How China's IPO Rules Will Affect Alibaba

Over the past few decades, China has been slowly and gradually moving toward free market capitalism. It is still a long way off from completely decentralizing its markets, but it keeps getting closer. Just this weekend, Chinese officials took yet another large step forward by promising to loosen regulations on Chinese companies going public.

These changes to listing requirements and procedures were likely speeded along by the fear of loosing extremely profitable companies to outside exchanges – such as China’s Alibaba, one of the largest e-commerce companies in the world, which openly expressed its preference for a listing in New York.

With an IPO expected to match or even beat Facebook’s (NYSE: FB) $16 billion offering, Alibaba is definitely worth making a few regulatory changes for. But will Chinese stock market reforms be enough to keep the company in its nation of origin?

China’s Tight Grip Became a Strangle-Hold

In its efforts to maintain a tight grip on its equity markets, the Chinese governing party put new listing applications through a stringent approval process to ensure the integrity and soundness of the stocks trading on China’s exchanges. Only the best of the best ever made it to the public arena, with a bias toward large state-backed enterprises over mid and small sized independent businesses.

It worked great for a while, with the Shanghai Composite Index rising to an all-time high near 6,400 by the end of 2007. But the index was not immune to the global financial crisis, and by the end of 2008 had fallen some 70% to 1,800. After rebounding to 3,200 by the end of 2010, the Shanghai Index has floundered to just over 2,200 today – still down some 65% off its all-time high, while America’s major indices have been setting one new all-time high after another.

One measure which the Chinese government believed would prop-up its stalling stock markets was to put a temporary freeze on IPOs on the fear that new offerings would divert investments away from existing stocks. While the 14-month IPO moratorium did manage to stop the index’s fall, wiser heads finally realized that the halt on new offerings was only driving away viable investment opportunities to distant shores.

Some $5 billion worth of IPOs had already been lost to the Hong Kong Stock Exchange during the IPO freeze. The remaining 700 applications left stranded in the lobby attracted a circle of vultures in the likes of Goldman Sachs (NYSE: GS), Morgan Stanley (NYSE: MS), Deutsche Bank AG (NYSE: DB), and JPMorgan Chase (NYSE: JPM), all looking to pick off what meaty IPOs they could grab. With the mega $16 billion offering expected from Alibaba in Q1 of next year, Chinese officials realized this was one gigantic whale they mustn’t let get away.

Letting the Markets Function

As one of the many reforms promised at the conclusion of last month’s Communist Party meeting, Chinese officials announced over the weekend that they would allow market forces to operate more freely.

By reducing its control over state-owned enterprises, the government promises to level the playing field for medium and small companies to fairly compete against the large caps for investors’ money. In shifting its focus toward providing greater transparency and freer access to financial information, the government seems to be growing more comfortable allowing investors to determine which stocks succeed or fail.

This opens the door for the backlog of 700 companies waiting for a public listing to finally ring the opening bell, with some 50 private enterprises expected to make their stock market debuts by the end of January in mainland China. But Alibaba remains undecided.

Is it Enough to Entice Alibaba?

Alibaba spokesman John Spelich as recently as mid November indicated the company has not yet decided where it will IPO – whether in Hong Kong, the United States, or mainland China. But unless the Hong Kong Stock Exchange’s policies or China’s listing regulations change, the likely home for Alibaba’s stock still looks to be in America.

Alibaba founder Jack Ma and company executives favor the two-class share structure offered in the U.S. – where preferred shares are for voting, and common shares are for trading. But Hong Kong and Chinese rules prohibit limited voting rights, requiring instead that all shareholders be given the right to vote on such matters as appointments to the board of directors.

It is still too early to tell if China’s listing reforms will grant Alibaba the listing conditions it is looking for. In the meantime, the Hong Kong Stock Exchange is reported to be considering making the dual-class structure available to its companies. So the ultimate home of the upcoming Alibaba stock remains to be determined.

Alibaba – A Force That Moves Nations

Wherever it ends up trading, investors everywhere should take a serious look at Alibaba’s offering. This isn’t just another typical internet company. This is a company of companies, some 25 e-commerce businesses operating under the one umbrella of Alibaba Holding Group.

So far, only one of its businesses – Alibaba.com – is trading publicly. The company’s 2014 IPO will be selling shares of the entire holding group and is expected to raise as much as Facebook (NASDAQ: FB) did – some $16 billion.

But don’t expect Alibaba to flounder like Facebook and so many others did. On the contrary, investors can expect great things from Alibaba’s stock for years to come, for its portfolio of 25 businesses contains some truly mega-sized e-commerce giants, including:

• AliExpress: A global e-commerce marketplace for consumers; more than 54 million products in 26 major product categories; 7.7 million registered users in more than 200 countries and regions. [Comparable to Amazon.com]

• Taobao Marketplace: China’s most popular C2C- online shopping destination; more than 800 million product listings and more than 500 million registered users; one of the world’s top 20 most visited websites. [Comparable to e-Bay.com]

• eTao: Comprehensive shopping search engine in China; product search, rebates, coupons, group buy search; more than 1 billion product listings; more than 5,000 business-to-consumer and group shopping websites; more than 200 million pieces of shopping-related information. [Comparable to Groupon.com]

• Alipay: Most widely used third-party online payment platform in China; more than 170 financial institutions including … Visa and MasterCard; more than 460,000 merchants; transactions in 14 major foreign currencies. [Comparable to PayPal.com]

Imagine combining the likes of Amazon (NASDAQ: AMZN), eBay (NASDAQ: EBAY), PayPal, Groupon (NASDAQ: GRPN), and others into one single stock. In 2012, the combined gross merchandise volume (GMV) of just two of Alibaba’s businesses – Taobao Marketplace and Tmall.com – exceeded RMB1 trillion, some U.S. $163 billion. That’s one-sixth of a trillion dollars of sales from just two of its 25 companies in a single year.

Meanwhile, Google reported $50.17 billion of gross revenue in 2012, Amazon reported $61.09 billion, eBay brought in $14.07 billion, and Groupon reported $2.33 billion. The four combined brought in $127.66 billion, or some 78% of just two of Alibaba’s 25 companies.

That is what Alibaba will soon make available to investors around the world. And the exchange that wins its listing will make a fortune in fees. Just how huge is Alibaba’s potential? Large enough to get China to speed up its listing reforms. Now that is influence.

Joseph Cafariello

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