By any measure, the listing of Alibaba Group on the New York Stock Exchange in September was a whopper. It raised $25 billion, making it the largest stock flotation in history. Overnight the diminutive Jack Ma, who founded his internet-based business services company in 1999, turned a handful of close friends from the eastern Chinese city of Hangzhou into billionaires, and transformed himself into one of the most famous entrepreneurs on the planet.
Alibaba is also an extraordinary success story, and testament to the calculated way an autocratic one-party state has constrained one facet of the internet, while giving another free rein. Mainland citizens cannot access Google, Facebook or Twitter, yet they can use the web for purely commercial purposes — booking holidays and taxis, trading unwanted for wanted goods, and gossiping about celebrities. Provided you keep away from political subjects, such as the future of Tibet or Taiwan, or avoid allusion to indelicate moments in the Communist Party’s recent past, you’re generally fine.
That’s how Ma turned Alibaba into an online powerhouse. He learned early in his business life to adhere to three strict rules. First, business is purely business: never stray into the political realm. Second, avoid flashy demonstrations of power or wealth. Beijing fears unrest stemming from a yawning wealth gap, and nothing stokes public ire more than a bejewelled billionaire in a flashy car. Finally, put on a good face for the country. Don’t make China look petty, small or cheap. Give it a successful mien, one that makes the People’s Republic look like a benevolent superpower in the making.
All of this Ma has done in spades. At home, his company is a Goliath — so commercially powerful that it would invite the attention of competition regulators in Britain or America in a heartbeat. By the time it listed in New York, it accounted for 80 per cent of all internet sales in China by volume, and half of all online transactions. Its consumer portal Taobao, similar to eBay, accounts for 60 per cent of all parcels shipped daily by the state delivery service, China Post. This dominance translates into heady financial figures: revenues rose by more than 50 per cent in the most recent full financial year, while net profit nearly tripled to 23.3 billion yuan (£2.4 billion).
All of this makes China look very good overseas. Alibaba is not a corporate marauder looking to snaffle market share from its western peers — at least not yet. Indeed, the group barely does any business outside the country’s borders. Nor does it inspire fear among foreign regulators in the way that, say, secretive telecoms equipment maker Huawei has done in India and the US. It’s not an industrial polluter, or a mining giant scraping away African and Latin American topsoil in a never-ending quest for natural resources. Even its brand, emblazoned in sunny orange, brings to mind a pleasant childhood memory: the tale of the poor woodcutter Ali Baba who discovers a secret cave filled with treasure.
Yet for all the hoopla surrounding Alibaba there is a murkier side to its flotation. For one thing, while it resembles a western firm in certain respects, the truth is quite different. Beijing’s strict capital controls forbid mainland firms from completing ‘normal’ foreign stock flotations — but they can skirt those rules by cloaking themselves in an obscure and complex structure called a Variable Interest Entity. This is the scheme that has enabled Alibaba to become China’s most celebrated firm, and its founder to become a corporate rock star almost as famous as the late Apple founder Steve Jobs.
For investors holding shares in Alibaba — or in scores of other US-listed mainland companies, from airlines and hotel chains to chipmakers and property developers — the VIE is, or should be, perturbing. VIEs are a form of camouflage, helping a company to mimic what a listed corporation should look like. Investors don’t buy shares in a Chinese company called Alibaba; rather, they buy securities in a company called Alibaba Holdings that’s actually registered in the Cayman Islands. Sure, you get to participate in the company’s eye-watering profitability, through a flow of quarterly dividends. But you get no say in how it is run, however much of its stock you buy. Those decisions are made by a small group of Chinese billionaires back in Hangzhou.
And there’s more. Because the company’s assets, owners and directors are based in the mainland, any future litigation would need to occur on Chinese, not American, soil. And because judges are subject to the Party’s interpretation of the law, they view legal wrangles through the eyes of their political masters. No foreign investor will ever have much luck pursuing corporate litigation within the walled confines of the People’s Republic.
And there’s a final worrying anomaly. Global auditing giants such as Ernst & Young and PricewaterhouseCoopers are well established in China, but Beijing forbids their Chinese affiliates from carrying out audits of US-listed mainland firms. There’s a kind of twisted logic at play here. Beijing fears opening its books to outsiders, lest the world sees how the country really works — and how much of it is owned by the families of the political elite. But the standoff has become increasingly bitter, with global auditors trapped between a stubborn Chinese leadership and a demanding US stock regulator.
None of this should be news to investors. And yet dissenting views on Alibaba in the lead-up to its record-breaking float were few and far between. One of the few clarion voices came from an unlikely source: Mark Mobius, long-time China bull and fund manager at Franklin Templeton Investments. Long before Alibaba’s listing, Mobius warned publicly that it was a bad bet, largely because of its unusual dual-share class, which left minority founders, headed by executive chairman Ma, in control of the company’s core asset. ‘If something goes wrong, there’s nothing you can do about it,’ he warned a week before the flotation. ‘That’s the bottom line. It’s a very dangerous situation.’
Nor was this advice specific to would-be Alibaba investors. Chinese firms have a wretched transparency record, wherever they are listed. In 2012, Sino-Forest, a plantation owner floated on the Toronto stock exchange, filed for bankruptcy after being accused of inflating its assets and earnings. This June, shares in Hong Kong-listed Tianhe Chemicals were suspended after accusations by ‘hacktivist’ group Analytics Anonymous that the firm had falsified its accounts. When trading resumed on 9 October, Tianhe’s stock slumped a further 40 per cent.
Sometimes these tales are just downright weird. In September, Frankfurt-listed Chinese shoemaker Ultrasonic announced that its chief executive, Wu Qingyong, had disappeared with $60 million of the company’s money. A week later, Wu surfaced in the Philippines, claiming that he had been on a medical holiday and had mislaid his mobile phone. Yet Ultrasonic maintains that the money is still missing.
It seems incredible that foreign investors continue to buy into these Chinese stock stories. But they do, and sometimes for good reason. Alibaba was a rare gem, at least on the surface. Floated at $68, its shares jumped 38 per cent on the first day of trading and remained, in late October, at around the $95 level.
Yet even that story could turn sour. China’s capricious political leaders may decide to nullify the VIE structure, throwing the firm’s listing structure into doubt. They could crack down on online commerce. Future or existing political leaders, jealous of the sway Alibaba holds over Chinese consumers, could seek to steal all or part of the company for itself. In China, as foreign investors have found to their chagrin time and again, anything is possible.
Subscribe to The Spectator today for a quality of argument not found in any other publication. Get more Spectator for less – just £12 for 12 issues.