Open Sesame: Revealing the Risk and Reward of an Alibaba IPO

 

Takeaway

  • In China, a company exists as long as the government lets it.
  • Stockholders could find it difficult to sue and have any ruling enforced in China.
  • Risk comes with reward: China’s middle class is growing, and they’re ready to shop with Alibaba.

“If you want to sell things internationally, you need to have a presence on the Web, and we can help you do that.” 

That’s how employees at a small company called Alibaba pitched their services to prospective clients, recalls McCombs School of Business Senior Lecturer John Doggett.

“I led a group of McCombs MBAs to China in 2003, and we went to Hangzhou and met Jack [Ma], who was the Chairman and CEO of Alibaba before anybody knew who he was.”

Doggett remembers seeing open offices, buzzing and full of energy. Young employees cold-called Chinese businesses and tried to convince them to let Alibaba connect them with customers using the World Wide Web.

Eleven years later, Alibaba has 24,000 employees, 25 business units, and is estimated to be worth upwards of $200 billion. And on September 18, the company will launch its IPO on the New York Stock Exchange — and it could be the largest in Wall Street’s history.

But with all this talk of Wall Street and the NYSE, it’s easy to forget that Alibaba is a Chinese-centric company, and investors might be wise to consult their history books (in addition to a good financial advisor) before buying.

Who’s in Charge?

“Political risk is high in China. Your company exists as long as the government lets it,” says Professor John Griffin in McCombs’ finance department.

For Alibaba — as with all major companies in China — this means that its senior-most official is a secretary with the Communist Party of China. Who that is for Alibaba is unclear, however. This past June, the Wall Street Journal identified Shao Xiaofeng as both Chief Risk Officer and secretary of Alibaba’s Communist Party Committee, but his page on a government website appears to have been removed, and Alibaba’s corporate site gives no indication that Xiafeng has ever held the title.

It’s this potential lack of transparency that has alerted experts. “Listing on the New York Stock Exchange requires a level of transparency that isn’t required in China,” explains Doggett.

That doesn’t mean Alibaba won’t comply with SEC regulations. In fact, Doggett says, it’s in the Chinese government’s best interest that Alibaba perform well for investors, and they know this. But Chinese politics dictates that Alibaba’s primary stakeholder is not individual or institutional investors, but the government itself, and it’s unclear just how much ownership (direct or indirect) the government has.

An unnamed source with Alibaba tells Texas Enterprise that, “…there is no SASAC, CIC, and other traditional government holding platform figure… From the perspective of corporate governance structure, there does not exist the so-called government background… Ali is an ordinary private joint-stock company…”

SASAC stands for State-owned Assets Supervision and Administration Commission, and CIC refers to the China Investment Corporation, both of which regulate and manage state-owned assets. 

Loyalty and the Law

But a recent New York Times analysis reveals deeper political connections that may fly under the radar for most casual investors. Several of Alibaba’s investment firms are run by family members of the most powerful officials of the ruling Communist Party, and Doggett adds that among publicly-traded companies, the Chinese government is often the majority owner — with its own set of rules.

“What most people don’t know is that for most of the publicly-traded companies in China,” he says, “the amount of stock that the public owns is anywhere between 15 and 30 percent, and the rest is owned by the government.” 

And why could this matter, especially to investors 7,000 miles away? The issue is a legal one, explains Doggett, who holds a J.D. from Yale University. “One of the things [President] Xi Jingping required all judges to do right after he came to power was to swear allegiance to the Chinese Communist Party as the number one priority in any decision they make — and then the law.”

For foreign stockholders, that could inhibit their power to sue. If something happened that caused Alibaba to get de-listed, the company could be sued in United States courts, but those rulings can’t be enforced unless the Chinese courts decide to enforce them, he says.

Risk vs. Reward

But that risk might be one investors are willing to shoulder for the possibility of a large payoff, and with good reason.

The ICF estimates that China is poised to overtake the U.S. as the largest economy in the world, possibly in the next year or two, when calculations factor in the country’s purchasing power. 

And when it comes to unlocking the purchasing power of China’s middle class, Alibaba holds the key: Its two main websites, Taobao Marketplace and Tmall.com, account for 60 percent of the packages shipped within China, the New York Times reports

The growth rate of China’s middle class, which now totals between 500-600 million, is unparalleled: It’s increasing by 25-45 million people annually, says Doggett. “That’s a new Scandinavia of Chinese middle class every year. And they want to buy everything, for the first time, that middle class people have. What you’re seeing is a transition from being a very export-oriented economy to having a balance between exports and consumption, all because the middle class is growing.”

Sanford Leeds, Distinguished Senior Lecturer in McCombs’ finance department, concurs. “From a theme perspective, this offering appeals to investors who want to participate in China’s growth and, particularly, the increasing role of consumer spending in China. Alibaba’s story also appeals to those interested in the increasing penetration of the Internet into the lives of the Chinese.”

U.S. Investment and Expansion

According to a source at Alibaba, “…In the future, Ali would not expand its market in the U.S., and foreign companies have no ability to compete in the related fields with Ali. The presence of Ali in the U.S. is just for financing, and then do better in China market development [sic]. Ali’s business model and market, in a short period of time, has nothing to do with America.”

But Doggett — and Alibaba’s latest investment moves — beg to differ.

“If Alibaba wants to become a global player, which obviously going on the New York Stock Exchange is an indication they do, then they’ve got to go where the big boys and girls are, and that’s here. There’s no question in my mind that they will develop a presence in the United States to learn how to compete,” Doggett asserts. 

Alibaba has recently invested more than $100 million in online companies such as Kabam and Fanatics, and some say that it will resume talks with Snapchat once the IPO is complete. While this doesn’t indicate the company plans to go head-to-head with the likes of Amazon or eBay (yet), it does give the company a solid foothold within up-and-coming American companies. 

At the same time, competition is increasing back home, and some tech experts give rival Tencent the edge when it comes to the mobile market, an area where Alibaba has yet to dominate in China. Tencent, the fourth largest Internet company in the world, is also expanding its portfolio and encroaching into Alibaba’s e-commerce and online bill pay territory. 

So what’s an investor to do? “Read the prospectus and understand the value of a company prior to purchasing. It’s easy to get caught up in the hype because the company, the underwriters, and the media all want to promote this excitement,” says Leeds.

Doggett is optimistic but urges people not to be naïve. He reminds investors that the iconic red phone still exists, and it resides in the chairman’s office of every major company in China, including Alibaba’s.

“When it rings,” says Doggett, “you know that somebody in the seat of the Communist Party in Beijing wants to talk to the chairman. And it will be answered, and whatever they ask will be given. Period. That’s just part of that reality. How they deal with that vis-à-vis the SEC is another issue, but anybody doing business with China has to understand that there is no such thing as a private sector that’s independent of politics. It does not exist.”


Recommended reading
The Party: The Secret World of China’s Communist Rulers by Richard McGregor

Austin American-Statesman Op-ed: Alibaba IPO Poses Risks, Benefits for U.S. and China

Photo Credit: Hong Wu/Getty Images News/Getty Images

The McCombs School of Business is dedicated to educating the leaders of tomorrow while creating knowledge today that shapes industry, society, and policy. Ranked 5th in the world for research, McCombs has one of the most productive faculties of any school, public or private. We educate more than 12,000 students each year and instill in them the desire for intellectual inquiry and integrity that defines The University of Texas at Austin.

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Faculty in this Article

John Doggett

Senior Lecturer, Management

John N. Doggett is a senior lecturer in the Department of Management. He received his B.A. from Claremont Men’s College, his J.D. from Yale...

John Doggett teaches in the Texas Executive Education program, featuring open enrollment, custom and certificate classes for executives and organization teams.

John Griffin

Professor of Finance McCombs School of Business

John Griffin is the Arthur Anderson & Co. Alumni Centennial Professor of Finance at the McCombs School of Business and has been a visiting...

Sandy Leeds

Distinguished Senior Lecturer, Department of Finance McCombs School of Business, The University of Texas at Austin

Sandy Leeds, CFA is a Distinguished Senior Lecturer at The University of Texas at Austin. He teaches graduate level classes in the MBA program and...

About The Author

Adrienne Dawson

Adrienne is the editor of Texas Enterprise. She holds an MBA and has previously been a writer and editor at Rice University and MD Anderson Cancer...

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