Alibaba filed its long awaited Form F-1 to begin the formal march to its U.S. IPO. Alibaba is too big to qualify as an emerging growth company under the Jobs Act, so it was not allowed to do a confidential filing. Most Chinese IPOs file under the Jobs Act, meaning we see only the penultimate filing right before the IPO takes place. This filing is likely to go through several rounds of SEC review and I would speculate that the IPO is not likely to happen until early autumn. Significantly, the document presently includes audited financial statements for 3/31/13 and I expect it will need to be updated with the 3/31/14 accounts before it goes final.
There is a lot to absorb in this filing, so I focused on the headline news about Alibaba’s use of the variable interest entity. As expected, Alibaba has a lot of VIEs since much of its business is in restricted sectors. There is an interesting discussion of how Alipay was extracted from Alibaba in 2011 included in Footnote 4. Alipay is not in the deal, although 49.9% of its income is included through the deal to settle the VIE dispute and Alibaba will get at least $2 billion up to $6 billion if Alipay does an IPO. But it might be worth much more than that.
Alibaba makes a bold statement about its use of the VIE structure:
Our holding company structure differs from some of our peers in that we hold our material assets and operations, except for ICP and other licenses for regulated activities, in our wholly-foreign owned enterprises and most of our revenue is generated directly by the wholly-foreign owned enterprises.
In other words, Alibaba claims it has minimized the use of VIEs to the extent possible. I have long argued that the least risky VIE structures are those that minimize the amount of business conducted in the VIE. My old gold standard for the best VIE structure was Baidu. I now award that to Alibaba.
Here is the proof, including for comparison New Oriental, which is perhaps the lead standard.
Alibaba Baidu New Oriental
Share of revenue in VIE 11.9% 28.3% 99.1%
Share of assets in VIE 7.5% 10.1% 65.5%
Net income in VIE 0% 0% 151.5%
Low numbers in the VIE structures minimize risks to shareholders. By conducting more of the business in the wholly foreign owned enterprises (WFOE), the risk of abuse by VIE shareholders is significantly reduced. Other problems, including deferred taxes and foreign exchange controls are also minimized. Accordingly, Alibaba does not appear to have the issues I have identified with these matters on other recent IPOs.
Don’t get me wrong. I still think that the VIE structures are terrible. But until China reforms the foreign investment rules, they are a necessary evil. Alibaba has done a commendable job mitigating the risk for investors.