by Duncan Clark
Did this frustration play a role? Or was another looming issue the reason? Five years had passed since Yahoo’s investment. Part of the investment agreement, conceded to by Alibaba only after intensive negotiations, gave Yahoo the right to appoint a second director to Alibaba’s board in 2010. Furthermore, the agreement also stipulated that a majority of the board could replace Alibaba’s senior management. If a hostile Bartz gained the support of Jerry Yang, who although no longer CEO still sat on Alibaba’s board, and enlisted the support of Masayoshi Son, she could outvote Jack and Joe, imperiling their positions. This was improbable—given Jack’s relationship with Jerry and Masayoshi Son, not to mention the difficulty for a foreign company to try to gain control over such an iconic company as Alibaba—but not impossible, especially if Bartz could strengthen her hand in negotiations over a sale of Yahoo’s stake. Yet even threatening such a move would have been highly destructive for Yahoo. “Then their investment would be worthless” is how another China Internet founder I spoke with put it.
In any case, the “nuclear option” never happened. As criticism of the transfer mounted Alibaba had little choice but to reach an agreement with Yahoo as quickly as possible. A number of domestic commentators were even harsher than foreign critics. In their eyes, the dispute threatened the interests of other entrepreneurs in China by undermining confidence in the VIE structure, and foreign investment in the country in general. After first criticizing the government for the vague and lengthy approval process for licensing payment providers, respected local magazine Caixin slammed Jack personally for “violating contract principles that support the market economy.” Jack had tarnished his international business reputation and diminished Alibaba’s long-term growth prospects, Caixin argued, by transferring an asset “to a concern under his name, for a price too low to be fair.” One China Internet company founder I spoke with, four years after the controversy, told me that even if that was the motivation, Jack was justified in doing it: “I perfectly understand it. Is it right? If I were Jack, I would have done the same thing. If he hadn’t resolved the incentive problem, Alibaba wouldn’t be today’s Alibaba.” Although few Chinese business leaders publicly endorsed that view, a number posted links to the Caixin article on social media.
Soon after its publication, Jack communicated with Hu Shuli, Caixin’s influential editor-in-chief, through a flurry of mobile text messages to discuss the issues she had raised. Their first texting session lasted two hours. Jack texted her to say he was very disappointed that Caixin published the comments without knowing the whole picture. He said that he “had no interest in politics at all,” he just wanted “to be himself” and “to be accountable to himself and to others.”
Jack said that “today’s situation is not designed [by us], but [we are] compelled to do it. The complexity of decision making of shareholders and the board is also a problem of corporate governance in the future.” He added, “I have three principles of doing things: first, one hundred percent legal; second, one hundred percent transparent; third, I must let the company develop sustainably and healthily.”
Interestingly, Jack revealed to Hu that Alibaba’s relationship with Yahoo was stronger at that point than with SoftBank: “The problems between me and Yahoo are easy to solve. They are problems of interests. But the issues between me and Masayoshi Son are not only issues of interests.” Beyond the Alipay dispute, at the height of the controversy, Jack disclosed24 that he had fundamental disagreements with Son on a range of HR issues, including employee incentive schemes and staff training:
He thinks that employees can be replaced at any time. I believe that we should give opportunities to young people in China, sharing the future with them. He thinks that’s not the case in Japan: I pay you wages anyway, so if you want to do it that’s fine, but if not there will be others. First of all, I don’t think [what happens in] Japan is necessarily right; second, this is totally wrong in China. I believe customers first, employees second. We wouldn’t have this company without our staff. We have completely different principles on this issue. . . . The issue has been there since day one.
Jack revealed that his disagreement with Son was long-standing, that they had been “fighting over it regularly in the past few years.” Jack also contrasted his approach to equity ownership. “Seventeen thousand employees at Alibaba all have shares,” he said. “You see that from the day that Alibaba was established until today, my share has been getting smaller and smaller.” Jack argued that Son, by contrast, had a stake in Alibaba of “thirty percent from day one, and now it is over thirty percent.” In a sign of the tension that had erupted between the two men, he invited journalists to look at Son’s approach to his own employees at SoftBank: “You can check if he’s given anything to his employees. . . . If he [Son] is asked to take out one percent [of his stake], it’s like pulling out a tooth from a live tiger.”
While Jack professed his admiration for Son’s skills of negotiations, he also said Son is the world’s number one “iron rooster” (tie gongji), a Chinese idiom describing people who are extremely stingy: Meaning, there is no chance whatsoever to pull out even one hair from an iron rooster.
Because many of the facts were disputed, and the stakes were so high, efforts to resolve the dispute dragged on for weeks, then months. Midway through the crisis,25 Jack described the negotiations over the compensation to be paid for the Alipay transfer as “very complicated,” comparing them to “peace talks at the United Nations.”
But reaching a settlement was becoming urgent. By the end of July, Yahoo’s shares had dropped 22 percent since the dispute began. A few weeks earlier, high-profile investor David Einhorn of Greenlight Capital sold his entire position in Yahoo, which he had built up because of its exposure to China, saying that the dispute “wasn’t what we signed up for.”
Finally, on July 29, an agreement was reached. The transfer of the assets would stand. But Yahoo, benefiting through its continued stake, would receive compensation of $2 to $6 billion from the proceeds of any future IPO of Alipay. Alibaba, Yahoo, and SoftBank were ready to put the dispute behind them. But investors in Yahoo were underwhelmed, particularly by the cap of $6 billion,26 and its shares fell 2.6 percent on the news. But in a call explaining the agreement to investors Joe Tsai pushed back vigorously, saying that the transfer was made to stay in line with government regulations: “If you own a hundred percent of the business that cannot operate, you own a hundred percent of zero.”
The Alipay episode left a bitter taste, but the compensation agreement had put an end to months of uncertainty. Now Alibaba could focus on its next priority: buying back as much as possible of Yahoo’s stake.
On September 30, 2011, Jack accepted an invitation to Stanford University to give a keynote speech at the China 2.0 conference series, which I had cofounded with Marguerite Gong Hancock a few years earlier. After I had introduced him onstage, I settled into a seat in the front row to watch what turned out to be a vintage performance of “Jack Magic.” Speaking in English, Jack started by acknowledging the elephant in the room—the company’s relationship with Yahoo. He said he was very tired from the events of the past few months, then, raising his right hand and looking at the audience, he said, “I still don’t know what the VIE is, right?” Of course it was obvious Jack knew all about the investment structure—it had been center stage of the Alipay controversy—but feigning ignorance was his way of winning over the crowd, even if the lawyers in the audience couldn’t contain their incredulity. Jack then ventured onto safer ground using some of his stock stories, before I started to field questions for him from the media. Asked, “Are you going to buy Yahoo?” Jack replied, “Yes, we’re very interested in that.” When Kara Swisher of Dow Jones’s AllThingsD asked him if he wanted to buy back just Yahoo’s stake in Alibaba, or all of Yahoo, Jack replied, in a sound bite that quickly went around the world: “The whole piece. Yahoo China is already ours right?” Then putting his right hand in his pocket he added, “It’s already in my pocke
t!” He concluded by adding that the situation was complex and would take time.
In the end, it would take nine months before a deal was completed. On May 21, 2012, the terms were made public: Alibaba would pay Yahoo $7.1 billion ($6.3 billion in cash and up to $800 million in preferred stock) to buy back half of Yahoo’s stake, or 20 percent of Alibaba, netting Yahoo some badly needed cash: $4.2 billion after tax. Alibaba also made a commitment to buy back a quarter of Yahoo’s remaining stake by 2015, or let Yahoo sell the stake in a future IPO27 of Alibaba Group. Yahoo and SoftBank also agreed to cap their voting rights on Alibaba’s board below 50 percent. Jack and Joe could feel secure in their seats. They set a course for their IPO (2.0).
Chapter Twelve
Icon or Icarus?
The communists just beat us at capitalism!
—Jon Stewart
IPO 2.0
On September 8, 2014, two days before Jack’s fiftieth birthday, Alibaba Group Ltd. kicked off its global roadshow in New York City.
Fifteen years after climbing the rough, cement staircase inside the Lakeside Gardens apartment complex, I walked up the polished marble steps of the Waldorf Astoria hotel in Manhattan. I had come to witness the birth of “BABA.”
Live-broadcast satellite trucks and black SUVs lined the block outside the hotel. Inside Jack, Joe, and the rest of the senior management team prepared to make their pitch. I walked alongside a line of investors that snaked all the way from Forty-Ninth Street up through the lobby to the hotel’s gilded elevators. Today was all about the New China. The venue was fitting, as the venerable Waldorf Astoria itself was acquired1 shortly after, for $2 billion, by a Chinese company.
On reaching the upstairs ballroom, the investors were issued with wristbands that determined whether they would hear the Alibaba pitch in the main ballroom or in one of the overflow rooms outside. One investor said it reminded him of an iPhone launch.
All eyes were on Jack. Although Jonathan Lu, as CEO,2 was the main front man for the presentation, Jack remained—as he does today—the personification of Alibaba. When it was his turn, Jack told the investors the story of his first, unsuccessful fund-raising trip with Joe to the United States fifteen years earlier. Seeking $2 million from venture capitalists, he returned, he said, empty-handed. But now he was back, and asking for a little more.
On that first trip Joe tried, without success, to convince Jack to present something to the investors they had flown to the United States to meet. But this time they came prepared. Each of the investors was handed a weighty, three-hundred-page prospectus. The bright orange cover’s cartoonlike graphics at the front made it look more like a children’s book than a serious document for grown-ups. But flipping past the artwork, the investors found the sobering text outlining the “Risk Factors”—standard for any public offering. The section ran thirty-seven pages long, detailing “intangible”3 and “tangible” risks, such as the company’s dependence on Alipay, a business it no longer owned. Jack addressed the issue of the Alipay transfer head-on, saying he had been given no choice. The decision, he said, was one of the hardest of his life, but one in retrospect he would make again.
The risk factors also included a discussion of the controversial but enduring VIE investment structure. But the offering had added, on top of the VIE, another layer of complexity for investors: the “Alibaba Partnership.” The partnership4 comprised thirty individuals, mostly5 members of Alibaba’s management team. Six,6 plus Joe Tsai, were original cofounders of Alibaba. The explicit goal of the partnership is to help Alibaba’s senior managers “collaborate and override bureaucracy and hierarchy,” to ensure “excellence, innovation, and sustainability.” In December 2015, Alibaba appointed four new partnering members, taking the total to thirty-four.7
Of course the implicit reason for the partnership is control. Even after becoming a public company, Alibaba wanted to ensure that the founders remained masters of their own destiny.
This had already caused controversy for Alibaba, prompting the Hong Kong Stock Exchange and its regulator8 to turn down Alibaba’s application for an IPO in the territory. Hong Kong was concerned that allowing the structure would signal a weakening of its commitment to the “one shareholder, one vote” system.
Alibaba countered that the partnership could not be compared to the narrow concentration of control of the “dual-class” or “high vote” share structures used by tech company peers in the United States like Google and Facebook. Instead it was proposing a new, more sophisticated form of corporate governance that gave each member of a larger group of managers a vote. But the distinction failed to convince the Hong Kong authorities, and Alibaba opted for an IPO on the New York Stock Exchange instead.
Saying “no” to Alibaba was costly for Hong Kong, depriving the city’s bankers and lawyers of a huge windfall. Joe Tsai didn’t pull his punches: “The question Hong Kong must address is whether it is ready to look forward as the rest of the world passes it by.”
So, Alibaba found itself in New York. Selling 12 percent of the company, it raised $25 billion, the largest IPO in history. Credit Suisse and Morgan Stanley, two of the six banks hired to lead the deal, raked in $49 million each. The haul for an army of lawyers on the deal was more than $15 million.
In New York, the deal caught the attention of Jon Stewart at Comedy Central. First he joked about Alibaba’s business, connecting buyers with sellers: “Craigslist with better graphics, is that what it is?” Then he poked fun at Alibaba’s convoluted ownership structure: Investors in the IPO were buying shares in Alibaba Group Holdings Limited, a company incorporated in the Cayman Islands, controlled by a partnership, which did not actually own the business assets in China. “So I paid for a share for something on an island, and I don’t own it?” Stewart continued, “You’re selling us a time share, is that what it is? A time share in a company. Without giving us a free vacation to sit through your pitch?” Finally, Stewart noted that Alibaba was listing in New York because it couldn’t list in China: “The communists just beat us at capitalism!” Stewart concluded by pretending to phone his broker to get his hands on, in vain, some BABA shares.
But this IPO9 was not about individual investors; it was all about big institutions, for whom ninety percent of the shares were reserved. Seventeen hundred institutional investors subscribed to the shares, including forty who each put in orders for over $1 billion. In the end the bulk of the shares were allocated to just a few dozen institutions.
Jack Magic, and the appeal of Alibaba’s huge business, worked. Demand10 for BABA shares outstripped supply by over fourteen times. A healthy first-day pop was inevitable. Demand was so strong that it took the New York Stock Exchange half an hour even to determine the opening trade. The stock was listed at $68 but the initial quotes came in at just under $100. BABA closed the day 25 percent higher than the initial price, valuing the company at over $230 billion, more than Coca-Cola. Among Internet companies, Alibaba was second only to Google, higher even than Amazon and Facebook. In the following weeks, its shares continued to climb, its valuation far surpassing Walmart and Amazon, almost breaking the $300 billion mark in early November. Mirroring his record-breaking $36 million purchase of an apartment in Hong Kong after Alibaba.com’s IPO in 2007, less than a year after the 2014 IPO, Jack bought another trophy asset, for $190 million this time, in the shape of a ten-thousand-square-foot, three-story house perched even higher up Hong Kong’s Victoria Peak.
However, just as Alibaba.com’s IPO in 2007 had sizzled, then fizzled, BABA-boom soon become BABA-bust: Alibaba Group’s shares sank by 50 percent before the summer of 2015 was out. In late August, they fell below the $68 IPO price for the first time. By September, Alibaba’s valuation had sunk11 by almost $150 billion from its November 2014 peak, in what Bloomberg described as “the world’s biggest destruction of market value.”
Newly appointed CEO Daniel Zhang reminded the company’s employees, “Our values do not waver with the fluctuations in stock price,” and that they were not j
ust fighting a battle, but were “in it for 102 years to win the war.” Thanks to the anticipated future IPO of the parent company of Alipay, renamed Ant Financial,12 Alibaba would also continue its practice of creating regular opportunities for employees to cash out some of their shares. Although Ant Financial’s IPO (on a domestic stock exchange) is likely still a year or two away, Alibaba has already started to distribute shares in the financial unit.
After a strong first few months, why did Alibaba’s shares fall so fast and so far? The sharpest drop was triggered by a public dispute between Alibaba and a Chinese government agency, a development that came as a shock to the foreign investors who had assumed that Jack was somehow the ultimate insider, immune from such entanglements.
Fighting over Fakes
On January 28, 2015, the State Administration for Industry and Commerce (SAIC), China’s business and licensing authority, posted a report13 on its website that detailed complaints, leveled the previous July, that accused Alibaba of selling fake goods and its employees of taking bribes from vendors in order to boost the rankings of their products. The report also detailed a subsequent SAIC investigation into the sale of counterfeit items on six leading e-commerce sites, including Taobao and Tmall. The SAIC found that of its sample purchases on Taobao only 37 percent were considered authentic, adding, “For a long time, Alibaba hasn’t paid enough attention to the illegal operations on its platforms, and hasn’t effectively addressed the issues.” Worse still, the report asserted that “Alibaba not only faces the biggest credibility crisis since its establishment, it also casts a bad influence for other Internet operators trying to operate legally.”
When the media picked up the story, Alibaba’s shares fell by more than 4 percent.