Sunday, September 21, 2014

BABA…and the 40 thieves

This week's record-breaking IPO for Alibaba (NYSE:BABA) was significant for a number of reasons.  First of all, at no time in the history of modern economies has a single day wealth transfer  between capitalists and communists rivaled what just happened.  Founder Jack Ma's holdings are worth about $25 billion and with a company trading at 60X projected earnings, that number is likely to climb.  Japan's SoftBank - the largest shareholder in Alibaba (with about 32%) - and Yahoo (the second largest shareholder albeit an unwelcome and soon to be exiting one at 22.6%) are obviously delighted to pocket and book significant value for this pathway into the cave of wonders called the Chinese consumer.  Singapore's Tamasek and Russia's DST round out the top five holders. 

This deal, naysayers notwithstanding, does not represent a market bubble-type valuation nor does it signal the irrational exuberance of the tech bubble experiences of the past.  Alibaba is a business.  It makes money.  And its market outlook signals not just a high probability for growth but it also signals a watershed moment for the Communist Party's attempt to control the ideology to which they still firmly hold.  5,000 Chinese employees of Alibaba are not a significant minority on any scale but the viral effect of their capital - flowing into everything from hedonism to entrepreneurial empowerment - is a bit more destabilizing than the government currently understands.  In short, there's a lot of positive market rationale behind what happened this week on the Alibaba IPO.

But, as the children's story portends, this story is not all about the cave filled with gold in the form of Chinese e-commerce (ala Amazon) and retail (ala WalMart).  Alibaba ripped a page from a number of U.S. tech companies in creating a capital structure in its IPO that gives shareholders virtually no meaningful governance.  With Credit Suisse, Deutsche Bank, Goldman Sachs, JP Morgan Chase, Morgan Stanley and Citigroup all in the syndicate of underwriters, there was little question that the offering would be fully subscribed.  Investors didn't buy the actual Chinese company for a number of practical and governance reasons.  They purchased shares in a company registered in the Cayman Islands which profoundly impacts shareholders' access to any venue for damage recoveries or legal recourse as the assets and management all reside outside the incorporated jurisdiction.  In their S-1, they disclose that the Alibaba Partnership (22 of the 28 of whom are affiliated insider managers) has the exclusive right to nominate board members.  There is no mechanism for civil or financial accountability anywhere in the capital structure. 

Among the businesses that Alibaba performs are the obvious - retail and e-commerce - but also the not-so-obvious: e-payment systems and cloud computing.  In their S-1, they disclose a major and growing dependence on technologies and businesses that they use but do not control.  When one considers the margins that have buoyed this business into its profitable position, it is notable to consider that a globalization impulse around Alibaba will necessarily put them in a position where the expediency of doing business will meet the intellectual property that others believe to own in the business of Alibaba.  When these conflicts arise - and with a stratospheric valuation, they will - how much of the wealth in this stock will flow to the company and its affiliates and how much will be "taxed" by those who believe to have the right to some or all of the wealth? 

It's reasonable to assume that none of this story is actually precisely as it appears.  The company's name comes from Antoine Galland's 18th century transcription of a likely Syrian story in Les Mille et Une Nuits.  The company's business is neither novel nor inventive.  In fact it's the proof that context is more valuable than content in the fickle world of capital markets.  The company's promoters did a fabulous job of pricing the stock low enough to make many of their network first day multi-millionaires on the back of institutions and pensions.  And we've still not seen what happens to Cassim, his gold-laden donkey, the tailor Baba Mustafa who has to stitch together what the robbers cut into pieces, the mysterious dancing beauty misericord Morgiana, and, of course, the 39 surviving thieves. 

The moral to the this story is simple.  We've just seen the poor woodcutter open the cave of wonders with the ring of the bell on the NYSE.  "Open Sesame".  Now we've got to see what happens when the myth and the legend meets the reality of a global market.  There are a lot of thieves in the forest and one day, I bet we'll see behaviors more befitting a Syrian fable than a transparent market deal. 

"Close Sesame."

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Thank you for your comment. I look forward to considering this in the expanding dialogue. Dave