SMARTPHONES: Coolpad Blasts Qihoo as Control Freak

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Bottom line: The next few months are likely to see a battle unfold for control of Coolpad, with Qihoo as the likely victor and a smaller chance that LeTV could emerge as a white knight savior.

Tug of war brews for control of Qihoo

What’s likely to become an entertaining battle for control of smartphone maker Coolpad (HKEx: 2369) has taken a new twist, with the company criticizing its joint venture partner Qihoo 360 (NYSE: QIHU) for being a control freak. The remarks from an unnamed Coolpad executive represent the first semi-official response to a surprise move by Qihoo to shut down their joint venture formed less than a year ago.

Qihoo’s said earlier this week that it planned to exercise a “put option” that would effectively shutter the joint venture, forcing Coolpad to pay $1.5 billion to buy out Qihoo’s stake. Qihoo said it was entitled to make the move after Coolpad violated a non-compete clause in their agreement by selling a major stake in itself to online video firm LeTV (Shenzhen: 300104), which was also planning a move into the smartphone business. But the struggling Coolpad can hardly afford the $1.5 billion price tag that Qihoo has said dissolution of the venture will cost.

Qihoo’s move didn’t come as a huge surprise, since the company itself was somewhat blind-sided by Coolpad’s tie-up with LeTV in June, just a half year after Qihoo and Coolpad signed their own joint venture agreement. Qihoo’s founder and CEO Zhou Hongyi is famous for his aggressive and often controversial business tactics, meaning this kind of tactical move was almost inevitable in response to the Coolpad-LeTV tie-up.

The latest reports focus on Coolpad’s response to Qihoo’s announcement of its plan to end the joint venture and force Coolpad to pay $1.5 billion for the breakup. Not surprisingly, no one at Coolpad was willing to speak on the record, and the executive who commented was only quoted as an anonymous company insider.

Soured Relationship

The remarks describe a relationship that quickly soured after Qihoo and Coolpad signed their joint venture agreement last December. That deal saw Qihoo give $420 million to Coolpad, which desperately needed the funds due to stiff competition that was eroding its profits in China’s smartphone market. Of course, if Coolpad had done its homework it would have quickly discovered that Qihoo is an extremely difficult and opinionated company to work with. And frankly speaking, anyone who accepts $420 million from a new partner should expect that the money will come with conditions attached.

The reports quote the Coolpad executive saying that Qihoo wanted to make big and unreasonable changes to Coolpad’s smartphone production operations almost as soon as the joint venture deal was signed. (Chinese article) That’s not too surprising, since most of China’s smartphones look and perform similarly and Qihoo probably wanted to create a new type of product that could differentiate itself from the group.

Perhaps Qihoo’s demands were unrealistic, but the bottom line seems to be that Coolpad was unhappy with the partnership from a very early stage. It’s unclear from the remarks if Coolpad deliberately made the new LeTV alliance in a bid to upset Qihoo. But Coolpad certainly must have known that Qihoo wouldn’t be happy about that newer tie-up with another smartphone newcomer.

The same reports also quote Qihoo’s Zhou making menacing remarks late last month, saying companies that stand in his way should beware. Those remarks came out around the same time that the Qihoo-Coolpad joint venture launched its first phones, and as speculation was brewing that Qihoo might make an aggressive move following Coolpad’s decision to tie-up with LeTV.

The moral in all this is that it’s good to understand your partners before forming a new major joint venture or other big agreement with another company. In this case Qihoo really does look like a Trojan horse that will probably ultimately  destroy Coolpad in its current form. I expect the months ahead will see in a heated battle for control of Coolpad, and that Qihoo will ultimately emerge victorious. But for anyone betting on such an outcome, I would also add there’s a small chance — perhaps 20-30 percent — that the cash-rich LeTV could emerge as a white knight to save Coolpad from such a fate.

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