The frenzy over Alibaba's (BABA) IPO this week is understandable. The company controls 70%-plus market share in the largest e-commerce market in the world. Alibaba is like the Amazon, PayPal and
I would caution investors to avoid Alibaba and find other ways to play growth in Chinese tech and consumer markets. There are four fundamental reasons you should avoid investing in BABA:
1. Currently it is illegal to invest directly in the company
The Chinese government strictly forbids that foreigners invest directly in Internet services in China so at first glance it would appear to be illegal for foreign investors to invest in Alibaba. The creation of the stock BABA, listed on the NYSE, gets around this. This is not some mealy-mouthed prohibition but a very specific ban on foreign investment in this sector. The complicated structures (called variable interest entities (VIEs)) designed to circumvent these laws are also illegal under Chinese law and Chinese courts have ruled against foreigners in a number of cases recently. To be completely clear, if you are investing in BABA you are investing in a structure that is illegal under Chinese law and your investment will have no protection in Chinese courts.
2. You are investing in a contract--not in the company
Though foreign investors can not invest in Alibaba the company they can invest in the security being offered in the IPO. The question is whether you would want to. Unlike a normal equity investment you are not investing in the company but you are investing in a contract. The VIE contract provides contractual rights to the profits of Alibaba China to a Cayman Islands company but most of Alibaba’s Chinese assets will be owned by Chairman Jack Ma and another founder and management member, Simon Xie. Why is this a problem? See item #3.
3. Jack Ma has already proven his willingness to abuse foreign minority investors by invoking Chinese law
In 2011 Jack Ma took for himself ownership of online payment services company Alipay out of Alibaba (and away from investors
Foreign investors can't invest in Internet services companies in China either--might this be a future excuse for Ma taking business of value away from foreign investors in the future? It is worth considering that he has done this before.
4. Market leaders in China typically face erosion of market dominance and shares underperform
Other market leaders in Chinese tech and telecom have seen their share prices routinely underperform relevant benchmarks as investors have become concerned about competition, falling market share and slowing percentage growth.
China Mobile shares have underperformed the Hang Seng China Enterprises (HSCE) index in 13 of the past 21 quarters and Baidu (BIDU) has underperformed the HSCE in 5 of the past 8 quarters. The Baidu underperformance is notable as it has been specifically related to investor concerns about the emergence of competitors and the decline in Baidu's market share (despite the fact that it is still a very healthy 60%).
E-commerce in China has shown impressive growth and will continue to grow and make Alibaba a lot of money. Whether it will make money for investors who have chosen to invest in an illegal structure with a management team that has proven their willingness to take assets from foreign investors and a business that will likely see percentage declines in growth rates and market share remains to be seen.
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David Riedel is founder of Riedel Research Group.
