Upon failing to read the F1, Alibaba edition (tweaked)

Back in 2007, during the early months of that year, before the financial crisis broke, there was a particularly comic rush-to-market amongst the alleged new breed of financial firm, eager to IPO before reality dawned.

It was a time when Fortress Investments floated — at circa 40 times prospective earnings, four times Goldman Sachs’ valuation multiple. Blackstone joined the market as a “limited partnership,” offering ‘units’ rather than stock. And a Wall Street old-timer called Thomas Peterffy took Interactive Brokers public with a calculated snub to the industry that had made him risk: sure, investors could put a value on his business, but a dual-class share structure would leave outsiders with just 5 per cent of the voting power.

The resultant share price charts…

The warning signs were all there, pre-float, set out in these companies’ S1 and F1 registration statements, lodged with the SEC.

What each firm here was doing (along with many others at the time) was riding roughshod over the basic protections and transparency standards expected when a company joins the public markets.

Take one example — from the Fortress filing:

“Our calculation of AUM may differ from the calculations of other asset managers and, as a result, this measure may not be comparable to similar measures presented by other asset managers. Our AUM measure includes, for instance, assets under management for which we charge either no or nominal fees, generally related to our principal investments in funds as well as investments in funds by our principals and employees.

“Our definition of AUM is not based on any definition of assets under management contained in our operating agreement or in any of our Fortress Fund management agreements.”

Fortress, being a manager of private equity assets, decided to dream up its own, completely opaque measure of assets under management.

And no one complained at the time — other than people like former Deutsche Bank hedgie Roger Ehrenberg, who asked, simply: Are you stoned?

All of which (hopefully) brings us to the Alibaba F1, a document quite unlike any previously filed with the US market authorities.

You can scroll through the 400 or so pages here, but that gist is that, rather than buying into a notion of ‘ownership’ that might be associated with a stock listing, what investors are being asked to purchase is a contract with bankers Citi to route some of the profits attributed to a Cayman company, taking it on trust that these profits will flow despite the Cayman entity not owning or controlling most of the assets promising to produce the profits. Oh, and voting power is as clear as mud.

Got that? Thought not. So sample Alibaba’s own prose instead. This is from the ‘related party transaction’ section, on the online payment service through which Alibaba primarily operates:

We originally established Alipay in December 2004 to operate our payment services business. In June 2010, the PBOC issued new regulations that required non-bank payment companies to obtain a license in order to operate in China. These regulations provided specific guidelines for license applications only for domestic PRC-owned entities. These regulations stipulated that, in order for any foreign-invested payment company to obtain a license, the scope of business, the qualifications of any foreign investor and any level of foreign ownership would be subject to future regulations to be issued, which in addition would require approval by the PRC State Council. Further, the regulations required that any payment company that failed to obtain a license must cease operations by September 1, 2011. Although Alipay was prepared to submit its license application in early 2011, at that time the PBOC had not issued any guidelines applicable to license applications for foreign-invested payment companies (and no such guidelines have been issued as of the date of this prospectus). In light of the uncertainties relating to the license qualification and application process for a foreign-invested payment company, our management determined that it was necessary to restructure Alipay as a company wholly-owned by PRC nationals in order to avail Alipay of the specific licensing guidelines applicable only to domestic PRC-owned entities. Accordingly, we divested all of our interest in and control over Alipay in 2011, which resulted in deconsolidation of Alipay from our financial statements. This action enabled Alipay to obtain a payment business license in May 2011 without delay and without any detrimental impact to our China retail marketplaces or to Alipay.

Following the divestment of our interest in and control over Alipay, effective in the first calendar quarter of 2011, the ownership structure of Alipay’s parent entity, Zhejiang Ant Small and Micro Financial Services Group Co., Ltd. (formerly known as Zhejiang Alibaba E-Commerce Co., Ltd.), which we refer to as Small and Micro Financial Services Company, a company organized under the laws of the PRC, was changed such that Jack Ma held a substantial majority of the equity ownership interest in Small and Micro Financial Services Company. The ownership structure of Small and Micro Financial Services was recently further restructured and currently approximately 58% of its equity interests are held by Hangzhou Junhan Equity Investment Partnership, or Junhan, a PRC limited partnership, and approximately 42% of its equity interests are held by Hangzhou Junao Equity Investment Partnership, or Junao, a PRC limited partnership.

The economic interests in Junhan are owned by Jack Ma and other employees of our company and employees of Small and Micro Financial Services Company. The interests in Junhan held by these employees are in the form of limited partnership interests and interests similar to share appreciation rights tied to potential appreciation in the value of Small and Micro Financial Services Company. The economic interests in Junao are held in the form of limited partnership interests by certain members of the Alibaba Partnership.

Happy with this company being in an ordinary investor’s pension portfolio? The Hong Kong Stock Exchange wasn’t, but the New York Stock Exchange clearly is.

Some very strange incentives at play here.

On any traditional, conservative, common sense measure, Alibaba is unfit to float.

Related link:
This is nuts. When’s the crash? — FT Alphaville series