by Duncan Clark
Since the 2005 deal, as Taobao grew in strength Alibaba and Yahoo enjoyed a long honeymoon. But a surprise event in early 2008 brought that to a dramatic end. On January 31, 2008, Microsoft made an unsolicited offer to buy Yahoo for $44.6 billion.13 If the deal went through, Jack realized, Microsoft would become his biggest shareholder. Although he had a good relationship with Bill Gates, Jack realized that in Microsoft he would have a very different partner to contend with, one known to get much more involved in the companies it invested in than Yahoo did. There was another risk: The Chinese government had contacted Alibaba for comment about the possible change in ownership.
Control Concerns
Microsoft and the Chinese government have long enjoyed an unpredictable, love/hate relationship. High points include the red carpet treatment President Jiang Zemin gave to Bill Gates on his visit to China in 2003 and the return favor Bill Gates gave to newly minted president Hu Jintao at a dinner hosted by Bill Gates at his home on Mercer Island, Washington, in 2006. But there had been tensions, too, with Microsoft expressing its exasperation at the rampant piracy14 of its products and the Chinese government accusing Microsoft of monopolistic behavior.
In public, Jack insisted that Alibaba would remain independent regardless of what happened with the bid. “Alibaba has been independent for nine years. . . . No matter what happens, we will go in our own way.”
But in private, he was alarmed. Alibaba wanted to trigger the “right of first offer” clause in the 2005 deal, which allowed it to buy back Yahoo’s stake in the event of a change of ownership, as now appeared likely. Alibaba hired Deutsche Bank and legal advisers to prepare. But in early 2008, as the global economy weakened, raising finance would be difficult, and Alibaba was a company with many moving parts. Taobao and Alipay were growing rapidly but still losing money. The listed company, Alibaba.com, was dropping in value. But if Alibaba couldn’t raise the money or agree on a price with Yahoo to buy back its stake, the 2005 deal stipulated that the price would be determined by arbitration instead—a long and unpredictable process.
In the end, in May 2008, Jerry Yang—now Yahoo CEO since the departure of Terry Semel the previous year—rejected Microsoft’s offer. Investors in Yahoo were furious, as management had turned down an offer that valued the company at a 70 percent premium. Yahoo’s share price started to drop, losing 20 percent in one day. Shareholder activists15 built up stakes in the company in an effort to force through the deal, but to no avail. When the global financial crisis hit a few months later, Jerry’s decision to reject the Microsoft bid looked like the height of folly. Investors called for his head. In November 17, 2008, Jerry announced he was stepping down as CEO, handing the reins over to Carol Bartz, the former CEO of software firm Autodesk.
Yahoo’s decision to reject Microsoft had cost Jerry Yang his job and dented his pride. Yet Alibaba had dodged a bullet, the uncertainty of an interloper intruding on its relationship with Yahoo, which, now on the back foot with investors, would continue to be its largest shareholder.
Any sense of relief, though, would evaporate a few months later when Jerry’s replacement, Carol Bartz, took up her position as CEO of Yahoo.
Bartz was in many ways the opposite of Yang. Jerry Yang was known as well mannered, amicable, even deferential. But Bartz was infamous for her aggressive style, frequently dropping the F-bomb in meetings.
When Jack and a delegation of his senior Alibaba executives traveled to Yahoo’s headquarters in Sunnyvale in March 2009 he was met at the entrance by Jerry.16 He welcomed them, then walked them to their meeting with Bartz. But on arriving Jerry made his excuses and left the room: Bartz was in charge now.
Alibaba proceeded to give Yahoo an update on the progress of the company, including the runaway growth of Taobao. But rather than congratulating them, Bartz lambasted Alibaba for the dwindling market presence of Yahoo in China under their watch, reportedly telling them, “I’m going to be blunt because that’s my reputation. . . . I want you to take our name off that site.” Jack later told a journalist,17 “If you cannot make the business cool, you have no right to be angry with me.”
The relationship between Jack and Bartz had instantly become frosty. Soon there were long periods when the two had no contact with each other at all.
Alibaba’s efforts to buy back Yahoo’s stake would increasingly take place in public, as did their ongoing disputes.
In September 2009, at the same time as Alibaba was celebrating its tenth anniversary, in a public vote of no confidence Yahoo sold18 the shares it had purchased in the Alibaba.com IPO. Then, in January 2010, as Google faced off with the Chinese government in a bitter spat over censorship and hacking, Yahoo came out in support of Google: “We condemn any attempts to infiltrate company networks to obtain user information. . . . We stand aligned with Google that these kind of attacks are deeply disturbing and strongly believe that the violation of user privacy is something that we as Internet pioneers must all oppose.”
Alibaba was livid to see its biggest shareholder square off against the Chinese government. Through a spokesman, John Spelich, Alibaba fired back, “Alibaba Group has communicated to Yahoo that Yahoo’s statement that it is ‘aligned’ with the position Google took last week was reckless given the lack of facts in evidence. . . . Alibaba doesn’t share this view.”
Worse was yet to come. In September 2010, Yahoo’s Hong Kong managing director said he was seeking mainland Chinese advertisers for the site, putting Yahoo in competition with Alibaba, which responded that they would reevaluate their relationship with Yahoo.
Alibaba.com CEO David Wei publicly questioned the relationship with Yahoo: “Why do we need a financial investor with no business synergy or technology?” He added, “The biggest thing that has changed is Yahoo lost its own search engine technology. The biggest reason for a partnership doesn’t exist.”
The relationship with Alibaba would never improve under Carol Bartz, who was fired by Yahoo in September 2011. But before she stepped down, Alibaba was buffeted by two crises that threatened to erode the company’s most precious commodity: trust.
The first crisis was an internal incident, the discovery of fraud within Alibaba’s B2B business, which damaged Alibaba.com’s reputation with its customers. The second was the controversy over the transfer of the Alipay asset outside Alibaba ownership, which damaged Alibaba Group’s reputation with some of its investors.
The fraud, in which an estimated one hundred Alibaba sales personnel were implicated, involved 2,300 merchant storefronts19 who were certified as trusted suppliers by the corrupt employees. The merchants then took in $2 million in payments for orders of computers and other goods on alibaba.com—bestselling items that were offered at very low prices—that they never shipped to the customers overseas.
Alibaba outed itself, sending its shares down by 8 percent, but Jack was most angry about the damage it had done to consumers trust. The salespeople were fired, and the accounts of more than 1,200 paying members were terminated. Although an investigation cleared the senior management of any wrongdoing, because the fraud happened on their watch Jack asked for the resignation of CEO David Wei and the company’s COO.20 Jack told the media that Alibaba is “probably the only company in China” where senior management takes responsibility, which prompted Forbes to describe Jack as “something of a rare species” in a nation “steeped in corruption.” When some accused him that the dismissal of the senior executives was a publicity stunt, Jack responded angrily, “I’m not the guy who created the cancer, I’m the guy curing it!”
David Wei didn’t oppose the move, crediting it as helping spur a similar crackdown within Taobao shortly after. “People said, ‘Wow it’s that serious?’” he told me. “And this triggered other cleanups within the group. It started within B2B, then to consumers. I feel very proud of my resignation. Without cleaning up the business, the IPO in 2014 would not have been so successful.”
But the other crisis, impacting its investors, would have a more pernicious
and long-lasting impact on Alibaba’s reputation. Even though the company insists it did nothing wrong, a position that many investors support, the controversy continues to serve as a lightning rod to the company’s critics. This crisis centered on who owned the Alipay business.
Firestorm
Alipay was a critical cog in the Taobao machine, handling more than $700 million a day in transactions, more than half of the total market in China. As it was so integral to Alibaba, it was hard to put a value on the business, but one analyst estimated that Alipay was worth $1 billion.
But on May 10, 2011, it emerged that the Alipay asset had actually been transferred out of Alibaba Group the previous year. The business was now owned by a company, personally controlled by Jack, called Zhejiang Alibaba E-Commerce Company Limited. Jack owned 80 percent of the company, and Alibaba cofounder Simon Xie (Xie Shihuang) held the rest. Investors first got wind of the transfer in a paragraph buried on page eight of the notes to Yahoo’s quarterly earnings report. It read:
To expedite obtaining an essential regulatory license, the ownership of Alibaba Group’s online payment business, Alipay, was restructured so that a hundred percent of its outstanding shares are held by a Chinese domestic company which is majority owned by Alibaba Group’s chief executive officer. Alibaba Group’s management and its principal shareholders, Yahoo and Softbank Corporation, are engaged in ongoing discussions regarding the terms of the restructuring and the appropriate commercial arrangements related to the online payment business.
A business potentially worth $1 billion just went missing? Investors were alarmed. Yahoo’s shares dropped like a stone—losing 7 percent on May 11 and 6 percent the day after—wiping $3 billion off its equity market capitalization. That evening, in an effort to limit the damage, Yahoo disclosed that neither it nor SoftBank had been told about the transfer of control until after the fact.
But ignorance wasn’t much of a defense. In Yahoo’s 2005 investment agreement, any transfer of assets or subsidiaries out of Alibaba Group that were worth more than $10 million required the approval of the company’s board of directors or shareholders.
At Alibaba.com’s annual general meeting in Hong Kong, Jack defended the transfer, arguing it was “a hundred percent legal and a hundred percent transparent.” He added that discussions were ongoing with Yahoo and SoftBank “regarding the appropriate commercial arrangements related to the Alipay business,” adding, “if we had not been doing everything aboveboard, we would not be where we are today.”
Alibaba also released a statement confirming the transfer and explaining that it was made to comply with regulations from the People’s Bank of China (PBOC), China’s banking regulator. Specifically the PBOC had issued its “administrative measures for the payment services provided by nonfinancial institutions,” which required, Alibaba explained, that “absolute controlling stakes of non-financial institutions must be domestically held.”
On May 15, in an attempt to calm the waters after days of turmoil, Alibaba and Yahoo issued a joint statement: “Alibaba Group, and its major stockholders Yahoo Inc. and Softbank Corporation, are engaged in and committed to productive negotiations to resolve the outstanding issues related to Alipay in a manner that serves the interests of all shareholders as soon as possible.”
But there was a gap between the public statements from Yahoo and Alibaba, opening up a series of troubling questions that were essentially: Who knew what? When?
Alibaba said the Alipay transfer had already happened. But Yahoo hadn’t informed its shareholders for months, perhaps even years. How long had Yahoo (and SoftBank) known about the transfer? Alibaba insisted that Yahoo and SoftBank had been told in a July 2009 board meeting that “majority shareholding in Alipay had been transferred21 into Chinese ownership.” The Chinese business publication Caixin confirmed, after an investigation, that Alipay was sold in two transactions, in June 2009 and August 2010, to Zhejiang Alibaba E-Commerce Company Limited, the firm controlled by Jack. The total price paid was 330 million yuan ($51 million). Critics argued that Yahoo was either dishonest or incompetent. If Yahoo knew about the transfer, why hadn’t they told their investors? If they didn’t know about it, why not?
Other troubling questions were also raised by the crisis. Did Alibaba really have no choice but to transfer such an important asset out of the company? Furthermore, did that transfer have to be made to a company under Jack’s personal control? And what was going to happen next?
Shareholders in Yahoo were exasperated, with one hedge fund manager telling the media, “It seems like this thing has evolved into a he-said, she-said battle via press releases. It doesn’t make Yahoo’s board look like they were on top of things.”
Critics of the VIE structure, and of investing in Chinese companies in general, were having a field day. But did Alibaba in fact, as it was arguing, have no choice but to make the transfer?
Behind the scenes, when the crisis first broke Jerry Yang was upset, but he remained calm. Masayoshi Son, however, was incensed. What was Jack thinking? To figure out what was going on, Jerry offered to fly to Beijing. Meeting there with a senior official at the PBOC, he was told that it was best he just “accept the situation.” When he pressed for an explanation, he was simply informed that the matter was “out of their hands.”
It was true that PBOC had introduced new rules, in June 2010, governing domestic third-party payment platforms on the Internet. The rules set out a longer application procedure for foreign-funded companies than for wholly domestically owned applicants. PBOC had been debating the issue of foreign ownership of payment companies since 2005. But the rules did not exclude foreign ownership entirely.
Jack’s defenders argue that he was simply first to see which way the regulatory wind was blowing. Parking the Alipay asset into a domestic company that he controlled could insulate Alibaba from the risk that new licenses expected to be issued by PBOC would be denied to foreign-invested companies. In an effort to clear up the matter in 2014 ahead of its IPO, Alibaba justified the transfer by explaining that the “action enabled Alipay to obtain a payment business license in May 2011 without delay and without any detrimental impact to our China retail marketplaces or to Alipay.”
Indeed, on May 26, 2011, Alipay, now entirely domestically owned, was the first of twenty-seven companies to be issued licenses22 and was awarded license number 001. But Jack’s critics charge that because PBOC also issued licenses to foreign-invested companies, such as Tencent’s Tenpay, and was the number two player in the market, then the argument that Alibaba had to transfer ownership of Alipay out of foreign hands doesn’t hold water. To this, Jack’s defenders argue that the comparison with Tenpay and other foreign-invested companies isn’t valid: Alipay already had such a dominant share of the market that it could not have expected such leniency. There were thousands of companies active in the third-party payment market, but with the first batch of licenses issued in May, PBOC also issued a deadline—September 1, 2011—for all companies to either obtain their own licenses or merge with an existing license holder. Inevitably this generated a lot of tension. Companies that had operated in a gray area now found themselves being divided into black and white, based on whether they had foreign investment and had obtained a license. Those that had not yet received licenses faced the risk of going out of business, and those that had received licenses but were foreign-invested were concerned that Alipay’s move threatened their own ability to have IPOs in the future, damaging the valuation of their business and, many feared, undermining the VIE investment structure on which so many Internet companies relied.
A number of Alipay’s rivals described to me a meeting hosted by PBOC soon after the licenses were issued, at which Jack was present. Many vented their unhappiness at Alibaba, but Jack remained silent. Yet even without the licensing issue, the reality was that too many companies were chasing after the oasis of fortunes to be made in payment riches. This turned out to be a mirage: With fees as low as 1 percent of transactions, if licensing
hadn’t thinned out the field, then competition would have done the job anyway. In this light, the Alipay incident—and the PBOC licensing regime it triggered—merely accelerated the inevitable: Many payment companies found themselves stranded in the desert, soon to run out of funding. One executive summed it up for me: “There were more ‘payment solution’ companies out there than consumer e-commerce companies. It was like being in a kitchen where there were more chefs than diners in the restaurant.”
In light of all of this, was Jack justified in making the transfer of Alipay to his control? Or are those who, to this day, criticize the transfer justified? Both sides of the argument relied on their interpretation of what the Chinese government, in the form of PBOC, had in mind. But that was clear as mud. PBOC had never said that foreign-invested entities could own payment platforms. But equally it had never said that they could not. One influential investor I spoke with summed it up: “PBOC were pissed. But Jack was very skilled at playing off different factions. No one could do anything about it because PBOC’s rules were so vague to start with.”
Was something else going on that drove Jack to take the risky move of transferring Alipay out of Alibaba? The deteriorating relationship between Yahoo and Alibaba certainly didn’t help. Under Carol Bartz, relations had become so bad that she and Jack were not even on speaking terms. Instead they started to communicate with each other by issuing statements or in interviews with the media.
Eight months before the Alipay crisis erupted, Bartz stated that she had no interest in selling Yahoo’s stake in Alibaba and that Jack was merely trying to get “some of his stock back” ahead of an IPO that would value those shares much higher. Alibaba immediately fired back, via the media, denying any plans to get an IPO and laying out its efforts at good faith negotiations23 with Yahoo to buy back its stake.
The reality for Alibaba, though, was that if Yahoo didn’t like the price Alibaba was prepared to pay there was little Jack could do about it.