Sunday, June 12, 2016

Follow up thoughts on "I would never say...(Part Deux)....."

I've received a number of excellent questions regarding my thoughts on the Alibaba SEC investigation.

Announcement of the Investigation in contained in the SEC filing below (Ref. pg 30 &187):
http://www.sec.gov/Archives/edgar/data/1577552/000104746916013400/a2228766z20-f.htm

Rather than try to address my readers questions individually, I thought I'd take some time within this post to discuss the general themes contained therein.  The following are common threads of my readers inquiries.

1.) How long do you think the investigation will take and how significant will the findings be?
2.) Why has the stock price held up so well?
3.) Should I short it?

I'll address these questions in reverse order:

"Should I short it?"

Let me be clear, I do not give Investment advice within this blog.  I accept no compensation from anyone re: any of my commentary.  My observations are mine and mine alone.  I have no "inside contacts" at any of the businesses discussed herein, although I do have friends in the Peoples Republic of China (PRC) off whom I bounce my ideas off of from time to time.  My modus operandi is simply to read the filings and SEC correspondence and interpret them based on sound judgment and reasoning developed over my years of accounting and investing experience.  If I have any positions in any of the investments discussed, I'll disclose the position.  Moreover, I have neither current nor had past positions in any of the individual stocks discussed within this blog.   In any case, whatever you decide to do with my input, I wish you the best of luck!

"Why has the stock price held up?"

Oddly, in this business, you can be absolutely "right" about a stock, but Mr. Market might not agree with you for ten years.  Unfortunately, again, in this business, being "right" in ten years has the same financial repercussion as being "wrong" for a decade.  On the other hand, it's worth pointing out that when fraud is discovered, stocks can tumble very, very quickly, Enron or Valeant style.  It's not like the stock slides neatly 3% per month for 36 months.  Investors who are waiting for the "perfect" time to short the stock may find that when the whiff of fraud becomes unmistakable, many of the long investors will get out very quickly and not wait for the full post-mortems.  For investors who short a stock, "no one rings a bell at the top".

First, Specifically with Alibaba,  based solely on some of the un-publishable comments I've received since I've started posting, Alibaba seems, for whatever reason, to have developed an almost cult-like following. I'll reiterate, I'm happy to post any comment re: whatever I say as long as it's free of profanity and includes some sort of actual thought process:

For example, the following would be acceptable for publication:

A: "DT, you are a complete moron and here's why......(insert well thought out commentary here.)"

Moreover, if I happen make a mistake in my analysis, math or documentation, I'd like to know about it.  You'd have my gratitude for pointing out my error(s).

The following will NOT be deemed acceptable nor will it be published:

B: "DT, you are a F-ing moron....(with no explanation as to your thought process)"

I seem to be getting more correspondence similar to B than A lately.

If you've read Thaler's "Nudge" or "Misbehaving" (I recommend both books.  Each is an easy, informative read.  Note that Rich is fully capable of delivering higher levels of math that would make your head spin and put you to sleep, but thankfully, for the sake of book sales, he's spared us the exercise, although the citations are fully available in the footnotes.) you've been armed with the knowledge that people/investors tend to develop all sorts of irrational, emotional "biases" toward a particular stock or investment.  Moreover, they tend not to sell it nor listen to reasonable arguments as to why their initial assessment (which was a hot tip from their commission-only broker) might be dead wrong.  They cling to their original thought process, like a dog to a bone, defending it and inevitably riding the stock all the way to the bottom.  "Buy the dip baby!" They become emotionally invested.  Their hubris, success and prior experience tells them that they can't possibly be wrong.  They are smarter than everyone else.   (See Thaler's survey describing how every respondent stated they were well above the average intelligence of their classmates.) In short, they've made up their minds and don't want to be "confused by the facts".

Second, because Alibaba is so closely held and thinly traded (I'll explain why I say that in a moment), with a significant proportion of the shares owned by insiders and "related" Caribbean Shell Corps, we really can't tell exactly where the price support in the public market is coming from.  See the full list as of the IPO at:
http://deep-throat-ipo.blogspot.com/2015/02/the-chinese-laundry.html


Given the above 80% insider holdings, lets take a look at the top twenty shareholders who've presumably purchased their shares on the open market.  Here's a list of non-insiders per Yahoo! Finance.



























So today, an additional 14% of the company is owned by the above 20 funds/investors.  Note that these funds are generally not considered to be quants or day-traders.  These are longer term, buy-and-hold investors.  So that leaves roughly 5% of the outstanding shares (125 million shares give or take) available for trading by "little-guy" investors on any given day.  Not much in the grand scheme of things.

Now, lets take a look at volume trend for Alibaba.  The chart below represents the average daily volume, calculated in three month periods for Yahoo!, BABA and AAPL as a percentage of their issued and outstanding shares.  The NYSE "index" is simply the quarterly volume divided by a constant to show the change in trading volume for the entire market over the same period of time.



We observe the following from the above:
  • BABA volume has dropped off substantially since the IPO, Average Daily Volume has decreased from 1.75% (45 million shares) to 0.50% (12 million shares) in that time..
  • This decrease in "enthusiasm" has persisted even though NYSE average daily volume has consistently increased over the same period.
  • Yahoo! average daily share volume has generally mirrored  BABA's, but at about three times the relative percent of shares outstanding.
  • The value of BABA is being determined by a relatively few number of shares changing hands. There are about 2.5 Billion shares outstanding and only a few million shares are exchanged in arms length transactions daily.
Don't get me wrong, I'm not a conspiracy theorist by nature. I'm not wearing an aluminum foil hat or looking over my shoulder right now.  I'm just pointing out that with daily volume that low, in relative terms, with tremendous wealth spread out over a number of insider controlled businesses, and the insider necessity to keep the collateral value as high as possible, it wouldn't be that difficult to manipulate or support the share price if you were properly financed and so inclined.  This might also explain the phenomenon that there is usually significant support for the stock even after negative news breaks. The stock usually takes a bit of a hit on the announcement and moves up a bit on lower volume days, irrespective as to what the market does.

Remember, you're not paranoid if they really are out to get you.

How long will it take and what will happen? 

To state the obvious, these things are complex.  If there is indeed a fraud brewing, it's almost impossible to catch.  Rating Agencies, Public Accountants and the SEC are nearly powerless to challenge management representations without a whistle-blower or insider-witnesses participation in the investigation.  Allow me to meander around for a few paragraphs to illustrate how difficult it is for really smart, trained, hard working people to catch these things.

There's a reason that PWC HK has the following disclaimer on Alibaba's Auditor's Opinion.  (Every Auditor's report has a similar Disclaimer)

"Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate."

What this means in "accountant speak" is that, if management colludes to produce fraudulent financial statements there's a good chance that a public accountant won't catch it,

Moody's Research

Interestingly, the day after Alibaba announced the SEC investigation, Moody's issued the obligatory press release stating that, in summary banker-speak ,everything is probably just fine.

https://www.moodys.com/research/Moodys-comments-on-SEC-Investigation-of-Alibaba--PR_349768?WT.mc_id=AM~WWFob29fRmluYW5jZTQyX1NCX1JhdGluZyBOZXdzX0FsbF9Fbmc%3d~20160527_PR_349768

"If the SEC determines certain reporting requirements were violated, this would likely result in a restatement of Alibaba's financials, as well as in fines and shareholder lawsuits. In addition, any significant restatement would bring reputational damage to the company.  The rating could come under pressure if Moody's concludes Alibaba's financial performance and credit strength are significantly weaker than previously believed.  However, at present Moody's views this scenario as unlikely in the absence of substantial restatement implications that there has been material misrepresentation."

Putting this in perspective, in just one day, with presumably no actual knowledge of what the SEC is actually looking at, Moody's fully reviewed more than two years of their own research and immediately concluded that everything they've done so far is absolutely error free.  It's amazing how much work they accomplished in just one day, don't you think?

With that preamble, here are my two favorite Moody's posts of all time:

March 23rd, 2000 - MOODY'S UPGRADES ALL ENRON CORP LONG TERM DEBT RATINGS
https://www.moodys.com/research/MOODYS-UPGRADES-ALL-ENRON-CORP-LONG-TERM-DEBT-RATINGS--PR_35633

And a year and a half later......

December 3rd, 2001 - MOODY'S DOWNGRADES ENRON CORP'S LONG-TERM DEBT RATINGS (SENIOR UNSECURED TO Ca); COMMERCIAL PAPER CONFIRMED AT NOT-PRIME
https://www.moodys.com/research/MOODYS-DOWNGRADES-ENRON-CORPS-LONG-TERM-DEBT-RATINGS-SENIOR-UNSECURED--PR_51015

The downgrade came the day after the bankruptcy filings of a number of Enron's subsidiaries.  As usual....the rating agencies were right on top of it.....Ooooppsss.

Another of my Favorite "Investigations"

The only reason I bring this one up is that it's "close to home" and I have some personal recollection of the details.  It's another great example of how a really smart, charismatic person can fool other really smart people for a long time.  Frank Gruttadauria was a "man about town" in Cleveland, Ohio, everyone knew him, he was connected......until the following (per the SEC Report):

On or about January 11, 2002, Gruttadauria sent a letter to the Federal Bureau of Investigation in which he stated: "During the course of the past 15 years I have caused misappropriation through various methods which resulted in other violations. It has occurred at Lehman Brothers, SG Cowen Securities Corp. Cowen & Co., Hambrecht & Quist, Inc. and LF Rothschild Inc." He continued: "It is a complicated and substantial interwoven fabric of digressions [, which] . . . . began as an attempt to make up lost monies for customers and mushroomed over the course of time." After he sent his letter, Gruttadauria disappeared. On January 25, 2002, the Office of the U.S. Attorney for the Northern District of Ohio obtained an arrest warrant against Gruttadauria. On February 9, 2002, Gruttadauria surrendered and is in federal custody.

https://www.sec.gov/litigation/complaints/complr17369.htm

It's a long story and an interesting read if you have the time .  When the dust cleared, it turned out that Frank was perhaps the worst investor in history and a really bad crook to boot.  His scheme was simple, confiscate client money for his own personal use, "invest it" in leveraged, high risk bets and issue fake statements to his clients showing out-sized gains.  At the time Frank wrote the letter to the FBI, total assets available to clients were $1.8 million and the fake statements showed more than $278 million in nonexistent assets.  The "who's who" of Cleveland Investors were bamboozled.  Frank was ahead of his time.  He was a mini-Madoff in training.

As you might suspect, after only fifteen years, the SEC was all over this fraud.  The investigation commenced as soon as the FBI forwarded Frank's confession letter along to them.

As I may have mentioned before, the SEC, Public Accountants, Bankers and Rating Agencies Investigative prowess seems to be at their best immediately after the voluntary confession hits the media.


Additional (Possibly) Unbiased Alibaba Research

One of my readers, and a correspondent at the South China Morning Post (an Alibaba Company) also sent me an "all is well" email.citing "independent" opinions from Morgan Stanley, Suntrust and Deutsche Bank (and to borrow a phrase from the Alibaba disclosure "and others"), whose logos, by pure coincidence, were prominently splattered all over the front page of the Alibaba IPO.  Again, like Moody's, these underwriters, with significant skin in the game, reputation risk and presumably no knowledge of the specifics of the investigation, have completely reviewed all of their work in just a few days and predictably determined, in Kevin-Bacon-esque style, that "all is well".   I'm extremely flattered that the South China Morning Post would take the time send me these "independent" opinions of the financial condition of their parent company and their assessment of the outcome of an investigation that, by its' nature, they can know absolutely nothing about.






SEC Process

These investigations, again, by their very nature are private matters.  Both the SEC and the subject of the investigation normally make no public disclosures, nor do they have anything to gain by doing so. However, we might be able to shed some light on the process by combing through the correspondence leading up to the IPO.  I've attached a few of the documents below for your review if you choose to take the time:

Example - 60 page SEC document Q&A 6/16/14 Response to 5/6/14 F1 fiing.
https://www.sec.gov/Archives/edgar/data/1577552/000119312514237452/filename1.htm

Example - 35 page SEC document Q&A 7/11/14 response to 7/3/14 Amended F1
https://www.sec.gov/Archives/edgar/data/1577552/000119312514266474/filename1.htm

Correspondence - 8/6/14
https://www.sec.gov/Archives/edgar/data/1577552/000119312514298625/filename1.htm

Correspondence - 8/12/16
https://www.sec.gov/Archives/edgar/data/1577552/000119312514306858/filename1.htm

Correspondence 8/22/14
https://www.sec.gov/Archives/edgar/data/1577552/000119312514318466/filename1.htm

Without getting into the gory details, I'll discuss the general format of the Q&A and then interpret some of my favorite interrogatories through the magic of my Dick Fuld Banker Speak Translator (BST) (patent pending):

Q&A Format:

SEC: "Dear Alibaba Management & Counsel, we see you've disclosed/described (Insert odd, unsupported metric here) which may or may not have a bearing on (Insert odd, unsupported additional metrics here).


BABA Respondent: "Thank you for the wonderful, insightful question"  From this point the response takes one (or more) of the following three possible directions:

  1. "I'm sorry, it appears that you just don't understand what we are doing in our business model.  You must understand, in China, eCommerce, financial reporting, mathematics perhaps even the laws of physics are totally different than they are in the US.  Let us try to help you get past your ignorance.  After all, the Chinese people invented mathematics well before Capitalism even existed.  Don't worry, we'll get you through this.  Please see the attached additional odd, unsupported, made-up, metrics."
  2. "I'm sorry, what you are asking us for is impossible.  Because of our laws in China we simply can't comply with your request.  Selling fake tchotchkes on the Internet is a highly guarded State Secret and the politburo will not allow us to discuss the matter.  Let's just move on and call it a day.  Once again, we'd love to help out, but our hands are tied, our deepest regrets.  I'm sure you understand."
  3. "I'm sorry, we've been advised by our Public Accountants, Investment Bankers and our Legal Counsel that we don't have to give that to you.  We don't think it's necessary and you don't need it.  You wouldn't know what to do with the information, or understand it anyway.  So that's that. Next question please."

Now, as promised, lets run a few of my favorite interrogatories through the BST and see what we get:

This one addresses a US$1 Billion dollar "loan" of Alibaba funds to be made directly to Simon Xie, Jack's buddy for "strategic investment purposes".  (Page 3 of the August 12th, 2014 Correspondence cited above)

SEC: We note the disclosure on page 226 regarding the RMB6.5 billion loan arrangement with Simon Xie. We also note that a company controlled by Jack Ma will serve as a general partner of the PRC partnership that will receive indirectly the proceeds of such loan. Please provide us with a detailed analysis of the nature of the loan and the extent to which the provisions of Section 13(k) of the Exchange Act are applicable to the loan. Your analysis should address both Mr. Xie and Mr. Ma.

SEC - BST - WTF??.....you are taking $1 Billion of Shareholder money and giving it to Jack's buddy?  Is this thing Jack Ma's own personal piggy bank?  

I'm not going to bother posting the entire Alibaba response.  It's long winded and barely understandable.  You can certainly muddle through the filing if you are so inclined. However, to keep things moving, here's the BST version of what they said:

Alibaba Respondent: - BST    "Ohhhh!.....I see what you are getting at.  You've got it all wrong. Here's what's really going on.  The loan to Simon isn't a 13(k) 'personal' loan....it's a 'business' loan!  See, even though the money is going to him, Simon is going to take the money and contribute it to a partnership that he and Jack have cooked up, and once the money is sufficiently laundered, the partnership is going to 'invest' it in Wasu Media, since Wasu media has a strategic relationship with Alibaba.  Jack isn't getting the money (It's going to a partnership) so he's not in violation of 13(k) either!  That's why we did it this way!....That way, Jack and Simon get a billion dollar loan, they can do whatever they want with the proceeds, maybe invest in Wasu, maybe not.   Moreover Simon isn't a qualifying executive under 13(k)...he's not a director or 'senior' manager.....we just want to give him a BILLION DOLLARS since he's a good guy.....he's just one of five 'strategic' vice presidents!   Who knows, if this works we might give all five of them a BILLION DOLLARS each!  US Shareholders are really generous that way.  That way all of the VP's can get access to Billions of US Shareholder Dollars, for 'strategic purposes', pay the interest from loan principal until the investments pay off (or not) and nobody is the wiser!   Isn't this an AWESOME IDEA! If you guys sign off on this one we will be actively looking for homeless people to start partnerships with Jack.  We understand that in America you can go to jail for things like this, but in China it's SOP.  We're sure glad you understand how this works now.  Thanks for asking about it."


Here's a follow up on pg 7 of the same August 12th, 2014 Document.

SEC: Please address in this risk factor any potential material conflicts of interest between you and Simon Xie and expand this risk factor to discuss any potential material conflicts of interest resulting from the manner in which you plan to invest in Wasu Media Holdings Co., Ltd.  It appears that the disclosure required by Item 6.A of Form 20-F is applicable to Simon Xie. In this regard, we note your apparent dependence upon Mr. Xie based on his role as one of your founders and as a member of your management, as well as his equity interests in Alipay, your material VIEs, and the partnership through which you plan to invest in Wasu Media Holdings Co. Please provide the disclosure required by Item 6.A of Form 20-F and in doing so disclose Mr. Xie’s roles and responsibilities in your company and where Mr. Xie falls within your management structure.

SEC - BST: "So you are making the loan to the partnership owned by Simon, Jack and Yuzhu Shi?  The partnership is going to buy the stock of Wasu media?  That's the same Yuzhu Shi, the guy who went bust trying to build the tallest skyscraper in China (that was never actually built) and then took a video game company, Giant Interactive public on the NYSE, raised $1 Billion on the IPO, milked it for all it was worth and took it private in China at a deep discount with US Shareholders left holding the bag? .......is that the same Yuzhu Shi that you are jumping into bed with on both Wasu and Yunfeng Capital??   And you don't see any conflict of interest here?  Really?" 

Here's the BST version of the Alibaba Response:

Alibaba Respondent: - BST  "Wowww....you guys are really sharp!  You've actually read through the whole filing and you know your securities law to boot!  Ok, here's what's really going on.  You think that Simon actually works here and that his employment would make him an employee 'upon whose work the company is dependent' as defined in Item 6.A of Form 20-F.   Again, you've got it all wrong.  Simon, is a peon, a nobody, he pushes a broom around and occasionally opens the mail....that's it!  In fact, if you don't let us structure this deal this way we're going to fire his sorry ass so that there is absolutely no conflict under 13(k).  Of course, we're still going to give him a Billion dollars,  just 'cuz we want to and you can't stop us. Moreover,  Yuzhu Shi is a wealthy visionary and great man.  He was able to amass a tremendous fortune by creating fake businesses out of nothing, pulling all of the cash out of them and selling the decaying shells to suckers....uh....I mean fortunate investors.  Anyway, all of these people are safe in China and you have no jurisdiction over them.  So mind your own beeswax."

The May 26th, 2016 20-F

Fast forward to the 20F - pg 40.  They did indeed "fire his sorry ass" to conform to 13(k) on this loan. I guess the other four "Strategic VP's" could easily pick up the slack.  However, it looks like the actual structure of the deal has changed significantly.   Per the recent 20-F, the RMB 6.9 Billion (US$1.06 Billion) loan was actually made to Simon by an unnamed PRC Bank.  Alibaba pledged RMB 7.3 Billion (US$1.12 Billion) of "Wealth Management Products" which are presumably carried on their balance sheet somewhere to guarantee the loan.  Alibaba also set up a RMB 2.0 Billion (US$ 300 Million) Credit Facility to Simon so he can afford to pay the substantial interest on the bank loan.

Here are a couple of questions I might ask about this reconstituted transaction if I were one of the SEC attorneys investigating this mess:

  • Where was the money that required the pledge/guarantee of Alibaba assets actually invested?  did it all go to Wasu or did Simon or Jack skim a bit off the top for vacation homes in the Adirondacks and/or Caymans?....Hey, don't get upset....I'm just asking a question.
  • Where did the "Wealth Management Products" come from?  What are they?  How did they come about and where are they on the balance sheet?  Did Alibaba buy a bunch of wonderful small business loans (aka non-performing) from ANT/Alipay using US Shareholder Money?  Is that the collateral pledged for the loan to Simon?  After all, it's a BILLION dollars 
  • What is the interest rate on the PRC Bank Loan to Simon?  What are the terms of this loan?  Which Bank is it?  They won't even disclose which banker was dumb enough to do this deal?
  • Does Simon really need a $300 Million Credit facility to pay interest on a billion dollar loan?  Even at 10% Simple Interest that's 3 years of Interest payments.  So whatever the hell the terms of the "investment" was in Wasu, it isn't flowing any cash?
  • WTF???....(This last question is just rhetorical and would add no value to the investigation).

Note: Wasu is a public company on the Shanghai Stock exchange.  On the date of the SEC Correspondence (August 12th, 2014) it was trading at $29/share.  It hit a high of $59/share in June of 2015 (Before the crash) and it's trading at $19/share today (a 33% haircut from August 2014).  The Market Cap today is about $4 Billion (Down from $6 Billion).  We don't know anything about the financial prospects of Wasu or the Ma, Xie, Shi partnership.  The only things we are certain of :

  • The value of the collateral (Wasu) underlying Simon's margin loan has declined substantially and is most likely under water. 
  • Based on the structure, Alibaba (and consequently US Shareholders) have credit risk by virtue of the pledge of (quite possibly dog-shit) "Wealth Management Products" to an unnamed PRC Bank, if for some reason Wasu stumbles into some cash flow or collateral valuation problems.  Apparently they already have since there is now a magical Alibaba credit facility in place to pay Simon's Interest on the PRC Bank "loan".


Perhaps that's why the SEC is looking into this?  I'm just sayin'....

.
Cainiao Network

If we perform a text search of the IPO Correspondence above the word "Cianiao" doesn't even come up once.  Apparently, this "rising star" wasn't even on the SEC's radar prior to the IPO two years ago.  Yet, it's a primary focal point of the recently announced Investigation.  Here's the disclosure from the recent 20-F (Buried on pg. 76 & 77)  As a point of reference the word "Cianaio" appeared 108 times in the current filing.

Cainiao Network completed a round of equity financing of approximately RMB10 billion (US$1.5 Billion) in March 2016. Existing shareholders and new investors, including major sovereign wealth funds and private equity funds, participated in the financing. We subscribed for Cainiao Network's shares on an approximately pro rata basis. As of March 31, 2016, we own an approximately 47% equity interest in Cainiao Network. See "Item 5. Operating and Financial Review and Prospects — A. Operating Results — Recent Investment, Acquisition and Strategic Alliance Activities — Logistics — Cainiao Smart Logistics Network Limited."

So....somehow, in just two years, they ended up with 47% of a money losing business, with an assigned a value of US$6.2 Billion? Astounding.....

Here's some more.....
"Through the platform approach, Cainiao Network integrates the resources of logistics service providers to build out the logistics ecosystem. As of March 31, 2016, Cainiao Network's fifteen strategic express courier partners employed over 1,700,000 delivery personnel in more than 600 cities and 31 provinces in China, according to data provided by them. Collectively they operated more than 150,000 hubs and sorting stations. The top six of these express courier partners handled the delivery of the majority of packages from our China retail marketplaces in the twelve months ended March 31, 2016. We believe that orders from transactions generated on our marketplaces represented a significant portion of these express courier partners' total delivery volumes in the twelve months ended March 31, 2016. Cainiao Network is still in an early stage of development. It has yet to monetize the majority of the value-added services it provides under the assisted-delivery model."  

"During the twelve months ended March 31, 2016, Cainiao Network and its logistics partners enabled the delivery of 12.2 billion packages from our China retail marketplaces. Currently, Cainiao Network primarily derives its revenue from end-to-end logistics solutions and generates a significant portion of its revenue from providing these services to Tmall Supermarket."

Hmmmmm......this is the first 1,700,000 employee "enterprise" that I've run across that is in the early stages of development and has yet to "monetize it's value".  Normally, when you are managing 1.7 million people you have some idea as to how to generate a profit.

Other notable FYE 3/31/2016 Cainiao statistics disclosed,. (pgs 76, 77, 108 122 & 156)

  • 12.2 Alibaba Billion Packages Delivered.  10 packages for every man, woman & child in China last year.
  • Alibaba Ecosystem deliveries accounted for 60% of Cainiao revenue/volume (So the Cainiao Network actually delivered 20 Billion Packages?)
  • Cainiao Revenue was RMB 3,099 Million (US$ 477 Million)
  • Cainiao Net Loss was RMB 617 Million (US$95 Million)
  • Alibaba Revenue US$ 15,686 Million
  • Alibaba GMV US 485 Billion
  • Alibaba owns 47% of Cainiao.  
  • Equity method accounting required Revenues and Income/Loss be consolidated at 47% of the above revenues and losses.
Now lets have some fun with ratios!
  • Alibaba GMV per package delivered is $39.75 (12.2 Billion Packages)
  • Alibaba Revenue per package is $1.29
  • Cainiao Revenue per package is $0.02 (at 20 Billion Packages)
  • Cainiao Revenue per "employee" is US$280 per year.
  • Cainaio packages delivered per day per employee is 33 (at 20 Billion Packages).
  • Alibaba Revenue per "employee"is roughly $450,000/yr.
  • Alibaba GMV per employee is roughly US$13.8 million per year.  
Based on the above, if economic theory holds true in China, you'd think that more than a few of the Cainiao employees would frantically filling out employment applications to get a job at Alibaba. There would simply be more money available to pay them.  Again, I'm not an expert at Chinese mathematics, but I'd guess that $450,000/yr. is still more than $280/yr., even in China.

How could this rate structure even exist?  Two (2) cents per package wouldn't be enough to pay for the electricity to power the computers for the Cainiao "ecosystem", much less pay for the rest of the overhead involved. Would a price increase really be so hard to push through?  Maybe go up to 4 cents per package and double the revenue?  Presumably, all of the buyers, sellers and delivery businesses are somehow exchanging payments with each other through the Cainiao network.  Does the money stay in the system to provide additional float?  Does Cainiao hold the money for an extended period of time?  How does this work?  But again, the disclosure is so lacking that we have no idea how this presumably significant business, appearing virtually overnight, magically valued at $6.2 Billion in the 20-F operates or functions.  

Things that the SEC must certainly be looking at here:
  • The Consolidation/Equity Method Accounting.
  • There's a chance that the actual cost to deliver 12.2 Billion packages might be s hair more than 2 cents each.  Where are these costs?  
  • Were any securities laws violated re: the "Cainiao Round of Funding"?  They took care in mentioning that the subscription of shares was "approximately pro-rata".  Who got paid? Was it an illegal transfer of shareholder money? 
  • WTF??? (ibid) 

Alipay/ANT

I've purposefully not included an analysis of the Alipay disclosures in this post.  The only thing that I'll say at this juncture is:  "How could the largest payment processor in China, with no real competition, possibly announce a surprise 4th quarter loss?"  In their press release they celebrated the US$4.5 Billion "financing round" setting the value of this business at US$60 Billion; about the same market cap as American Express. (Founded in 1965, $5 Billion Annual Earnings)  Really?  Stay tuned....


Summary:

Of course, the very existence of the above described discussions in an SEC filing should ring the alarm bells and strike fear in the heart of any Investor.  The level of disclosed insider self dealing is unprecedented.  I can't even imagine the level of the potential undisclosed chicanery taking place.  How could anyone (other than highly compensated lawyers like Simpson, Thacher & Bartlett, paid handsomely to zealously represent the interests of their client) possibly argue that the basis of any of these convoluted transactions or relationships could be in the best interest of US Shareholders? The couple of examples above are the most egregious but most likely just the tip of the iceberg.  The responses to SEC questions in the pre-IPO documents are a nice window into how the investigative process works.  As we can see by the Wasu disclosures (i.e. Shareholders taking it "up the Wasu".) that the SEC either lacks the will or the political clout to stop any of this.....but they will, of course, continue to ask excellent questions!

If I were a betting man, as per past experience, the SEC will continue to ask direct, pointed, intelligent questions, Alibaba will continue to give absurd, confusing ridiculous responses and the dance will go on.   Investors will continue to read (or not read) the correspondence and try to parse the meaning of Alibaba Counsel's cryptic answers.  But, as always, the music will eventually stop and the dance will finally end when someone actually pulls the plug.  It could be the unnamed PRC Bank seizing the pledged Wealth Management Products after Simon Xie's default.  It could be US Investment Banks shutting off the capital spigot after really taking a hard look at the endless string of odd acquisitions and continuous thirst for financing which dwarfs "real" operating cash flow.  It could be a few insiders, in an effort to do the right thing (and save their skin) filling out the whistle-blower forms available on the SEC website, fully documenting all of the (alleged) dirty little secrets buried in the bowels of the corporate records.

In any case, just about anything could cause this silly house of cards to collapse.  But what history tells us is certain, is that the SEC, Accountants, Regulators and Rating Agencies won't do anything meaningful until Investors are severely damaged by this mess. They will need to see the "confession letter" to change their inherent bias.  The inevitable, can always be delayed, but it simply can't be stopped.

So my question is: As an investor, there are so many places out there to park your money.  There are growing, thriving, well run honest businesses listed on exchanges all over the world.  You can park money in any of these stocks.  You can hold cash, mutual funds, bonds, ETF's  etc.  You can put money in your mattress.  There are more investment alternatives than ever before. So why in the world, as an investor or a banker, would you put your hard earned money in the Alibaba ADR?

6 comments:

  1. Maybe a foolish question, but are the SOX documents all signed by the same senior manager?

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  2. Thanks Bart. It's really not a silly question at all. I know Tim Steinert signs a few things here & there. But I couldn't tell you who signs off on the Sarbox docs. Normally it's the CEO and CFO, so according to the Org Chart it should be Daniel Zhang & Maggie Wu (Safe in China). Maybe they'll do a web-cast for the Congressional perp-walk?...LOL. But again, I've not seen the signed docs. If anyone has them feel free to post the link(s).

    http://docs.alibabagroup.com/assets2/pdf/Audit_Committee_en.pdf

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  3. Because it is Sunday, so time to play and maybe funny but correct analysis of all your work in one picture
    https://pbs.twimg.com/media/CCetVXSUMAEiGdE.jpg

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  4. This is brilliant!! I have never seen so much common sense displayed analyzing BABA which, as a US traded companies go, stinks to high heaven. I agree with every word. Though I never had the time and wits to put together something like this.

    I also enjoyed tremendously your wry sense of humor. BST translator must be open sourced for the good of all the humanity!!

    disclosure: I have made and lost money trading BABA short and long. Mostly short.

    Now, the 64K question is of course when this house of cards folds. I have been watching in awe as Oppenheimer, Baird, Goldman Suchs and today Morgan Stanley continue fluffing the BABA stock up even post SEC investigation announcement. Why? They are sophisticated operators. This is not their first rodeo. They know what will come eventually. Why expose themselves to another wave of shareholder lawsuits? Is their malpractice insurance so bulletproof and retroactive? What am I missing and what/who supports this stock?

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    Replies
    1. Thanks for the kind words Baerrus. I've received a few comments along the same lines from other readers. (i.e. how could this happen?) In a convoluted way, everything makes at least some sense when we connect the dots. I'll do a little deeper dive on my next post re: the price "support". This really is fascinating & thanks again for following my work.

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