Governance experts are warning investors to take note of some troubling facts about the Alibaba initial public offering before plunging in when trading begins.
Alibaba, the China-based e-commerce company whose IPO is exuberantly anticipated by U.S. capital markets on Friday, is expected by some to potentially be the biggest IPO in U.S. history. Based on the enthusiasm of investors in placing early orders, the company bumped up its original offer price target of $60 to $66 on 320 million shares to a new range of $66 to $68.
Lucian Bebchuk is professor of law, economics and finance at Harvard, warns in a recent essay that investors should “keep their eyes on the serious governance risks” associated with an Alibaba investment. The company has established that insiders will have a permanent lock on control of the company even while holding only a small minority of the equity capital, along with ways to divert value to affiliated entities and weak mechanisms to prevent it. “Public investors should worry that, over time, a significant amount of the value created by Alibaba would not be shared with them,” he wrote.
The “Alibaba Partnership,” which consists of present managers in the Alibabi group or related companies, will have control forever, Bebchuk warns, with exclusive rights to nominate candidates for a majority of board seats and the right to appoint directors. It’s not uncommon for public companies to have a large shareholder with a lock on control, he says, but they often own a substantial portion of the equity capital as well. “In the case of Alibaba, investors need to worry about the relatively small stake held by the members of the controlling Alibaba Partnership,” he wrote.
Alibaba’s financial statements report an ”extraordinary” net profit margin of 44 percent in its most recent fiscal period, according Brian Hamilton, chairman of financial analysis firm Sageworks. The net profit margin is an indicator of profitability, dividing net profit by revenue. “I can’t remember a larger net profit margin, ever,” he said in a recent webcast. “To me, that is the big deal with this company. For every dollar they generate, they are earning 44 percent in profit.” Hamilton stopped short of questioning the validity of the numbers. “Is it credible? I hope so,” he said.
The company’s Form F-1 with the Securities and Exchange Commission indicates PwC in Hong Kong reviewed the company’s financials. Alibaba includes in its prospectus an acknowledgement that the firm is not inspected by the Public Company Accounting Oversight Board as a result of an ongoing dispute involving the SEC, the PCAOB and officials in China over U.S. demands for regulatory access to entities in China that are doing business in the United States. The SEC has delisted a number of companies in China in recent years over allegations of accounting improprieties and access to investigate.
Paul Gillis, a professor at Peking University, says Alibaba “appears to have the deep resources to deal with regulatory compliance in the United States.” He says the company will certainly fall under “intense regulatory scrutiny.” He acknowledged the unusual control structure allowing management to make decisions along with variable interest entities where some operations are not owned by the company but controlled through contracts. “I think sophisticated investors have priced those risks into the offer,” he says.