle turned out to be live-streamed retail. As envisioned by Zhao Lidong – a young Taobao employee who had a brainstorm in an elevator in 2015 and is now the head of the live retail division – Taobao would offer a platform where merchants and influencers could sell products live in real-time, interacting with viewers and making it simple for them to purchase by clicking a shopping-bag icon. 

While televised home shopping networks had been around since the early 1980s, Taobao’s new livestreamed-from-a-smartphone model added an additional layer of intimacy and immediacy… like purchasing something from a friend while on a FaceTime call. You don’t get much swifter guanxi than that. 

Taobao debuted the “Taobao Live” concept in 2016… and since then, the streaming platform has grown to attract almost a billion users a month, with the average user spending around $230 per month there. Between 2017 and 2022, the amount of livestream commerce generated on Taobao leaped from $3 billion to $106 billion. In 2020, one live event alone – the yearly Chinese “Singles Day” sale – brought in about $7.5 billion during the first 30 minutes of sales on the platform. (Taobao Live is cagey about releasing revenue numbers, but their business model captures about 1% of every sale as an escrow fee.) 

Before long, the West took notice. By the early 2020s, more and more non-Chinese companies realized that “swift guanxi” might help boost their bottom line and decided to copy Taobao’s live streaming model. German beauty retailer Douglas and American fashion brand Tommy Hilfiger were early adopters, hosting livestream events that netted stellar 40% conversion rates (for Douglas) and sold 1,300 hoodies in two minutes (for Hilfiger). Walmart took the idea mainstream in 2020 with a TikTok fashion livestream that garnered seven times more viewers than projected (and effortlessly added 25% more people to its follower base). 

That 25% reflects growing consumer demand: according to a recent survey, about 25% of adults outside China are interested in discovering new products via livestream. In 2023, the livestream commerce market in the U.S. alone reached $50 billion (with the average U.S. livestream shopper spending around $1000 per year, not far behind the $1550 spent yearly by Chinese users). 

On The Cutting Edge For 40 Years

The company we’re examining in this issue is a televised shopping network that performed well during the pandemic only to be tested by fire (literally) right in the middle of a crippling supply-chain bottleneck. Since then, it has incorporated livestream retail as a significant part of its own turnaround plan. 

As a business that’s long relied on a fan-base-like core of loyal customers, this company, in many ways, has been practicing the art of guanxi without realizing it. The swift guanxi of livestream retail is a natural next step to help it present its well-loved brand to a broader audience.

 The bond we look at in this report:

• Trades at a discount of 16% to its $1,000 
• Generates an annual return of 9.6% at the current market price 
• Is secured by shares now owned by a legendary investor
• Is backed by a company with a comfortable cash cushion, and its operations generate more cash year after year
• The company can comfortably service its debt, which equates to roughly 3.5x this year’s projected operating income
• Its operating profits are more than 4x the company’s interest expense

The Leader In Shopping From Home