Here's why we need a rethink on tech giant
- By Robert Hardy
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E-mail China Daily, September 9, 2014
Given this complex structure, not all legal contracts may be on solid footing, because the contracts are only legal and binding if Chinese courts are willing to accept them. The big risk for foreign investors is that Chinese shareholders could steal such an entity, ignoring the legal structure on which the system is based.
On the Chinese side, there is a strategic reason for all this. Its Internet companies list abroad to obtain financing and use the existing structures to their advantage. The reason such entities choose to list abroad is that they have to rely on unrestricted foreign investment for the expansion of their business operations. This is because they are unable to raise sufficient capital from China's State-controlled banking system - or from the country's tiny corporate bond market.
Even so, the companies still need permission from Chinese regulators to list overseas. To get around this restriction, China's leading Internet companies use something called a variable interest entity (or VIE), which is essentially a holding company that connects foreign investors to a company via a complex set of legal contracts. And VIEs, you guessed it, tend to be based in tax havens such as the Caymans.
It is worth noting that when Alibaba filed with the US Securities and Exchange Commission in May 2014, its filings indicated it will use a VIE and a preferred share structure that will consolidate all the company's decision-making with the company's founders in China. Alibaba's controversial history with Yahoo, its first major foreign investor, highlights the kinds of risks foreign investors face in buying Chinese Internet companies under the VIE structure.
When Alibaba's founder-chairman Jack Ma used the company to spin-off an online payment mechanism called Alipay, the mirror image of PayPal, Yahoo received no direct benefit. Under the VIE structure, the parent company has no obligation to notify foreign investors of these kinds of moves. This proved to be very costly to Yahoo. Similar moves in the future could see foreign investors lured by the hype over Alibaba lose out.
It's not about Alibaba alone. A flood of Chinese Internet IPOs have recently hit Wall Street, including Baidu, JD.com, which is the largest Internet retailer after Alibaba, as well as Renren and Weibo. They are all structured using VIEs.
While Alibaba's shares will be in great demand when its IPO is launched, there is plenty of reason for long-term investors to think twice.
The author is the principal at TheGeostrat.com LLC, a consulting firm.
The Globalist.
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