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Jack Ma, a Concern for U.S. Investors

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U.S. Investors Must be wary of Jack Ma

In a month’s time, Alibaba Group Holdings will open its shares for U.S. investors in a grand IPO that is expected to raise more than the $16 billion raised in 2012 by Facebook  Inc. (NASDAQ:FB). The Chinese e-commerce giant, founded and headed by Jack Ma, has already chosen the New York stock Exchange as its preferred destination under the ticker BABA.

Most analyst valuation puts Alibaba in league with the top five most valuable tech companies. Therefore, its IPO will present the U.S. investors with an opportunity to hold a large cap stock. And while everything about this Chinese conglomerate is huge, there is one pressing concern that every investor must look at with an open eye and sober mind, Mr. Jack Ma.

Jack Ma is a shareholder but an even bigger force

Ma holds 8.9% of Alibaba stake. This is a partly fraction to the 22.6% that Yahoo! (NASDAQ:YHOO) or 34.4% that Japan’s SoftBank (SFTBF) owns. Nevertheless, Ma is the most powerful shareholder and member of the board. His capabilities transcend his official title; he is a public figure and enjoys the backing of the Beijing regime.

Here is why every U.S. investor should be wary of Ma:

Ma and Alibaba Partnership

Alibaba amended its IPO filing to accommodate a strange clause that allows a committee of merely 27 partners to collectively nominate more than half of the board of directors. The shareholders then vet the nominees and can veto whoever they are not comfortable with.

However, the partners have the power to choose an alternative in acting capacity until the next AGM. It is surprising that both majority shareholders, SoftBank and Yahoo have backed this partnership. The SEC listing amendment meant that the total power of the company rested with Ma and his small clique of partners. This follows that the U.S. investors who will buy alibaba shares will have trusted this clique to make decision on anything regarding the company affairs.

Jack Ma Political Influence and Alibaba Legal Structure

Jack Ma’s political influence is another pressing concern if the legal structure is anything to go by. Interestingly, one of Alibaba’s funds is founded by the son of Wen Jiabao, a former premier.

Alibaba’s important licenses are held through variable interest entities (VIEs) to bypass the Beijing legislation on foreign ownership. He is very familiar with these structures, and that’s why he was able to divest Alipay (PayPal like payment unit) from Alibaba without Yahoo!’s prior knowledge, let alone its consent. Then Yahoo! was Alibaba’s largest foreign shareholder. His argument was that the unit needed an important license from the People Bank of China (PBC) in a moment notice.

The company’s existence in Zhejiang where China’s president, Xi Jinping, was formerly the province’s party chief, has helped Ma to enjoy Beijing’s support. This influence has helped the company overcome many obstacles that has hindered the progress of many non-state companies in China. However, this influence could play against U.S. investors should there be conflict arising from the company’s legal structure.

Conflict of Interests

As at now, Mr. Ma owns the foreign vehicle that owns both Alipay and its money-market fund affiliate. Since the two money units are still in partnership with Alibaba through complex contracts, there could be a conflict of interest in the future.

Other reasons that highlights Ma’s unilateral decision includes the recent impulse purchase of stake in irrelevant sectors such as acquiring stake in Chinese soccer team, and irregularly lending cash to one of his partners in the disguise of acquiring stake in cable TV company. There also other cases where his private equity funds has been lined up as a co-investor.

Conclusion

Jack Ma founded Alibaba and he has been the force behind it since its inception. He has watched the company grow from just one platform, Taobao, to multiple platforms with almost 85% control of the world’s largest e-commerce market. The company’s quarterly revenue (2014 Q1) stands at $1.5 billion, an increase of about 39% a year earlier.  It would be ridiculous to question Ma’s leadership given this success. However, company is now going public and a public company would want a leader who serves the best interests of its shareholders. Can Jack Ma do that?

VIE Structure of Alibaba Pose a Major Risk to Investors

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VIE Structure is used by Chinese Internet Companies Seeking U.S. Investors for Legal Reasons

VIE, Structures, Baidu. AlibabaU.S. investors interested in the Alibaba IPO have been told to be aware of the risks associated with the legal structure of the Chinese ecommerce giant together with other Chinese internet firms.  A commission whose mandate is to advice Congress on U.S. – China trade and economic issues has warned that such investors face major risks terming the companies’ legal arrangement as complex and highly risky and could make the U.S. shareholders suffer huge losses.

The report issued on June 18 was in response to surge in number of Chinese internet firms seeking financing from the U.S. market. The report has put Alibaba in the bad light, given that the company has filed to be listed in the New York stock exchange as early as August this year. If successful, its IPO might go down in history as the largest ever.

The Structure in Question

The commission took issue with the variable-interest entity (VIE) used by Chinese companies to bypass Beijing’s restrictions on foreign ownership in a specified industries, including internet businesses.

The report focuses on a structure called a variable-interest entity, or VIE. Chinese companies seeking to sell shares on U.S. markets use the structure to circumvent Chinese government restrictions on foreign ownership of businesses in sensitive industries, including Internet-related businesses.

In China, foreigners are not allowed to own more than half of the equity interests in any telecommunication service provider, which also include internet businesses. So while sourcing for capital in the U.S., such businesses create VIE structures, but these structures may not hold any water in Chinese courts.

The VIE structures include complex legal contracts between a holding company that connects foreign investors to the Chinese firms. These holding companies are often based in tax friendly nations, e.g. Cayman Islands.

According to the report, the main purpose of VIEs is to trick the Chinese lawmakers into believing that the business in question is Chinese-owned, and at the same time make foreign investors believe the same business is foreign-owned. This is potentially illegal in China, and both claims leave the ownership of the company in question.

Yahoo’s Case

To support its case against VIEs, the independent agency highlights the dispute that ensured between Yahoo! (NASDAQ: YHOO) and Alibaba over Alipay.

In 2011 Jack Ma, Alibaba’s founder and chairman, secretly spin-off Alipay – a payment tool similar to PayPal – from the Chinese ecommerce giant without informing Yahoo!, the then largest shareholder in the foreign entity.

According to the report, Alibaba’s VIE gives Jack Ma another chance of stealing part of Alibaba as all decision-making authority has been consolidated with the company’s founders in China.

Investors haven’t seemed too concerned about VIEs. Several companies including Baidu and JD.com have so far have been winners for investors.

The report also mentions the already U.S. listed Chinese companies including

  • Chinese search engine firm, Baidu Inc.
  • Alibaba rival JD.Com Inc. (ADR) (NASDAQ:JD), which IPOed last month.

The agency has raised a red flag over allowing Chinese entities to own important licenses, leaving Chinese shareholders with more control than their foreign counterparts. In Alibaba’s case, Mr. Mr controls the company’s assets.

Conclusion

Though this is not the first time complains are being raised about VIEs, many investors tend to be more concerned about company’s financials and thus ignore the risk these structures pose. Nevertheless, investors agree that owning companies through VIEs is not as effective as direct ownership.

Yahoo Will Go Head to Head With YouTube

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Yahoo soon will have another business division solely making profits from video streaming services. According to the sources, the newly recruited CEO, Marissa Mayer, has now set a prospective business expansion plan to excite the company investors and help Yahoo turn into an ambitious conglomerate. However, industry analysts believe this recent initiative is not any random go getter attitude of Yahoo. The company has been diligently following the business trend evolutions currently taking place in the market. Perhaps Yahoo also has been able to sense how prosperous the future of the video streaming industry is going to be in the next 5 years.
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Yahoo Stake Rises: Yahoo Hopes For Investment Rises

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Yahoo stake rises, if the proposed floatation on the US stock market happens as currently predicted. Yahoo holds a major investment in the company Alibaba and if the floatation proceeds, they too, are going to benefit from the floatation.

The date of this floatation is still under wraps, but it could be as soon as April, but at present the date is still unknown. But the floatation of this company could do even more for Yahoo; the ripple effect could mean that the company experiences a rise in its own value. This would give Yahoo a double blessing from the release of the Alibaba on the US stock market.
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