In late October 1999 Alibaba’s founder Jack Ma received an email from a banker inviting him to meet a potentially-useful contact.
That person turned out to be Softbank’s Son Masayoshi. But on arriving at the venue, Ma realised that heavy-hitters from 10 other Chinese internet firms were also waiting to present their cases to Softbank. Seven-month-old Alibaba was a minnow, so Ma only got six minutes to make his pitch.
Ma told Son two things. First, that Alibaba wanted to become China’s largest online marketplace. Second, that his start-up didn’t need any money. (Alibaba had just concluded a $5 million angel investment round.)
Son was looking for a man who would shape the future of Chinese cyberspace, says 21CN Business Herald, to mirror the success he’d had with Softbank’s investment in Jerry Yang’s Yahoo in the early 1990s which gave the Japanese firm a presence in North America. Within a month, a deal had been struck, although Ma took only two-thirds of the $30 million that was being offered. He also insisted that his team hold a controlling number of shares. Son wasn’t convinced at first but Chauncey Shey, head of Softbank’s China division, convinced him that Ma was the right guy to back.
“Why we picked Jack Ma? We found him and his team very special,” 21CN quoted Shey as saying this month. “Alibaba has 18 founding partners. To be able to pull 18 ambitious and capable young people together, sit tight and share his vision, Ma must have some special abilities.”
Shey also says that Ma’s right-hand man, Joseph Tsai, underscored his conviction that Alibaba was going to be a good investment.
Born in Taiwan and educated at the prestigious Ivy League college Yale (Ma says his own application to Harvard was rejected 10 times), Tsai was working as lawyer at an investment firm before Ma convinced him to join Alibaba for $50 a month. He’s since become one of the most sought-after executives on Wall Street, and all the more so after Alibaba filed for its US listing last week. “The detail man to Mr Ma’s vision”, as the New York Times puts it, Tsai “holds the key to what will most likely to be the largest initial public offering of this generation”.
But there are a few key details missing in Alibaba’s registration statement, which runs to more than 2,300 pages. For example, we still don’t know the expected price range for the flotation or the size of its proposed fundraising. There is plenty of hype around the IPO, but not much company guidance on Alibaba’s future earnings. So investors are left to ponder Ma’s vision and how he and Tsai will take Alibaba forward.
Who owns Alibaba?
Regular readers of WiC won’t need reminding of Alibaba’s mammoth scale and sprawling business reach. Its status as China’s largest e-commerce company makes it the world’s biggest online marketplace. Based on the average estimate of 12 analysts, Bloomberg puts Alibaba’s post-float valuation at $168 billion. The IPO documents say that it will raise at least $1 billion, although analysts seem to think the total is more likely to end up at between $15 billion and $20 billion. A higher amount would top Facebook’s $16 billion offering in 2012, the record for the internet sector.
Alibaba’s filing also names four principal shareholders. Softbank owns 34.4%, while Yahoo has a 22.6% stake. Jack Ma owns the large majority of an 8.9% share held by founding partners, via an offshore vehicle. Tsai, executive vice chairman, holds a further 3.6% shareholding himself.
The remaining 30% is held by “shareholders of record in the United States”, i.e. financial institutions that have invested in the internet firm during its first 15 years.
Using Bloomberg’s estimate of the firm’s valuation, Softbank’s stake is worth a whopping $58 billion, or 2,900 times its investment 15 years ago. Softbank has pledged to keep hold of more than 30% of Alibaba – for the time being at least. “Of course, that doesn’t mean we promise to hold it forever, but for now we consider Alibaba a core strategic partner,” Son told Reuters last week.
However, Yahoo is expected to sell almost half of its Alibaba stake as a consequence of the offering. It will also relinquish its only seat on Alibaba’s four-person board (the others held by Ma, Tsai and Son).
As such, a big chunk of Alibaba’s IPO proceeds will see existing shareholders exit, rather than raising new money for the company itself. Perhaps that’s why Jack Ma has returned to a similar script to the one he pitched to Softbank in 1999: that this deal isn’t about money. Tsai has also tried to play down the significance of the offering, pointing more to the company’s future. “There’s lot of life after an IPO,” he told the New York Times.
So why go public now?
Two factors seem to be setting the tempo. One is that some existing investors want to exit. Another is that Alibaba’s shareholders think that it’s a good time to IPO, with market conditions supporting a high valuation.
Barron’s says that Alibaba wants to sell stock while the major US indices are close to historic highs. That’s ominous, the magazine thinks. A handful of deals are now looked back on as watersheds in market cycles, it warns, drawing comparison to Blackstone’s high-profile listing in 2007. Ma and Tsai want to time it right too. “Alibaba’s message: sell high, in any language,” it suggests.
But New York wasn’t Alibaba’s preferred IPO destination. The company worked throughout 2013 to list in Hong Kong, only to pause when the territory’s regulators rejected its dual-class share structure. (The arrangement allows Ma and Alibaba’s founding partners to retain voting control, even as minority shareholders.)
Yahoo is said to be fed up with the power imbalance. According to the Chinese media, its chagrin with Ma is a primary reason for why Alibaba is going public.
For this, some history is required.
Back in 2005 Softbank’s Son arranged for Yahoo to acquire a 40% stake in Alibaba for $1 billion and then agree to inject it own Chinese assets into the firm. It looked like a sound strategic partnership. Indeed, the timely capital infusion helped Taobao, Alibaba’s online C2C (customer to customer) shopping platform to defeat eBay (which had topped China’s C2C market in 2004).
But relations between company executives and Yahoo began to deteriorate, especially after 2010 when Yahoo rejected an offer to sell its stake (then 40% and valued at $11 billion, see WiC79) back to Alibaba.
The tension worsened in 2011 when ownership of Alipay, an online payment system underpinning all of Alibaba’s e-commerce businesses, was transferred to a company controlled by Ma.
Yahoo raged publicly that the switch was made without shareholders’ approval (see WiC112). Before the transfer, Alipay was owned by Alibaba. Beyond that it gets more complicated. Yahoo enjoyed an economic interest in Alibaba’s success via a so-called “variable interest entity”, or VIE, a structure devised to get around rules disallowing foreign ownership in certain Chinese assets.
Ma countered Yahoo’s complaints over the Alipay disposal by claiming he was forced into the move after warnings from the Chinese central bank about foreign shareholdings in a domestic payments system. By any definition, the move exposed the inherent flimsiness of the VIE structure – more on which later…
(Separately, Alipay isn’t included in Alibaba’s listing, at least not at this point. Meanwhile if it goes public separately – most likely in China – Alibaba will receive a one-off cash payment of about $6 billion.)
Indeed, Yahoo wasn’t convinced, accusing Ma of breaching his contractual commitments with his partners. So the first phase of the divorce was made in 2012 with Alibaba buying back nearly half of Yahoo’s stake. Under the agreement, Yahoo said it would cut its Alibaba stake by another half should an IPO take place. Critically, existing shareholders have first rights to buy the shares. But this option is set to expire by the end of 2015, which Century Weekly cites as another factor in driving the IPO timetable.
How will Alibaba’s IPO reshape the internet world?
Clearly, it will impact Yahoo. The veteran portal operator has struggled with its core business, and was increasingly viewed more as a proxy for faster-growing Alibaba. (When Microsoft launched a $53 billion takeover bid for Yahoo in 2008, Chinese media saw it as an indirect raid on Alibaba.)
By selling down its Alibaba stake, Yahoo will realise upwards of $10 billion, or more than double its existing cash stockpile. It could return cash to shareholders through a buyback or a special dividend, or use the money to make acquisitions. Bloomberg says the windfall represents Yahoo’s “best shot yet at narrowing the ever-widening gap between web rivals Google and Facebook”.
Or might Alibaba turn the tables and buy further into Yahoo? That was something Jack Ma proposed rather playfully three years ago. “After nine years, the pair have swapped positions,” 21CN says, suggesting that Alibaba must go global if it is to continue its supercharged growth. “Alibaba only needs to acquire 20% in Yahoo to become its biggest shareholder. It is worth about $6.4 billion. Given Yahoo owns a 35% stake in Yahoo Japan, such a deal would also give Alibaba a solid presence in Japan,” 21CN opines. “Alibaba’s vision to become the number one global internet firm could turn to reality – from once being just a Chinese dream.”
The Financial Times’s Lex Column concurred that deals of that size barely warrant a second thought from Alibaba bosses. “Super-charged with a superior ‘growth stock’ valuation, it will be in a strong position to beat Silicon Valley at its own game,” the FT reckons.
So far Alibaba’s international expansion has been slow, although it has started making investments in the US, including ShopRunner, an e-commerce firm that rivals Amazon’s Prime free-shipping service. It has also added Lyft, a ride-sharing service, and Tango, a mobile messaging operator, to its global business portfolio.
But could a bigger, more transformational bid for Yahoo be in the offing? If so, it might encounter political opposition. “Will Americans and the American government tolerate the rise of Chinese internet firms on their soil? More than that, will Alibaba and other rising Chinese companies manage cultural differences any better than American firms did in China?” the New York Times asked.
What other risks lie beneath?
Another worry for some investors is the IPO’s structure i.e. its reliance on VIE arrangements. In an interview on CNBC, Antoine Chemali, chief investment officer at Digital World Capital, said many American investors won’t be able to buy into the flotation because of the risk the structure poses. The VIE acknowledges an inconvenient fact: that foreigners aren’t allowed to own Chinese internet assets. Instead ownership benefits (i.e. the profits) are transferred to the US-listed entity, without ceding ownership of the assets that generate them.
“The US investors will own shares in this variable interest entity, and that has a contract with the mother company in China. That poses concerns to a lot of different investors,” Chemali says. Why? “Because they don’t have title to the shares of the mother company but instead rely on the contract between the two companies so as to enjoy their economic rights. A large class of investors will not invest in this company because of the regulatory risk.”
We wrote in WiC197 about the risks involved in this opaque (though quite common) ownership structure and Gordon Chang returned to the same theme in an article about Alibaba’s IPO for Forbes. Chang says that investors who purchase the New York-listed stock will assume that Beijing has consented to these VIE arrangements, even though they contravene the spirit of Chinese rules that foreigners cannot own internet firms.
“People believe that if Beijing were to declare a VIE arrangement illegal, it would be like setting off a nuclear weapon, shutting off new Chinese companies from foreign equity markets,” he writes.
But Chang reaches a somewhat different conclusion. “In reality, the legality of Alibaba’s contractual arrangements is very much in doubt. As a result, Beijing has the right to effectively confiscate the business of the issuer. Investors are making a bet that Chinese officials will not do so, but the risk of such an adverse event is not small – and there are indications that the risk will increase over time.”
Chang also reiterates the recent experience among Alibaba’s foreign shareholders. Alipay was previously part of Alibaba’s Cayman Islands VIE. When its ownership changed in 2011 there was little recourse for foreign investors, as Yahoo discovered.
Those who buy the New York IPO are buying into the same Cayman VIE.
“There are substantial uncertainties regarding the interpretation and application of current and future PRC laws, rules and regulations,” Alibaba’s IPO documents have also noted.
Of course, the flotation process has also provided more clarity on Alibaba’s ownership. For one thing, it shows that a company usually portrayed as a Chinese giant actually only has a small minority of Chinese shareholders. Alibaba may become a giant in other e-commerce markets outside China. But if it does, a disproportionate number of foreign investors will be cashing in.
Back at home this has aroused nationalist sentiment as more people become aware of Alibaba’s foreign owners. “Who is Jack Ma working for?” was one of the questions being asked on weibo. There were even accusations that Ma was a “big traitor” when the level of Japanese ownership became clear. Noting the continued tension between the two country’s over disputed islands, Reuters reported that there were calls for boycotts of Alibaba’s websites.
Revelations about the ownership of the VIE are unlikely to damage Alibaba’s core business but they highlight that the offshore arrangements are becoming more controversial. And in Alibaba’s case this structure is hardly something in the prospectus marginalia: it is underpinning what is likely to be one of the biggest IPOs ever.
What’s Ma’s vision?
Never too bothered by the dangers of hubris, Ma has said that he wants to build a company that lasts at least 102 years, so that it spans three centuries from its founding in 1999.
Five years ago, Ma had already identified a much-vaunted set of peers. “If Alibaba cannot become a Microsoft or Walmart, I will regret it for the rest of my life,” he told an interviewer in 2009.
And since then Alibaba has been trying to transform itself into a much more diverse beast. To name just a few of the initiatives added to its e-commerce core, it is taking on the financial monopoly of the state banks, has started to venture into the movie industry, and last year launched a logistics venture that competes with couriers that have long supported its online trading businesses.
To put this in perspective: an American equivalent to Alibaba’s multi-industry goals would knit together the likes of eBay, Wells Fargo, Disney and UPS. And the same 18 founding partners will be making all the important decisions about these strategies. (After all, the New York listing is deliberately structured to cements their managerial control; a Hong Kong IPO would have shifted more power to minority shareholders.)
Can they continue to steer the firm to ever-greater heights? Many of Alibaba’s own staff seem to believe so. According to the Oriental Morning Post, the price of company shares on its in-house trading platform has climbed from $60 last year to $160 as of late.
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