A Ponzi Scheme of Acquisitions - 21 Vianet Group Exposed

WWW.TRINITYRESEARCHGROUP.COM SEPTEMBER 10, 2014

A Ponzi Scheme of Acquisitions: 21 Vianet Group Exposed

A PONZI SCHEME OF ACQUISITIONS: 21 VIANET GROUP EXPOSED SEPTEMBER 10, 2014

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TABLE OF CONTENTS

Disclaimer ....................................................................................................................................... 2

Executive Summary ........................................................................................................................ 6

List of Exhibits .............................................................................................................................. 11

Introduction ................................................................................................................................... 14

Field of IDC Dreams ..................................................................................................................... 17

What VNET Does ................................................................................................................... 17

Serving Two Masters, Cabinet Growth and Utilization.......................................................... 17

China’s Massive IDC Oversupply .......................................................................................... 20

Defying Gravity: VNET’s Stable Margins ............................................................................. 20

Inconsistent Sales Force Productivity ..................................................................................... 21

Feeding the Beast .......................................................................................................................... 23

Part I: Lie ................................................................................................................................ 23

Investigation of IDC Network Shows Material Overstatement ........................................ 23

Quickly Losing Partners ................................................................................................... 23

Financial Impact of Overstatement ................................................................................... 24

VNET’s Balance Sheet Problem ............................................................................................. 25

Accounts (Not) Receivable ............................................................................................... 25

Hemorrhaging Cash .......................................................................................................... 27

Increasingly Indebted ........................................................................................................ 28

Part II: Cheat and Steal, the Ponzi Scheme at Work ............................................................... 29

Master Pumpers ................................................................................................................ 29

(Ab)Use of Proceeds ......................................................................................................... 29

An Acquisition Inquisition ................................................................................................ 32

VNET’s Midas Touch ....................................................................................................... 32

VNET’s Impeccable Timing ............................................................................................. 33

Vicious Cycle .......................................................................................................................... 36

A Track Record of Value Destruction .................................................................................... 38

iJoy: Ghost in the (Cache) Machine .............................................................................................. 40

iJoy’s Filings: The Basics ....................................................................................................... 40


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Corporate Structure ........................................................................................................... 41

iJoy’s Ghost Offices .......................................................................................................... 42

A Ghost Board of Director [sic]........................................................................................ 44

Undercapitalized, Low Employee Count and Other Peculiarities .................................... 45

iJoy’s Orchestrated Acquisition .............................................................................................. 46

Woeful Financial Performance ......................................................................................... 46

Peng Yang’s Takeover ...................................................................................................... 47

Two Suspicious Transactions ........................................................................................... 48

iJoy’s Transformation ............................................................................................................. 50

Literally Incredible Post-Acquisition Performance .......................................................... 50

Increasingly Far-Ranging Business Scope ........................................................................ 52

The Taxing Search for iJoy’s Products ................................................................................... 53

A Complete Unknown Selling Useless Software ............................................................. 53

Clues from China’s Tax Authority ................................................................................... 54

iJoy’s Sale of Useless Software to a Trading Company ......................................................... 56

The MNS Shell Game ................................................................................................................... 59

Cheng Ran and the Seven MNS Dwarfs (the Fable of the “Managed Network Entities”) .... 59

MNS Entities Before VNET Acquisition ......................................................................... 60

MNS Entities After VNET Acquisition ............................................................................ 60

Review of the MNS Entities’ SAIC Filings ............................................................................ 62

More Ghost Offices........................................................................................................... 62

More Ghost Boards ........................................................................................................... 62

Tiny Registered Capital .................................................................................................... 62

Minimal Employee Count ................................................................................................. 62

Inconsistent Registered Business Scope and Licensing .................................................... 63

Cheng Ran Missing from Registrations ............................................................................ 63

Suspicious Ownership Changes Before Acquisition ........................................................ 63

SAIC Numbers Show SEC Numbers 51% Overstated ........................................................... 63

Other Notable MNS Tuck-Ins ................................................................................................. 65

A Virtual Tour of VNET’s MNS Shells ................................................................................. 66

What Business Are They Really In? ....................................................................................... 80

Not Licensed to Offer MNS Services ............................................................................... 82

Music Player and Online Gambling: Managed Network Services? ................................. 85

Shrinking Pool of IP Addresses .............................................................................................. 91


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A Sad Ending to the MNS Fable............................................................................................. 91

MNS, A Ticking Time Bomb ....................................................................................................... 94

Bandwidth Reselling ............................................................................................................... 95

How Bandwidth Is Distributed in China ........................................................................... 95

Chinese Law Prohibits Bandwidth Reselling ................................................................... 96

China’s Grey Market for Bandwidth ................................................................................ 97

China Telecom and China Unicom’s Response to the PLB/MNS Industry ..................... 98

VNET’s MNS Is Mainly a Front for an Illegal Bandwidth Reselling Operation ................... 99

How VNET Describes Its MNS Business ........................................................................ 99

VNET Is China’s Largest PLB ....................................................................................... 100

VNET’s Largest MNS (PLB) Customer Is China Mobile .............................................. 102

MNS Revenue at Great Risk ................................................................................................. 106

VNET Blacklisted by State-Owned Telcos .................................................................... 106

Regulatory Intervention to Obsolete PLB ....................................................................... 106

iPoo: VNET’s Longtop Moment ................................................................................................ 108

Persona Non Grata of the Broadband Industry ..................................................................... 108

Rejected by the People .................................................................................................... 108

iPoo, on Watch by the Government, Already Banned in Three Cities ........................... 109

Stiff-Armed by the Chinese SEC, I-Poo-O Fails ............................................................ 110

A Commoditized, Overleveraged Declining Business ................................................... 110

Insiders’ Garbage, VNET’s Treasure ................................................................................... 112

History of iPoo Insider Valuation Marks ........................................................................ 112

VNET’s Whopper of a Price in Context ......................................................................... 113

The Pony In the iPoo............................................................................................................. 113

Giantstone, Part II ................................................................................................................. 114

Conclusion .................................................................................................................................. 116

An Educated Estimate of VNET’s Actual Financials ........................................................... 117

Liquidation Analysis ............................................................................................................. 118

Appendix ..................................................................................................................................... 121


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EXECUTIVE SUMMARY

SELL — Target Price: $0 Ticker: VNET FD ADS Outstanding (mn): 66.4 Last Close: $21.88 Free Float (mn): N.A. 52 Week Range: $14.95 - 32.34 Daily Volume Range (ADS): 581,734-7,857,662 Market Cap (mn): $1,455 Short Interest (mn): 6.21

We conducted a six-month investigation of 21 Vianet Group (“VNET”) with an expanded team of local accountants, lawyers, telecom and Internet industry executives/insiders and VNET customers, partners and former employees. Our beliefs based on our key findings follow. We rate VNET a zero due to overwhelming evidence that the company is committing

accounting and securities fraud. We expect VNET will end up delisted from the Nasdaq.

Since listing in 2011, VNET has reported fraudulent financials and operating metrics. At least 31% of total revenue and 100% of EBITDA is fabricated (see Exhibit 1). An incremental one third of total revenue is illicitly derived and therefore worthless.

VNET perpetrates its fraud through a Ponzi scheme (see Exhibit 2). VNET overstates cabinet growth and utilization in the core Internet Data Center (IDC) hosting business which burns through 27% of (overstated) revenue in cash due to exceedingly aggressive construction. To make up for the IDC shortfall, VNET fabricates revenue and profits by acquiring tangential businesses that do not consume cash. The cycle is then repeated through constant financings. Since the 2011 IPO, VNET has raised 5.7 billion RMB ($915 million) and done at least 23 non-core acquisitions.

VNET is overleveraged (Exhibit 3), hemorrhages cash (Exhibit 4) and is technically

insolvent. If even a portion of our findings is confirmed by auditors or debt holders, VNET will be in official violation of basic debt covenants. A run on the balance sheet from debt holder redemptions would cause a liquidation that wipes the equity out.

Our field checks of the acquired subsidiaries found mostly ghost offices, no visible assets or

operations of any kind and a litany of red flags in the local filings. iJoy (one of VNET’s two VIEs) in particular is a complete fraud that exists only to roundtrip cash into VNET.

VNET’s Managed Network Services (MNS), the other third of total revenues, is a front for China’s largest illegal bandwidth reselling operation that was blacklisted by state-owned China Telecom after investigation (see Exhibit 5) but continues to operate illegally.

The 2014 acquisitions of Aipu (“iPoo”) and Dermot Holdings (“Dermot”), VNET’s two largest ever, are signs the Ponzi scheme is spinning out of control. As previous acquisitions end their useful life as shells used to launder acquisition proceeds back in as revenue, VNET was forced to sustain the Ponzi by going “all in” with these two deals reminiscent of Longtop Financial’s acquisition of Giantstone. iPoo failed to gain regulatory approval to


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list in China, was banned by the government in Guangzhou (a Tier 1 city), Wuhan and Changsha and was featured in an inflammatory CCTV (largest state-run TV channel) exposé. VNET acquired iPoo at a monster 2,000% premium to, or 20x, its 2012 valuation.

Management has pumped the stock through promises of huge cloud revenue and a telecom license that will never materialize. Despite Microsoft subsidizing the cost of VNET’s offerings (they are effectively free), revenue is still only 3% of total. Recent regulatory actions against Microsoft include an unfavorable SAIC investigation and a ban of Microsoft and IBM from the government’s procurement program. Telecom authorities indicate the national “basic telecom” license needed to offer interconnection will never be issued to a private company, which explains why expectations for its issuance were pushed back from 1H2014 to 2H2014 to now sometime in 2015.

Exhibit 1: VNET’s falsified financials belie a materially smaller unprofitable business

Exhibit 2: Illustration of VNET’s Modus Operandi, the Ponzi Scheme

Figures in thousand RMB

FY 2013(reported)

Fabricated IDC

revenue

Fabricated MNS

revenue

Fabricated iJoy revenue

FY 2013 (clean)

Variance %

Net revenuesHosting and related revenues 1,259,303 270,950 - 118,905 869,448 69.0%

Managed network services 707,414 - 175,082 - 532,332 75.3%Total net revenues 1,966,717 270,950 175,082 118,905 1,401,780 71.3%

Gross profit 516,872 270,950 175,082 109,519 (38,679) (7.5%)Gross margin % 26.3% (2.8%)

Net income(loss) -47,003 270,950 175,082 109,519 (602,554) 1281.9%Net margin % (2.4%) (43.0%)

Adjusted Net income 120,466 270,950 28,013 109,519 (288,016) (239.1%)Adjusted net income margin % 6.1% (20.5%)Adjusted EBITDA 365,613 270,950 28,013 101,500 (34,850) (9.5%)

Adjusted EBITDA margin % 18.6% (2.5%)

Data Center Build and

Cabinet Expansion

Capital markets

Cash

Equity (ADS)

d Non-Core Aquisitions (shell companies

and asset-light companies)

Cash

Cash and

Equity

Sale of Equity (ADS)

Cash (Proceeds of Sale of Equity)

Fake revenue and profit but no free cash inflow

Step 1

Step 2a

Step 2b

Step 4

Steps 3, 5


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Exhibit 3: Constant financings to fund acquisitions and IDC expansion leave VNET increasingly indebted

Exhibit 4: VNET’s alarming cash outflow

(200.0)

(100.0)

0.0

100.0

200.0

300.0

400.0

500.0

Revenue Financings M&A Net Debt

2010 2011 2012 2013 1H2014 Run rate

Figures in thousand RMBItems FY 2010 FY 2011 FY 2012 FY 2013 Total

Net revenues 525,203 1,020,929 1,524,158 1,966,717 5,037,007

Net cash generated from operating activities 81,372 166,135 173,923 64,531 485,961 as % of net revenues 15.5% 16.3% 11.4% 3.3% 9.6%

Deduction: investment on capital expendituresPurchases of property and equiptment (58,619) (255,755) (446,725) (419,126) (1,180,225)

Purchases of intangible assets (730) (802) (133,882) (36,181) (171,595) Total (59,349) (256,557) (580,607) (455,307) (1,351,820)

Proceeds from disposal of property and equipment 26,713 7,598 202 241 34,754

Free cash inflow (outflow) 48,736 (82,824) (406,482) (390,535) (831,105) as % of net revenues 9.3% (8.1%) (26.7%) (19.9%) (16.5%)

Deduction: investment on acquisitions and related party transactionsLoans to related parties - - (15,024) (37,050) (52,074)

Receipt of loans to a related party - - - 1,219 1,219 Payments for business acquisitions, net of cash received (47,560) (107,744) (67,067) (61,793) (284,164)

Loans to seller of iJoy - - (12,885) - (12,885) Loans to seller of BJ Yichengtaihe - - - (24,000) (24,000)

Deposit for acquisition of BJ Yichengtaihe - - - (1,000) (1,000)

Free cash inflow (outflow) after deduction of cash outflow on acquisitions and related party transactions 1,176 (190,568) (501,458) (513,159) (1,204,009) as % of net revenues 0.2% (18.7%) (32.9%) (26.1%) (23.9%)

TotalCapital expenditures (32,636) (248,959) (580,405) (455,066) (1,317,066) Cash used for M&A (47,560) (107,744) (94,976) (122,624) (372,904)


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Exhibit 5: Internal China Telecom notices we obtained show VNET is blacklisted as an illegal operation

Exhibit 6: Summary of our in-person investigation of VNET’s most significant acquisitions through 2013

Ghost offices (no

physical location)

Ghost boards

(only 1 director)

T iny registered

capital (1 mn RMB)

Registered under wife's /

sister's / friends' names

Registered business scope

different from MNS

or IDC

Revenue suddenly spikes

enormously right after acquisit ion

Profit suddenly spikes


While rev spiked,

employee count

plummeted

Large injection of capital from seller right

before acquisition

Transfer of ownership

before acquisit ion

Websites not

aligned with

business

Beijing Chengyishidai Network Technology Co., Ltd. (“CYSD”)

X X X X X X X X NA X X

Zhiboxintong (Beijing) Network Technology Co., Ltd. (“ZBXT”)

X X X X X X X X X Xno

website

Beijing Bikonghengtong Network Technology Co., Ltd. (“BKHT ”)


website

Xingyunhengtong Beijing Network Technology Co., Ltd. (“XYHT”)


website

Beijing Bozhiruihai Network Technology Co., Ltd. (“BZRH”)

X X X X X X X NA NA NAno

website

Jiujiang Zhongyatonglian Network Technology Co., Ltd. (“ZYTL”)

X NA NA NA X X X NA NA NAno

website

Fuzhou Yongjiahong Communication Technology Co., Ltd. (“YJH”)


website

Guangzhou Gehua (“Gehua”) NA NA NA NA X NA NA NA NA NA X

iJoy Holdings Limted, its subsidiary Suzhou Aizhuoyi Information Technology Co., Ltd. and affiliate Beijing iJoy Information Technology Co., Ltd. (“ iJoy")

X X X NA X X X X NA X X

Beijing T ianwang Zaixian Communication Technology Co., Ltd. andBeijing Yilong Xinda Technology Co., Ltd. (“TWYL”)

X X X NA X NA NA NA NA NA X


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Exhibit 7: A history of value destruction: Outcome of VNET’s significant acquisitions

Year Acquisition Rationale O utcome Summary of Findings

May 2007 Tiantian Online Expansion into online video business

Ceased supporting operations Speculative acquisit ion that eventually failed. Today, the website provides outdated news to minimal traffic.

October 2007 Shanghai Stateline Network

ISP Shut down Corporate website's last update is in 2004.

December 2007 VV91 Regional expansion Southwest

NA No public or government sources have any information or registration for this business. Nobody in our industry network has heard of it .

May 2008 Lanmang IDC network expansion Shut down All services have been moved to 69hds.com, a subsidiary of Alibaba Group.

September 2010 Managed Network Entities (7 total)

Managed network expansion Business degradation. Failed to meet profit targets stiputlated in merger agreement.

Network of shell companies with no verifiable physical presence or operations. Multiple business registrations by same owner used to obfuscate centrally managed illegal bandwidth reselling operations from telcos. Blacklisted by China Telecom for violation of bandwidth contract.

Prior to October 2010 pre-IPO reorganization

Five undisclosed companies

Expansion into new businesses (specifics undisclosed)

All written off F-1 discloses disposal during pre-IPO reorganization of five "subsidiaries/investees" with "insignificant business operations" and "insignificant assets, liabilit ies and operating results."

November 2011 Guangzhou Gehua Managed network expansion Business degradation. Failed to meet profit targets stiputlated in merger

Shell company with no verifiable physical presence or operations. Acts primarily as bandwidth reseller (illegal). Only licensed as an ISP.

September 2012 Fastweb Expansion into Content Delivery Network (CDN) b i

Losing market share, achieved only 6% net margin

Financial guidance by management team of 200%+ growth inconsistent with locally filed financial performance.

February 2013 Tianwang Online Managed network expansion Together with Yilong Xinda, achieved only 3% net margin

Shell company with no verifiable physical presence or operations. Related party to Yilong Xinda.

February 2013 Yilong Xinda Managed network expansion Together with Tianwang Online, achieved only 3% net margin

Shell company with no verifiable physical presence or operations. Acts primarily as bandwidth reseller (illegal). Only licensed as an ICP (content provider). Only evidence of existence is a website with a music player that streams pirated music.

April 2013 iJoy Holdings Limted and related entit ies

Expansion of CDN business TBD Shell company with no verifiable physical presence or operations. Numerous related party and intercompany transactions despite no evidence of operations. Sold software to fictitious customer. 95% of revenue fraudulent and round-tripped, contributing nearly 100% net margin to VNET's consolidated financials.

2014 Aipu Holdings Expansion into consumer/retail last-mile services

TBD Filed to go public in Chinese domestic market but failed to get regulatory approval last year. Gave up IPO due to deteriorating financials and lack of proper licenses to operate their business. Banned in Guangzhou due to customer complaints. Subjeect of negative cCTV exposShell company with no verifiable physical presence or operations. Numerous related party and intercompany transactions despite no evidence of operations. Sold software to fictitious customer.e. Aquired by VNET for 20x valuation at which private equity firm sold its stake in 2012.


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LIST OF EXHIBITS 1: VNET’s falsified financials belie a materially smaller unprofitable business (Page 7) 2: Illustration of VNET’s Modus Operandi, the Ponzi Scheme (Page 7) 3: Constant financings to fund acquisitions and IDC expansion leave VNET increasingly indebted (Page 8) 4: VNET’s alarming cash outflow (Page 8) 5: Internal China Telecom notices we obtained show VNET is blacklisted as an illegal operation (Page 9) 6: Summary of our in-person investigation of VNET’s most significant acquisitions through 2013 (Page 9) 7: A history of value destruction: Outcome of VNET’s significant acquisitions (Page 10) 8: VNET’s capacity expansion vs. utilization (Page 18) 9: VNET has consistently lagged guidance (per earnings calls) for capacity expansion (Page 18) 10: VNET’s capacity expansion by quarter vs. utilization (including 2H14 and 2015 projections) (Page 19) 11: Historical versus projected impact of aggressive cabinet expansion (Page 19) 12: Sales Force Productivity Inconsistent with Utilization (Page 21) 13: Summary of investigation of key IDC metrics (as of 2Q ’14) (Page 23) 14: Wechat conversation with China Telecom Nanjing sales team (Page 24) 15: Account receivable (right hand side) overlaid on top of cabinet deployment (left hand side) (Page 25) 16: VNET’s low account concentration (VNET investor presentation) (Page 26) 17: Days Sales Outstanding (DSO) vs. Utilization (Page 26) 18: Free Cash Flow Analysis: 2010-2013 (Page 27) 19: Net Debt (Page 28) 20: VNET Financings: 2010-1H2014 (Page 29) 21: VNET M&A Activity (Page 30) 22: MNS’ declining contribution to total revenue (Page 31) 23: Summary financials for VNET’s major acquisitions before and after acquisition (Page 33) 24: History of cabinet expansion and suspicious acquisition timing (Page 34) 25: VNET’s profitable IPOs courtesy of a well-timed profit peak in the well-timed acquisition of MNS Entities (Page 34) 26: iJoy’s impact on VNET’s consolidated margins (Page 35) 27: Financial consequences of feeding the IDC beast (Page 36) 28: Capex per cabinet (Page 37) 29: A long history of value destruction through acquisitions (Page 39) 30: There are no results for a search for “iJoy” on VNET’s own website (Page 40) 31: Corporate structure of iJoy Holdings Limited (Page 41) 32: Business License of Suzhou Zhuoaiyi and Share Pledge Agreement by Peng Yang and Suzhou Zhuoaiyi (Page 42) 33: iJoy’s registered office does not exist (Page 43) 34: List of all registered addresses for iJoy and results of our in-person investigation (Page 44) 35: Suzhou iJoy’s corporate structure with single-director governance (Page 45) 36: Beijing iJoy’s business license just before acquisition by VNET (Page 45) 37: Timeline of iJoy’s Corporate History (Page 46)


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38: Summary financials from Beijing iJoy’s with SAIC filings for 2009, 2010 and 2011 (Page 47) 39: Summary financials from Beijing iJoy’s with SAIC filings for 2012 (Page 48) 40：SAIC filing of Suzhou Aizhuoyi (Page 49) 41: Summary of iJoy’s income statement before and after acquisition by VNET (Page 50) 42: Comparison of gross margins for leading CDN companies (Page 51) 43: Beijing iJoy’s business scope registered with the SAIC (Page 52) 44: Beijing iJoy’s shareholder resolution to change business scope (Page 52) 45: Product offerings on www.unionread.com’s (iJoy’s corporate website) (Page 53) 46: Historical copyright registration records for iJoy’s software (Page 55) 47: Change of Beijing iJoy’s business scope to include import and export of technology (Page 57) 48: July 2013 receipt from sale of iJoy CDN software to CBNB, a top 5 Chinese iron ore importer (Page 57) 49: Corporate Structure of seven Managed Network Entities (Page 59) 50: Consolidated Summary Financials for Managed Network Entities Post VNET Acquisition (Page 60) 51: Acquisition Valuation for MNS Entities (Page 61) 52: Effect of MNS Entities’ Acquisition on VNET’s Consolidated Financials (Page 61) 53: Employee count of MNS entities (Page 62) 54: Revenue Reported to SAIC by MNS Entities (Page 64) 55: Revenue from MNS Entities Reported to SEC (F-1 filing) for 1Q2010 – 3Q2010 (Page 64) 56: Summary of findings from investigation of seven MNS Entities (Page 66) 57: Headquarters for Beijing Chengyishidai (“CYSD”) reported to SAIC (Page 67) 58: Pictures of our CYSD office visit (Page 67) 59: Headquarters for Jiujiang Zhongyatonglian Network Technology Co., Ltd. (“ZYTL”) reported to SAIC (Page 68) 60: Pictures of our ZYTL office visit (Page 67) 61: Headquarters for Beijing Zhiboxintong (“ZBXT”) reported to SAIC (Page 69) 62: Pictures of our ZBXT office visit (Page 70) 63: Headquarters for Fuzhou Yongjiahong Communication Technology Co., Ltd. (“YJHT”) reported to SAIC (Page 72) 64: Pictures of our YJHT office visit (Page 72) 65: Headquarters for Beijing BikonghengtongNetwork Technology Co., Ltd. (“BKHT”) reported to SAIC (Page 73) 66: Pictures of our BKHT office visit (Page 73) 67: Headquarters for Xingyunhengtong Beijing Network Technology Co., Ltd. (“XYHT”) reported to SAIC (Page 74) 68: Pictures of our XYHT office visit (Page 75) 69: Headquarters for Beijing Bozhiruihai Network Technology Co., Ltd. (“BZRH”) reported to SAIC (Page 76) 70: Pictures of our BZRH office visit (Page 77) 71: Headquarters for Beijing Tianwang Online (“TWYL”) reported to SAIC (Page 78) 72: Pictures of our TWYL office visit (Page 79) 73: Job posting by CYSD on 51Job.com (Page 80) 74: CYSD’s website (Page 81)


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75: Job posting by ZBXT on 51Job.com (Page 81) 76: Check results on www.miit.cc for 7 MNS entities’ licenses (Page 82) 77: Beijing Tianwang Online introduction on Baike (Page 85) 78: Beijing Tianwang Online website (Page 86) 79: Job posting by Yiling Xinda on chinahr.com (Page 86) 80: Results of Check on www.miit.cc for Yilong Xinda’s Licenses (Page 87) 81: Yilong Xinda’s website (Page 87) 82: Job posting by Yiling Xinda on alljobsearch (Page 88) 83: Another website of Yiling Xinda (Page 88) 84: Yilong Xinda’s website had suddenly transformed into an online gambling site (Page 90) 85: Comparison of IP address allocations to CYSD as of June 30, 2013 (L) and December 31, 2012 (R) (Page 91) 86: Performance of MNS Entities through FY2013 (Page 92) 87: Effect of MNS Entities’ Sudden Margin Erosion on VNET’s Consolidated Financials (Page 92) 88: VNET acquisition- related accounts due to related parties, 2013 20-F (Page 93) 89: VNET Is Blacklisted at China Telecom as an Illegal Bandwidth Reseller (Page 94) 90: Notice of Investigation of VNET by China Telecom (Page 95) 91: Network topology for a traditional PLB (Page 98) 92: Network topology for a PLB2.0 (Page 98) 93: Internal Notice and regulations issued by CT to stop MNS connections (Page 99) 94: List of 7 MNS entities’ licenses (Page 100) 95: China Mobile Henan Branch Bandwidth Auction Results (Page 103) 96: China Mobile Xinjiang Branch Bandwidth Auction Invitation and Results (Page 104) 97: China Mobile Hainan Branch Bandwidth Auction Invitation and Results (Page 105) 98: China Mobile Hunan Branch Bandwidth Auction Invitations. BKHT is on the list of bidders. (Page 106) 99: VNET’s revenue mix over time (Page 107) 100: Notice of ban from Guangdong Telecommunication Administration (Page 110) 101: Key Metrics for iPoo (Page 111) 102: Debt-to-Asset Ratio for iPoo and Comparable Companies (Page 111) 103: Key metrics for top three “last-mile” broad band companies (Page 113) 104: VNET’s reported income statement vs pro forma without fabricated revenues (Page 118) 105: Liquidation analysis as of December 31, 2013 (Page 119)


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INTRODUCTION At first glance, VNET’s vision is attractive. VNET is purportedly in the early innings of building China’s leading Internet infrastructure company. The problem is VNET’s vision requires that industry dynamics support it, and they do not. It is not only that China’s Internet Data Center (IDC) industry is dominated by the monopolistic state-owned fixed line telecom carriers China Telecom and China Unicom. The industry is in a state of massive oversupply, with the average IDC running significantly below half capacity. This has resulted in a mass exodus from hosting as data center operators refashion themselves into providers of Content Delivery Network (CDN), Virtual Private Network (VPN) and other bandwidth services. Except for VNET. Citing insatiable demand for its quickly expanding IDC network, VNET went public on April 21, 2011 setting irrational expectations for cabinet growth and profitability. Unable to deliver what the industry could not support, VNET overstated its assets and financials and embarked on a string of acquisitions to make up the shortfall in revenue and profitability. Management executed record financing after another by pumping the share price with promises of continued expansion. And with the proceeds, VNET continued overbuilding while acquiring non-core assets in between financings to keep the Ponzi scheme going. Management’s hope all along was that the development of the Chinese Internet infrastructure industry would catch up to the vision. That demand as well as margins and new, legitimate sources of profits would evolve quickly enough to cover up the fraud. But that hope never materialized. Instead, VNET was forced to do increasingly larger financings and increasingly riskier acquisitions to feed the beast of cabinet expansion. Over time, the Ponzi scheme got harder, not easier, to sustain. The capital intensive core IDC business burns cash much too quickly and the fledgling cloud business VNET hoped would save the day is not ramping enough. Even with Microsoft’s partnership, cloud software revenue is under 3% of total, hopelessly behind the pace needed to overtake the rate of fraud. So the Ponzi scheme goes on as it spins out of control. Beyond the Ponzi scheme’s unsustainability, three major structural problems signal imminent collapse.

1. VNET is technically insolvent with a balance sheet that will not sustain the recently stated goal of adding 10,000 cabinets in 2014 (to a base of 14,000 cabinets from 2013) and then another 10,000 cabinets in 2015. The additional debt and cash burn required to increase cabinets by almost 2.5 times in two years will cripple the company.

2. The Managed Network Services (MNS) business that VNET uses to make most of its

fraudulent acquisitions is run illegally. VNET’s SEC filings paint a very inaccurate picture of MNS. In reality, aside from housing most of the fraudulent acquisitions, MNS is a front for an illegal bandwidth reselling operation that has already been dinged for violation by China Telecom and could be shut down any day. Moreover, recent regulatory developments will soon make bandwidth reselling obsolete.


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3. VNET hopes that cloud software revenue and the receipt of a basic telecom license to

provide high-margin interconnection services will solve the company’s cash flow problem. Neither initiative will deliver. The cloud software business which at the moment is just Microsoft (soon IBM too) has no hope of achieving the type of growth promised to investors. Our field work revealed that VNET was only able grow cloud sales because Microsoft is subsidizing customer costs (offering products for free) in an effort to gain share of a market it could not penetrate otherwise. Even with those subsidies, if the Internet industry’s preference for open source platforms doesn’t severely limit Microsoft, regulation will. Already, the Chinese government’s xenophobic policies have banned Microsoft and IBM from their procurement program. As for the telecom license, there is a reason why management has pushed back expectations three times already from 1H2014 to 2H2014 and now to sometime in 2015. Our regulatory contacts are confident that the government will never issue such a license at a national level to a private company.

This report presents the results of six months of investigative work aided by an extended team of local Chinese accountants, lawyers, telecom industry executives and insiders, former VNET employees, current and former VNET customers and current and former VNET service providers (e.g. data center construction companies). We organize our findings and their supporting evidence into the following sections.

Field of IDC Dreams We investigated all 72 data centers in VNET’s IDC network for over three months, visiting in person and conducting over 50 interviews of sales staff, partners, customers, contractors and competitors. We found VNET overstates cabinets and utilization, overstates 27% of IDC revenue and has negative EBITDA (not the 20% EBITDA margins IDC purportedly has). Our field work points to a highly overbuilt network of overpriced cabinet inventory that has drained VNET’s balance sheet. As management keeps delaying the data center rollout hoping demand or the fledgling cloud business will eventually catch up, they have been forced to lie about the assets and performance of their IDC business while fabricating the shortfall in revenue and margins through fraudulent acquisitions.

iJoy: A Ghost in the (Cache) Machine A deep dive on iJoy, one of VNET’s two VIEs. iJoy, with no fixed assets and nearly 100% net margin, is a shell company whose acquisition was orchestrated by VNET to roundtrip cash. We provide evidence of the acquisition’s orchestration and the subsequent money laundering so critical to VNET’s margins.

The MNS Shell Game


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A deep dive into roughly one third of VNET’s consolidated revenue, the MNS business. We review key findings from our in-person investigation of all 10 of VNET’s major MNS acquisitions, including evidence collected from our in-person field work, review of local government filings and review of public records. Although we found no assets, offices or required licensing, we did find a long list of red flags in the government filings and public records, e.g. fake business registrations, tiny registered capital and employee count, suspicious asset transfers and most of all huge inconsistencies between their financial contribution to VNET’s consolidated numbers and historical performance reported to PRC authorities.

MNS, A Ticking Time Bomb MNS was the perfect place to hide the fraud but is now the Ponzi scheme’s weakest link as it faces shutdown of its illicit operations and technical obsolescence at once. We reveal evidence of the illegal operations and VNET’s blacklisting at China Telecom.

iPoo: VNET’s Longtop Moment The massive back-to-back acquisitions of Aipu (“iPoo”) and Dermot make little strategic sense but needed to be done to sustain the Ponzi scheme. As ridiculously outsized IDC expansion looms and the MNS business used to prop margins deteriorates, VNET had no choice but to acquire again, this time in enormous size. As with Longtop’s acquisition of Giantstone, these deals mark the top for VNET shares.

Conclusion Our concluding thoughts end with a detailed liquidation waterfall that shows what will happen to every stakeholder across the capital structure in the event of a forced liquidation of the company due to debt holder redemptions, a shutdown and/or further erosion of the MNS business or a balance sheet event driven by sustained cash burn and overleveraging.


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FIELD OF IDC DREAMS

What VNET Does

VNET has two major lines of business and one minor. Through its core business, hosting and related services, the company operates a network of Internet data centers (IDCs) from which they lease cabinets to customers looking to outsource hosting of their Internet servers. IDC is largely the product of massive capex-driven organic expansion over the years and is the primary beneficiary of VNET’s capital expenditures. All major strategic initiatives, particularly VNET’s partnership with Microsoft to offer cloud software services on top of their hosting, have been undertaken through this business. IDC is the business that investors value. Depending on the year, between 60-80% of VNET’s business is IDC. VNET’s other major business, managed network services (MNS), is a mystery to most. It is usually an afterthought few focus on. MNS purports to operate much of the technology related to running and maintaining an efficient network, but as VNET acknowledges in the 2013 20-F, “our managed network services are primarily offered in the form of bandwidth.”1 Through MNS, VNET buys bandwidth from China’s major telecom carriers, mainly China Telecom and China Unicom, and packages its own technology services such as “hosting area network services” and “route optimization” on top of it. Unlike IDC, MNS is not capital intensive, is low in value-add and has low barriers to entry. MNS is the result of many small acquisitions. Starting in 2013, the acquisitive VNET entered a third line of business, content delivery network (CDN), also by acquisition. CDN offers content caching, like competitors ChinaCache (Nasdaq: CCIH), China NetCenter (CNC, listed in China’s A-share market), and others. This is the smallest of the three businesses. Even though it does not belong in IDC, VNET consolidates CDN into IDC and does not break CDN out separately when reporting earnings.

Serving Two Masters, Cabinet Growth and Utilization

Because IDC is highly capital intensive and it is the majority of revenue, VNET’s business model is not that different from traditional offline retail. Just as a retailer’s value is driven off of the size of its geographic footprint and the trend in same store sales, number of cabinets in the IDC network and their overall utilization are the two masters VNET must serve. If VNET can grow cabinets in its IDC network every quarter and keep utilization up, the business model must be working. That is the hope VNET has sold to investors and those two metrics are what ultimately drive VNET’s stock price. The reality is VNET has never been able to make this simple model work because capacity expansion significantly outpaced demand.

1 2013 20-F filing.


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Exhibit 8: VNET’s capacity expansion vs. utilization

Management focuses investors on the cabinet growth story, consistently setting overly aggressive targets they fail to meet.

Exhibit 9: VNET has consistently lagged guidance (per earnings calls) for capacity expansion

Variance

Actual Results vs. Expectations Deployed Guidance Count %FY2012 Cabinet Additions 4,101 5,000 (899) (18.0%)FY2013 Cabinet Additions 2,124 8,000 (5,876) (73.5%)4Q2013 Cabinet Additions 1,081 5,000 (3,919) (78.4%)1Q2014 Cabinet Additions 734 1,000-1,500 (516) (41.3%)2Q2014 Cabinet Additions 1,870 2,000 (130) (6.5%)

Despite an expansion much slower than guided, utilization still dropped sharply in 2012 and 2013 from the previous three years due to the overly aggressive pace of cabinet deployment. Undeterred, VNET continues building and building like the construction companies building out China’s famous ghost cities2. Plunging utilization be damned, management continues selling the story that if they build it, customers will eventually come. In the latest earnings call CFO Shang Hsiao of Camelot (NYSE:CIS) fame3 provided color on VNET’s cabinet expansion plans for 2014 and 20154:

“And like I mentioned earlier, this year, we will [be] adding 10,000 cabinets. Next year, again, we will add an additional 10,000 cabinets.”

2 http://www.businessinsider.com/60-minutes-chinas-ghost-cities-2013-3 3 http://www.camelotchina.com/investors/investors_corporateGovernance.htm 4 http://seekingalpha.com/article/2456295-21vianet-vnet-on-q2-2014-results-earnings-call-transcript?all=true&find=vnet%2Bearnings%2Bcall

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As if that wasn’t absurd enough, after breaking out the remaining portion of that massive ramp (3,000 in Q3 and 4,000 more in Q4), he goes on to say that utilization won’t change much:

“But going forward, okay, this is starting from the utilization rate, right now, we have currently around 73,9%. I think this utilization rate probably will be between 70% to 71% in the third quarter. Again, probably 69% to 70% in the fourth quarter.”

Do the following two charts, which put Mr. Hsiao’s words to the eyeball test, make any sense?

Exhibit 10: VNET’s capacity expansion by quarter vs. utilization (including 2H14 and 2015 projections)

Exhibit 11: Historical versus projected impact of aggressive cabinet expansion

Utilization dropped 15 points in two quarters when VNET ramped capacity by 3,620 cabinets. Does anyone really believe that utilization is barely going to move when twice as many cabinets are deployed in the next two quarters, and then another 10,000 on top of that in 2015? If that passes someone’s eyeball test, we have a smell test for them.

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1Q2012 2Q2012 3Q2012 4Q2012 1Q2013 2Q2013 3Q2013 4Q2013 1Q2014 2Q2014 3Q2014P 4Q2014P FY2015Cabinets 8,027 10,394 11,647 11,917 11,963 12,226 13,307 14,041 15,074 16,944 19,944 23,944 33,944 Increase (cabinets) 211 2,367 1,253 270 46 263 1,081 734 1,033 1,870 3,000 4,000 10,000 Increase (%) 2.7% 29.5% 12.1% 2.3% 0.4% 2.2% 8.8% 5.5% 7.4% 12.4% 17.7% 20.1% 41.8%Utilization 82.4% 81.2% 67.7% 66.3% 68.1% 70.2% 73.7% 71.2% 73.8% 73.9% 70.5% 69.5%


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China’s Massive IDC Oversupply

If VNET hits the goal of 10,000 new cabinets in 2014, it is on pace for a 5-year CAGR of 42%, a nearly 6-fold increase in the face of serious degradation in utilization and industry-wide oversupply. How much oversupply, you ask? The Chinese government has an answer. On July 30 of this year, the Ministry of Industry and Information Technology (MIIT), the regulatory body that oversees the technology sector, issued a report on the state of the data center market5, Circular No.225(2014), “Report on Planning and Construction Schedule of China Data Centers since 2011”. Among the various industry facts disclosed, we highlight these to put VNET’s insane capacity expansion plans through the smell test:

From 2011 through the first half of 2013, 255 data centers have been built and 177 of them have been put to use. About a third of all construction has yet to be commercialized

The 255 data centers break out as follows: 23 are super data centers (over 10,000 cabinet capacity), 42 are mid-sized data centers (3,000 – 10,000 cabinet capacity) and 190 are small data centers (under 3,000 cabinet capacity)

The industry hugely overestimated demand, since demand was estimated at 7.28 million servers but only came in at 0.57 million, less than 8% of estimates!

Here is the kicker: Utilization rates for super, mid-sized, and small data centers are 1.8% (1 point 8%, not a typo), 21.5% and 40%, respectively

VNET’s IDC network contains mainly small and mid-sized data centers (some partnered cabinets might be hosted in larger ones), so the benchmark for their purported industry-leading 73.9% utilization is between 21.5% and 40%. Does that not smell fishy? Against this kind of industrial oversupply, is VNET really going to add 10,000 extra cabinets this year on top of the 14,000 they ended 2013 with, of which 30% were not utilized? And then another 10,000 extra cabinets in 2015?

Defying Gravity: VNET’s Stable Margins

VNET’s CFO himself has stated at conferences and road shows that VNET (as does any IDC business) has a high degree of operating leverage because over 80% of the cost structure is fixed, with bandwidth and cabinet leasing making up most of it. Operating leverage, like any kind of leverage, cuts both ways. When business is booming and data centers are running at full capacity, any incremental utilization turns into revenue that flows right to the bottom line since the costs, being fixed, have largely been incurred. But when you have high fixed costs and monetization drops suddenly, the negative effect on margins is enormous as the shortfall in revenue has a disproportionate impact on the bottom line for every point of utilization lost.

5 http://www.miit.gov.cn/n11293472/n11293832/n12845605/n13916973/16084590.html


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As dubious as VNET’s capacity expansion plans may look relative to utilization or, even worse, relative to the Chinese industrial backdrop, what is really unbelievable is that margins – gross, EBITDA, net or any other – have held their levels throughout the entire process. This is a huge red flag. Any IDC business’s margins are highly sensitive to utilization metrics. That is especially true when utilization falls while capacity ramps by a factor of two or even three times the base, as it did for VNET.

Inconsistent Sales Force Productivity

A look at sales force productivity reveals another key operating metric inconsistent with VNET’s reported utilization trend. VNET breaks out their employee base by function in their 20-F filings, including head count for “sales, marketing and customer support” (S&M). S&M head count went from 241 in 2011 to 323 in 2012 and 252 in 2013. For the full years 2011, 2012 and 2013, reported utilization was 80.6%, 66.3% and 70.3%, respectively. Even though utilization dropped by over 10 points, which is a massive swing for a business with high fixed costs, sales per sales and marketing employee almost doubled in 2013 versus 2011.

Exhibit 12: Sales Force Productivity Inconsistent with Utilization

Even in 2012, when utilization plunged year on year, sales force productivity somehow went up. Since management has consistently indicated monthly recurring revenue has risen in the order of 10% historically, pricing cannot be the reason behind this discrepancy. Moreover, we learned from our many interviews with management teams and sales executives in the IDC industry that on average, it takes 12-18 months to fill a new data center to more than half capacity. VNET appears to be a huge outlier in that they can fill as much as half the new cabinet capacity coming online within a quarter. In their latest earnings call, management reported that about half of the approximately 7,000 cabinets coming online throughout the remainder of the year had been sold already.6

6 http://seekingalpha.com/article/2456295-21vianet-vnet-on-q2-2014-results-earnings-call-transcript?all=true&find=vnet%2Bearnings%2Bcall

2011 2012 2013IDC Hosting Revneue (RMB 000) 614,612.0 866,882.0 1,259,303.0 Number of S&M employees 241 323 252

Revenue per S&M employee 2,550.3 2,683.8 4,997.2 Growth 5.2% 186.2%

Full-year utilization 80.6% 66.3% 70.3%


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Whether VNET’s numbers make sense is a rhetorical question. They don’t. The more interesting question is how VNET gets away with so much overbuilding without taking a hit on margins or driving the balance sheet right into a wall with what must be an unbelievable amount of cash burn. How does VNET feed the beast? As the old saying goes:

“Lie, cheat and steal.” Let us first discuss the lies.


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FEEDING THE BEAST

Part I: Lie

VNET lists the locations of its 72 data centers on the Chinese version of its corporate website. Click on each section of the map on this webpage to show a complete list of data centers by region: http://www.ch.21vianet.com/?page_id=927. (Interestingly, the English version of the corporate website does not list the individual data centers. Clicking on the map does nothing: http://www.en.21vianet.com/?page_id=176).

Investigation of IDC Network Shows Material Overstatement

Using these regional lists of data centers, which we confirmed with management are updated and accurate, we conducted an exhaustive field study of VNET’s national IDC footprint throughout China. We determined the number of cabinets and utilization for each data center by doing a 360 degree review consisting of:

In-person visits Telephone interviews with data center staff, direct and indirect sales channels and

headquarter sales staff In-person and telephone interviews of key VNET customers In-person interviews with two contractors responsible for construction of VNET’s data

centers In-person interviews with senior management of major IDC and CDN companies Telephone interviews with telecom carriers

Our investigation concluded that VNET has overstated the number of cabinets in its IDC network by at least 2,460 (14.5% of reported) and overstated their utilization by at least 11.1 points.

Exhibit 13: Summary of investigation of key IDC metrics (as of 2Q ’14)

VarianceReported Actual Count % Reported Actual

Partnered Cabinets 5,462 3,950 (1,512) (27.7%) Utiliized Cabinets 12,522 9,090 Self-built Cabinets 11,482 10,534 (948) (8.3%) Utilizaation Rate 73.9% 62.8%Total 16,944 14,484 (2,460) (14.5%)

Appendix A lists the results of our investigation of all 72 VNET data centers, both partnered and self-built, by location.

Quickly Losing Partners

Of the 72 data centers that VNET lists in their IDC network, only 12 are self-built. 60 are partnered, meaning VNET leases cabinets from other companies who own the data centers and related fixed assets. As you can see from our investigation results in Appendix A, 31 of the 60


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alleged partnerships had been terminated at the time of our visits and interviews. Given that the state-owned telcos from whom VNET provisions their bandwidth are also VNET’s biggest IDC partners, the fact that VNET has managed to get blacklisted for illegal bandwidth reselling at the largest telco, China Telecom, cannot be helping that partnership. As already noted, throughout our investigation, we gave VNET the benefit of the doubt when the state of a partnership was inconclusive, but in doing so we may have undercounted the terminated partnerships given more recent data points such as the Wechat sales inquiry below. (As you can see from the breakout of our investigation results by data center, we gave VNET credit for 40% utilization of 250 partnered cabinets in Nanjing.)

Exhibit 14: Wechat conversation with China Telecom Nanjing sales team

It makes a lot of sense that VNET has lied mainly by overstating partnered cabinets. It is much easier to tell investors you are leasing some extra cabinets from the enormous China Telecom data center down the road than it is to lie about having built a data center from scratch or making your own data center appear three or four times busier than its 15% utilization.

Financial Impact of Overstatement

A hopeless optimist might say, overstating cabinets by 15% isn’t that bad, is it? It’s not like they lied about half their cabinets or anything, right? It might as well be half. Because margins are highly sensitive to utilization in a data center business, 11 extra points of utilization is the difference between being profitable and losing money. Having 14.5% fewer cabinets running at 62.8% versus 73.9% utilization means VNET’s income statement gets hit with the double whammy of materially lower utilization off a materially


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smaller base. This translates to a 27.3% overstatement in revenue. (If you have 100 cabinets running at 73.9%, you have 73.9 billable cabinets. If you have 85.5 running at 62.8%, you only have 53.7, or 27.3% less.) Due to the IDC business’s high fixed cost, this 27.3% comes off the top line and hits the bottom line almost dollar for dollar. Since VNET has an adjusted EBITDA margin around 18% or 19%, a 27% hit to EBITDA means the company goes from being in the black with respectable margins to being deeply in the red.

VNET’s Balance Sheet Problem

Obviously, if VNET is overstating IDC revenue, the overstatement has to come from somewhere. The balance sheet is a sensible first place to look.

Accounts (Not) Receivable

Below is a chart that shows how accounts receivable changed as VNET built beyond their ability to fill their data centers to acceptable levels.

Exhibit 15: Account receivable (right hand side) overlaid on top of cabinet deployment (left hand side)

The 99% four-year CAGR in AR, nearly three times the aggressive pace of cabinet deployment, raises all types of red flags. All of VNET’s IDC businesses should have little variance in collection terms. They are all recurring revenue businesses and over two thirds of the revenue is IDC, a well-diversified business. VNET’s own investor presentation boasts that account concentration is low with the top customer being under 5% of revenue and the top five customers being under 14%.

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Exhibit 16: VNET’s low account concentration (VNET investor presentation)

VNET has never had a problem collecting. Bad debt charges have never been an issue. Very low churn proves VNET has a good relationship with customers. In the last second quarter earnings, overall churn rate was down to almost zero with top customers having literally zero churn. So what is going on with AR? A closer look reveals that it was not only AR that spiked as utilization started to plunge. Days Sales Outstanding (DSO) for AR started to spike upwards, eventually more than doubling from a stable trend in the 40s throughout the year of the IPO.

Exhibit 17: Days Sales Outstanding (DSO) vs. Utilization

For a business with recurring revenue, minimal account concentration (one huge “bad” customer cannot derail AR and DSO), good customer relationships with minimal churn and minimal bad debt, how can these charts be explained? There are only four possibilities:

1. Billing terms have changed (they haven’t)

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2. Customer composition has turned from diversified to concentrated with huge customers who pay really late (It hasn’t… VNET has low account concentration)

3. Customer relationships have soured (they haven’t, evidenced by very low churn) 4. The AR is not revenue waiting to be collected

We are convinced VNET is fabricating revenue to make up for the shortfall in actual revenue from the massive ramp in cabinets that coincided with a massive drop in utilization. Of course it makes sense that AR and DSOs would ramp most aggressively as utilization plunged.

Hemorrhaging Cash

An analysis of VNET’s free cash flow over the years shows what happens when cabinets go from 5,750 in 2010 to 14,041 in 2013 while utilization goes from mid-80s to 60s and low-70s, even if you fake those numbers substantially to make growth appear more robust than it is.

Exhibit 18: Free Cash Flow Analysis: 2010-2013

VNET has burned through 28% of its past three years of inflated revenue in cash! Of course, this 28% assumes every dollar of reported revenue is real, which we very strongly doubt is the case. We believe VNET actually burns through more than half of its actual revenue in cash. The FCF analysis only goes through 2013 because VNET does not report cash flow quarterly. We cannot wait to see what 2014 will look like when cabinets soar to 24,000 and utilization sags back down to high 60s or 70% as management projects. Although we won’t know the official number until next year, we can guarantee it will be stunning… Especially as we expect actual

Figures in thousand RMBItems FY 2010 FY 2011 FY 2012 FY 2013 Total

Net revenues 525,203 1,020,929 1,524,158 1,966,717 5,037,007

Net cash generated from operating activities 81,372 166,135 173,923 64,531 485,961 as % of net revenues 15.5% 16.3% 11.4% 3.3% 9.6%

Deduction: investment on capital expendituresPurchases of property and equiptment (58,619) (255,755) (446,725) (419,126) (1,180,225)

Purchases of intangible assets (730) (802) (133,882) (36,181) (171,595) Total (59,349) (256,557) (580,607) (455,307) (1,351,820)

Proceeds from disposal of property and equipment 26,713 7,598 202 241 34,754

Free cash inflow (outflow) 48,736 (82,824) (406,482) (390,535) (831,105) as % of net revenues 9.3% (8.1%) (26.7%) (19.9%) (16.5%)

Deduction: investment on acquisitions and related party transactionsLoans to related parties - - (15,024) (37,050) (52,074)

Receipt of loans to a related party - - - 1,219 1,219 Payments for business acquisitions, net of cash received (47,560) (107,744) (67,067) (61,793) (284,164)

Loans to seller of iJoy - - (12,885) - (12,885) Loans to seller of BJ Yichengtaihe - - - (24,000) (24,000)

Deposit for acquisition of BJ Yichengtaihe - - - (1,000) (1,000)

Free cash inflow (outflow) after deduction of cash outflow on acquisitions and related party transactions 1,176 (190,568) (501,458) (513,159) (1,204,009) as % of net revenues 0.2% (18.7%) (32.9%) (26.1%) (23.9%)

TotalCapital expenditures (32,636) (248,959) (580,405) (455,066) (1,317,066) Cash used for M&A (47,560) (107,744) (94,976) (122,624) (372,904)


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utilization to hit a level between 30-35%, more in line with the top end of the MIIT-reported industry average of 21.5-40%.

Increasingly Indebted

So far, VNET’s approach to creating shareholder value appears to be as follows.

1. Promise growth that defies not only the competition’s but also the government’s own assessment of market demand

2. Burn 28% of (materially faked) revenue in cash to keep the growth story going by building out the IDC network far beyond what is prudent

3. Deliver hugely outlying utilization and revenue performance by faking the difference between actual revenue and what the street demands in utilization and cabinets to keep the share price going

4. Let AR balloon at a 99% CAGR while DSOs are on pace to triple With this approach, something has to give. And that something is the balance sheet. Since VNET’s April 2011 IPO left the company in the enviable position of having RMB 1.1 billion of net cash, there has been an enormous 2.7 billion RMB swing in net debt.

Exhibit 19: Net Debt

Clearly, lying about IDC metrics and faking revenue might make the income statement look pretty but it does a real number on the balance sheet. Most important of all, falsifying IDC metrics does not put cash on the table. For VNET, as capital intensive a business as we have ever seen, putting cash on the table to fund the enormous and sustained burn is a matter of life and death, solvency and bankruptcy. So where does VNET get all that cash to keep feeding the insatiable beast?

All figures in thousands RMBQ2 2014 Pro Forma

FY 2010 FY 2011 FY 2012 FY 2013 Q2 2014 Post-AcquisitionsShort-term bank borrowings 35,000 100,000 176,961 173,726 296,736 296,736 Current portion of long-term bank borrowings - - 167,879 197,000 64,779 64,779 Current portion of capital lease obligations 15,824 26,012 36,719 14,600 18,076 18,076 Long-term bank borrowings - - 63,000 965,740 924,166 924,166 Non-current portion of capital lease obligations 58,190 73,896 52,352 337,139 355,578 355,578 Redeemable preferred stock/noncontrolling interests 991,110 - - 100,000 100,000 100,000 Bonds payable - - - 998,505 2,263,977 2,263,977

Less:Cash and cash equivalents 83,256 410,389 432,254 1,458,856 2,138,589 2,138,589 Short-term investments - 894,540 222,701 1,101,826 1,103,634 1,103,634 Restricted cash used as pledge for bank borrowings - - 290,766 292,099 128,087 128,087

Less:Cash consideration for Aipu (assume 50% of 700,000 RMB) (350,000) Cash consideration for Dermot (assume 60% of 1,050,000 RMB) (600,000) Net Debt 1,016,868 (1,105,021) (448,810) (66,071) 653,002 1,603,002


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Part II: Cheat and Steal, the Ponzi Scheme at Work

They raise it. LOTS of it. Because to pay Paul, you must first rob Peter.

Master Pumpers

Nobody pumps their company better than VNET, which has successfully executed over RMB 5.7 billion ($915 million) in financings since 2011, the year of the IPO. That is greater than half the entire market cap of VNET today, after the stock has shot up more than 300% in the past year and a half!

Exhibit 20: VNET Financings: 2010-1H2014 Figures in RMB millions

Capital Inflow (Outflow)Date Type Financing Activities Counterparty RMB USDFY 2010 Debt Proceeds Increase in short-term bank borrowings domestic banks 35.0 5.2FY2011 February 28 Equity Sale Equity stake Cisco 32.3 5.0FY2011 April 1 IPO VNET IPO, issuing 14.95m ADS for ~$204.3m IPO investors 1,320.5 204.3

FY 2011 Debt Proceeds Change in Bank Debt domestic banks 65.1 10.1FY 2011 Debt Proceeds Change in Capital Leases domestic leasing companies 25.9 4.0FY 2012 Debt Proceeds Change in Bank Debt domestic banks 303.3 48.1FY 2012 Debt Proceeds Change in Capital Leases domestic leasing companies (10.8) (1.7)FY2013 March 15 Debt Proceeds Proceeds from Dim Sum Bonds Bond investors 972.8 158.2FY2013 October 13 Equity Sale Secondary equity stake for $100 million (87%

new shares, 13% existing shareholders)Temasek 533.3 87.0

FY 2013 Debt Proceeds Change in Bank Debt domestic banks 928.6 151.0FY 2013 Debt Proceeds Change in Capital Leases domestic leasing companies 262.7 42.7FY 2014 June 30 Debt Proceeds Proceeds from Dim Sum Bonds Bond investors 1,265.5 205.5FY 2014 June 30 Debt Proceeds Change in Bank Debt domestic banks (50.8) (8.3)FY 2014 June 30 Debt Proceeds Change in Capital Leases domestic leasing companies 21.9 3.6

Total Financings 5,705.2 914.7

(Ab)Use of Proceeds

And what has VNET done with all that money?


PAGE 30 / 121

Obviously, a substantial portion of the proceeds has been burned to fund the massive data center build. As we have discussed already, a cumulative $406 million in non-acquisition driven capex has been burned from 2010 to 2Q2014. Most of the rest of the proceeds (the majority) from all the non-stop financings went to buy 24 non-core subsidiaries light on fixed assets.

Exhibit 21: VNET M&A Activity

Figures in RMB millionsCapital Inflow (Outflow) Capital Inflow (Outflow)

Date Type Names of Entities Counterparty Type of Business % Stake RMB USD RMB USDBefore 10/2010 Acquisition Five acquisitions (names not disclosed)

through aBitCoolHosting

6/22/2007 Acquisition Shanghai Guotong Network Co., Ltd. Hosting (61.8) (61.8)4/30/2009 Disposal Shanghai Guotong Network Co., Ltd. aBitCool Hosting 68.9 68.93/1/2010 Disposal Guangzhou Juliang Internet Information aBitCool Hosting 10.8 10.8

9/30/2010 Acquisition Beijing Chengyishidai Network Technology Co., Ltd

Beijing Shi Dai Tong Lian Technology Co., Ltd., a third party company controlled by Mr. Cheng Ran

Managed Network Services

51% (172.4) (25.5) (252.6) (37.3)

Zhiboxintong (Beijing) Network Technology Co., Ltd.


51%

9/15/2011 Acquisition Telehouse Beijing Co., Ltd. aBitCool (21Vianet Zhi Hui Ke Ji Co., Ltd. and Beijing 21Vianet Zhi Hui Neng Yuan System Technology Co., Ltd., both controlled entities of aBitCool)

Manufacturing and rental of cabinets. KDDI is the joint investor of Teleohouse Beijing.

10% (8.2) (1.3) (8.2) (1.3)

10/1/2011 Acquisition Shanghai Cloud 21Vianet Network Co., Ltd. aBitCool (21Vianet Zhi Hui Ke Ji Co., Ltd. controlled entities of aBitCool)

Shell company without any operation

100% (18.2) (2.8) (18.2) (2.8)

10/19/2011 Acquisition Guangzhou Gehua Network Technology and Development Company Limited

Tianjin GuanBang Network Technology Co.and Beijing Huibang


100% (77.5) (12.0) (116.4) (18.0)

10/27/2011 Acquisition Shenzhen Cloud Information Technology Co., Ltd.

aBitCool (21Vianet Zhi Hui Ke Ji Co., Ltd. controlled entities of aBitCool)

Shell company without any operation

100% (7.9) (1.2) (7.9) (1.2)

12/15/2011 Acquisition Beijing Chengyishidai Network Technology Co., Ltd

Beijing Shi Dai Tong Tian Network Technology Co., Ltd. and Concept Network Limited


49% (169.2) (26.2) (242.7) (37.5)

Zhiboxintong (Beijing) Network Technology Co., Ltd.


49%

2/15/2012 Acquisition Radio spectrum in the 2.3 GHz band in Hong Kong

OFTA Radio spectrum license (121.4) (19.3) (121.4) (19.3)

4/1/2012 Acquisition Yizhuang Venture Investment Fund Yizhuang Venture Investment Fund Venture Capital Fund NA (101.0) (16.0) (101.0) (16.0)7/2/2012 Acquisition 21Vianet@Xian Holding Ltd. aBitCool Inc. Hosting 100% (16.0) (2.5) (16.0) (2.5)9/9/2012 Acquisition Fastweb International Holding Lyzh Consulting Ltd. DFS & DFJ Funds CDN 100% (116.0) (18.4) (119.6) (19.0)

2/28/2013 Acquisition Beijing Tianwang Online Communication Technology Co., Ltd

Beijing Kaihua Kewei Technology Co., Limited

Virtual Private Network Services / MNS

100% (73.4) (11.9) (77.5) (12.6)

Beijing Yilong Xinda Technology Co., Ltd. Virtual Private Network Services / MNS

100%

4/30/2013 Acquisition iJoy Holding Limited Peng Yang CDN 100% (96.9) (15.8) (178.7) (29.1)10/21/2013 Acquisition Beijing Yichengtaihe Investment Co., Ltd Land use 100% (198.8) (32.3) (198.8) (32.3)4/16/2014 Acquisition Minority stake in M87(Series A) Mobile software (18.5) (3.0) (18.5) (3.0)6/4/2014 Acquisition Sichuan Aipu Network Co., Ltd. Sichuan Aipu Network Co., Ltd. ISP 50% (700.0) (113.7) (700.0) (113.7)

TBD Acquisition Dermot Holdings Limited and its subsidiaries Diyixian.com Limited Virtual Private Network Services / MNS

100% (1,050.0) (170.5) (1,050.0) (170.5)

Total M&A (2,927.5) (472.4) (3,209.5) (516.2)

Acquisition Date Revalued Up To Date


PAGE 31 / 121

There are some important observations that do not jump out of this chart.

VNET has been about as acquisitive as any of China’s largest Internet companies, having done 24 acquisitions since it prepared to go public in 2011.

But unlike Alibaba, Tencent, Baidu or Qihoo 360, VNET’s total acquisition consideration is a very large percentage of its market cap (almost 30%) and revenue (about 100% of 2014 revenue guidance).

Despite having acquired a total consideration of RMB 3.2 billion ($516 million), close to 30% of its current market cap, only 0.5% of total acquisitions went towards assets for its core IDC business, hosting, and that negligible amount was for an intercompany transaction with aBitCool (one of VNET’s own VIEs).

None of the acquisitions targeted companies with substantial fixed assets, which is surprising since an IDC network is essentially a large fixed asset. In the US, IDC companies (e.g. Equinix) have claimed to be REITs and applied for conversion to REIT status. VNET’s highly unusual M&A strategy is analogous to that of a commercial real estate company that only buys tangential service businesses with no buildings or other fixed assets.

The vast majority of the acquisitions have been tucked quietly into the commoditized, slower-growth, asset-light MNS business that management rarely talks about.

And yet, despite all the acquisitions, MNS revenue contribution is sharply declining.

Exhibit 22: MNS’ declining contribution to total revenue

The two CDN acquisitions (FastWeb and iJoy) are consolidated into IDC even though

they have no IDC assets and offer no hosting services.

0.0%10.0%20.0%30.0%40.0%50.0%60.0%70.0%80.0%90.0%

100.0%

Hosting and related revenuesManaged network services


PAGE 32 / 121

The consideration values have gone up consistently and exploded in size in 2014 with the back to back acquisitions of iPoo and Dermot, which collectively represent over half the total consideration paid throughout the entire period.

An Acquisition Inquisition

This pattern of constant non-core acquisitions begs many questions.

It is unusual for a company in massive organic expansion mode to also go on acquisition binges right before periods of high execution risk when the distraction of M&A is least desirable. Why is that the only time VNET acquires anything significant?

For example, why would VNET’s management acquire iPoo and Dermot back to back for

a combined consideration significantly greater than VNET’s own IPO in 2011 right before it expands capacity by a combined 17,000 cabinets (over 120% growth)?

Why is virtually all the capital deployed into non-IDC assets, especially the MNS business the company acknowledges is much less strategic?

Why does VNET only acquire service businesses with no fixed assets?

Why would a company confident in its core business bother with so many tiny acquisitions into the non-core MNS business that is declining in revenue contribution?

Why is there such poor disclosure about VNET’s many acquisitions? Truly minimal information such as the names of the acquired entities and occasionally some high level valuation information is about all we get in SEC filings. Why is there little to no information reported about the acquired entities’ financial performance and corporate history before acquisition?

Why do non-hosting businesses get reported with core IDC? CDN and Microsoft cloud software do not belong in IDC. The excuse management gave when we asked was that they are not broken out separately because they are too small. Shouldn’t management want to report emerging businesses off a small base to show their strong growth? That is what the large majority of other public companies in this situation do.

VNET’s Midas Touch

Before we decided to investigate VNET’s major acquisitions in person, we spent considerable time trying to figure out their performance. Although VNET discloses little information about its acquisitions, we were able to get our hands on filings to China’s State Administration for Industry and Commerce (SAIC)7 to get a view of their pre-acquisition performance to compare to the post-acquisition performance reported in SEC filings

7 http://www.saic.gov.cn/english/aboutus/


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Exhibit 23: Summary financials for VNET’s major acquisitions before and after acquisition

It is not hard to see that VNET’s acquisitions deliver stunning outperformance in growth, profitability or both immediately after consolidation.

VNET’s Impeccable Timing

It is very unusual for a company to acquire non-core businesses that outperform that dramatically as soon as they are tucked in. It is even more unusual, and also highly counterintuitive, for that to happen during critical periods of heightened execution risk e.g. before the IPO (MNS Entities), when margins plunged (Fastweb) and before substantial ramps in cabinet expansions (Gehua, TWYL and iJoy, iPoo and Dermot). And yet that is exactly what happens without fail for VNET. It is practically a law, as the chronological chart of acquisitions overlaid with cabinet growth shows below.


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Exhibit 24: History of cabinet expansion and suspicious acquisition timing

Six months before its April 2011 IPO, as VNET realized that a cash-burning unprofitable data center business might not be well-received by the public markets, VNET got serious about MNS, a business it was not in previously. On September 30, 2010, VNET acquired the two parent companies of a seven-company network of MNS businesses it refers to as “Managed Network Entities” in the 2011 20-F. As Exhibit 23 shows, the MNS Entities’ net margins from 2009-2013 were -2.4%, 7.7%, 18.5%, 19% and 8.6%. The effect of that sudden peak in profitability between 2011 and 2012 was a successful VNET IPO driven by a company that appeared to have turned the corner in profitability just in time for its listing. We note that profitability was achieved by acquisition in spite of the core IDC business’s underperformance. Exhibit 25: VNET’s profitable IPOs courtesy of well-timed profit peak in well-timed acquisition of MNS Entities

-

5,000

10,000

15,000

20,000

25,000

30,000

35,000

7 MNS Entities Gehua (MNS)

Fastweb TWYL iJoy

iPoo

Dermot

IPO

Plunge in utilization


FY 2010 FY 2011 FY 2012 FY 2010 FY 2011 FY 2012

Net revenues 525,203.0 1,020,929.0 1,524,158.0 465,028.0 750,929.0 1,174,158.0 Cost of sale (396,858.0) (744,371.0) (1,098,477.0) (363,761.8) (582,371.0) (877,977.0) Gross profit 128,345.0 276,558.0 425,681.0 101,266.3 168,558.0 296,181.0

Gross margin % (25.0%) (25.0%) (25.0%) # (25.0%) (25.0%) (25.0%)

Operating expenses (353,614.0) (198,468.0) (327,312.0) (339,027.6) (143,118.0) (267,812.0) Changes in the fair value of contigent purchase consideration payable (7,537.0) (63,185.0) (17,430.0) (7,537.0) (63,185.0) (17,430.0) Operating income(loss) (EBIT) (232,806.0) 14,905.0 80,939.0 (245,298.3) (37,745.0) 10,939.0

Other income(expense) 1,792 34,170 7,951 1,792 34,170 7,951 Interest income(expense) -2,213 10,541 4,925 -2,213 10,541 4,925

Income(loss) before income tax -233,227 59,616 93,815 -245,719 6,966 23,815 Income tax benefit (expense) (1,588.0) (13,677.0) (36,159.0) (963.4) (11,044.5) (32,659.0) Net income(loss) (234,815.0) 45,939.0 57,656.0 (246,682.7) (4,078.5) (8,844.0)

Consolidated with 7 MNS Entities Consolidated without 7 MNS Entities


PAGE 35 / 121

Fresh with cash from the IPO, VNET acquired another MNS company named Gehua towards the end of 2011, right before the company’s most aggressive period of cabinet deployment theretofore. Similarly fortuitous timing can be seen in the acquisition of Fastweb, a CDN business that is also not core to IDC, right after the plunge in utilization we discussed in the last section (see Exhibit 8 for utilization trend). Exhibit 23 shows a business that declined between 2010 and 2011, both unprofitable years, before it was acquired by VNET in 2012. Suddenly, revenue doubled and net margins went from negative to a robust 19%. Our calls to the IR team and the CFO over the past two quarters resulted in wildly bullish projections for Fastweb in 2014 and 2015, although the level of wild bullishness varied by the day and the source. We were told Fastweb would deliver anywhere between 150-300% year on year growth in 2015, just in time for the huge 27,000 cabinet build out in 2H2014 and 2015 that will depress utilization and therefore margins. Throughout our diligence of Fastweb, we were able to interview engineers from Microsoft who can be found any day of the week at VNET’s headquarters (they are easy to spot, many being of Indian descent). Who does Microsoft, VNET’s loyal and exclusive partner for cloud software, use for CDN services in China? Apparently Microsoft’s commitment and loyalty to VNET only goes so far, since we were able to confirm with both Microsoft engineers and the management team of industry leader ChinaCache (Nasdaq:CCIH) that Microsoft uses CCIH and not Fastweb, a business everyone in the industry other than VNET confirms is losing market share. How Fastweb loses share but projects 150-300% growth next year is as curious as the explosion in growth and profit immediately after VNET acquired it. Another case of prescient timing occurs in 2Q2013 when VNET acquired another non-core CDN business referred to as “iJoy” in the 2013 20-F. This was right after the plunge in utilization that somehow had no impact on margins but apparently was bad enough to stall cabinet deployment for three quarters until iJoy was acquired. Not only did cabinet growth resume immediately thereafter, it is not hard to see how margins held throughout that period from the analysis below.

Exhibit 26: iJoy’s impact on VNET’s consolidated margins


PAGE 36 / 121

It was only after consolidating iJoy that VNET was able to maintain gross margin around 26% from 2Q2013 to 2Q2014. Similarly, adjusted EBITDA margin was held between 18% and 19% throughout that period. Without the consolidation of iJoy’s gross profit, VNET’s organic gross margins would have dropped to as low as 15% and adjusted EBITDA margin would have decreased to as low as 9% in the last quarter of 2013. Most recently, right ahead of the exceedingly aggressive 17,000 cabinet build of 2H2014 and 2015, VNET suddenly decided to diversify into two other non-core businesses, consumer broadband services (“last mile” broadband) and virtual private network (VPN) services, by making the two largest acquisitions in their long history of non-core acquisitions. The back to back timing of acquisitions of this size notwithstanding, more curious is their timing ahead of an epic cabinet ramp as the acquired MNS subsidiaries’ revenue is stalling and margins are quickly eroding. Even for these much larger acquisitions, VNET will not get much in the way of fixed assets, so investors might hope there is at least significant strategic value to the core IDC business. Alas, there is not. They are both non-core add-ons, with iPoo having practically zero synergy as it is a consumer business. By now the answer to why VNET, a purportedly high growth business in a developing industry, would deploy so much of its precious cash to acquire low-growth established companies outside of its core industry should be obvious. It will be impossible for VNET to survive the massive cabinet build ahead without inorganic financial help.

Vicious Cycle

It is clear that financings are VNET’s key growth driver. VNET raises a huge percentage of revenue and market cap to acquire increasingly larger non-core companies to make up for the shortfall in revenue from the core business. That core business consumes about half the cash from financings to fund an IDC build that burns cash at an alarming rate. The result has been a massive swing in the balance sheet from net cash to net debt in three short years.

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

Gross margin % (without iJoy) Gross margin % (with iJoy)


PAGE 37 / 121

Exhibit 27: Financial consequences of feeding the IDC beast

While management waits for its nascent cloud software business to ramp, the IDC business is burning a hole through the balance sheet that will require an enormous amount of fundraising. Between 2011 and 2Q2014, by far VNET’s period of largest cabinet expansion, capex per self-built cabinet (since partnered cabinets incur no capex) was approximately RMB 139,000.

Exhibit 28: Capex per cabinet

VNET plans to launch 17,000 incremental cabinets through the end of 2015, which at a rate of RMB 139,000 per cabinet, would require over RMB 2.4 billion ($396 million) to finance. Note that this is a conservative assumption since we are not charging the balance sheet with commitments for the completion of ongoing data center construction and other associated IDC network expansion costs.

(200.0)

(100.0)

0.0

100.0

200.0

300.0

400.0

500.0

Revenue Financings M&A Net Debt

2010 2011 2012 2013 1H2014 Run rate


PAGE 38 / 121

What will that do to the company’s net debt position, and how will the company’s trailing three year track record of burning 28% of its total net revenue in free cash flow factor into the company’s liquidity? More importantly, if VNET is overstating cabinet count and utilization to such a degree that the overstatement alone wipes out all the reported EBITDA, an assumption for which we have provided ample evidence (we have yet to discuss the acquisitions in detail…), how will VNET stay solvent, let alone support its current expansion plans? Investors, stockholders in particular, should respect their place in the capital structure and act accordingly, because a liquidation of VNET today would render all of VNET’s equity worthless, even without the planned capacity expansion.

A Track Record of Value Destruction

Most companies use acquisitions to consolidate the industry of their core lines of businesses. Less frequently, smaller acquisitions are used to gain access to promising new lines of business as established companies saturate their slowing industries. VNET’s acquisitions fly in the face of these tried and true best practices. VNET only acquires outside of its core business and uses acquisitions to troubleshoot growth problems in the core. Since VNET tucks these acquisitions into only two categories, IDC and MNS, breaking out only revenue separately, investors cannot track regularly whether their capital is being deployed productively or not. What happens to these acquisitions over the long term is a critical question—not merely one of management competence but more importantly, solvency. We have seen that roughly half the capital raised in VNET’s non-stop financings has yet to deliver an economic benefit as the IDC network bleeds cash like a stuck pig, making VNET increasingly indebted. Does the other half of the funds from financings deliver acceptable returns in future cash flows for investors? VNET’s track record suggests the answer is a resounding no.


PAGE 39 / 121

Exhibit 29: A long history of value destruction through acquisitions

Out of the two dozen acquisitions the company has closed so far (Dermot has yet to close), only two companies have yet to sorely disappoint: Aipu, which was consolidated into VNET just last quarter, and the mysterious iJoy, an outlying winner (so far) from a long list of miserable failures. So naturally, we began our extensive six-month investigation of VNET’s many acquisitions with iJoy.

Year Acquisition Rationale O utcome

May 2007 Tiantian Online Expansion into online video business Ceased supporting operations

October 2007 Shanghai Stateline N k

ISP Shut down

December 2007 VV91 Regional expansion Southwest NA (no evidence of its existence)

May 2008 Lanmang IDC network expansion Shut down

September 2010 Managed Network Entit ies (7 total)

Managed network expansion Business degradation. Failed to meet profit targets stiputlated in merger agreement. Rapidly shrinking contribution to total revenue.

Prior to October 2010 pre-IPO reorganization

Five undisclosed companies

Expansion into new businesses (specifics undisclosed)

All writ ten off

November 2011 Guangzhou Gehua Managed network expansion Business degradation. Failed to meet profit targets stiputlated in merger agreement. Rapidly shrinking contribution to total revenue.

September 2012 Fastweb Expansion into Content Delivery Network (CDN) business

Losing market share, achieved only 6% net margin

February 2013 Tianwang Online Managed network expansion Together with Yilong Xinda, achieved only 3% net margin. Rapidly shrinking contribution to total revenue.

February 2013 Yilong Xinda Managed network expansion Together with T ianwang Online, achieved only 3% net margin. Rapidly shrinking contributioon to total revneue.

April 2013 iJoy Holdings Limted and related entities

Expansion of CDN business TBD

2014 Aipu Holdings Expansion into consumer/retail last-mile services

TBD (just consolidated as of 2Q2014)


PAGE 40 / 121

IJOY: GHOST IN THE (CACHE) MACHINE In April 2013, VNET completed the acquisition of 100% of iJoy, its subsidiaries and consolidated affiliates (collectively known as “iJoy”) with a purchase consideration of RMB 97.0 million as part of a purported strategic expansion into CDN/content caching. VNET had previously acquired another CDN company, FastWeb, and appeared to be getting serious about the CDN space. We paid particularly close attention to iJoy because it is listed in the 2013 20-F filings as one of VNET’s two VIEs, an entity called aBitCool being the other. Also, iJoy appears to be an incredibly profitable business with nearly 100% net margins.8 Despite all that, we wondered why VNET is so secretive about iJoy, disclosing so little about this company in its 20-F filings despite its substantial contribution to consolidated margins. Uncharacteristically, VNET never issued a press release about iJoy’s acquisition despite issuing one for the less significant FastWeb9 and the two acquisitions of iPoo10 and Dermot11 that were done immediately after. If iJoy is significant to VNET, it is certainly hard to tell. iJoy doesn’t even show up on a search on VNET’s own corporate website:

Exhibit 30: There are no results for a search for “iJoy” on VNET’s own website

iJoy’s Filings: The Basics

As skeptical as we were going into our review of iJoy’s SAIC filings, even we were surprised by the number of red flags that our first cursory scan of iJoy’s SAIC filings revealed.

8 2013 20-F, page F-39 9 http://ir.21vianet.com/releasedetail.cfm?ReleaseID=708303 10 http://ir.21vianet.com/releasedetail.cfm?ReleaseID=852392 11 http://ir.21vianet.com/releasedetail.cfm?ReleaseID=865464


PAGE 41 / 121

Corporate Structure

iJoy’s consolidated PRC variable interest entity is called Beijing iJoy Information Techonology Co., Limited (“Beijing iJoy”). The wholly owned PRC subsidiary of iJoy Holding Limited is named Suzhou Zhuoaiyi Information Technology Co., Limited (“Suzhou iJoy”).12 The following diagram illustrates the current corporate structure of the principal operating entities controlled by and affiliated with iJoy Holdings Limited:13

Exhibit 31: Corporate structure of iJoy Holdings Limited

iJoyHoldingLimited

AsiacloudWirelessLtd.(HongKong)

SuzhouZhuoaiyiInformationTechnology

Limited(“SuzhouiJoy”)

BeijingiJoyInformationTechnologyLimited(“BeijingiJoy”)

SuzhouAizhuoyiInformationTechnology

Limited

PengYangThefounderandsellerof

iJoy

OutsidePRC

InPRC

VIE 99%equityownerRelatedparty

Relatedparty

100%acquiredonApril30,2013

ShanghaiiJoyInformationTechnologyLimited(“ShanghaiiJoy”)

100%owned

PengYang’sfather

1%equityowner

WFOE

PRC regulation currently restricts foreign ownership of telecommunications value-added businesses.14 The shareholder(s) of Beijing iJoy must be PRC citizen(s) who is (are) forced to enter into a share pledge agreement with Suzhou iJoy to provide effective control for Suzhou iJoy. According to SAIC filings, Peng Yang is the sole owner of Beijing iJoy with a personal registered permanent residence in Beijing’s Xicheng district. On October 30, 2012, Peng Yang signed a definite loan and share pledge agreement with Suzhou iJoy to pledge his 100% shares in Beijing iJoy (北京阅联信息技术有限公司, “北京阅联”). Per Suzhou iJoy’s SAIC filings, its sole investor is a Hong Kong company, iJoy Information Limited which was renamed to Asiacloud Wireless Limited in late 2013. This Hong Kong based company is entirely invested and controlled by iJoy Holdings Limited (BVI). Below is the

12 2013 20-F, page 52 13 iJoy Information Limited (Hong Kong) was renamed to Asia wireless Limited in June 2013. 14 2013 20-F, pages 52, 53 and 54


PAGE 42 / 121

scanned copy of Suzhou iJoy’s business license and share pledge agreement entered into by Peng Yang and Suzhou iJoy.

Exhibit 32: Business License of Suzhou Zhuoaiyi and Share Pledge Agreement by Peng Yang and Suzhou

Zhuoaiyi

Translation of Business License of Suzhou Zhuoaiyi: Name of Company: Suzhou Zhuoaiyi Information Technology Co., Limited. The sole owner of Company: iJoy Information Limited (Hong Kong) Translation of Share Pledge Agreement by Peng Yang and Suzhou Zhuoaiyi: The parties who entered into the agreement include Peng Yang and Suzhou Zhuoaiyi Information Technology Co., Limited. Pursuant to the share pledge agreement, Peng Yang as the nominee shareholder has pledged all his equity interest in Beijing iJoy Information Technology Co., Limited to guarantee the repayment of the loan specified in the Article 2.0 of the agreement.

The important points are that Peng Yang was the sole owner of iJoy before its acquisition by VNET and that Mr. Peng apparently went out of his way to set up offshore entities in preparation for a sale to a foreign-listed company such as VNET.

iJoy’s Ghost Offices

iJoy is registered with the SAIC under a ghost office that is occupied by another company.


PAGE 43 / 121

Exhibit 33: iJoy’s registered office does not exist

We tried to find iJoy’s operations everywhere it made sense to find them but mostly struck out. We obtained all of iJoy’s registered addresses from Beijing iJoy and Suzhou iJoy’s SAIC filings, iJoy’s website and other public sources. All but one of the addresses led to ghost offices that could not have been used for real operations, and two of the ghost offices were occupied by different companies.


PAGE 44 / 121

Exhibit 34: List of all registered addresses for iJoy and results of our in-person investigation

Name of Company Registered Address Note Source

Beijing iJoy

(北京阅联信息技术有限公司)

北京市西城区德胜门外大街83号楼4层40

8室 Room 408, 4th Floor, Building No.83, Deshengmenwai Avenue, Xicheng District, Beijing

Ghost address. The room is occupied by another company.

SAIC15

Beijing iJoy

(北京阅联信息技术有限公司)

北京市海淀区西土城10号北京邮电大学科研大厦202室 Room 202, 2nd Floor, Science Research Building, Beijing University of Posts and Telecommunications

Real office address with less than 10 people.

Company website16

Suzhou Zhuoaiyi / “Suzhou iJoy”

(苏州卓爱易信息技术有限公司)

江苏省昆山开发区前进东路科技广场150

5室 Room 1505, TechnologyPlaza, Qianjin Road East, Kunshan Development Zone, Suzhou, Jiangsu Province

Ghost address. The room is occupied by another company.

SAIC

Suzhou Aizhuoyi

(苏州爱卓易信息技术有限公司)

江苏省昆山开发区伟业路18号现代广场A

座2009室 Room 2009, Modern Plaza, Weiye Road, Kunshan Development Zone, Suzhou, Jiangsu Province

Ghost address only for registration purpose. Occupied about 60-65 square meters and nobody found working there.

SAIC

Shanghai iJoy

(上海阅联信息技术有限公司)

Established on May 30, 2013 with registered capital of RMB 5,000,000

上海市浦东新区张江高科技园区郭守敬路351号2号楼A637-16室 Room A637-16, Building No.2, No.351 Guoshoujing Road, Zhangjiang High Tech Zone, Pudong District, Shanghai

Ghost address only for registration purpose. Occupied about 30-35 square meters and nobody found working there.

SAIC

A Ghost Board of Director [sic]

iJoy not only has ghost offices, it also has a ghost board. SAIC filings show only one director who apparently runs board meetings with himself.

15 http://qyxy.baic.gov.cn/ 16 http://www.unionread.com/company_info_contant.html


PAGE 45 / 121

Exhibit 35: Suzhou iJoy’s corporate structure with single-director governance

Undercapitalized, Low Employee Count and Other Peculiarities

iJoy’s tiny RMB 10 million ($1.6 million) of registered capital and, depending on the year, five to eight employees were also surprising given its acquisition by VNET, a nearly two-billion USD market cap public company that runs a fundamentally different business. How much strategic value could such a puny company really have to VNET?

Exhibit 36:Beijing iJoy’s business license just before acquisition by VNET

We found it quite strange too that on March 14, 2013, a month before the acquisition by VNET on 4/30, there was a sudden large increase in registered capital from RMB 5 million to 10 million. As we dug deeper, we noticed this was preceded by a transfer of ownership to Peng Yang from the prior owners on July 2012 (see Appendix B).


PAGE 46 / 121

As we dug deeper into iJoy’s articles of incorporation and the various shareholder resolutions filed locally, what went on between 2012 and iJoy’s April 2013 acquisition became clear to us, as did the purpose of iJoy’s acquisition by VNET.

iJoy’s Orchestrated Acquisition

The following timeline illustrates iJoy’s corporate history.

Exhibit 37: Timeline of iJoy’s Corporate History

Woeful Financial Performance

The first thing to note is iJoy’s woeful financial performance for the first three years it was in business. For 2009, 2010, and 2011, all iJoy did was lose money. Particularly notable are the steep operating losses of RMB 3.71 million from a tiny RMB 0.91 million of revenue in 2011.

Peng Yang, Shu Huaying and Hu Yiwen establish iJoy, contributing 10 mln RMB of registered capital

Registered business scope: developing/selling hardware and software, developing information systems, related technical services and IT consulting

2009 rev. / net income: 0 RMB /

(0.01) mln RMB

2010 rev. / net income: 0.47 mln RMB /(0.27) mln RMB

Registered capital cut in half to 5 mln

RMB

2011 rev. / net income:0.94 mln RMB /(3.71) mln RMB

Shu and Hu sell 10% each to Peng

Shu and Hu sell 13.5% each to

Peng

Peng Yang establishes iJoy

Holding Limited, a BVI (offshore)

company

Shu and Hu sell 10% each to

Peng

Peng establishes iJoy Information Limited,

a Hong Kong company (later

renamed to Asiacloud Wi l )

Peng pledges all his shares in Suzhou

Zhuoaiyi to borrow a nominal 0.5 mln RMB

Peng estalishes PRC WFOE

named Suzhou Zhuoaiyi

Information Technology Co.,

Limited

2012 rev. / net income:8.38 mln RMB /2.45 mln RMB

Peng increases his investment in Beijing iJoy

to 10.08 mln RMB contributing intellectual

property

VNET acquires 100% of iJoy for

97 mln RMB

Business scope changed to include

technology and goods import and export

2013 rev. / net income:118.91 mln RMB /

103.3 mln RMB

Business scope changed to include Internet

virtual network services, IDC services, Internet access network

services and information services

VNET lends 12.885 mln RMB to Peng Yang


PAGE 47 / 121

Exhibit 38: Summary financials from Beijing iJoy’s with SAIC filings for 2009, 2010 and 2011

Right before the end of that brutal year, the founders resolved to cut the registered capital of iJoy in half from RMB 10 million to 5 million. It is no wonder two of the three co-founders, Shu Huaying and Hu Yiwen, could not bail fast enough after that. In three transactions throughout 2012, Shu and Hu sold all their shares to Peng, who clearly had other plans (See Appendix B.)

Peng Yang’s Takeover

Before Peng even took possession of all of iJoy’s shares, he began establishing a much more sophisticated corporate structure that was clearly intended to put the company up for sale. Why else would a tiny, struggling Chinese company with barely any revenue go through the legal motions of creating an offshore structure to hold the onshore entities? The result of Peng’s efforts is the corporate structure depicted in Exhibit #, which includes a VIE and a WFOE wholly owned by an offshore company, not exactly a run-of-the-mill structure for a Chinese company with registered capital of under a million USD. A funny thing started to happen as Peng gained control of iJoy. The financial performance started to improve, with a nice swing in profitability from being so hopelessly in the red in 2011 that two of the three co-founders threw in the towel to being very nicely profitable in 2012 after a near 10-fold improvement in revenue. Peng was suddenly proving to be some kind of operator indeed.

2009 2010 2011


PAGE 48 / 121

Exhibit 39: Summary financials from Beijing iJoy’s with SAIC filings for 2012

On March 2013, Peng Yang increased his investment in Beijing iJoy in the form of valued intellectual property, rather than cash, to RMB 10.08 million. In China, it is a common practice for shareholders without the necessary cash to contribute to increase their company’s registered capital via non-cash intellectual assets. The process involves engaging a valuation firm to appraise the value of so-called “high tech intellectual property”. The valuation firm’s report is then presented to the SAIC for approval. The motivation behind this is to meet the minimum registered capital threshold of RMB 10 million in order to gain approval for value-added telecommunication licenses.

Two Suspicious Transactions

Right around the time of this increase in registered capital, VNET issued a loan of RMB 12.885 million ($2.1 million) to Peng Yang.17 No more than three or four months later VNET acquired 100% of iJoy. The timing and size of the loan relative to the company’s registered capital made us wonder for what purpose VNET would issue a loan to the seller of a company it was weeks away from acquiring. We noticed an even more irregular transaction disclosed on VNET’s 2013 20-F18:

17 2013 20-F, page F-9 18 2013 20-F, page 92


PAGE 49 / 121

For the year ended December 31, 2013, we paid RMB61.2million (US$10.1 million) to Suzhou Aizhuoyi Information Technology Company Limited, a company controlled by seller of iJoy, for the computer and network equipment purchased by us.

Recall from Exhibit # that Suzhou Aizhuoyi (not to be confused with Suzhou Zhouaiyi, i.e. Beijing iJoy) the company from which VNET bought RMB 61.2 million worth of hardware is a related party 99% owned by Peng Yang and 1% owned by Peng’s father. A review of Suzhou Aizhuoyi’s SAIC filings revealed an even smaller company than iJoy ever was, with registered capital of RMB one million.

Exhibit 40: SAIC filing of Suzhou Aizhuoyi

(Note: The registered capital was increased from RMB1m to RMB 10m on August 11, 2014)

We do not believe Aizhuoyi ever even existed, since its registered office is not only in the same exact building as Suzhou iJoy (Technology Plaza, Qianjin Donglu, Kunshan Development Zone), but also occupied the same room 1505 that we were unable to verify (recall another unrelated company occupied that room) from through November 2013, after VNET had acquired iJoy, at which point Peng Yang filed with the SAIC to change the registered office address. It makes little sense that large publicly listed VNET bought servers from little Suzhou Aizhuoyi when all logic would point to that transaction going the other way. VNET is obviously the much larger and more financially capable company with much more scale economies to exploit in the pedestrian act of buying servers. Interestingly, that was the only time VNET has ever “bought servers” from an acquired company that we could find. Both the loan to Peng pre-acquisition and the surprising large purchase of hardware from a shell company reeked to us, leaving several obvious questions unanswered:

How exactly did little Suzhou Aizhuoyi, the company with RMB1 million of registered capital gain a hold of that much valuable equipment at the time of transaction?


PAGE 50 / 121

What was the real purpose of this transaction? Could VNET, with all its vendor relationships, not find a better source from which to procure its hardware?

What equipment exactly did VNET purchase from SuZhou Aizhouyi? How much profit did Suzhou Aizhuoyi and therefore Peng Yang make from this

transaction? No matter how hard we tried, we could not reconcile the facts that VNET bought a company with horrible financials not core to either of its major businesses, IDC or MNS, with no registered office location, with no board of directors, with only minimal registered capital and only eight employees for RMB 97 million and then immediately bought RMB 61.2 million worth of servers from a shell company controlled by the seller. That was really strange. Then there was the change in ownership from multiple owners to a single owner who sold his company less than a year after spending a year buying it for himself and going through the pain of legally restructuring the company into a dual onshore/offshore holding structure, right before receiving a large loan from VNET. Things were getting interesting.

iJoy’s Transformation

Literally Incredible Post-Acquisition Performance

The most telling finding related to iJoy is the financial transformation it made right after the change in ownership in 2012 and then again right after it was acquired into VNET’s IDC business in the beginning of 2Q2014.

Exhibit 41: Summary of iJoy’s income statement before and after acquisition by VNET


FY 2011 FY 2012 FY 2013Q1

FY2014Q2

FY20142013Q1 2013Q2 2013Q3 2013Q4

Consolidated amounts after

acquisition date

Net revenues 942 8,376 118,905 31,106 25,600 2,182 18,735 18,209 79,779 116,723 Cost of sale -377 -1,526 -9,386 -4,344 -3,200 -80 -303 -1,356 -7,647 -9,306 Gross profit 565 6,850 109,519 26,762 22,400 2,102 18,432 16,853 72,132 107,417

Gross margin % 60% 82% 92% 86% 88% 96% 98% 93% 90% 92%

Operating expenses -4,243 -4,760 -13,203 -4,197 -3,700 -286 -873 -1,428 -10,616 -12,917 as percentage of revenues 450% 57% 11% 13% 14% 13% 5% 8% 13% 11%

Operating income(loss) (EBIT) -3,678 2,090 96,316 22,565 18,700 1,816 17,559 15,425 61,516 94,500

Other income(expense) - 360 4,491 3,709 230 - - 196 4,295 4,491 Interest income(expense) -30 4 2,498 790 770 - 1 3,711 -1,214 2,498

Income(loss) before income tax -3,708 2,454 103,305 27,064 19,700 1,816 17,560 19,332 64,597 101,489 Income tax benefit (expense) - - - - - - - - - - Net income(loss) -3,708 2,454 103,305 27,064 27,064 1,816 17,560 19,332 64,597 101,489

Net income margin % -394% 29% 87% 87% 106% 83% 94% 106% 81% 87%

Breakdown of FY 2013


PAGE 51 / 121

It is not only iJoy’s explosion of growth that is rather difficult to believe. iJoy’s improbable profitability raised our eyebrows as well. iJoy’s gross margin in 2013 and Q1 2014 was 92% and 86% respectively, much higher than that of the two dominant Chinese CDN players ChinaCache and ChinaNetCenter and even higher than the number 1 global CDN service provider Akamai Technologies’.

Exhibit 42: Comparison of gross margins for leading CDN companies

Key CDN Players GP % 2012 GP % 2013 GP % Q1 2014

ChinaCache 蓝汛 19 31.4% 31.4% 30.3%

ChinaNetCenter 网宿 20 30.5% 38.7% 36.1%

Akamai Technologies 21 61.4% 67.6% 69.2%

iJoy 82.0% 92.0% 86.0%

iJoy spent a mere 13% of total net revenues in operating expenses in 2013. Such extremely high operating leverage is implausible. What exactly was iJoy doing to turn in such incredible performance? And why was VNET being so quiet about the cash cow it had clearly acquired for next to nothing? Why was VNET only talking about Fastweb as its CDN play while never mentioning iJoy in conference calls, investor meetings, press releases or industry events?

19 According to ChinaCache filing in Form 20F and 6-K with U.S. SEC 20 According to ChinaNetCenter official website at http://www.chinanetcenter.com/Home/Notice/41?val=2 21 According to Akamai Technologies Inc. filing in Form 10-Q and 10-K with U.S. SEC

942 8,376

118,905

-3,708

2,454

103,305

-20,000

-

20,000

40,000

60,000

80,000

100,000

120,000

140,000

FY 2011 FY 2012 FY 2013

Net revenues Net income(loss)

2,182

18,735 18,209

79,779

1,816

17,560 19,332

64,597

- 10,000 20,000 30,000 40,000 50,000 60,000 70,000 80,000 90,000

2013Q1 2013Q2 2013Q3 2013Q4

Net revenues Net income(loss)


PAGE 52 / 121

Increasingly Far-Ranging Business Scope

VNET claims iJoy is a CDN software business but before its acquisition in April 2013, the registered business scope was computer hardware/accessories development and computer technology service, neither related to CDN.

Exhibit 43: Beijing iJoy’s business scope registered with the SAIC

On October 15, 2013, Beijing iJoy modified its business scope by adding technology import and export. This is a very strange addition. Then on March 28, 2014, iJoy’s registered business scope was modified again to include a variety of data center and networking areas.

Exhibit 44: Beijing iJoy’s shareholder resolution to change business scope

Translation of Shareholder Resolutions on October 15, 2013: To change the business scope by adding technology and goods import and export.


PAGE 53 / 121

Translation of Shareholder Resolutions on March 28, 2014: To change the business scope by adding Internet virtual network services (B-14), Internet Data Center services (B-11), Internet access network services (B-15) and information services (B-25)

The Taxing Search for iJoy’s Products

Wondering how such a tiny company with historically atrocious financial performance could reinvent itself so many times, we turned to iJoy’s own website for answers. iJoy’s corporate website www.unionread.com shows three different products for sale: UR-Market, UR-CDN and UR-Cloud services.

Exhibit 45: Product offerings on www.unionread.com’s (iJoy’s corporate website)

Products Descriptions

UR-Market 3G Fueling Content Delivery Platform

Helps customers deliver wireless content to end users throughout iJoy’s nationwide promotion and distribution channels

UR-CDN

Basic CDN software

UR-Cloud

Basic cloud computing software

Confused by the product descriptions and failing to understand how CDN or cloud computing could be sold as packaged software, which is purportedly what iJoy does, we tapped our expert network and conducted dozens of interviews for several weeks.

A Complete Unknown Selling Useless Software

Our biggest problem was finding anyone who had heard of iJoy or any of the “UR” products. We interviewed many management teams, including those of the three dominant CDN players in China, ChinaCache (Nasdaq:CCIH), ChinaNetCenter (SH:600804) and Dnion Technology, among other industry veterans. We spoke with over 20 of China’s most successful wireless application developers and operators. We asked them whether they or any of their teams had

heard about 北京阅联 or 苏州卓爱易 as an independent CDN or cloud computing services provider. The feedback was unanimous. None of them had ever heard of iJoy. Towards the end of a multi-week effort, we finally met a telecom industry professional who had heard of UR-CDN. According to our source, iJoy had tried to persuade China Telecom to adopt their UR-CDN technology but China Telecom declined, citing poor quality and reliability as well as lack of scalability as major issues. We interviewed all the major telcos, all the major third-party CDN service providers and dozens of content providers (both Web-based and mobile) and the feedback was once again unanimous. Nobody could see a market for CDN being sold as software for implementation by whoever would buy such a thing.


PAGE 54 / 121

Turning to more developed Internet markets to see if there are any precedents for companies that sell CDN software (as opposed to offering it as a service like all the successful CDN companies do), we were unable to find any precedent. All our interviews were negative on the concept of a company that sold CDN software. After months of trying to find anyone else who had heard of iJoy or might buy their products, we gave up and turned to the regulatory filings once again to seek clues as to how iJoy could be making significant revenue and profit for VNET. This time, we struck gold.

Clues from China’s Tax Authority

VNET’s 2013 20-F states the following22:

Our other income decreased fromRMB11.6 million in 2012 to RMB6.2 million (US$1.0 million) in 2013. Other income in 2012 was primarily attributable to a bargain purchase gain related to the acquisition of 21VXi’an. Other income in 2013 was primarily attributable to the value-added tax refund enjoyed by Beijing iJoy.

The VAT refund referenced in the 20-F can only be the result of the sale of qualified software filed with and approved by China’s State Taxation Bureau. On October 13, 2011 the Ministry of Finance and the State Taxation Bureau jointly announced a rule, Circular No. 100(2011), with a term effective from January 1, 2011 which permits sellers of PRC software to be eligible for a VAT refund only if the following conditions are satisfied in accordance with the State Taxation Bureau’s rules and regulation23.

1. The vendor obtains a testing report issued by independent software test institutions certified by the governing provincial qualified testing bureau

2. The vendor obtains a Software Certification issued by the local software registration associations and the Computer Software Copyright Certification issued by China’s Copyright Protection Center

3. The rate of VAT refund is 14% of the contractual value excluding VAT (17%) Our legal counsel advised us that in order to avoid abuse, the application process is designed to be complicated and time-consuming, taking at least three months from the day of application to the State Tax Bureau. According to China’s tax code, an enterprise that sells software must pay VAT rather than business taxes. Therefore, whatever Beijing iJoy sells to its customers must be software and not some kind of service. Based upon SAIC filings and the 2013 20-F, we know Beijing iJoy received a VAT refund of RMB 4.5 million in Q3 and Q4 2013 which corresponds to taxable revenues recognized in the period from April 30, 2013 to the end of third quarter of 2013. We estimate iJoy’s software sales below:

22 2013 20-F, pages 71 and 74 23 http://www.shui5.cn/article/19/51620.html


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Realized contractual value for the corresponding period = VAT refund * 1.17/14%

= 4491 * 1.17 / 14% = 37,532 million Recognized revenue for the corresponding period = Realized contractual value / 1.17

= 37,532 / 1.17=32,078 million The recognized revenues from software sales were about RMB 32.1 million, or 86% of total revenues for the corresponding period. Since iJoy collected a VAT refund, it must have sold software, and since it must have sold software, that software must have been registered with China’s Copyright Protection Center. We searched www.ccopyright.com.cn for any computer software developed and registered by

北京阅联 and finally found some signs that iJoy existed at all. Below is a list of all of iJoy’s computer software with copyright registration records:

Exhibit 46: Historical copyright registration records for iJoy’s software

Registration No. Classification Series No.

Name of software copyright Copyright Series No.

Date of Initial

Publication

Date of Registration

2014SR028116 30000-0000 3G 加油站积分平台系统 3G Gas Station Royalty Points Platform System

V1.0 2013-10-08 2014-03-07

2014SR028114 30000-0000 3G 加油站佣金发放系统 3G Gas Station Commission Distribution System

V1.0 2013-10-12 2014-03-07

2013SR123789 30200-0000 移动互联网内容云分发平台 Mobile Internet Contents Distribution Platform System

V1.0 2013-08-09 2013-11-11

2013SR120067 30000-0000 基于 4G TDD-LTE 移动教育内容分发平台 Mobile Education Contents Distribution Platform System, based on 4G TDD-LTD

V1.0 2013-08-08 2013-11-06

2013SR119270 30000-0000 基于 4G TDD-LTE 移动内容分发网络系统 Mobile Contents Distribution Platform System, based on 4G TDD-LTD

V1.0 2013-08-08 2013-11-05

2013SR119167 30000-0000 全球移动漫游 SIM 卡(Cloud-SIM)解决方案平台 Global Mobile Cloud-SIM Platform System

V1.0 2013-08-01 2013-11-05

2013SR032514 10000-0000 云联 CDN 计费系统 UR-CDN Billing System

V1.0 2012-08-17 2013-04-10

2013SR032512 10000-0000 云联 CDN 调度系统 UR-CDN Traffic Dispatching System

V1.0 2012-08-16 2013-04-10

2013SR032456 10000-0000 云联 CDN 监控系统 UR-CDN Monitoring System

V1.0 2012-08-16 2013-04-10

2013SR032452 10000-0000 云联 CDN 客户系统 UR-CDN Client Management System

V1.0 2012-08-15 2013-04-10

2013SR028217 10000-0000 云联 CDN 缓存系统 UR-CDN Caching System

V1.0 2012-08-17 2013-03-26

2013SR028214 10000-0000 云联 CDN 系统 UR-CDN System

V1.0 2012-08-15 2013-03-26

2013SR028131 10000-0000 云联 CDN 操作系统 UR-CDN Operation System

V1.0 2012-08-15 2013-03-26

2013SR013091 30209-8400 阅联公开课 iPad 客户端软件 Open Class iPad Client End Software

1.0 2012-04-20 2013-02-16

2012SR067089 30000-0000 站点设备管理系统平台 Website Equipment Management System

V1.0 2012-06-01 2012-07-24


PAGE 56 / 121

2012SR058363 30206-0000 3G 手机应用辅导站助手系统软件 3G Mobile Cellphone Assistance System Software

V1.0 2012-03-21 2012-07-03

2012SR051820 30104-0000 3G 加油站平台系统软件 3G Gas Station Platform System Software

V2.0 2012-03-01 2012-06-16

2012SR006458 30100-0000 手机加油站平台系统软件 Mobile Phone Gas Station Platform System Software

V1.0 2011-04-19 2012-02-03

2011SR080034 30200-0000 3G 加油站平台系统软件 3G Gas Station Platform System Software

V1.0 2011-03-03 2011-11-04

2011SR079527 30100-6000 移动应用和资源云存储系统软件 Mobile Application and Cloud Storage System Software

1.0 2011-04-15 2011-11-03

2011SR079488 30205-6100 泛在教育应用商店系统平台软件 Fanzai Education Application Store System Platform Software

1.0 2011-06-09 2011-11-02

2011SR079486 30104-6000 移动教育社区系统软件 Mobile Education Society System Software

1.0 2011-05-06 2011-11-02

2011SR079461 30104-6000 移动应用和资源分发平台系统软件 Mobile Application and Resources Distribution Platform System Software

1.0 2011-02-03 2011-11-02

2011SR066748 30200-6200 手机精品软件安装系统软件 Mobile Phone Software Installation Software

2.1.1 2010-11-08 2011-09-19

2011SR066745 30200-6100 平板电脑电子报纸交互式平台系统软件 Pad Electronic Newspaper Interactive Platform Software

1.0 2011-01-07 2011-09-19

2011SR063253 30209-8400 泛在教育资源库系统软件 Fanzai Education Resources Bank System Software

1.0 2011-03-09 2011-09-03

2011SR063242 30200-8400 泛在教育资源分发系统平台软件 Fanzai Education Resources Distribution Platform Software

1.0 2011-03-04 2011-09-03

2011SR062862 30104-6000 手机软件下载平台系统软件 Mobile Phone Software Download Platform System

2.3 2011-03-03 2011-09-02

2010SR005891 65000-0000 阅联书库管理系统 Unionread Book Store Management System

V1.0 2010-01-10 2010-02-01

These registration records help explain what happened throughout iJoy’s timeline. Before 2012, iJoy was focused on developing software for mobile carriers for reading, education, application download, mobile resource storage and other such uses. As the numbers show, that did not go very well for iJoy’s three co-founders. Having burned through much of the capital they contributed in 2009 when they started the company, two of them called it quits while the persistent Peng Yang decided to reinvent the company. August 2012 was an inflection point. By then, Peng had become sole owner of iJoy and was well on his way to finalizing the corporate structure that would allow VNET to eventually acquire his company. As he was busy preparing his company for sale, Peng ditched any prior focus on mobile software and began registering CDN software with the copyright authority.

iJoy’s Sale of Useless Software to a Trading Company

The nagging question of who would buy iJoy’s products remained unresolved until we remembered that one of iJoy’s various business scope changes made little sense: technology import and export. Why would a tiny Chinese CDN software company find any business importing and exporting technology?


PAGE 57 / 121

Exhibit 47: Change of Beijing iJoy’s business scope to include import and export of technology

We were able to obtain evidence that iJoy has in fact successfully sold CDN software before, but not to anyone investors might expect. After months of due diligence, the only iJoy customer we were able to verify was none other than state-owned enterprise China Base Ningbo Group Company (“CBNB”), one of China’s largest iron ore importers.

Exhibit 48: July 2013 receipt from sale of iJoy CDN software to CBNB, a top 5 Chinese iron ore importer

Beijing Yuelian Information

Technology Co., Ltd

UR-CDN V1.0

CBNB

Beijing VAT invoice


PAGE 58 / 121

CBNB’s corporate website www.cbnb.com.cn describes CBNB as a comprehensive trading company engaged in import and export, trade logistics and automobile sales and services. Imports include iron ores, asphalt, plastics, liquid chemicals, coal, copper and cotton. But no CDN software. Exports include steel, textile, garment, hardware machinery and automobile accessories. But again, no CDN software. China-Base imports over 15 million tons of iron ore annually and is one of China’s five largest iron ore importers. Why such a company would buy CDN software from a tiny no-name Chinese company not even its industry peers have heard of, and in such relatively small amounts to boot, is incomprehensible. A much more plausible explanation is that Peng Yang has taken advantage of a personal relationship to forge contracts used to launder into VNET cash received from the pre-acquisition loan from and the sale of his company to VNET.

Data Center Build and

Cabinet Expansion

Capital markets

Cash

Equity (ADS)

d Non-Core Aquisitions (shell companies

and asset-light companies)

Cash

Cash and

Equity

Sale of Equity (ADS)

Cash (Proceeds of Sale of Equity)

Fake revenue and profit but no free cash inflow

Step 1

Step 2a

Step 2b

Step 4

Steps 3, 5


PAGE 59 / 121

THE MNS SHELL GAME VNET has been most acquisitive into the MNS business which made up roughly one third of the consolidated revenue in 2013. Before 2014, the year of the monster acquisitions of iPoo and Dermot, the company’s most significant M&A transaction was the acquisition of two companies referred to as the “Managed Network Entities” from a seller named Cheng Ran.

Cheng Ran and the Seven MNS Dwarfs (the Fable of the “Managed Network Entities”)

In the children’s fable that Disney made famous, Snow White is a plain scullery maid destined to live a life of misery with seven nondescript dwarfs until she bites the infamous poisoned apple that puts her in a coma. The fable ends well when Snow White awakens miraculously to the kiss of a heroic prince who rescues her and makes her a princess and then it’s happily ever after. The VNET version of this rags to riches fable is no less dramatic than Disney’s animated film. The story starts before the VNET IPO with a man named Cheng Ran who is the owner of a funky roll-up of seven MNS companies consolidated into two related parent companies called Beijing Chengyishidai (“CYSD”) and Beijing Zhiboxintong (“ZBXT”). Collectively, these seven entities are referred to in VNET’s 20-F filings as the “Managed Network Entities” (“MNS Entities”). Below is a chart that shows the legal structure of the Managed Network Entities from the latest SAIC filing (post-acquisition by VNET).

Exhibit 49: Corporate Structure of seven Managed Network Entities


PAGE 60 / 121

MNS Entities Before VNET Acquisition

Like Snow White before her prince, Cheng Ran and his seven MNS dwarfs, CYSD, ZBXT, ZYTL, YJHT, BKHT, XYHT and BZRH lived a nondescript life. The seven MNS Entities together were barely profitable as they faced stiff competition in a commoditized industry with little differentiation beyond price. Top line was growing for everyone as early demand in the data center services industry grew quickly off a tiny base. But it was a race to the pricing bottom that nobody could win for a long, long time and is still playing out four to five years later. The already razor-thin margins were getting squeezed down to around 5% gross margin and tinier net margins.

MNS Entities After VNET Acquisition

On September 2010, before the 2011 IPO, VNET came to the rescue like Snow White’s charming prince. VNET offered to buy 51% of both CYSD and ZBXT from Cheng Ran for the fantastic total price of RMB 172.4 million plus a call option to buy 100% of both for the total price of RMB 270.5 million. Giving the MNS Entities full credit for their run rate FY2010 financials from Exhibit 51 that works out to a P/E of 104x. For Cheng Ran, it was like being kissed by the proverbial prince and the deal was done. What happened immediately after the acquisition was magical indeed.

Exhibit 50: Consolidated Summary Financials for Managed Network Entities Post VNET Acquisition

Immediately after acquisition and as soon as their financials were consolidated by VNET, the MNS entities cranked out a record growth quarter that brought in more than half the prior year’s

Figures in thousand RMBCYSD + ZBXT: Pre-Acquisition CYSD + ZBXT: Post-Acquisition

FY2009Q1-Q3FY2010

FY2010 run rate as of

end of Q3

Q4FY2010

FY2011

Net revenues 111,242.0 125,427.0 167,236.0 60,175.0 270,000.0 Cost of sale (105,492.0) (118,442.0) (157,922.7) (33,096.3) (162,000.0) Gross profit 5,750.0 6,985.0 9,313.3 27,078.8 108,000.0

Gross margin % 5.2% 5.6% 5.6% 45.0% 40.0%

Operating expenses (4,795.0) (5,794.0) (7,725.3) (14,586.4) (55,350.0) Changes in the fair value of contigent purchase consideration payable - - - - - Operating income(loss) (EBIT) 955.0 1,191.0 1,588.0 12,492.3 52,650.0

Other income(expense) - (757.0) (1,009.3) - - Interest income(expense) 5.0 7.0 9.3 - -

Income(loss) before income tax 960.0 441.0 588.0 12,492.3 52,650.0 Income tax benefit (expense) (3,614.0) 2,000.0 2,666.7 (624.6) (2,632.5) Net income(loss) (2,654.0) 2,441.0 3,254.7 11,867.7 50,017.5

Adjusted Net income (2,654.0) 2,441.0 3,254.7 11,867.7 50,017.5 Adjusted net income margin % (2.4%) 1.9% 1.9% 19.7% 18.5%

Adjusted EBITDA 2,989.0 5,876.0 7,834.7 14,054.0 61,290.0 Adjusted EBITDA margin % 2.7% 4.7% 4.7% 23.4% 22.7%


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total revenue at a 45% gross margin, a nine-fold improvement, and a 20% net margin, a 10-fold improvement! Suddenly, a deal so expensive only a moron would do it turned into the steal of the century.

Exhibit 51: Acquisition Valuation for MNS Entities

The effect on VNET’s consolidated performance was enough to get VNET finally profitable, just in time for its 2011 IPO.

Exhibit 52: Effect of MNS Entities’ Acquisition on VNET’s Consolidated Financials24

What kind of cost synergies might explain this miraculous jump in growth and profitability? Were the MNS Entities operating under ridiculously punitive contracts with their suppliers that VNET was able to immediately remedy with their superior ones? Were the MNS Entities bloated with hundreds of employees that were suddenly laid off?

24 Source: SAIC filings, VNET F-1, 2001, 2012 and 2013 20-F


Consideration for 51% of MNS Entities 172,439.0 Implied consideration for 100% 338,115.7 FY2010 P/E 103.9xFY2011 P/E 6.8x

Consideration for 100% of MNS Entities 270,458.0 FY2010 P/E 83.1xFY2011 P/E 5.4x

FiguresinthousandRMB

FY2010 FY2011 FY2012 FY2013 FY2010 FY2011 FY2012 FY2013

Netrevenues 525,203 1,020,929 1,524,158 1,966,717 465,028 750,929 1,174,158 1,606,717Costofsale ‐396,858 ‐744,371 ‐1,098,477 ‐1,449,845 ‐363,762 ‐582,371 ‐877,977 ‐1,176,245Grossprofit 128,345 276,558 425,681 516,872 101,266 168,558 296,181 430,472

Grossmargin% 24.4% 27.1% 27.9% 26.3% 21.8% 22.4% 25.2% 26.8%

Operatingexpenses ‐353,614 ‐198,468 ‐327,312 ‐419,217 ‐339,028 ‐143,118 ‐267,812 ‐365,217Changesinthefairvalueofcontigentpurchaseconsiderationpayable

‐7,537 ‐63,185 ‐17,430 ‐55,882 ‐7,537 ‐63,185 ‐17,430 ‐55,882

Operatingincome(loss)(EBIT) ‐232,806 14,905 80,939 41,773 ‐245,298 ‐37,745 10,939 9,373

Otherincome(expense) 1,792 34,170 7,951 9,820 1,792 34,170 7,951 9,820Interestincome(expense) ‐2,213 10,541 4,925 ‐88,272 ‐2,213 10,541 4,925 ‐88,272

Income(loss)beforeincometax ‐233,227 59,616 93,815 ‐36,679 ‐245,719 6,966 23,815 ‐69,079Incometaxbenefit(expense)

‐1,588 ‐13,677 ‐36,159 ‐10,324 ‐963 ‐11,045 ‐32,659 ‐8,704

Netincome(loss) ‐234,815 45,939 57,656 ‐47,003 ‐246,683 ‐4,079 ‐8,844 ‐77,783

ConsolidatedwithCYSD&ZBXT ConsolidatedwithoutCYSD&ZBXT


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Looking for rational explanations, we dug through the MNS Entities’ SAIC filings. We found all the red flags iJoy had and then some.

Review of the MNS Entities’ SAIC Filings25

More Ghost Offices

Every single one of the seven MNS Entities is registered with the SAIC under a ghost address, meaning none of them has an actual physical office. You can see for yourself in the virtual tour of the MNS Entities that follows this section.

More Ghost Boards

As with iJoy, the MNS Entities do not just have ghost offices. They also have ghost boards. All seven MNS Entities hold board meetings with a grand total of one director.

Tiny Registered Capital

Each MNS Entity has registered capital of under RMB one million, which is the minimum required to enter the bidding process for bandwidth reselling run by potential customers such as China Mobile and other large third-party bandwidth purchasers. Even stranger is that several of the MNS Entities did not even pass that low bar despite purportedly being in the MNS business. BKHT and XYHT only have RMB 30,000 in registered capital.

Minimal Employee Count

Aside from the magnitude of the MNS Entities’ improvement in financial performance post-consolidation, the fact that it occurred so suddenly while employee count decreased makes the feat even more improbable.

Exhibit 53: Employee count of MNS entities

25 Appendix C

All figures in RMB except empoyee count

2007 2008 2009 2010 2011 2012CYSDRevenue 14,220,700 49,509,300 48,444,177 62,198,243 82,862,275 n/aProfits 71,100 818,300 221,292 131,943 9,877,896 n/aNumber of Employees 7 23 23 25 15 n/a

BKHTRevenue - - 1,641,850 8,114,316 11,428,581 26,305,701 Profits - - (503,504) 103,636 940,430 4,746,002 Number of Employees - - 2 25 17 14

XYHTRevenue - 2,308,200 5,612,915 7,081,500 7,013,028 n/aProfits - 1,300 2,094 337,828 796,074 n/aNumber of Employees - 3 3 24 15 n/a


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Inconsistent Registered Business Scope and Licensing

None of the MNS Entities had registered a business scope that made sense given their line of business. BKHT, CYSD, XYHT and YJHT are examples, with bizarre entries such as technology development, information consulting, cultural exchange, conference service, advertising and logo design. While looking to confirm business scope for the MNS Entities, we were unable to find corporate websites for most of them. Only CYSD had a website which had no content relevant to managing a network service and offered a bunch of consumer Internet service products instead.

Cheng Ran Missing from Registrations

You would expect the MNS Entities to be registered under their owner, Cheng Ran. But if Cheng Ran really does own the businesses, he certainly went out of his way to hide that fact. All seven MNS Entities are registered under Cheng’s wife, sister or friend. It was only after we confirmed that the MNS Entities were really just a network of bandwidth resellers (refer to following section: “MNS, a Ticking Time Bomb”) that this strange pattern made any sense. Bandwidth reselling is illegal for third parties (non-telecom carriers), so there is plenty of reason why Cheng Ran would want to hide behind the names of friendly parties who cannot be investigated since they are not involved in the operations of his companies. The various registered names serve another important purpose. In the bidding process for the resale of bandwidth, each bidder can only bid once. However, some rogue companies register multiple subsidiaries under different owners to enter multiple bids at once, a process called “wei biao” (围标). Wei biao (围标), of course, is illegal.

Suspicious Ownership Changes Before Acquisition

BKHT and XYHT transferred ownership to ZBXT right before being acquired by VNET. In the process, XYHT’s registered capital went from RMB 30,000 to 100,000.

SAIC Numbers Show SEC Numbers 51% Overstated

Below are the revenue figures reported to the SAIC by the MNS Entities. Note that for the full fiscal year 2010, which is the same as calendar year for the MNS entities, the MNS Entities (i.e. CYSD and ZBXT plus their five subsidiaries) reported RMB 122.89 million.


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Exhibit 54: Revenue Reported to SAIC by MNS Entities

VNET acquired the MNS Entities on 9/30/2010 and consolidated them for the full fourth quarter of 2010. The following comment can be found in their F-1, on page F-33:

The revenue and net profit of Managed Network Entities since the acquisition date included in the consolidated statements of operations for the year ended December 31, 2010 were RMB 60,175,000 and RMB 11,869,000, respectively.

Later in the F-1, on page P-2, VNET breaks out how much revenue the MNS Entities purportedly did for the first nine months of the year:

Exhibit 55: Revenue from MNS Entities Reported to SEC (F-1 filing) for 1Q2010 – 3Q2010

To state the very obvious, VNET claims that the MNS Entities did more revenue in the first nine months of 2010 than the MNS Entities told the SAIC they did for the entire year. And then, they have the audacity to claim that Q4 was by far the best quarter, generating a big increase of RMB 60.18 million on top of the overstated RMB 125.43 million, bringing the total to RMB 185.61 million for 2010, or over 51% more than the MNS Entities actually did! Now we know where some of that fabulous synergy VNET and their accomplice Cheng Ran found actually came from.


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Other Notable MNS Tuck-Ins

On October 19, 2011, ABC acquired 100% equity interest in Guangzhou Gehua (“Gehua”) to expand its MNS business at a total consideration of RMB 77.5 million. To keep the MNS gravy train going, VNET followed Gehua up with the acquisitions of Beijing Tianwang Online Communication Technology Co., Ltd (“Tianwang”) and Beijing Yilong Xinda Technology Co., Ltd. (“Yilong”) in February of 2013 for a combined consideration of RMB 73 million. We put these three MNS subsidiaries, Gehua and the combined TWYL, through the same examination as the MNS Entities. The results are summarized below.


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Exhibit 56: Summary of findings from investigation of seven MNS Entities

Ghost offices (no

physical location)

Ghost boards

(only 1 director)

Tiny registered

capital (1 mn RMB)

Registered under wife's /

sister's / friends' names

Registered business scope

different from MNS

or IDC

Revenue suddenly spikes


Profit suddenly spikes


While rev spiked,

employee count

plummeted

Large injection of capital from seller right

before acquisit ion

Transfer of ownership

before acquisit ion

Websites not

aligned with

business

Beijing Chengyishidai Network Technology Co., Ltd. (“CYSD”)

X X X X X X X X NA X X

Zhiboxintong (Beijing) Network Technology Co., Ltd. (“ZBXT”)


website

Beijing Bikonghengtong Network Technology Co., Ltd. (“BKHT ”)


website

Xingyunhengtong Beijing Network Technology Co., Ltd. (“XYHT”)


website

Beijing Bozhiruihai Network Technology Co., Ltd. (“BZRH”)


website

Jiujiang Zhongyatonglian Network Technology Co., Ltd. (“ZYTL”)

X NA NA NA X X X NA NA NAno

website

Fuzhou Yongjiahong Communication Technology Co., Ltd. (“YJH”)


website

Guangzhou Gehua (“Gehua”) NA NA NA NA X NA NA NA NA NA X

Beijing Tianwang Zaixian Communication Technology Co., Ltd. andBeijing Yilong Xinda Technology Co., Ltd. (“TWYL”)

X X X NA X NA NA NA NA NA X

iJoy Holdings Limted, its subsidiary Suzhou Aizhuoyi Information Technology Co., Ltd. and affiliate Beijing iJoy Information Technology Co., Ltd. (“ iJoy")

X X X NA X X X X NA X X

A Virtual Tour of VNET’s MNS Shells

We visited all seven of the SAIC-registered companies known as MNS Entities as well as the two subsidiaries TWYL and found that all of them had registered as their headquarters either ghost offices that did not actually exist or offices that had no evidence of operations whatsoever. Below are screen shots of the SAIC registrations for each of the seven MNS entities and pictures that we took in person of their registered office locations. Our first visit to the MNS Entities was to CYSD, which is supposedly headquartered in Beijing No. 110, Zhaojia Rd., Room 423A.


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Exhibit 57: Headquarters for Beijing Chengyishidai (“CYSD”) reported to SAIC

Our visit revealed that the SAIC-registered headquarters referenced a room that does not exist, Room 423A. The last room on the floor was 422. Moreover, all the rooms in the fourth floor were empty.

Exhibit 58: Pictures of our CYSD office visit


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Our next visit was to the wholly owned subsidiary of CYSD, a company called Jijujian Zhongya Tonglian Network (“ZYTL”) that is supposedly headquartered in the 3rd Floor of Xingang Town in Jiujiang.

Exhibit 59: Headquarters for Jiujiang Zhongyatonglian Network Technology Co., Ltd. (“ZYTL”) reported to SAIC


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Exhibit 60: Pictures of our ZYTL office visit

Next, we visited ZBXT, supposedly headquartered in Room 5307 of Beijing Zhichunlu No. 111 in Lixiang Plaza.

Exhibit 61: Headquarters for Beijing Zhiboxintong (“ZBXT”) reported to SAIC

There was a technology company headquartered in Room 5307 but unfortunately it was not ZBXT. A company called Beijing Neteon Tech occupied that room and there was no sign of ZBXT in the entire building. We searched the entire building and found in Room 5323 a


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company named Zhibo Lianhe Tech, which sounded close enough to ZBXT to investigate. 5323 was a classroom, not a corporate office.

Exhibit 62: Pictures of our ZBXT office visit


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We then headed to Fuzhou Yongjiahong Telecommunication Technology (“YJHT”), one of ZBXT’s four wholly owned subsidiaries, supposedly headquartered in Fuzhou No 21-1-702, Longtingjing. We found no signs of YJHT in what was a residential area and not even a corporate location.


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Exhibit 63: Headquarters for Fuzhou Yongjiahong Communication Technology Co., Ltd. (“YJHT”) reported to SAIC

Exhibit 64: Pictures of our YJHT office visit

The second ZBXT subsidiary we visited was Beijing Bikong Hengtong Network (“BKHT”), supposedly headquartered in Beijing No. 42, Unit 3, Room 418, Shiliu Yuan Beili.


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Exhibit 65: Headquarters for Beijing BikonghengtongNetwork Technology Co., Ltd. (“BKHT”) reported to SAIC

Exhibit 66: Pictures of our BKHT office visit By this point, we were not surprised to find an empty office room that had not been occupied for two years.


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The third ZBXT subsidiary we visited was Xinyun Hengtong Network (“XYHT”), supposedly headquartered in Beijing No. 2, Room 9A, Youanmenwai Daijie.

Exhibit 67: Headquarters for Xingyunhengtong Beijing Network Technology Co., Ltd. (“XYHT”) reported to SAIC


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Again we found that the room was empty and has not been occupied in some time. To make sure there had not been a careless mistake made in XYHT’s filing, we checked 9B as well but no luck. 9B was occupied by a company called Enjiwei where employees had never heard of XYHT.

Exhibit 68: Pictures of our XYHT office visit

Finally, we visited the fourth and last subsidiary of ZBXT, a company called Beijing Bozhi Ruihai Network (“BZRH”) supposedly headquartered in Beijing No. 72-B, Room 2605, West Third Ring, Beilu.


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Exhibit 69: Headquarters for Beijing Bozhiruihai Network Technology Co., Ltd. (“BZRH”) reported to SAIC

This time, we were not even able to check the room due to a sign on the door of Room 2605 that warned “This door does not open”. Even if it were to open, it would open to a company called Renrunda Culture and not BZRH, as the company listing at the lobby suggests.


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Exhibit 70: Pictures of our BZRH office visit


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Our visits to Beijing Tianwang Online and Bejing Yilong Xinda Tech (TWYL) were no more productive, as you can see below.

Exhibit 71: Headquarters for Beijing Tianwang Online(“TWYL”) reported to SAIC


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Exhibit 72: Pictures of our TWYL office visit


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What Business Are They Really In?

Of all the purported facts about VNET’s MNS subsidiaries we tried to verify, we had the hardest time pinning down exactly what business they were really in. From the wildly inconsistent registered descriptions in the SAIC filings to the lack of corporate websites for most of them to the lack of recognition by any industry insider of the dozens we interviewed, we found the task impossible. Confusing the matter further was how some of these MNS companies described themselves publicly. Some examples follow. In a job posting on 51Job.com, China’s leading consumer job portal, CYSD describes their business scope as voice service, private line rental, corporate telecom, system integration, SDH renting and bandwidth renting.

Exhibit 73: Job posting by CYSD on 51Job.com

But on their own website, they describe their core service as ISP (Internet service provider).


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Exhibit 74: CYSD’s website

Also on 51job.com, ZBXT describes itself as a provider of ISP, private line, bandwidth rental and fiber rental. Gehua is also an ISP, per their own job posting.

Exhibit 75: Job posting by ZBXT on 51Job.com


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Not Licensed to Offer MNS Services

The main problem with these self-descriptions is that as ISPs, VNET’s MNS subsidiaries are not allowed to resell bandwidth. Only telecom carriers, registered properly with a basic telecom license, can trade bandwidth among each other. We checked the license registration records for all MNS Entities and found that CYSD was only licensed for regional Internet Access Service and Information Services (B-15 & B-25). Other MNS Entities hold the license for regional Information Services (B-25).

Exhibit 76: Results of Check on www.miit.cc for 7 MNS Entities’ Licenses


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PAGE 84 / 121


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Music Player and Online Gambling: Managed Network Services?

We were thoroughly confused after our diligence of the two subsidiaries TWYL. According to VNET’s 2013 20-F, these two companies principally provide virtual private network services and managed network services. If that is really the case, we found no evidence of that in filings, registrations, other public sources or even in these companies’ own self-descriptions. According to Baike (China’s version of Wikipedia), Beijing Tiawang Online’s self-reported description is software developer that also provides internet dial-up, long-distance telephone and IDC hosting services.26 We checked their official website: www.trionet.cn and were surprised to see the website was actually China Unicom’s Beijing website.

Exhibit 77: Beijing Tianwang Online introduction on Baike

We later found that Tianwang Online’s website is registered under the name Encrypt Cyber Digital. You can see at the bottom of the home page that Encrypt’s website is owned by Tianwang Online. This website has the exact same content that CYSD’s website has, offering ISP application services to consumers, not businesses.

26 http://www.baike.com/wiki/%E5%8C%97%E4%BA%AC%E5%A4%A9%E7%BD%91%E5%9C%A8%E7%BA%BF%E9%80%9A%E4%BF%A1%E6%8A%80%E6%9C%AF%E6%9C%89%E9%99%90%E5%85%AC%E5%8F%B8


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Exhibit 78: Beijing Tianwang Online website

Our search for signs of life for Yilong Xinda (the other half of TWYL) was quite amusing if not more productive. We found all job descriptions online for Yilong Xinda were actually operated by Tianwang Online, which seemed to confirm that the two businesses are really just one, split for optical purposes only. The job posting on public job board ChinaHR below shows Yilong and Tianwang are actually the same company.

Exhibit 79: Job posting by Yiling Xinda on chinahr.com


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Our search for MIIT filings revealed that Yilong Xinda is only licensed as an Internet Content Provider (ICP) and is therefore only allowed to provide Internet content such as news, music, pictures and other online media.

Exhibit 80: Results of Check on www.miit.cc for Yilong Xinda’s Licenses

Wondering why Yilong Xinda too was improperly licensed, and this time licensed for a business that is very far removed from offering B2B managed network services, we looked for evidence that it was operational at all, even as an ICP. We found that the website www.Jeloog.com is operated by Yilong, as confirmed by the same registered address as Yillong.

Exhibit 81: Yilong Xinda’s website


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This address also matched the address on Alljobsearch.cn, another public job board.

Exhibit 82: Job posting by Yiling Xinda on alljobsearch

The most surprising finding of all is that Yilong’s website, www.yloog.net, was nothing more than a consumer music player for nine pirated songs despite the corporate-looking home page below.

Exhibit 83: Another website of Yiling Xinda


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We checked www.yloog.net again recently and found that the website had suddenly transformed into an online gambling site.

Exhibit 84: Yilong Xinda’s website had suddenly transformed into an online gambling site


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Shrinking Pool of IP Addresses

Recall that CYSD is one of the two holdcos for the MNS Entities. According to VNET’s 2013 20-F, CYSD has operated a private line business (PLB) since 2009. Is it not curious that during a period of strong double-digit growth, the allocation of IP addresses decreased by not one but two orders of magnitude for CYSD as of June 30, 2013?

Exhibit 85: Comparison of IP address allocations to CYSD as of June 30, 2013 (L) and December 31, 2012 (R)

How that technical fact reconciles with CYSD’s reported financial performance is beyond us.

A Sad Ending to the MNS Fable

Alas, it is only in fairy tales that the good times roll on forever unabated. In a real-world Ponzi scheme, there is only so much money you can launder in before you run out of it. Predictably, the MNS Entities’ explosive breakout performance was not long-lived, and Cheng Ran had to start taking numbers down. In 2013, margins plummeted by 65% and the profit contribution to VNET’s consolidated financials sank by more than half the prior year’s.


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Exhibit 86: Performance of MNS Entities through FY201327

The effect on VNET’s consolidated bottom line was obvious as VNET went back into the red without the MNS Entity gravy train running at full steam.

Exhibit 87: Effect of MNS Entities’ Sudden Margin Erosion on VNET’s Consolidated Financials

27 Source: SAIC filing, 2013 20-F

Figures in thousand RMBCYSD + ZBXT: Pre-Acquisition CYSD + ZBXT: Post-Acquisition

FY2009Q1-Q3FY2010

FY2010 run rate as of

end of Q3

Q4FY2010

FY2011 FY2012 FY2013

Net revenues 111,242.0 125,427.0 167,236.0 60,175.0 270,000.0 350,000.0 360,000.0 Cost of sale (105,492.0) (118,442.0) (157,922.7) (33,096.3) (162,000.0) (220,500.0) (273,600.0) Gross profit 5,750.0 6,985.0 9,313.3 27,078.8 108,000.0 129,500.0 86,400.0

Gross margin % 5.2% 5.6% 5.6% 45.0% 40.0% 37.0% 24.0%

Operating expenses (4,795.0) (5,794.0) (7,725.3) (14,586.4) (55,350.0) (59,500.0) (54,000.0) Changes in the fair value of contigent purchase consideration payable - - - - - - - Operating income(loss) (EBIT) 955.0 1,191.0 1,588.0 12,492.3 52,650.0 70,000.0 32,400.0

Other income(expense) - (757.0) (1,009.3) - - - - Interest income(expense) 5.0 7.0 9.3 - - - -

Income(loss) before income tax 960.0 441.0 588.0 12,492.3 52,650.0 70,000.0 32,400.0 Income tax benefit (expense) (3,614.0) 2,000.0 2,666.7 (624.6) (2,632.5) (3,500.0) (1,620.0) Net income(loss) (2,654.0) 2,441.0 3,254.7 11,867.7 50,017.5 66,500.0 30,780.0

Adjusted Net income (2,654.0) 2,441.0 3,254.7 11,867.7 50,017.5 66,500.0 30,780.0 Adjusted net income margin % (2.4%) 1.9% 1.9% 19.7% 18.5% 19.0% 8.6%

Adjusted EBITDA 2,989.0 5,876.0 7,834.7 14,054.0 61,290.0 81,200.0 43,920.0 Adjusted EBITDA margin % 2.7% 4.7% 4.7% 23.4% 22.7% 23.2% 12.2%

FiguresinthousandRMB

FY2010 FY2011 FY2012 FY2013 FY2010 FY2011 FY2012 FY2013

Netrevenues 525,203 1,020,929 1,524,158 1,966,717 465,028 750,929 1,174,158 1,606,717Costofsale ‐396,858 ‐744,371 ‐1,098,477 ‐1,449,845 ‐363,762 ‐582,371 ‐877,977 ‐1,176,245Grossprofit 128,345 276,558 425,681 516,872 101,266 168,558 296,181 430,472

Grossmargin% 24.4% 27.1% 27.9% 26.3% 21.8% 22.4% 25.2% 26.8%

Operatingexpenses ‐353,614 ‐198,468 ‐327,312 ‐419,217 ‐339,028 ‐143,118 ‐267,812 ‐365,217Changesinthefairvalueofcontigentpurchaseconsiderationpayable

‐7,537 ‐63,185 ‐17,430 ‐55,882 ‐7,537 ‐63,185 ‐17,430 ‐55,882

Operatingincome(loss)(EBIT) ‐232,806 14,905 80,939 41,773 ‐245,298 ‐37,745 10,939 9,373

Otherincome(expense) 1,792 34,170 7,951 9,820 1,792 34,170 7,951 9,820Interestincome(expense) ‐2,213 10,541 4,925 ‐88,272 ‐2,213 10,541 4,925 ‐88,272

Income(loss)beforeincometax ‐233,227 59,616 93,815 ‐36,679 ‐245,719 6,966 23,815 ‐69,079Incometaxbenefit(expense)

‐1,588 ‐13,677 ‐36,159 ‐10,324 ‐963 ‐11,045 ‐32,659 ‐8,704

Netincome(loss) ‐234,815 45,939 57,656 ‐47,003 ‐246,683 ‐4,079 ‐8,844 ‐77,783

ConsolidatedwithCYSD&ZBXT ConsolidatedwithoutCYSD&ZBXT


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So what did Mr. Cheng Ran do? Cheng RAN. For the hills, it appears. As disclosed in VNET’s 2013 20-F, he did not get any additional proceeds from the contingent portion of the purchase consideration for his MNS Entities in 2013 as he missed his profit targets.

Exhibit 88: VNET acquisition- related accounts due to related parties, 2013 20-F


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MNS, A TICKING TIME BOMB If we are to believe that the MNS Entities and other related acquisitions are mainly shell companies, there is a good question that remains unanswered. Let us give these subsidiaries a little benefit of the doubt and assume that they generate at least a small portion of their reported revenue. Let us assume that they do not exist only on paper and that they do not generate literally zero revenue, fraudulent or otherwise. What kind of substantial business, even if fraudulent, can be run by a handful of employees without real offices to work in, without meaningful capital to spend (remember how tiny the registered capital was for each MNS Entity) and with minimal supervision (hence, the one-person board meetings and Cheng Ran’s notable absence in any of the operating records)? The short answer is an illegal one.

Exhibit #: VNET Is Blacklisted at China Telecom as an Illegal Bandwidth Reseller


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Exhibit 90: Notice of Investigation of VNET by China Telecom

Translation: Important Notice of Investigation Enterprise Business Unit, China Telecom – Urgent – Confidential Sent to: Every provincial China Telecom Enterprise Business Unit Title: Notice on 21 Vianet, Client Report Content: In order to further terminate illegal high bandwidth access service, China Telecom decides to investigate 21 Vianet’s high bandwidth access business. The detailed requests are as follows: (1) every provincial China Telecom unit collects, reviews and investigates all 21 Vianet’s client contracts, agreements, etc. Provincial China Telecom units need to report investigation results to headquarters no later than September 10 of 2010. You need to conduct investigation thoroughly on 21 Vianet and its clients to verify any illegal business and contracts. Every Provincial China Telecom unit needs to report to headquarters on whether 21 Vianet contract and price violate China Telecom regulation.

Bandwidth Reselling

How Bandwidth Is Distributed in China

Due to antiquated networking infrastructure and a quickly growing Internet industry, bandwidth in China is a scarce commodity. Even though China has the largest Internet population in the world and one that is three times larger than the US population, the country’s legacy telecommunications infrastructure is not well-suited to handle all the bandwidth consumption.


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This is why the Internet in China is notoriously slow and the government controls bandwidth trading, allocation and pricing with a tight regulatory fist. A license is required to do practically anything related to the Internet in China, build a data center, operate a data center, run an ISP (Internet service provider), offer content to consumers, etc. and a license to operate as a telco is especially required and practically impossible to get for everyone but a handful of state-owned companies. These state-owned companies control the underlying Internet in China and are heavily regulated as to how they sell bandwidth, for how much and to whom. At the highest level, bandwidth is mostly supplied by a state-owned monopoly in each half of China. In the north it is state-owned telco China Unicom (CU). In the south it is state-owned telco China Telecom (CT). Even other major state-owned companies like leading mobile carrier China Mobile who may be appropriately licensed to sell bandwidth but are not given enough allocation by the government must buy bandwidth from the two dominant licensed telcos (CU and CT) by law. One of the ways the government controls the bandwidth supply problem is by making it illegal for anyone other than a company in possession of a general telecom license to sell bandwidth. Of course, even as state-owned enterprises, the telcos compete with each other, so CU and CT sell bandwidth at high prices to the smaller telcos to ensure their own industrial dominance.

Chinese Law Prohibits Bandwidth Reselling

The Chinese telecom industry’s laws have changed to suit the times over the years, but it has never been legal to resell bandwidth without a basic telecom license. The only bandwidth trading allowed in China is among the licensed telcos themselves through a network of interconnections to facilitate the traffic flow. Anyone else without a basic telecommunication business license cannot resell bandwidth nor can they operate interconnections commercially. Here are some relevant passages.

China Telecommunication Law 2000 Article 8 The telecommunications business is divided into basic telecommunication services and value-added telecommunication services. Basic telecommunication services provide public network infrastructure, public data transmission or basic voice communication services. ……… Article 9 An applicant to operate a basic telecommunications business shall meet the following conditions: A. The State-owned stakes or shares in the company shall be no less than 51%;… ……… Article 13 A telecommunications business operator may not provide telecommunications resources, public network infrastructure, public data transmission, or connection services to an organization or individual which has not been granted a telecommunications business permit. Revised Catalogue of Telecommunication Services 2013


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A14 The first category of data transmission service includes but is not limited to transmitting IP data packets from customers’ origin server to target network by utilizing IP technology. Revised Catalogue of Telecommunication Services 2003 Valued added telecom services B4-2-3: The second category of Internet access services is defined as providing Internet access services to various users by utilizing access servers and service nodes that are built up on certain software and hardware sources and connected to public telecom infrastructure…..Internet access services include two kind of applications, one is to provide Internet access services to ICPs who provide contents, online trading and online application services. Another service is to provide Internet access services to end users.

We interviewed several PRC lawyers to discuss the difference between Internet data transmission services under catalogue of basic telecom services and Internet access service under that of valued added telecom services. We were told that if the service recipient is either ICP or end user, data transmission services are categorized as value added services and the operator of value added services should apply for an ISP (B-25) license. Otherwise, the provider of data transmission services to telecom carriers should obtain a basic telecom service license. With regards to MNS business, the service provider transmits Internet data packets from one telecom carrier to another carrier by utilizing network address transfer technology. The recipients of services are telecom carriers or Internet access service providers, rather than either Internet content providers or end users. Therefore, MNS business is very likely to be categorized as the basic telecom service (A-14) that requires at least 51% equity interest invested a state-owned entity.

China’s Grey Market for Bandwidth

As Chinese bandwidth demand surged from the early 2000s, smaller Internet access providers like China Mobile, China Railcom and the emerging cable TV operators became so bandwidth-constrained and were so severely squeezed in pricing by the CU/CT telco duopoly that they turned to an emerging grey market for bandwidth operated by small traffic trading companies that stayed purposely small to fly under the telecom authority’s radar and avoid discovery. They would buy bandwidth at favorable prices legally from the telcos and then resell the bandwidth at a premium by diverting traffic illegally to their customers using technology to mask their actions (through use of techniques such as IP routing and optical fiber butting at self-built network access points). These rogue trading operations became known as Third-Party Private Line Businesses (PLBs), and the smaller telcos and other large corporate consumers of bandwidth increasingly turned to them to lower their total cost of procurement.


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Exhibit 91: Network topology for a traditional PLB

As technologies advanced, and competition within the obviously unregulated PLB industry intensified, the PLBs evolved to offer additional services packaged with their resold bandwidth, like security and content caching (an effective way to save on bandwidth costs is to cache content on the network to make it accessible without another network round trip to access it).

Exhibit 92: Network topology for a PLB2.0

China Telecom and China Unicom’s Response to the PLB/MNS Industry

China’s system of delegating literally 80% of its bandwidth allocation to two competitive telcos is clearly not scalable, but it is the system nonetheless, and the dominant telcos have the legal right and the industrial motivation to squash PLBs. It should come as no surprise that CT and CU carry out strict network-wide inspections so on a regular basis, maintaining proprietary monitoring systems to ensure compliance and keeping internal records of customer violations. And when they discover violations, the consequences for the perpetrators are dire. PLBs has hurt the financial interest of CT and CU and reduce their competitive advantages against China Mobile and other carriers. Despite the strong market need for PLBs, especially as mobile Internet usage has surged in China, CT and CU routinely crack down on illegal private interconnections, which cause network instability and poor service quality. In a recent example of how seriously the telcos are willing to pursue perpetrators, in 2010 China Telecom stopped serving bandwidth to other carriers who had procured bandwidth from illicit sources and as a

ChinaUnicom

ChinaMobile

CableTVoperators

ChinaTelecom

ChinaRailcom

IP

translationrouting

Opticalfiberbutting

ChinaUnicom

ChinaMobileZhejiang

ChinaMobileJiangsu

ChinaTelecom1

ChinaMobileJiangsu

ChinaTelecom2

Cache

Security

Cache

Security

2.4G3G


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result, many China Railcom and China Mobile end users nationwide were not able to get access to Internet.

Exhibit 93: Internal Notice and regulations issued by CT to stop MNS connections

VNET’s MNS Is Mainly a Front for an Illegal Bandwidth Reselling Operation

How VNET Describes Its MNS Business

In its F-1 registration filing, VNET explains the MNS business with this description. “Our managed network services are primarily offered in the form of bandwidth, which is optimized through our proprietary smart routing platform and supplemented by our hosting area


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network and our data transmission network. Our managed network services primarily consist of the following: • Hosting Area Network Services. Our data centers are distributed throughout China. We connect most of our data centers with private optical fibers, forming our hosting area network. Our hosting area network connects the servers housed in our data centers so that data transmission among our customers can be achieved without going through telecommunication backbones or internet hubs, enabling secure, faster and more reliable data transmission. • Route Optimization. In China, carriers generally operate their independent systems, and their networks are not connected with each other. Because we are connected to all major carriers, customers that use services from one carrier can reach users of other carriers through our network or through other internet hubs. Our proprietary system is a smart routing platform, which functions like an intelligent switchboard automatically selecting the best and fastest routes and directing traffic through our own or others’ networks. For example, from our data centers, we can direct data to the networks of China Telecom or China Unicom, or, when the networks of China Telecom and China Unicom are congested or otherwise experiencing problems, to our own transmission networks. Through our proprietary smart routing technology, we are able to optimize the connectivity of our network and deliver data in a fast and efficient manner.” Is it really plausible that Cheng Ran and his seven dwarfs can do all that? That description, while full of buzzwords like “smart routing” and “hosting area network” and “data transmission network”, is a gross misrepresentation of what VNET actually does in its MNS division.

VNET Is China’s Largest PLB

What VNET mainly does in its MNS division is resell bandwidth, procuring it directly from the only entities that can supply it legally in China, the state-owned telcos and some smaller government-affiliated networks with the appropriate telecom licenses. And without question, when VNET resells bandwidth, it does so illegally, because the only licenses that VNET has are an IDC license to build and operate data centers and an ISP license to offer Internet services to customers. VNET does not have and never has had a basic telecommunications license.

Exhibit 94: List of 7 MNS entities’ licenses

Subsidiary Business Scope from SAIC filings

License held Source Violation

Beijing Chengyishidai Network Technology Co., Ltd. (“CYSD ”, 北京诚亿时代网络工程技术有限公司)

Internet access service, technology development, technical services, technology assignment and consultancy

Local ISP and ICP license (Jing B2-20060078 B15 & B25 and Jing ICP090377) to authorize the provision of Internet Access Services and Information Services in Beijing only

SAIC and MII online research28

Illegal operation of basic data transmission nationwide

28 http://qyxy.baic.gov.cn/andhttp://www.miit.cc/


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Zhiboxintong (Beijing) Network Technology Co., Ltd. (“ZBXT ”, 智博信通北京网络技术有限公司)

Information services in category B of Value added telecom service, technology development, technology assignment and information consultancy

Local ISP and ICP license (Jing B2-20090073 B25 and Jing ICP080074)to authorize the provision of Internet Access Services and Information Services in Beijing only

SAIC and MII online research


Beijing Bikonghengtong Network Technology Co., Ltd. (“BKHT ”, 北京碧空亨通网络科技有限公司)

Information services in category B of Value added telecom service, technology development, technology assignment and information consultancy

Local ISP license (Jing B2-20090112 B25)to authorize the provision of Internet contents in Beijing only



XingyunhengtongBeijingNetwork Technology Co., Ltd. (“XYHT”,

兴运恒通（北京）网络技术有限公司)

Information services in category B of Value added telecom service, technology development, technology assignment and promotion

Local ISP and ICP license (Jing B2-20110150 B25 and Jing ICP120073)to authorize the provision of Information Services in Beijing only



Beijing Bozhiruihai Network Technology Co., Ltd. (“BZRH”, 北京博智睿海网络科技有限公司)

Information services in category B of Value added telecom service, technology development, technology assignment and promotion

Local ISP license (Jing B2-20090091 B25) to authorize the provision of Information Services in Beijing only



Fuzhou Yongjiahong Communication Technology Co., Ltd. (“YJH”, 福州永嘉鸿通信技术有限公司)

Telecom technology services and consultancy, telecom equipment wholesale, purchase and sell agent

Local ISP license (Min B2-20090006 B25) to authorize the provision of Information Services in Fujian province only



Jiujiang Zhongyatonglian Network Technology Co., Ltd. (“ZYTL”, 九江中亚通联网络科技有限公司)

Information services in category B of Value added telecom service, telecom and network development, sale of telecom equipment and maintaince

Local ISP license (Gan B2-20120051 B25) to authorize the provision of Information Services in Jiangxi province only



Notes: for example, the series No. of license of Jing B2-20060078 represents the following facts: 1) This license was registered with Ministry of Information and Industry in the year 2006 with a series no. 78 2) The holder of this license is authorized to provide value added services falling into Category B (A stands for basic telecom

services and B stands for value added telecom services) 3) The value added services belong to 2nd tier services, including storage transfer, call center, Internet access and information

services, respectively. 4) The license holder is authorized to operate in the province of Beijing and serves Beijing customers only. VNET’s MNS network is nothing more than a front for a major PLB operation, which we believe is China’s largest. VNET basically admits this fact in its own description, “Our managed network services are primarily offered in the form of bandwidth…” All the other flowery talk of optimization and hosting within its MNS division is largely a hoax. Could Cheng Ran even host a single server in any of his seven ghost offices? No, but he sure knows how to trade bandwidth illegally. Our many interviews with industry insiders pegged Mr. Chen as one of the pioneers in the PLB space and one of the larger operators of PLB networks.


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Chen’s humble beginnings illustrate how low the barriers to entry are for PLBs and how little resource is required to set one up. Cheng Ran was a telecom engineer who worked at Beijing Teletron Engineering Company (“Beijing Teletron”, 北京电信通电信工程有限公司) and moonlighted as a bandwidth pirate while working a full-time job. His moonlighting initiatives began in 2006 and by 2008, he found enough success to quit his day job and run a PLB full-time. VNET’s network of PLBs which feature Cheng’s MNS Entities has gone undiscovered because it is spread out across many smaller acquired subsidiaries each with their own shells to better hide their illegal trading activities from the telcos. This explains why the MNS Entities’ SAIC filings show an overly complicated corporate structure of shell companies registered under various individuals’ names without any physical locations, all the harder to track. It is also easier for multiple seemingly unrelated companies to provision bandwidth from the telcos without getting outed as a related PLB operation that pools that bandwidth for resale.

VNET’s Largest MNS (PLB) Customer Is China Mobile

We extensively interviewed some of China’s more prominent PLB operators as well as leading companies in the data center industry to gain a better understanding of how the PLB market is split among its larger participants. We found consensus on three key points.

1. There are three key purchasers of PLB services: China Mobile, China Railcom and cable TV operators as a group. The total market for PLB is about 1,000 Gbps, of which China Mobile represents about 600, China Railcom about 300, and the cable operators about 100.

2. The level of sophistication varies widely among these purchasers. The execution price paid by China Railcom is the highest, up to 100,000-150,000 RMB/Gbps/month. China Mobile pays the least, roughly 60,000-90,000 RMB/Gbps/month. In 2014, with about 1,000 Gpbs of demand, the PLB market size is approximately RMB 1.2-1.5 billion. While China Railcom pays the most, it is also the customer that is hardest to get. They have trained third-party bandwidth purchasing organizations since 2002 that have built relationships with small suppliers for over a decade, so newer entrants like VNET stand little chance of servicing them.

3. Most of VNET’s PLB efforts are focused on China Mobile. Unfortunately for VNET, CM is such a sophisticated bandwidth buyer that they have their own systematic dynamic pricing system based on local reverse auctions run for PLBs to bid for their business. This has crushed VNET’s MNS margins recently.

As we did our field work, it became obvious that China Mobile is indeed VNET’s largest PLB and therefore MNS customer. Screen shots of results from local China Mobile bandwidth auctions follow.


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Exhibit 95: China Mobile Henan Branch Bandwidth Auction Results


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Exhibit 96: China Mobile Xinjiang Branch Bandwidth Auction Invitation and Results


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Exhibit 97: China Mobile Hainan Branch Bandwidth Auction Invitation and Results


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Exhibit 98: China Mobile Hunan Branch Bandwidth Auction Invitations. BKHT is on the list of bidders.

Why does VNET not disclose very proudly a Tier 1 customer like China Mobile in its filings and in its investor presentations and earnings calls?

The obvious answer is that there is nothing to be proud of in operating an illegal rogue operation for as much as 35% of your total revenue. The not so obvious answer is that the revenue is about to go away.

MNS Revenue at Great Risk

VNET Blacklisted by State-Owned Telcos

We confirmed with numerous industry insiders that the telcos were catching on to what was going on within VNET’s MNS business. Unbeknownst to VNET at the time of their acquisitions, many of their fraudulent and illicit shells had already been blacklisted or sent “cease and desist” warnings for violations.

Regulatory Intervention to Obsolete PLB

If law enforcement forces are unable to regulate the PLB industry as is often the case with grey markets that service legitimate markets, market forces driven by regulatory change will. Even more damning than the proof of VNET’s illegal MNS operations is our finding that the Chinese telecom authorities are finally waking up to the realities of their antiquated method of managing national bandwidth procurement, allocation and distribution. We were notified that recently, China Mobile and China Telecom have entered into a new mutual agreement to set forth new standards for the financial settlement of inter-networks bandwidth link-up. As


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stipulated in the agreement, CM and CT will increase the scale of traffic peering with lower fees for Internet backbone interconnections. In the coming few months, CT and CM will establish new NAPs (network access points) to enlarge total interconnection capacity by an estimated 150-200 Gbps as a first step. When this happens, it is inevitable that CM and CU will enter into a similar alliance to solve the problems of backbone interconnection. Such a major unified step forward in the commercial development of China’s Internet backbone would effectively obsolete PLBs. We were also notified recently that in recent months, as requested by the MIIT, more NAPs have been built and opened to enlarge total interconnections among telcos. Regions so far include Wuhan, Hangzhou, Shenyang, Chongqing, Shenzhen, Chengdu and Xi’an. Whether consciously, by recognition that they need to start weaning themselves off the illicit PLB teat, or because they recognize how fragile the MNS revenue really is as violation notices from telcos keep mounting, PLB is clearly losing share of VNET’s revenue and VNET is clearly losing share of the PLB market.

Exhibit 99: VNET’s revenue mix over time

How will VNET replace all the lost MNS revenue? What will VNET do if the primary place from which it fabricates financials is obsoleted? Enter iPoo and Dermot.

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

90.0%

100.0%

2010Q1

2010Q2

2010Q3

2010Q4

2011Q1

2011Q2

2011Q3

2011Q4

2012Q1

2012Q2

2012Q3

2012Q4

2013Q1

2013Q2

2013Q3

2013Q4

2014Q1

Hosting and related revenues Managed network services


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IPOO: VNET’S LONGTOP MOMENT Every Ponzi scheme reaches a critical point at which it begins to collapse under its own weight. For VNET, we believe the massive back to back acquisitions of iPoo and Dermot will mark the peak of VNET’s financing-driven bubble. Although sell-side analysts and investors alike have focused on their potential impact to VNET’s P&L assuming that VNET is a going concern, we draw your attention to the balance sheet instead because we do agree VNET is a huge concern, but not of the going variety. As discussed previously (see Exhibit 28), VNET will require another RMB 2.4 billion ($396 million) if it goes through with the planned 17,000 cabinet ramp through 2015. That would take its net debt from the current post-Dermot RMB 1.6 billion ($261 million) to RMB 4.0 billion ($657 million), not quite double. The acquisitions of iPoo and Dermot alone have more than doubled VNET’s leverage and next year’s cabinet goal would nearly double it again. Given the amount of balance sheet risk VNET is taking this year, can any reward offset that kind of risk? What is VNET getting in their biggest purchases ever, which together exceed the cumulative consideration of all their past acquisitions?

Persona Non Grata of the Broadband Industry

To say iPoo is a troubled, unwelcome company with little industrial support is not an opinion. It is a statement of fact. We point investors to the following facts.

Rejected by the People

No less than five different government-affiliated organizations have already responded negatively to iPoo to varying degrees over the past three years. Since iPoo is a consumer “last mile” broadband company, we will start with state-owned CCTV, China’s dominant TV broadcast company which featured iPoo in an exposé warning consumers about fraudulent consumer broadband operators. An online replay of the program can be viewed here: http://tv.cntv.cn/video/C10354/7b5cc96153864f8f95ca119dae739058. The exposé highlights iPoo’s poor product quality, complete lack of customer service and the illegal operations in the city of Changsha in which iPoo claims to have a business but has not been authorized by the local telecom authority. Mr. Chen, a duped customer, had the following to say:

“I cannot access my [iPoo] broadband, it keeps showing that the connection is not working…. [Then in response to whether he had called customer service:] I called for five, six days, but nobody answered the phone. I called the Telecom Administration Bureau and they told me the only three legal broadband operators are China Telecom, China Unicom and Great Wall. They don’t have [iPoo] on the legal operator list!"

The reporter then gives the following public service announcement:


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“We received a lot of calls regarding [iPoo’s] broadband problem and we encourage viewers to call us if you find more issues and we encourage the government to look into this issue."

The SAIC, a department of the central government, corroborates the key points from the CCTV exposé in this article: http://hb.qq.com/a/20110425/000492.htm. We urge investors unable to read Chinese to use Google Translate to give that report a skim. The article reports false advertising, lack of service (as in, payment made, zero service provided), terrible customer service (as in, no customer service at all) and technology that simply does not work upon installation. Is it any surprise that Aipu’s unhappy customers reportedly logged 120 complaints per day?

iPoo, on Watch by the Government, Already Banned in Three Cities

The regulators of not just Changsha, as reported by CCTV, but also two major Chinese cities—Guangzhou (a Tier 1 City) and Wuhan—have already banned iPoo from building or operating a consumer last-mile broadband network in their cities. iPoo admits these facts in their own IPO filing from June of last year:

“根据《中华人民共和国电信条例》第七条规定“国家对电信业务实行许可证制度”，公司依

旧存在未取得用户驻地网经营资质，持因特网接入经营许可证经营用户驻地网业务，被武汉、广州经营所在地通信管理局出具行政处罚风险，从而影响公司经营” Translation: According to the 7th rule of China’s Telecom Laws, Licensing and Permit to Telecom service, [iPoo] failed to obtain the required local access network operator license while using Internet access permit instead to operate local access networks. Consequently, our business was affected by the government’s penalty and ban from doing business in Guangzhou and Wuhan.

The following notice from the China Telecom Administration of the enormous Guangdong province make iPoo’s own admission crystal clear.


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Exhibit 100: Notice of ban from Guangdong Telecommunication Administration

Stiff-Armed by the Chinese SEC, I-Poo-O Fails

So far, we count four government organizations whose opinions of iPoo are far from supportive (CCTV, SAIC, Guangzhou government, Wuhan government). China’s securities exchange commission makes it five. In June 2013, iPoo filed an IPO prospectus in anticipation of a public offering later this year in China’s A-Share market29. We have obtained and uploaded the document (in Chinese) here: http://www.scribd.com/doc/239150666/IPoo-Prospectus. Those who cannot read Chinese need not fret, you will not miss much. Suffice it to say the IPO was not approved when China’s Securities Commission reviewed the application on January 201430. The state will probably never release the exact reasons for rejecting the application. However, it is not hard to find industry executives who mention accounting problems along with governance issues and iPoo’s widely known past transgressions as reasons for the failed listing, especially since some of those executives include iPoo’s own employees. Throughout our due diligence, iPoo’s employees were among our best sources of information about their own company.

A Commoditized, Overleveraged Declining Business

Aside from iPoo’s penchant for angering customers with false advertising and lack of service, the failure to obtain the appropriate licenses to operate in all its regions and the bans in major cities that it was dealing with, iPoo had other more fundamental business problems. For one, its business is shrinking rather rapidly:

29 http://finance.china.com.cn/stock/xgdt/20130618/1559937.shtml 30 http://finance.ifeng.com/a/20140121/11513093_0.shtml


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Exhibit 101: Key Metrics for iPoo31

This trend is no surprise to anyone familiar with the telecom industry in China which, by the way, includes iPoo’s own Lei Ke, a Vice President who had the following to say to government-affiliated Chongqin Evening News32:

“Aipu’s broadband business has reached a bottle-neck with profit margin dropping lower. Low-profit broadband operators are in urgent need of restructuring.”

That was on December 2012, almost two years ago. “Immediate” already happened a long time ago. Last-mile broadband access is not where the action was then and it certainly is not where the action was last quarter, when VNET paid an enormous sum for a declining commoditized business. Why would VNET, purportedly growing at a long-term CAGR of 30-40%, buy a business that is so saturated and commoditized that even its own executives admit it freely in media interviews? Although we cannot fathom a guess, it certainly could not have been for the financials. Not only is iPoo low in profit and declining, it is also the most leveraged company in its peer group even when compared to businesses many multiples larger in size that have much larger fixed asset requirements.

Exhibit 102: Debt-to-Asset Ratio for iPoo and Comparable Companies33

Company Debt-to-Asset RatioChina Telecom 51.19%China Unicom 59.06%Dr. Peng 56.44%Sinnet 13.75%Gehua Cable 47.15%Topway Cable 22.93%Aipu Network 75.60% (2012)

88.35% (2011) 31 Source: iPoo IPO Prospectus, CICC research, Morgan Stanley research (http://www.ch.21vianet.com/?p=2260), iPoo employee interviews 32 http://www.cqwb.com.cn/cqwb/html/2012-12/28/content_338556.htm 33 Source: iPoo IPO Prospectus, 2013

All figures in RMB thousandsexcept for Users

2010 2011 2012 2013 2014ERevenue 298,020.6 524,176.6 682,255.3 650,000.0 510,000.0

Growth 75.9% 30.2% (4.7%) (21.5%)

Users 582,700 839,000 1,020,000 980,000 740,000 Growth 44.0% 21.6% (3.9%) (24.5%)

ARPU 59.0 58.6 59.1 58.5 58.0

Net Income 16.6 49.9 92.4 60.0 51.0 Growth 199.6% 85.3% (35.0%) (15.0%)

Cash 22.9 56.7 35.5 NA NAAccounts Receivable 26.5 17.5 33.6 NA NAAccounts Payable 17.3 9.2 5.7 NA NA


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An iPoo employee who was sick of working at the terribly managed eroding business that he believes iPoo is went as far as writing a public letter neatly summarizing iPoo’s various fundamental problems34. Per the former employee’s own admission (translated):

“Aipu faces many problems such as a decline in user base, lacking capex to upgrade its network, revenue lost every month and service quality issues … Aipu’s enemy is not China Unicom, Not China Telecom, Not Dr.Peng, but itself.”

Apparently, it wasn’t just VNET employees who felt that way.

Insiders’ Garbage, VNET’s Treasure

History of iPoo Insider Valuation Marks35

If insiders are most in the know at their own companies, especially when they are private, then watching their actions are most telling. Indeed, iPoo insiders’ actions speak much louder than any angered employee’s or duped customer’s words. The history of insiders’ view on what iPoo is worth is tragically comical. In 2010, Aipu Investment, a captive investment fund within iPoo, attempted a sale of 27.5% of its equity stake in its parent company iPoo for RMB 27.5 million in China Southwest United Asset and Equities Exchange. This implied a valuation of RMB 100 million for iPoo. However, not one bidder showed up. In November 2011, domestic private investment firm JD Capital invested RMB 46 million in iPoo for 17% ownership, valuing the company at RMB 250 million. The 49.9 million of net income that iPoo disclosed for 2011 in its IPO prospectus would make the JD Capital mark approximately 5x trailing P/E. In 2012, Chengdu Guotao Investment (“Guotao”) sold their 22.5% stake in iPoo for RMB 27.5 million. The RMB 92.37 million in net profit that iPoo reported for 2012 in its IPO prospectus sets the Guotao mark at a lowly 1.4x trailing P/E. Not exactly a vote of confidence from the second largest shareholder. Unfortunately, we did not get a mark in 2013 because the I-Poo-O flopped. However, we got the mother of all marks in 2014. On June 4, 2014, VNET agreed to acquire iPoo for the whopping valuation of RMB 1.4 billion36, paying the first RMB 700 million installment up front. Our inquiries to VNET’s management resulted in a vague response that stated about half of the acquisition was agreed to be paid in cash. Our sources differ and confirm that iPoo’s sellers have asked for 100% cash. That would certainly be more aligned with past insider behavior and the way the transaction will be consummated since the iPoo acquisition will not use a VIE structure 34 http://tieba.baidu.com/p/3077123918 35 http://tech.sina.com.cn/i/2012-05-18/02377126726.shtml 36 http://ir.21vianet.com/releasedetail.cfm?ReleaseID=852392


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and iPoo’s institutional shareholders are domestic firms that cannot be paid in anything but RMB. The very large cash component (if it is not 100% cash) would also explain why the Chinese media reported that VNET plans to raise an incremental RMB one billion of debt to fund the acquisition of iPoo, which the company has yet to discuss with US investors: http://news.idcquan.com/news/59752.shtml.

VNET’s Whopper of a Price in Context

To put the enormous RMB 1.4 billion price tag that VNET put on iPoo in perspective, it is not enough to simply refer to Guotao’s 2012 mark. After all, that is bottom picking a bit and 2012 was two years. A lot can change in two years… such as iPoo’s financials, which shed 25% of its 2012 top line and 45% of its 2012 bottom line. That makes VNET’s price on a P/E basis over 2,000%, or 20x, higher than the Guotao valuation. As far as comps go, the next best thing to an internal mark is a direct competitor’s precedent acquisition value. As luck would have it, Great Wall, the dominant non-state-owned last-mile bandwidth provider in China was acquired by Dr. Peng, a publicly listed company (in the A-Share market) in two tranches, 50% at a price of RMB 600 million in December 2011 and 50% at a price of RMB 712 million in December 2012. Dr. Peng’s blended acquisition valuation was RMB 656 million. VNET paid 2.13x more for iPoo than Dr. Peng did for Great Wall. Naturally, we must ask, is iPoo more than twice the business Great Wall is? After the iPoo deal announcement, CICC issued a sell-side report on June 5, 2014 with the following stats for iPoo and its two largest direct competitors, Great Wall and Founder.

Exhibit 103: Key metrics for top three “last-mile” broad band companies

Great Wall iPoo Founder2013 Revene (RMB mln) 3,902.0 500.0 387.0 User base (mln) 6.16 1.00 0.38 Profit margin 10.0% NA 12.0%

We note that CICC got iPoo’s 2013 revenue figures wrong. iPoo projects RMB 500 million for 2014. In 2013, their revenue projection at the time of the IPO prospectus was actually higher, RMB 650 million. For a business that is literally 6 times larger than iPoo by either revenue or by user base, Dr. Peng paid less than half the price VNET paid for iPoo.

The Pony In the iPoo

In so many ways, the iPoo acquisition makes absolutely no sense. Certainly not from a strategic sense, not from a shareholder value perspective and not from a debt holder’s perspective either. But as they say, beauty is in the eye of the beholder.


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iPoo, viewed from the eyes of a Ponzi schemer, makes all the sense in the world. VNET has some major structural problems to deal with. They need to continue showing strong growth in the core IDC business, which requires enormous amounts of cash to sustain. That cash needs to be financed, which requires that the company be able to show positive and growing EBITDA to be able to raise debt. Since the core business generates no EBITDA, VNET has to find it in non-core businesses that it must keep acquiring to manufacture revenue (AR and FCF be damned), since none of the acquired businesses have proven to be able to keep up with the promises for core business growth VNET has sold to investors. The great majority of them have not even sustained themselves, let alone kept pace with growth. The difficulty of executing that initially simple Ponzi scheme increased dramatically as the financings and the acquisitions got bigger. That MNS revenue is being jeopardized by regulators catching on and the MNS industry is in overall margin free fall are not helping. And that little iJoy is being squeezed for all it is worth, all 100% net margin’s worth, puts a limit on where else the company can go to find the financial growth promised to investors. iPoo is a necessary acquisition for VNET as all these problems pressure the Ponzi scheme and an epic capacity expansion period begins. The exact same can be said of Dermot. Have we not seen this movie before?

Giantstone, Part II

The similarities between VNET and Longtop Financial, arguably the most famous US-listed Chinese fraud of all time, are endless. But we need only focus on one: when the music stopped, and why. Like VNET, Longtop manufactured revenue by laundering cash into the business as revenue, using both falsified core business contracts and round-tripped acquisition proceeds to promise unending long-term growth to investors. Both companies’ AR and DSOs shot up as fast (for VNET faster) than any metric on the income statement that public market investors seem to focus on at the exclusion of everything else. So the mounting debt and AR went unnoticed until the Ponzi got so out of control that the only way a balance sheet disaster could be averted was to buy more time with the largest possible acquisitions that were available. Longtop acquired Giantstone in the largest deal it ever did by a very large margin, and used the acquired subsidiary primarily as a vehicle to roundtrip acquisition proceeds in as revenue, fueling the stock price until one of two things was to happen: either the core business actually started to deliver or until the next large acquisition was executed. Longtop collapsed and was delisted soon thereafter. Those are the key similarities. Now on to the differences which are even more important. The urgency with which VNET did two very substantial acquisitions, back to back, and the incredibly low quality of iPoo in particular stand out even from the Giantstone precedent. Then there is the severity of the balance sheet damage VNET is willing to inflict in its quixotic quest to build what is, at the current ridiculous pace, destined to become a data center ghost town. At


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least Longtop was a software and service business without the need to invest so heavily in fixed assets that depreciate as they sit severely underutilized. The sheer volume of acquisitions that VNET has done to date, which puts it on par with Chinese peers ten or even thirty times its size, and the percentage of market cap and total revenue that VNET acquires and raises every year makes VNET unique in the ADR space. And let us not forget another VNET differentiator, its audacity to generate as much as a third of its total revenue illicitly and acquire to do more of it. Also worth another mention is the fact that management never decides to acquire anything that is truly strategic, a core part of its IDC business, never putting their money where their mouth is. Quite telling indeed.


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CONCLUSION VNET’s story is one that we plan to continue telling. Consider this report part 1 of several more. In future editions, we plan to cover less critical topics such as Dermot (since the deal is not closed yet) and the cloud partnership (since it is but 3% of revenues at the moment and in our opinion doomed). The purpose of this report was to set forth our key findings from six months of investigative work so that investors, long or short, could consider them and act accordingly. While some of what we have stated is in fact opinion, we humbly suggest that the majority of what we presented is inarguable. In our concluding thoughts, we would like to remind you of some of these points.

VNET has misrepresented its IDC network assets and performance. While some may argue about the accuracy of our findings, as extensively researched as they were, there is no denying that VNET has claimed to be operating 72 data centers when a significant percentage of their outsourced data center partnerships have been terminated. By our count, it’s over 50%, which results in roughly a quarter of the cabinets being overstated and all the EBITDA being stripped away, but someone else may spend the three months we spent and come forth with a marginally different number. In our view, the question is binary and not one of degree. Either VNET overstated IDC figures or it did not, and the evidence is overwhelmingly in favor of the former.

According to the SAIC, VNET has misrepresented the financials of at least some if not

all of its acquired companies. While the SAIC is not the SEC, the discrepancy is large and impossible to ignore, particularly for a company for which M&A appears to be a critical priority.

Almost a full third of VNET’s revenues comes from a business unit that VNET rarely talks about and is almost universally known as illicit in Chinese IDC circles. China Telecom, the largest fixed line carrier in China and one of two monopolistic players in the telco industry, has blacklisted VNET and various of its MNS subsidiaries for breaking the law. How any investor attributes any value to this business line is beyond us.

VNET has raised over half its market cap in various financings of equity and debt since

its listing in 2011 and burned a substantial portion of it building a highly underutilized (and overstated) network of IDCs. The other substantial portion, more than half, has been spent on two dozen non-core acquisitions, the majority of which have failed as businesses.

Despite such poor return on invested capital (whether invested in fixed assets, non-core

assets or shells) and an IDC network that is clearly underutilized (even when you use VNET’s overstated figures), VNET’s margins have held within a tight band for practically ever. This makes zero sense and begs many questions as to how it is possible.


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VNET’s balance sheet is scary. It is. The rate of growth in net debt, the even greater rate of growth in AR and DSOs and the amount of acquisitions and their unknown impact are not good complements to a free cash outflow of nearly 30% of the past three years’ revenues. If you cast the overstated income statement aside for a moment, VNET is the very picture of a terminally ill company. That alone makes VNET a fantastic short. The rest is almost merely icing on a very big cake.

The timing of almost all if not all the many acquisitions VNET has done, all but one tiny intercompany transaction being non-core to IDC, is uncanny. Right before an IPO, right before a big financing, right before a large cabinet deployment or IDC build, right as margins are beginning to show some compression, right as previously acquired businesses are slowing or even declining… Uncanny.

That highly suspicious timing does not go well with the types of acquisitions VNET does. The illicit MNS Entities with no visible operations anywhere, iJoy the shell with 100% net margins that sells to iron ore trading companies a ridiculous product that no other software company in the world sells and iPoo, perhaps the most overvalued company we have ever seen. It is little wonder that VNET’s M&A track record is horrific, with most of the companies it has acquired being shut down, disposed of, or seriously degraded.

What does this all mean? It means the business you thought VNET had is not really what it has. How different it is in actuality is up to interpretation.

An Educated Estimate of VNET’s Actual Financials

The following summary financials compare key line items from VNET’s reported income statement to the same figures pro forma everything we were able to verify, particularly the overstated IDC metrics and the overstated MNS revenue and margins. We would like to remind investors that as bad as our numbers look next to VNET’s, the reality is that they still include a very significant portion of MNS revenue, which we value at zero but have kept in our analysis anyway to give Cheng Ran and his cronies the benefit of the doubt they do not deserve.


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Exhibit 104: VNET’s reported income statement vs pro forma without fabricated revenues

Liquidation Analysis

We have yet to make an investment recommendation throughout this entire report, so we will make one now. Consider the following analysis. It shows what happens to your investment, no matter which security you hold or where you hold it, if any significant debt holder reads this report and agrees with even one or two of the points we just made above. In other words, it only takes one significant lie or misrepresentation to bust a covenant, and as we stated, VNET’s balance sheet is outright scary. Know your place in the capital structure because we believe a lot of investors are going to get wiped out. Note: The following liquidation analysis relies on information from VNET’s 2013 20-F, which classifies VNET’s various corporate entities as set forth in the F pages (F-14). Inputs into the analysis for the Consolidated VIEs and the Holding Parent Company are found on F-20 – F-21 and F-75 – F-76, respectively. From those inputs and the consolidated balance sheet information (F-3 – F-4), we can calculate the figures for the Consolidated HK and PRC Subsidiaries. This allows us to effectively analyze a liquidation process not only in consideration of the capital structure but also the order of liquidation within VNET’s entities.


FY 2013(reported)

Fabricated IDC

revenue

Fabricated MNS

revenue

Fabricated iJoy revenue

FY 2013 (clean)

Variance %

Net revenuesHosting and related revenues 1,259,303 270,950 - 118,905 869,448 69.0%

Managed network services 707,414 - 175,082 - 532,332 75.3%Total net revenues 1,966,717 270,950 175,082 118,905 1,401,780 71.3%

Gross profit 516,872 270,950 175,082 109,519 (38,679) (7.5%)Gross margin % 26.3% (2.8%)

Net income(loss) -47,003 270,950 175,082 109,519 (602,554) 1281.9%Net margin % (2.4%) (43.0%)

Adjusted Net income 120,466 270,950 28,013 109,519 (288,016) (239.1%)Adjusted net income margin % 6.1% (20.5%)Adjusted EBITDA 365,613 270,950 28,013 101,500 (34,850) (9.5%)

Adjusted EBITDA margin % 18.6% (2.5%)


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Exhibit 105: Liquidation analysis as of December 31, 2013

Comparison of Consolidated Group and VIEs Balance Sheet

Consolidated as of December 31, 2013

(1)Consolidated VIEs as of December 31,

2013

Consolidated Holdings and WFOEs

as of December 31, 2013

(3) Holding Parent Company as of

December 31, 2013

Consolidated HK and PRC Subsidiaries as of December 31, 2013

(2)Re-classified Consolidated HK and PRC Subsidiaries as of

December 31, 2013

Current AssetsCash and cash equivalents 1,458,856 259,987 1,198,869 590,682 608,187 608,187 Restricted cash 193,020 3,020 190,000 190,000 - - Accounts receivable, net 610,413 605,205 5,208 - 5,208 5,208 Short-term investments 1,101,826 900,000 201,826 81,826 120,000 120,000 Prepaid expenses and other current assets 154,875 110,865 44,010 76,606 -32,596 - Deferred tax assets 17,816 22,811 -4,995 - -4,995 -4,995 Amount due from PRC and HK subsidiaries - - - 1,672,335 -1,672,335 - Amount due from VIEs - - - - - 634,755 Amount due from related parties 67,498 9,800 57,698 24,387 33,311 33,311

Total 3,604,304 1,911,688 1,692,616 2,635,836 -943,220 1,396,466

Property & equipment, net 1,402,177 813,939 588,238 - 588,238 588,238 Intangible Assets, net 336,889 230,607 106,282 - 106,282 106,282 Goodwill 410,500 410,500 - - - - Restricted cash 219,056 - 219,056 100,000 119,056 119,056 Non-current Deferred tax assets 14,149 13,482 667 - 667 667 Other non-current assets 37,760 11,645 26,115 26,115 - - Investment in subsidiaries - - - 895,390 -895,390 - Investment 106,727 98,526 8,201 - 8,201 8,201

Total Assets 6,131,562 3,490,387 2,641,175 3,657,341 -1,016,166 2,218,910

Current LiablitiesShort term bank borrowings 173,726 173,726 - - - Accounts payable 188,217 186,381 1,836 1,836 34,432 Notes payable - - - - - Accrued expenses and other payables 292,421 195,817 96,604 255 96,349 96,349 Advances from customers 33,104 33,104 - - - Income tax payable 11,476 11,427 49 49 49 Amounts due to related parties 147,699 47,754 99,945 99,945 - - Amounts due to inter-companies - 634,755 -634,755 -634,755 - Deferred tax liabilities 3,115 3,115 - - - Current portion of Long term bank loans 197,000 - 197,000 197,000 197,000 Current portion of capital lease obligations 14,600 14,600 - - -

Total 1,061,358 1,300,679 -239,321 100,200 -339,521 327,830

Long-term LiabilitiesAmounts due to related parties -Non current 78,321 - 78,321 78,321 - - Amounts due to Holdings loans - Non current - - - - - 1,672,335 Non-current portion of capital lease obligations 337,139 337,122 17 - 17 17 Non-current portion of Long term bank loans 965,740 900,000 65,740 21,265 44,475 44,475 Bonds 998,505 - 998,505 998,505 - - Unrecognized tax benefits 18,559 18,559 - - - - Deferred tax liabilities 78,593 74,417 4,176 - 4,176 4,176 Deferred government grant 18,046 18,046 - - - - Mandatorily redeemable noncontrolling interests 100,000 100,000 - - - -

Total 2,594,903 1,448,144 1,146,759 1,098,091 48,668 1,721,003

Total Liabilities 3,656,261 2,748,823 907,438 1,198,291 -290,853 2,048,833

Total mezzanine equity - - -

Treasury stock -8,917 - -8,917 -8,917 - - Ordinary shares 26 - 26 26 - 895,390 Additional paid-in capital 3,944,764 107,797 3,836,967 3,836,967 - - Accumulated other comprehensive income -82,589 - -82,589 -82,589 - - Statutory reserves 35,178 - 35,178 - 35,178 35,178 Accumulated deficit -1,429,410 617,518 -2,046,928 -1,286,435 -760,493 -760,493 Total Shareholders' Equity 2,459,052 725,315 1,733,737 2,459,052 -725,315 170,075

Non-controlling interest 16,249 16,249 - - -

Total Liabilities & Shareholders' Equity 6,131,562 3,490,387 2,641,175 3,657,343 -1,016,168 2,218,908

(Figures in RMB '000)


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Liquidation Analysis for VIEs, Subsidiaries and Holding Company

Order of liquidation within VNET Group

Assets realization rate

(1)Consolidated VIEs as of December 31,

2013


(2)Consolidated HK and PRC Subsidiaries

as of December 31, 2013


(3) Holding Parent Company as of

December 31, 2013

Company's Title To property in Possession1 Cash and cash equivalents 100% 259,987 100% 608,187 100% 590,682 2 Restricted cash 100% 3,020 100% - 33% 62,000 3 Accounts receivable, net 55% 332,863 55% 2,864 55% - 4 Short-term investments 100% 900,000 100% 120,000 100% 81,826 5 Prepaid expenses and other current assets 0% - 0% - 0% - 6 Deferred tax assets 0% - 0% - 0% - 7 Amount due from PRC and HK subsidiaries 0% - 100% - 0% - 8 Amount due from VIEs 100% - 0% - 100% - 9 Amount due from related parties 100% 9,800 100% 33,311 100% 24,387

10 Property & equipment, net 70% 569,757 70% 411,767 70% - 11 Intangible Assets, net 0% - 0% - 0% - 12 Goodwill 0% - 0% - 0% - 13 Restricted cash 100% - 100% 119,056 100% 100,000 14 Non-current Deferred tax assets 0% - 0% - 0% - 15 Other non-current assets 0% - 0% - 0% - 16 Investment in subsidiaries 0% - 0% - 0% - 17 Investment 100% 98,526 100% 8,201 100% -

Total 2,173,953 1,303,386 858,895

Liquidation Process in Order

1 Liquidators costs (1% of total assets) 6,981 4,438 7,315 2 Costs incurred by an administrator (1% of total assets) 6,981 4,438 7,315 3 Amounts owing to employees for leave 33,098 33,098 - 4 Payments owing in respect of employee social insurance 13,239 13,239 - 5 Unpaid amounts owing to tax bureaus 11,427 49 - 6 Secured banks with fixed charge over assets 1,049,085 241,475 21,265 7 Secured capital leasing companies with fixed charge over assets 351,722 17 8 Banks without security over assets 124,641 - - 9 Trade creditors without security over assets 382,198 130,781 -

10 Operating lease, capital and bandwidth/cabinets purchase commitments 258,304 1,168,088 355,958 11 Amounts due to related parties - - - 12 Amounts due to inter-companies WFOE -10% -63,722 -17% -292,236 - 13 Bonds payable to bondholders - - 47% 467,042 14 Ordinary Shareholders - - -

Total 2,173,953 1,303,386 858,895 Unsettled portion of liabilities -63,722 -292,236

Notes:1. In this analysis, we derived all financial figures from page F3-6, F20-21,F75-76 of 20F 2013.2. We determined assets realization rate for each catogories of assets at our best estimation and average industry level.3. We determined liquidation preference order that is accepted in the most legal systems, especially applicable in PRC, Hong Kong and Cayman Islands.4. The Bonds are unsecured and rank senior in right of payment to any of the Company’s indebtedness that is expressly subordinated to the Bonds;; equal in right of payment to any of the Company’s liab

that are not so subordinated; but rank lower than any secured indebtedness of the Company and all liabilities (including trade payables) of the Company’s subsidiaries and Consolidated VIEs.5. We assumed that all amounts due to related parties are in association with payment of acquisition consideration in shares and will not be paid in cash.All amounts due from related parties will be fully co6. As per 20F 2013, there was 1,471 employeed working for VNET as of December 31, 2013. We assumed that VNET shall pay average three months salary for employee leave and related social insurance

for the same period of time, based on average monthly salary of RMB 15,000.7. The liquidation order starts from PRC VIEs, HK and PRC subsidiaries and then Holding company in Cayman.8. We assumed that assets realization rate for AR and property is 55% and 70%, respectively. We think that 40% of AR balance is fraudulent.

70% assets realization rate for property is in line with current discount ratio for a property mortgage loan.9. We assumed not considering any payment related to acquisition of iPoo and Dermont.10. VNET has huge amounts of outstanding non-concelable commitments as of December 31, 2013, including capital commitments to purchase computer and network equipment, operating lease

commitments related to premises and data center space, bandwidth and cabinets capacity purchase commitments. (Page F-72 and 73, 20F 2013)11. VNET should pay off all unpaid portion in relation to non-concelable commitments from Holdings company before settling with Bondholders.

(Figures in RMB '000)


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APPENDIX

NOTE: Appendix A, Appendix B and Appendix C are made available separately in order to limit the file size of this report. Download them here: http://www.scribd.com/doc/239278904/A-Ponzi-Scheme-of-Acquisitions-21-Vianet-Group-Exposed-Appendix

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A Ponzi Scheme of Acquisitions - 21 Vianet Group Exposed

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