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Is Alipay Disturbance a False Alarm?

|Includes: Altaba, Inc. (AABA)

Note: The news that Jack Ma took Alipay away from major stakeholder Yahoo may well be a false alarm. Part of it comes from each party's misunderstanding of the VIE (variable interest entities) structure, which carries heavy Chinese characteristics, and part of it comes from the awkward relation between Alibaba and its major stakeholder Yahoo.

This Tuesday, files submitted by Yahoo to SEC showed that Alibaba Group had transferred online payment company Alipay to a new company, whose ownership belongs to Mr. Ma. On Thursday, when the market was about close, Yahoo issued another statement saying that Alibaba Group did not inform stakeholders Yahoo and Softbank of the transference of Alipay's ownership. On Friday, regarding Yahoo’s statement, Alibaba responded that during a board conference in as early as July 2009, Alibaba Group discussed andapproved a transference of 70% of Alipay's equity to an independent Chines company. Because of this, Yahoo's stock price slid significantly. And there appeared a popular comment that Mr. Ma managed to "recover Alipay's ownership and have it under a Chinese company's control." On the Internet, even awide-scale debate on business "patriotism" and business ethics broke out.

What exactly has happened between Yahoo and Alibaba surrounding Alipay's ownership? Let's scrutinize what is this "Chinese company" that Alipay's ownership has been transferred to.

According to Notice of Alipay (China) Network Technology Company's Application  Business License published by Hangzhou Central Branch of People's Bank of China on Dec. 22, 2010, we can see that Alipay's sole investor is Zhejiang Alibaba E-commerce Company Ltd (Zhejiang Alibaba).

Then what is Zhejiang Alibaba Zhejiang Alibaba was founded in October 2000. Currently it had a registered capital of 710 million yuan. Thelegal representative of the company is Jack Ma. Shareholders are Mr. Ma and Shihuang Xie (Mr. Xie is one of the 18 founders of Alibaba). The two invested, respectively, 568.8 million yuan and 142.2 million yuan and the holding ratio was 8 to 2.

(Screenshot of Basic Information of Alibaba from the Website of Zhejiang Administration of Industry and Commerce)

According to relevant materials onthe prospectus of Alibaba.com Investment Holding Limited (Alibaba.com) when itwas listed on Hong Kong Stock Exchange, before the group's equity carve-out of B2B business and restructuring and through Zhejiang Alibaba E-commerce Company Ltd, which was founded in China and had necessary licenses for operation of Internet information services and other B2B business-related services, Alibaba Group operates its business in the Chinese market.

This is to say that before Alibaba.com went public in 2007, Zhejiang Alibaba was responsible of Alibaba Group's B2B along with other businesses. Necessary licenses for the group's operation of Internet information service-related B2B business and other services (for example, the ICP that runs Internet information services) were handled by this company. (In 2007, Alibaba Group listed its B2B business. As Zhejiang Alibaba E-commerce Company Ltd also ran non-B2B business of Alibaba Group, the group established Hangzhou Alibaba Group to run the B2B business. On Jun. 30, 2007, Hangzhou Alibaba acquired all Zhejiang Alibaba's B2B-relatedassets, liabilities and business at the cost of 100 thousand yuan. Hangzhou Alibaba has a similar structure to Zhejiang Alibaba.)

Since its foundation, Zhejiang Alibaba was shared privately by Jack Ma and Shihuang Xie. The company onceacquired important assets of Alibaba, but this does not mean that the assets belong privately to the two natural shareholders. We can see in the prospectus of Alibaba.com that Zhejiang Alibaba is contractually a subsidiary of Alibaba (China) Network Technology Company Ltd. See the details in the following chart:

Simply put, Zhejiang Alibaba was adomestically funded company originally used by the group to apply for licenses (for example, the ICP that runs Internet information services) for pure domestic fund. There is also an agreement specifying its relation with the group's assets.

After Alibaba.com went public in HongKong in 2007, Zhejinag Alibaba appeared in the 2008, 2009 and 2010 annual reports of Alibaba.com:

The 2008 annual report discloses that Zhejiang Alibaba E-commerce Company Ltd is affiliatedto the group with consolidation treatment of financial reports.

The 2009 annual report discloses that Zhejiang Alibaba E-commerce Company Ltd is arelated corporation of Alibaba.com that went public in Hong Kong and is affiliated to the group with consolidation treatment of financial reports. Its actual owner is Jack Ma and registered capital is 211 million yuan. Mr. Ma holds 80% of the stock. The 2009 annual report has such description as "the company provides online paymentplatform which is jointly run by Zhejiang Alipay Network Technology Company Ltd, Alipay Software (Shanghai) Company Ltd (the two are Alibaba Group's fullyfunded subsidiary companies) and Zhejinag Alibaba E-commerce Company Ltd (affiliated to the group with consolidation treatment of financialreports)(jointly known as Alipay)."

The 2009 annual report discloses that Zhejiang Alibaba E-commerce Company Ltd is a related corporation of Alibaba.com that went public in Hong Kong and is affiliated to the group with consolidation treatment of financial reports. Its actual owner is Jack Ma and registered capital is 211 million yuan. Mr. Ma holds 80% of the stock. The 2009 annual report has such description as "the company provides online paymentplatform which is jointly run by Zhejiang Alipay Network Technology CompanyLtd, Alipay Software (Shanghai) Company Ltd (the two are Alibaba Group's fully funded subsidiary companies) and Zhejinag Alibaba E-commerce Company Ltd (affiliated to the group with consolidation treatment of financial reports)(jointly known as Alipay)."

NOTICE: EVEN THOUGH THE PROSPECTUS OF ALIBABA IN 2007 DISCLOSES THE EXISTENCE OF VIE STRUCTURE BETWEEN ALIBABA GROUP AND ZHEJIANG ALIBABA E-COMMERCE COMPANY, IT IS UNCLEAR THAT WHETHER THE ANY MODIFICATION HAS BEEN APPLIED SINCE 2007. 

This is a typical example of companies during the development of Internet industry in China. Most companies became "foreign funded companies" through financing in foreign countries but most licenses can only be held by domestically funded companies. ICP is one of the licenses that can only be obtained by a domestically funded company. Even though third-party payment license is not specified to be entitled exclusively to domestically funded companies, several other third-party payment companies obtain the license through domestically funded companies. Therefore, often times,these companies establish companies controlled by people residing in China mainland to hold the licenses and contractually specify the relation betweenthe domestically funded companies and foreign funded companies. This is theso-called VIE structure.

(Pre-restructuring)

(Above is Screenshot From 1688 prospectus of Alibaba.com, page63)

(Post-restructuring)

(Above is Screenshot From 1688 prospectus of Alibaba.com, page64)

So what most likely will happen to Alipay is that Alibaba Group transfers Alipay's ownership to Zhejiang Alibaba, which is controlled by Mr. Ma. It is also a natural adjustment in order toapply for payment license. The relation between Zhejiang Alibaba and Alibaba Group remains a contractually controlling relation. Similar to the situation where the B2B business Zhejiang Alibaba used to run did not belong privately to Mr. Ma and Mr. Xie, Alipay, whose ownership has just been transferred to the company, will not be their own fortune. If it would, not only major shareholders but other investors and shareholders would not agree to it.

This incident drew so much attention probably because major shareholder Yahoo failed to accurately interpret theinformation. This further proves that the communication between Alibaba Groupand Yahoo was nowhere near smooth. The former is a growing leading enterprise of China's e-commerce industry and the latter is the declining "portal website" in the United States. Their development trends vary so much that it strikes everyone as an awkward thing to learn the latter owns 43% stock of the former.

Similarly, the two parties have sofar disclosed limited information of the incident and this caused obstacles forus to learn the whole story. 

Disclaimer: Our analysis may be biased. This article does not constitute any suggestion of investment.

(By Ricky Zhong and Yuming Wang, iChinaStock.com)