Alibaba recently did the largest IPO in United States’ history. And the $21+ Billion IPO was just a notch lower than the largest one ever done in the world. And with listing day gains of almost 38%, the company now has a market cap of $230 Billion. Compare this with our Indian giant TCS’s market cap of $85 Billion and you will understand the massiveness of the number.
For those who are not aware of what Alibaba does, the following headline in Wall Street Journal will be a good starting point:
A Mix of Amazon, eBay, Paypal with a Dash of Google.
You can click the link above to know more about the company. And chances are that this simple description may not be 100% accurate or complete. But this post is about something else.
I was going through Professor Aswath Damodaran’s coverage of Alibaba (link), when I came to know about a very interesting fact about this IPO, and the Chinese company’s ownership laws in general.
When you (or anyone in US) buy shares of Alibaba, then it does not mean that you get a part ownership in the company.
Strange…isn’t it?
So what exactly is that investors are buying into?
And I quote the professor:
You are not getting a piece of Alibaba, the Chinese online merchandising profit-machine, but a portion of Alibaba, the Cayman Islands shell entity that has a contractual arrangement to operate its Chinese counterpart. While the Chinese government has granted legal standing to that contractual agreement, at least for the moment, it reserves the right to change it’s mind and if it does, Alibaba’s shareholders will be left with just the shell.
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| Source: Prof Aswath Damodaran’s Blog |
And that is because the Chinese government restricts foreign ownership of key strategic assets. And like Alibaba, many other Chinese companies get around this using a complex structure – Variable Interest Entity or VIE In Alibaba’s case, the VIE is based in the Cayman Islands and is entitled to the profits that Alibaba in China generates.
As far as the management is concerned, Alibaba uses the above structure to take away any right whatsoever from the shareholders, which could affect the choice of people joining its board. The Board will be named by a group of partners and shareholders will have no say in it. Period.
So much for investing in a red hot IPO… isn’t it?
So what notes can average Indian investors like us take from this?
I ask this because very soon, investors would be falling head over heels to get shares in IPOs which are scheduled to hit Indian markets in coming months.
And it is that when you plan to invest in shares of a company, that too of a company going for a new listing, make sure you know more than just about nature of business of the company. You should know whether you are actually getting what you are made to believe. In Alibaba’s case, its much safer and you have a visible, full-fledged, massive, cash-generating business.
But there are companies which are neither good nor honest. And the number of such companies coming up with IPOs generally increases in bull markets.
And this very fact demands that as an investor, you need to be cautious of what you getting into, where you are putting your money and most importantly, keep a sane head.
No point repeating mistakes like investing in Reliance Power IPO. Isn’t it?
And don’t forget – IPO stands for Its Probably Overpriced.
you have a knack of producing very good articles ,, good article !!
Reliance Power IPO was the worst possible mistake that i did.
wow… good catch! Forewarned is forearmed…. Will keep this kind of point in mind when looking at any company from now on! Least interested in IPOs anyway, but this would apply for normal companies as well…
Dev,
What would have been more interesting is if you had explained to the reader how long it would take to become a crorepathi, real value and not nominal.
Just a thought.
-V
Thanks for your kind words Anish.
But credit must to go to people like Prof Damodaran who identify such facts and share it with learners like us.
Hi Sachin
You are not alone. Many among us have made that mistake 🙂
That's true Bharat…there might be many small Indian companies which might be doing things which should have already caught the regulator's eye. But it hasnt…
And in case of Alibaba, even the Hong Kong Stock Exchange denied a listing because of this ownership structure. Credit to them. But NYSE could not refrain itself from being attracted towards this big-size listing. Greed they say ;p
Ofcourse he knew how to make money Sunny. And I dont think I mentioned anywhere that his riches were only because of crimes or dishonesty.
Thanks V…I guess I need to do a post on time value of money soon. 🙂
BY ACCIDENT I VISITED YOUR BLOG.I find it makes an interesting reading.
IT has to be studied to form opinions,revert to you on certain issues.
you are passionate on the subject you are dealing with and must have spent
lots of time.
Excellent work,i believe.good on time series.
will write to you in a couple of days
bye for now
Dhaveji
Thanks for your kind words Dhaveji
And feel free to drop me a mail whenever you wish to. Or in case you find something to discuss which I have already written about, you can always comment on the relevant article