Jack Ma, founder of Alibaba, raises a ceremonial mallet during the company's IPO at the New York Stock Exchange, Sept. 19, 2014. (AP/Mark Lennihan)

The dangerous truth about Wall Street's favorite new company

Alibaba's glorious emergence in America is the product of a system designed to benefit the very few


R. H. Greene
October 12, 2014 5:00PM (UTC)

In the fable "Ali Baba and the Forty Thieves," a poor Syrian woodcutter unlocks the secret of an outlaw treasure cave, and uses it as a portal to immeasurable riches.

Both metaphorically and from a branding perspective, Alibaba has proved a shrewd name choice for the gargantuan Chinese e-commerce site currently readying its major push into Western markets. Even without much penetration outside China, Alibaba.com is already the world's biggest online retailer. Its annual sales are a staggering $248 billion — more than Amazon and eBay combined. When Alibaba started trading on the NYSE last month, its founder, Jack Ma, instantly became China's richest man.

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The fable Alibaba is named for isn't just a story about treasure, though. It's a saga of wealth based on theft. And while almost all the recent commentary on Alibaba.com has focused on unimaginable bounty, the banditry aspects of the folktale may have some resonance for Alibaba investors as well.

The giddy gold-rush mindset gripping Wall Street in the run-up to the record-setting Alibaba IPO represents a spectacular victory for the Chinese variant of state-controlled "command" economics — a triumph made all the more amazing by the Cayman Island shell company shadow play America's captains of finance were willing to tolerate to get their piece of the Alibaba pie. When the dust cleared, the NYSE had helped Alibaba raise $25 billion dollars — an amount so huge that the underwriting commissions alone came to $300 million.

It would be remarkable for any foreign company to launch such a successful IPO in the heart of American finance. For Alibaba — an e-commerce entity whose very existence is subject to the whims and patronage of the ruling and nominally Communist Chinese bureaucracy, and whose IPO gives every appearance of having been carefully (and clandestinely) stage-managed to benefit a wide swathe of China's ruling elite — snatching such an important "free market" crown is a stunning and seemingly self-contradicting feat, one that highlights aspects of our own financial system that could be considered both economically and politically perverse.

This was actually Alibaba's second IPO, not that most of the reporting mentioned it. The first, in 2007, was on the Hong Kong exchange. (The stock from this initial initial public offering was bought back by Alibaba in 2012, in anticipation of the current investor blitz.)  This may come as a surprise even to dedicated China watchers, because Hong Kong has been defined in the recent press almost solely by its having "lost out" on the current Alibaba IPO as a result of its strict "one share, one vote" governance requirement for all listed companies — a policy designed to protect small investors.

In the run up to Alibaba's second IPO, the company asked Hong Kong for an exemption, allowing it to retain its current and somewhat shadowy partnership system, under which a small group of stakeholders can select the majority of the company's directors without controlling a majority of its shares. Hong Kong refused to bend its regulations. So Alibaba's second IPO was made on the NYSE.

Setting aside the irony that a Chinese stock exchange has stronger rules for protecting shareholder democracy than the American one, it should be pointed out that there's nothing inherently sinister about a "dual-class" stock system. (Or, rather, that there's nothing more than usually sinister inherent in it.) As AP business writer Kelvin Chan has pointed out, American tech titans, including Facebook and Google, empower a privileged class of stockholders by a similar mechanism. Like freedom itself in the old patriotic cliche, American corporate governance practices aren't free.

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However, what matters more than the undemocratic shareholder structure Alibaba fled to New York to preserve is an as-yet-unanswerable question: Whose control is Alibaba protecting, exactly?

And here's where things get interesting — and worrisome.

Despite the general impression that Alibaba just made a U.S. stock offering, not one share in Alibaba itself has been sold through the New York Stock Exchange. This is because foreigners are not allowed to own even a scintilla of a major Chinese company without permission from the Chinese government.

To skirt this problem, Alibaba created a shell company called Alibaba Group Holding Limited, headquartered in that offshore financial laundromat favored by both Mitt Romney and the Medellin cartel: The Cayman Islands.

Shares in the Cayman-based Alibaba Group are what just set an IPO record. Despite their high price, they are essentially profit participation vouchers. They confer no participation in Alibaba governance, and indeed no actual ownership of Alibaba, causing one financial wag to refer to Alibaba Group buyers as potential "stuckholders."

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There are actual owners of Alibaba stock though. They include Yahoo, the wounded giant of American tech, who got in early, and whose corporate history in China includes turning compromising electronic data about journalist and democratic activist Shi Tao over to the Chinese authorities, leading directly to Shi's torture and his imprisonment as a political criminal for eight and a half years. According to a 2008 report by Amnesty International, "Yahoo has cited its relationship with Alibaba ... to explain its lack of ability to resist government requests for information," though Yahoo says it has reformed its Chinese information sharing practices somewhat over time.

As an "angel" investor, Yahoo was able to purchase 40 percent of Alibaba in 2005 with the Chinese government's blessing, for the bargain basement price of $1 billion. It was a deal Alibaba founder Jack Ma allegedly came to resent, and he reportedly worked to countermand it.

In 2012, at least 50 percent of Yahoo's Alibaba stock, or a 20 percent stake in Alibaba, was bought back, in a $7.6 billion deal financed in large measure by a coalition of China's government-operated sovereign wealth fund and three Chinese investment firms. According to a DealBook expose in the New York Times, these three financial firms had a few salient commonalities: deep political connections, and a preponderance of Communist "princelings" (i.e., sons and grandsons of the two dozen men who have served on China's elite Politburo Standing Committee since 2002) within their executive ranks.

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Quoth the Times:

"A fourth investor [also] bought Alibaba shares [in 2012]: New Horizon Capital, a private equity firm co-founded by the son of China's prime minister at the time, Wen Jiabao."

Imagine if you will the government-toppling cries of "Corruption!" and "Fraud!" that would have ensued if Facebook had pre-sold privileged stock to members of the Boehner, McConnell, Obama and Reid clans before its similarly hyped IPO ran up their value. Never mind the Securities and Exchange Commission — the Justice Department would have become involved. But somehow, a Chinese company whose similar business practices have been exposed in the pages of the New York Times just made a record-setting IPO without a blip.

An (enormous) "princeling payday" might be a secondary consideration for China's rulers though — just a nice little multi-billion dollar dividend on the side. In a country where stability is preserved by a high-tech police state, the truest currency is control. And that's where that "dual-class" share structure that Alibaba fled to the NYSE to preserve comes in.

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The Times again, on those "princelings:" "[Their] sway [within Alibaba] may be significant, even if their stakes are not."

Given the Chinese Party elite's fiercely repressive approach to all things tech — including its outright suppression of non-Chinese search and social media companies like Facebook, Twitter and Google — government control over Alibaba, or at least unfettered access to its data, would be a true plum.

Alibaba is a ferocious harvester of Big Data; according to Reuters, Alibaba logs 45.1 percent of all e-commerce transactions in China, a country where, in 2013, the average consumer made 8.4 online purchases a month, as compared to 5.2 in the United States.

And Reuters' is the low estimate, one which may be based on conflating Alibaba's market penetration with the fact that only 46 percent of Chinese homes have internet access. Most other observers peg Alibaba's Chinese e-commerce share at a mind-boggling 80 percent of transactions.

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As anyone paying attention to their Amazon and eBay "recommendations" already knows, you can learn a lot about someone by how he or she spends money. Alibaba isn't limiting its reach to e-commerce though. It's also a growing presence in Chinese cloud storage, amongst other sensitive Big Data growth sectors.

Meanwhile, the same Chinese authorities who have such a cozy relationship with Alibaba are doing everything they can to inhibit major American tech players in China. In July and again in August, China's State Administration for Industry & Commerce raided Microsoft's Chinese offices, seizing documents and electronic data from servers and computers, allegedly as part of an antimonopoly investigation. At the same time, Google continues to flounder against the ever-shifting restrictions inflicted on its information services, even as Wired magazine touts Alibaba as being "ready to become the next Google."

None of this gives Alibaba the sheen of a "free market" paragon. But far from being discouraged by the appearance of a hand-in-glove-in-pocket relationship between China's rulers and Alibaba, U.S. investment giants appear to have run up Alibaba's stock price in part because they believe the Chinese government's thumb is pressing down hard in Alibaba's favor on China's valuable e-commerce scales.

For all the rhetorical coupling of "democracy and free markets" we hear at home, and the loud accusations of "socialism" that get bruited about whenever an American president emerges who is less conservative than, say, Ross Perot, the American business class frequently favors a sure thing over ideological concerns. And what can be surer than a command economy, overseen by a handful of well-connected political families, which has a vested interest in insuring Alibaba's continuing dominance and success across a range of e-commerce and info-tech sectors?

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As investment analyst Anne Stevenson-Yang told the Times, "It would take, at this point, a seismic effort to topple an Alibaba ... They've got so many different allies across so many different ministries." Alibaba's privileged  access to China's power elite and to the vast and growing domestic market it controls represent a competitive advantage no American multinational can match — and one that will increase in value as more Chinese go online.

Strengthening the hand (and the ruling elite) of a repressive and anti-democratic regime by underwriting flagrant crony capitalism is in itself a direct, and possibly even illegal, betrayal of "free market" capitalism. But consider the larger ramifications of providing Alibaba with such an enormous financial "war chest," with which it plans to do battle against established American and international companies.
In Jack Ma's triumphant post-IPO press conference, he didn't target Amazon or eBay, the entities Alibaba is most frequently compared to. He said he wanted to become "bigger than Wal-Mart," America's single largest employer, and the world's largest public corporation.

In a timorous 2013 article published under the full-throated headline, "Alibaba Is a Threat to Amazon, eBay, Walmart and Everyone Else," no less a booster of unbridled capitulation to Chinese market dominance than Forbes Magazine sounded a strong and possibly prescient note of caution. After singing the praises of both Alibaba and Jack Ma for approximately a thousand very Forbesian words ("The company is a master of online shopping ..." "With so much success at home, Alibaba's management has voiced ambitions to grow globally ..."), retail reporter Walter Loeb provided an O. Henry "twist ending" in his very last sentence about Alibaba's future, which he believes will include undercutting every single retailer on the planet, including the brick-and-mortar goliaths like Costco and Walmart.

Said Loeb: "For the first time, in a long time, I am afraid of what's to come in global retailing."

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If Forbes is afraid of Alibaba, you should be too.

R.H. Greene is a Los Angeles-based broadcaster and documentarian. 


R. H. Greene

R. H. Greene is an L.A.-based documentarian. His latest film is the biographical documentary "Vampira and Me."

MORE FROM R. H. Greene

Related Topics ------------------------------------------

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