Saturday, February 7, 2015

The Chinese Laundry.....





I wanted to take some time to think through and discuss the odd turn of events which took place over the last week or so.  Alibaba announced earnings and the stock took a US$30 billion haircut. We all know what happened, but the most profound questions anyone can ask relate to "who, when, where and most importantly.... why?"....all page references refer to the 424(b)4 IPO filing. (Link below)

Who lost money last Friday?

Let's start with some background. There are about 2 Billion BABA shares in lock-up right now, or 81% of the roughly 2.5 billion shares outstanding. (p16-17).  429 million are due to "un-lock" as of March 21st and an additional 1.5 billion shares are set to unlock on September 20th, 2015. According to the filing, the shares involved in the March lockup expiry are largely employee and director shares. (p250 thru p255)  Institutional shareholders are generally subject to the one year lock-up period.

The chart below is a "rounded" summary of the confusing chart & footnotes described on p250-255. To establish value I arbitrarily used a $100/share because: a.) it was representative of recent activity and b.) it makes the math cleaner and less confusing.






Who Owns Alibaba?
424(b)4 - (p250-255)
(mlns)
Value (mlns) @
Shell
Insider/Locked Shares
Shares
US$100/shr
%
Domicile
(mlns) $
Jack Ma (x)
386
$38,600
15.50%
See ©
$20,400
Joe Tsai
79
$7,900
3.20%
PROC
Other Officers/Directors
51
$5,100
2.00%
PROC
SoftBank
798
$79,800
32.00%
Japan
Yahoo
401
$40,100
16.10%
US
Fengmao Inv
52
$5,200
2.10%
PROC
Silver Lake (a)
54
$5,400
2.20%
Caymans
$5,400
Yunfeng (a)
28
$2,800
1.10%
Caymans
$2,800
CITC (a)
21
$2,100
0.80%
Caymans
$2,100
Broad Sino (a)
5
$500
0.20%
BVI
$500
Prosperous WS (a)
10
$1,000
0.40%
BVI
$1,000
Evergreen Growth (a)
2
$200
0.10%
BVI
$200
Asia Alt Mgmt (a)
1.6
$160
0.10%
BVI
$160
Pavilion Cap (a)
1.3
$130
0.10%
Singapore
$130
Li Ka Shing Foundation
1
$100
0.00%
Canada
$100
Cressent Holdings
1
$100
0.00%
Austria
$100
Siguler Guff BRIC (a)
0.5
$50
0.00%
US
Siguler Guff HP (a)
0.2
$20
0.00%
US
Arctic Capital
0.1
$10
0.00%
BVI
$10
Certain Employees  (b)
67
$6,700
2.70%
PROC
Certain Affiliates (b)
18
$1,800
0.70%
PROC
Underwriters (f)
26
$2,600
1.00%
US
Total "Locked" Shares
2,003.70
$200,370
80.40%

$32,900
US Float
 US Hedge Funds (per November 13fs)
  Third Point
7.2
$720
0.30%
  Soros
4
$400
0.20%
  D. E. Shaw
4
$400
0.20%
  John Paulson
1.9
$190
0.10%
  Julian Robertson
1.2
$120
0.00%
  David Tepper
0.7
$70
0.00%
  Total
19
$1,900
0.80%

  Other Float (f)
468.3
$46,830
18.80%
Total Issued Shares
2,491.00
$249,100
100.00%
(a) Multiple entities.
(b) ESOP & employee/contractor/partner agreements
(x) Shares directed by Jack Ma in caymans/BVI Shell Corps        (APN, SymAsia, JC Properties, ASM Ltd) p251 - Note #1
(d) Pension Funds, Day Traders, Retirees, Widows & Orphans    
(f) Presumably, based on the price movement, the Underwriters exercised their purchase options.


Note the significant number of shares held by Shell Companies in the Cayman Islands, BVI, etc. Today, roughly $32.9 billion in BABA stock is sitting in these Shell Companies.  Jack Ma alone controls roughly $20.4 Billion through a series of Cayman Islands Shells (APN, SymAsia, JC Properties, ASM Ltd. & related subs)  Like most things in life, there's probably a very good reason for this.  Keep reading.

Also of note, the number 8,108,115 shares is listed three (3) times in the Prospectus.  On page 298 it's revealed that the entire lot of these shares belongs to one entity/shareholder.  For some reason this tranche (and only this tranche) was given a favorable lock-up period of only 90 days.  It would be interesting to know which shareholder was allowed to sell $800 million worth of stock only 90 days after the IPO and why they were allowed to do it. The IPO document is silent on this disclosure.

Moreover, based on the book values reported, specifically, the absence of significant Paid-In-Capital and Equity Balance, it looks like the shares issued prior to the IPO were practically given away.  The chart below illustrates the Equity Balance, Shares Outstanding and Book Value from 2010 thru 2014. (p 98)



Alibaba Book Value
2010
2011
2012
2013
2014
Total Equity (mlns RMB)
26,493
28,402
34,383
513
30,417
 
Total Equity (mlns US$)
$4,273
$4,581
$5,546
$83
$4,906
Outstanding Ordinary Shares
2,421,257,567
2,435,156,669
2,491,952,201
2,160,220,739
2,193,810,660
Book Value Per Share - US$

$1.76
$1.88
$2.23
$0.04
$2.24
 
(a) Oddly, the entire equity of the company disappears in 2013 and magically reappears in 2014.  Here's the footnote:
"The decrease from March 31, 2012 to March 31, 2013 was primarily due to the repurchase of our ordinary shares from Yahoo
in September 2012 and the privatization of Alibaba.com, partially offset by the issuance of ordinary shares to finance the repurchase."

Generally, we see that the shares outstanding remain relatively constant.  The Shareholder Equity Account (generally) tracks with the presumed increase in Retained Earnings. Unfortunately, there is no schedule analyzing the equity account(s) year over year.  The number of shares issued/retired since 2010 was not necessarily material.  Moreover, the calculated book value per share in 2010 was a mere $1.77.  Although, there are no figures available to support this, presumably most of the book value is due to the accumulation of Retained Earnings. illustrating that  the shares issued prior to 2010 must have been issued at values significantly less than today's perceived ($100 per share) economic value of the business.  At about a $1.00 per share (or less) cost basis, the insiders really don't have any skin in the game.  Put another way, if the stock drops to $10/share (which sounds about right based on the "real" financials and economic prospects of the company) the insiders would have a "10 bagger" in just a few years......nice work......of course, the US shareholders who bought at $100/share would be less than pleased.


What's all the "Hub-bub" about?

Now, lets get back to the SAIC report. (Summary URL Posted below) The content and timing of the release of this report is as puzzling as it was alarming. In a July meeting at the Alibaba headquarters, months before the IPO, the SAIC's Internet Relations Director, Liu Hongliang, presented the following:
  • 63% of the the merchandise held for sale on the platform were either illegal, non-conforming or fake.  (Author's note: No kidding?...I always thought Ralph Lauren was based in Somalia....who knew?)
  • Alibaba employees had been engaged in fraud, bribery and cover-ups.
  • Alibaba had "lax controls" over every aspect of it's listing process.
  • Alibaba participated and condoned a pattern of "False advertising" by listers.

The curious release of the SAIC report just prior to the BABA earnings conference call is likely no coincidence. Even more interesting is the odd language indicating "The meeting was not made public in order not to impact Alibaba’s IPO" .  US Securities lawyers jumped all over this and immediately began advertising for class clients.  Mr. Hongliang certainly knew, or should have known what the impact of a report like this might mean for the shareholders of Alibaba. Yet he chose to keep the report under wraps until the time was right, and post it at a most opportune time (or inopportune time for BABA). Moreover, the BABA fire-drill response was frantic (Joe Tsai's rant during the earnings call), Jack Ma's emergency trip to the SAIC resulting in the removal of the report from the SAIC website, along with a BABA press release announcing "vindication" are all indications as to how far BABA executives will go to keep their e-commerce charade alive.

Why?....this is always the tough one.

Let's talk hypothetically for a moment.  Again, I'm just speculating, posing a hypothesis, here.   I'm not naming names or accusing anyone of any wrongdoing or anything like that. This is just a theory as to "why" things like this could happen.  Anyone familiar with "the way things are done" in China understands the deep rooted system of political patronage, business networks, kickbacks and gray/black money which constitutes the pay-to-play environment  for China's political elite. Today's China is much like Post-Prohibition Chicago....with egg rolls.  Everyone (connected) makes money...and everyone gets a cut.  This is the fuel that powers the Chinese economic engine.   This is the system that "gets things done".

You may also know that China's economy is heavily regulated, but, unfortunately, the regulations are "selectively enforced".  Let's say hypothetically, that Jack Ma and/or some Alibaba execs did something to disrupt the pay-to-play system, or perhaps, someone in the patronage food chain was looking for a bigger piece of the pie.

Lets say that Mr. Hongliang, for some reason, just didn't like the way things were going at Alibaba. Maybe his monthly patronage check didn't come in?  Maybe he was cut out of the IPO?  Maybe he heard that another public official was getting a bigger cut than he was?....and for all he'd done to help protect Alibaba from political/public scrutiny!...keeping all of this illegal activity out of the limelight....it's an outrage!  Let's say that the SAIC report and it's timely release were actually a shot across the bow of the Alibaba juggernaut.  Could it be that the politicos were quick to withdraw the report once it had done sufficient damage and once they were sure that their message was heard loud and clear?  Just imagine what a headlines like "Chinese government considers nationalizing Alipay" or "Jack Ma arrested on corruption charges" might do to the stock price?

Let's also hypothesize that all of those Shell Companies are, in actuality, vehicles to get elite money out of the PROC, out of the Chinese banking system and out from under the radar of China's selective enforcement of the new Anti-Corruption Laws.  After all, there's no better way to hide money from Chinese authorities (and avert confiscation) than to keep it out of China in the first place.  It's no secret that China's elite are continually looking for better ways to move money/wealth out of the PROC.  Money laundering has become more than a cottage industry in China, it's a blood-sport. Flows of elite money leaving the country have increased geometrically over the last few years. Equity Deals, Hard to Value Assets, Cruise Lines, Underground Banks...and my favorite, “Ants moving house”: transit companies around Guangdong that offer a service, hiring a large number of individuals to carry cash over the border, relying on the legal limit of US$ 10,000 each.  Free Caribbean and Seychelles vacations offered to Chinese Nationals just to get cash out of the country.

It's no accident that there are now one-hundred-and-seven (107) US listed Chinese ADRs with an aggregate Market Cap of US$ 1.3 Trillion as of 12/31/14.  It's no coincidence that significant shares of these ADRs are owned by shell companies in the Caribbean.  It's no happenstance that all of the IPO's are done on the same boilerplate, issued by the same Investment Banks, using Caribbean shell companies, with only the numbers, charts, logos and the officer names changed.  My understanding was that the original template came from Morgan Stanley and was used for the Infosys IPO (6/1/2005) but I've never been able to confirm that.   Anyway, let's say, hypothetically, that these ADRs are not as advertised.  Let's say there's a possibility that these IPOs are not the great investments they are touted to be, opening up the tremendous growth potential of the worlds second largest economy to the US Capital Markets.  Lets say that there's at least a possibility that these "investments" are primarily vehicles for China's political and business elite to launder money.  I really can't think of a better reason for US$ 32 Billion to find it's way into Caribbean banks and brokerages.

Alibaba insiders alone have US$ 32 Billion of direct-able resources offshore.  Jack Ma personally received an additional US$ 13 Billion from the IPO.   The 107 other offshore ADRs with a Market Cap over US$ 1.3 Trillion are also locked and loaded.  All of this resource could/will  provide a virtually unlimited, untraceable war chest to fund kickbacks, bribes, payola, grease, juice and Xínghuì for China's political and business elite for years to come.

Of course, let's not forget to give credit where credit is due.  All of the future carnage has been designed and meticulously implemented by US Investment Bankers who, for huge fees, were more than happy to do the wash.   They were more than willing to provide access to all that naive (sucker) US capital for a price. 107 IPOs, billions in fees, US$ 1.3 Trillion in Market Cap/Wealth,. much of which is sitting in accounts waiting to be tapped by insiders.  When the Anti-Corruption investigator comes knocking maybe Jack can just sign over a few shares from the BVI account and the problem just goes away.  Perhaps a couple of phone calls and a stock transfer made an oddly timed SAIC report from an out of the loop public official disappear?  Poof!

Here are a few people who can probably shed some light on this phenomenon:

Anthony Kontoleon, Managing Director: Credit Suisse
Joseph P. Coleman, Managing Director & John Reed, Director: Deutsche Bank
D. Binnion, Managing Director; Goldman
Mike Millman, Managing Director: JP Morgan
Crawford Jamieson, Managing Director: Morgan Stanley
James Perry, Managing Director: CitiGroup

As far as I can tell, these men are the architects of this "Chinese Laundry".  US$1.3 Trillion in US ADR Stock Market Value at risk (Much more if you calculate the Lehman/LTCM effect).  At best, this looks like bad judgement, perhaps with a side-order of systemic misrepresentation and consistent violation of securities law.....at it's worst.... it's treason.

Now if you'll excuse me, I have to sign off.  I've just received an e-mail letting me know that my Anthem Health Care account might have been hacked by the Chinese government......as always, timing is everything.



IPO Filing:
https://www.sec.gov/Archives/edgar/data/1577552/000119312514347620/d709111d424b4.htm

Summary SAIC Report:
http://qz.com/335675/the-chinese-government-has-erased-a-damning-report-on-alibaba-but-you-can-read-it-here/


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