Investor CentralAlibaba Group Holding Limited - MANAGEMENT REPLY: Where will IPO money be spent?
19/9/2014 – The public listing of Alibaba Group Holding Limited on the New York Stock Exchange is remarkable, but not just for the reasons the mainstream financial media are breathlessly reporting on.
Sure, the IPO price range has been increased from between US$60 and US$66 to final pricing at US$68, making it one of the biggest IPOs in history.
But while this has grabbed headlines, there are bigger questions about the structure and the business operations of the company.
First, investors will not be buying ordinary shares in Alibaba, but American Depositary Shares (ADS). These are backed 1-for-1 by ordinary shares, which are deposited with Citibank in Hong Kong.
But, as the prospectus says, "We will not treat ADS holders as our shareholders and accordingly, you, as an ADS holder, will not have a shareholder’s rights."
For example, when Alibaba shareholders – excuse me, ADS holders – receive dividend payments, Citibank will deduct an unspecified amount in "fees and expenses".
The reason why Alibaba is even listing in the US, rather than Hong Kong, have to do with the shareholding structure of the company.
The board of directors of Alibaba Group Holding Limited will be dominated by nominees from the Alibaba Partnership – a club of currently 30 members with at least a five year history with the company.
The Partnership has the right to nominate a simple majority of directors on the board – no matter what shareholders at the AGM have to say.
The Partnership itself is a body with a revolving door. It will bring on board new partners once a year.
Candidates are reviewed by the Partnership Committee – which consists of Alibaba Co-founder and Executive Chairman Jack Ma and four others – before they are proposed to the remaining partners (page 229-230 of the prospectus).
Even as Ma positions himself as Western-friendly, this arrangement sounds remarkably like the Politburo Standing Committee of the Chinese Communist Party, controversially ruling that candidates for election in Hong Kong must be approved by a special committee first.
Notable also is that more than half the proceeds raised in the IPO will go to Ma and his co-founders, not the company.
Those proceeds that will go to the company have not been earmarked for any specific purpose.
Or at least, none that it has disclosed publicly.
The prospectus only says: "We plan to use the net proceeds we will receive from this offering for general corporate purposes."
In other words, it will have US$8.1 bln at its disposal, but it won’t tell ADS holders until later what it will do with it.
One point of comfort for weary Western investors: the cash will not be repatriated to China.
But this begs the question how the company will grow in China, if it won’t actually spend any of the IPO proceeds there.
Not to mention that China’s economy is in trouble, struggling to achieve 7.5% growth in 2014.
Bloomberg reported recently that China's central bank will inject about US$81 bln into nation's largest banks to boost liquidity.
Not the sort of market with run-away consumer growth.
Chinese consumers are anyway not big spenders, with the prospectus saying they only make up one-third of the economy (35.8% in 2013), compared to American consumers which make up two-thirds of the US economy (67.1% in the same year).
Scant details are contained in the prospectus regarding plans to expand in other markets.
For example, the word "Europe" only appears six times, and only once in a way which might give a hint to its growth strategy there: "We will continue to develop and market AliExpress globally, especially to consumers in emerging economies such as Russia, Eastern Europe and South America, where quality products from China at direct-to-consumer prices offer significant value".
The words "International", "International consumers", "US consumers" or "United States consumers" don’t appear at all.
One other interesting feature in the prospectus is Alibaba’s much-touted payment services provider Alipay.
The problem for Alibaba ADS holders is that this system is not owned by Alibaba.
It is owned by what the prospectus refers to as Small and Micro Financial Services Company, whose real name is actually Zhejiang Ant Small and Micro Financial Services Group Co., Ltd.
And Zhejiang Ant Small and Micro Financial Services Group Co., Ltd in turn is controlled by Jack Ma.
No word on where the name came from.
The company warns on page 30 of the prospectus that there is no guarantee that any conflict with Zhejiang Ant Small and Micro Financial Services Group Co., Ltd will be resolved in Alibaba’s favour.
Finally, while Alibaba positions itself as merely a platform which helps people and companies buy and sell goods, it also has a history in China’s notorious shadow banking system.
Shadow banking really just means: loans issued by companies other than banks.
All manner of companies, even including ship builders, are earning high interest rates on loans they’ve made to businesses and consumers which would otherwise not be able to get loans.
The problem is that bad loans made by all these non-bank companies are now so big – no one knows exactly how big – that they threaten the entire economy.
We have no information about how Alibaba’s shadow banking loans, which it calls the "SME loan business", is doing. Perhaps it’s doing really well.
Then, just a month ago, on August 12, Alibaba sold its "SME loan business" to Zhejiang Ant Small and Micro Financial Services Group for US$519 mln, plus 2.5% of the loan book for the next three years, with the final payment in 2017 being repeated in 2018, 2019, 2020 and 2021.
The loan book was valued at US$2 bln as at FY13.
Assuming it remains the same till 2021, it will receive about another US$350 mln as fee from Small and Micro Financial Services Group.
The prospectus says Jack Ma "…intends to reduce and thereafter limit his direct and indirect economic interest in Small and Micro Financial Services Company over time, to a percentage that does not exceed his and his affiliates’ interest in our company immediately prior to our initial public offering".
Another commitment worth highlighting is "He has entered into a deed to, and will, donate all distributions he may receive by virtue of his 40% indirect interest in the general partners of the three Yunfeng Capital funds to, or for the benefit of, the Alibaba Foundation".
It’s just a shame that the business was not declared sold until the sixth revision to the prospectus.
One wonders why the company left it so late to do this.
Did Alibaba’s investment bankers, or prospective investors, think this would be a face-saving way of divesting its interest in an industry which is cause for some concern?
One thing we do look forward to is the letter to shareholders which Jack Ma promises he and his partners in the Alibaba Partnership will write every year.
If his first letter (page 80 of the prospectus) is anything to go by, it should be a fairly candid affair.
He writes: "When an Internet company of our scale that originated from China enters the global scene, you should expect that it will encounter skepticism [sic] from different directions due to differences in cultural perspectives, values and even geopolitical positioning," and also acknowledges that Alibaba could be used for "intellectual property infringement and those who seek to exploit our ecosystem for unfair gains".
He also trots out Sir Richard Branson’s business philosophy which, written in quotation marks, is that "we will put 'customers first, employees second, and shareholders third.'"
One final comment from his letter, which sums up the expectations investors have of Alibaba: "In the past decade, we measured ourselves by how much we changed China. In the future, we will be judged by how much progress we bring to the world."
It wanted to first list on the Hong Kong Stock Exchange but officials in Hong Kong disallowed the complex share structure, and so Alibaba headed to America.
In fact, it was listed on the Hong Kong Exchange from 2007 as Alibaba.com but was privatised in June 2012 "to enable Alibaba.com Limited to enhance and realign its strategies with a focus on longer term benefits to its business".
The company has replied to our questions in this story saying it was in a quiet period and therefore unable to respond.
Investor Central. Asian insights for global investors. We ask the tough questions of Asian companies which global investors need answers to.
ISSUE DETAILS
Total Offer Size: 320.1 mln ordinary shares
Price per share: US$68/share
New shares: 123 mln shares
Vendor shares: 197 mln shares
Public shares: 320.1 mln shares
While the company has assumed a mid-range for its IPO price, New York University finance Professor Aswath Damodaran values Alibaba at US$65.98.
KEY FINANCIALS AT LISTING
Market cap: US$ 167.1 bln
Price/Book: 1.17x
Price/Earnings: 42.2x
BACKGROUND
Alibaba is the largest online and mobile commerce company in the world in terms of gross merchandise volume in 2013.
It operates its marketplaces as a platform for third parties, and does not engage in direct sales, compete with its merchants or hold inventory.
It operates the Taobao Marketplace, China’s largest online shopping destination, Tmall, China’s largest third-party platform for brands and retailers, and Juhuasuan, China’s most popular group buying marketplace by monthly active users.
In addition, it operates Alibaba.com, China’s largest global wholesale marketplace, 1688.com, its China wholesale marketplace, and AliExpress, its global consumer marketplace, as well as provide cloud computing services.
In addition, its success also lies in Alipay, the entity providing payment processing and escrow services, and micro loans.
But it had to divest its interest in Alipay in 2011 due to uncertainties of the PRC government's restriction on foreign ownership.
It also announced the divestment of its micro loan business on August 12, 2014 (Page F-115 of the prospectus), pending regulatory approval.
This divestment was only announced in its amended prospectus released on September 5th.
The reason it highlighted was "The disposition [sic] allows us to focus on our core e-commerce businesses and eliminates the direct risks and disadvantages of carrying a loan portfolio on our balance sheet" (page 259 of the prospectus).
Jack Ma – who is frequently referred to only by his first name – will remain a substantial owner these two divisions under the parent company, Zhejiang Ant Small and Micro Financial Services Group Co. Ltd, and plans to come up with an IPO which may be valued at about US$25 bln.
1. Why did it decide to divest its micro loan business just before the IPO?
IPO PROCEEDS
US$ 8.1 bln for general corporate purposes
US$ 45.6 mln for listing expenses
A US$1 change in the initial public offering price of US$67 per share would change the net proceeds by US$122 mln.
There are many selling shareholders listed on page 250 of the prospectus.
The major shareholders are SoftBank, whose shareholding will fall from 34.1% to 32.1%, Yahoo's stake will fall from 22.4% to 16.3% and Jack Ma's stake will dilute to 7.8% from 8.8%.
2. How will Alibaba use the IPO proceeds?
Alibaba currently intends to use the net proceeds from this offering outside of China, and does not expect to transfer proceeds into China.
Due to PRC legal restrictions, it does not intend to finance the activities of its PRC subsidiaries or its variable interest entities with the IPO proceeds.
Further details can be found on page 71 of the prospectus.
(Total number of questions in the full story: 11)
The full story also contains most recent financials, growth drivers, key risks, details of management, on-going litigation and divided policy.
Management Reply: Thank you for your interest in Alibaba Group.
Please note that we are in a quiet period and unable to respond to your enquiries.
I’d be happy to explore editorial opportunities in the future.
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