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Published On: Thu, Sep 11th, 2014

Some Alibaba risks you might not be aware of before its grand IPO

Alibaba is expected to launch its IPO in a matter of days; it is worth having a look in some of the risks, logged into its prospectus, before taking the decision to buy into the e-commerce giant’s stocks.

Some Alibaba risks you might not be aware of before its grand IPO

The Jack MaAlibaba e-commerce business could raise up to $20 billion via the IPO. Analysts expect the valuation of the group at $250 billion, after it commences trading. Thus the IPO becomes the most massive technology IPO to have ever been made, larger than the 2012 Facebook one raising $16 billion.

In Alibaba’s prospectus, no details are included of the number of shares to be offered, or on the amount that could be raised. But there is sufficient information on the unconventional shareholder structure which stirred outrage in Hong Kong.

In a nutshell, the structure will let Ma together with “Alibaba Partnership” which consists of 28 members, appoint a simple majority of the board, even in cases where the founder’s stake is lower than 10%. The structure resembles the structure offered for the Hong Kong listing, so the Alibaba Partnership in fact controls the board.

New York, dissimilar to Hong Kong, is used to such structures. The prospectus outlines in detail the issues raised owing to this, and what part Ma, together with other shareholders Softbank and Yahoo, play.

After the IPO, Softbank will retain its ownership of over 30% of Alibaba; Yahoo will have to sell down its stake of 23%; Ma’s ownership is about 9%; finally, Executive Vice-Chairman Joseph C. Tsai has 3.6%.

The voting on partnership nominees to the board is to occur at an AGM, but both Softbank and Yahoo already stated agreement to back them. By dint of a reciprocal clause, Softbank will be able to nominate its own member, aided by partnership backing from Yahoo and Tsai.

Alibaba expects nine directors to comprise the board, so it leaves just minuscule wiggle room for investors, which is recognised in the prospectus. It warns that the arrangement on the voting between the key shareholders limits investors capability of impacting corporate matters, inclusive of those resolved on board level.

With such governance structure, the partnership (Ma) gains effective control of the board makeup and direction. On the one hand, that is auspicious for good periods, on the other hand, it is adverse when times take a turn towards the bad.

According to Asian Corporate Governance Association research director Michael Cheng, regardless of what the structure is, the best interests of investors will be abided by. It ought to offer rewarding governance. With Alibaba’s structure, prospects for shareholders democracy are not apparently so bright.

In the Alibaba prospectus, it is pointed out that Softbank will exert “significant influence” on matters involving shareholder votes, as well as on business matters and corporate matters. It is also pointed out as a warning by Alibaba that at times Softbank’s interests may be conflicting with other shareholders’ interests.

The further provisions of the structure are as follows: first, the board of directors will have the authority to occasionally establish, without shareholders’ action, a series or more series of preferred shares, and determine both terms and rights for such series; second, the board will have the right to create a staggered terms classified board, to prevent a majority of directors being simultaneously replaced.

According to Alibaba warning, the above provisions could act as delaying, deterring, or preventing a change in control, and shareholders’ opportunities for receiving premiums on their American depositary shares could be curbed.

Mark Chan has pointed that the partnership structure operates on condition that the few key management members bear the primary responsibility for these companies’ growth. Such companies have retained their success over a sufficient period, so the market looks favorably on their taking charge.

There are indeed some extents of risks. According to some market watchers, buying into Alibaba means betting on China, because Ma’s company comprises a diversity of business models, each of which comes with its own challenges.

The financial services regulation via Alipay, the structure’s online payment processing service, is of complex nature, functioning with sporadic and unpredictable fluctuations. The service development relies on the mobile technology industry which itself is unpredictable as well. It heavily depends on the wishes and whims of Chinese middle class. Finally, there are a number of competitors around.

Another issue is posed by VIEs, or variable interest entity structures, thanks to which Alibaba can hold certain domestic assets which are regarded by the Chinese government as sensitive; these assets have foreign investors. They evade Chinese ownership rules, so investors in the IPO will not actually buy into the Chinese assets of the group.

The prospects underlines that at best, VIEs are not covered by a certain Chinese legal framework, and at worst they could be declared illegal according to Chinese laws. Hence in the future Alibaba could be forced to abandon assets in such VIEs. Thus betting on Alibaba would be tantamount to guessing the Chinese government’s mood, which is daunting.

The above risks are all included in the prospectus.The Security and Exchange Commission (SEC) cannot ban IPOs on account of risk level, but it requires companies to point out those risks, for the investors to get a clear picture before they take their decision.

Whereas Hong Kong was hesitant, New Yorkwelcomed the IPO. Now looks are directed towards investors.

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