Alibaba Fraud Scandal May Help Google, Global Sources

Alibaba.com Ltd., owner of China’s largest online-commerce site, has been the go-to marketplace for Western companies seeking gaskets, garden gnomes and gelatin. Disclosures that its salespeople helped defraud buyers may send business to rivals Google Inc. and Global Sources Ltd. (GSOL)

Since Alibaba announced the scam Feb. 21, its chief executive officer and chief operating officer resigned, and the Hangzhou, China-based company has lost about $1 billion in market value. The flagship of Alibaba Group Holding Ltd., which counts Yahoo! Inc. (YHOO) as its biggest shareholder, also may struggle to sign up new clients, analysts said.

“This will hurt the company’s reputation and its ability to attract global buyers,” said Paul Wuh, head of Internet research at Samsung Securities Co. Ltd. in Hong Kong. “This could be positive for its competitors.”

Alibaba.com shares have fallen 13 percent in Hong Kong trading since the announcement, and three analysts downgraded their recommendations from buy to hold. Wuh, the top Alibaba analyst over the past year according to Bloomberg Absolute Return Rank, maintained his sell recommendation.

There were no upgrades. Seven of 27 analysts, or 26 percent, tracked by Bloomberg recommend buying Alibaba shares.

Alibaba declined 4 percent to HK$14.52 today, the lowest close this year.

‘Same Company’

The scandal hasn’t changed Alibaba’s prospects, said John Spelich, the company’s Hong Kong-based spokesman.

“We are the same company today that our customers have known for the last 11 years, and the whole point of the announcement earlier this week was to demonstrate our sacrosanct commitment to integrity,” he said last week. “We believe, over time, our customers will understand that.”

Alibaba.com, founded in 1999 by Jack Ma, is a business-to-business, or B2B, website. Its target audience is companies in the U.S. and Europe buying from low-cost manufacturers in China, Vietnam and Pakistan, among others. The buyers typically are too small to travel thousands of miles to meet suppliers and inspect factories.

The company operates marketplaces in Chinese, English and Japanese. Buyers use the services for free while suppliers pay an annual fee of 29,800 yuan ($4,500) to appear on the English-language website as a “Gold Supplier” for a year, Spelich said.

‘Some Bad Eggs’

The site offers tips for avoiding fraud and hosts a forum where users can notify each other of potential scammers. Alibaba also posts the names of suppliers who have been banned.

Alibaba.com may have been victimized by its own success, Wuh said. Sales more than tripled to $567.2 million in 2009 from $171.1 million in 2006, according to data compiled by Bloomberg.

That growth was fueled by company claims a third party verifies the credibility of all suppliers with paid memberships. Its database of registered suppliers almost tripled to 108,000 last year from about 30,000 in 2008, Wuh said.

The frauds recently disclosed involved vendors offering small quantities of electronics at attractive prices, with payments settled using “less reliable” methods, Spelich has said. Alibaba employees either intentionally or negligently allowed the vendors to evade authentication and verification measures, the company said.

“During that period, it was more difficult to manage and harder to check the quality of all the people on your network,” Wuh said. “There has to be some bad eggs in there.”

Google Benefits

Google Inc. (GOOG), the Mountain View, California-based operator of the Internet’s most-used search engine, may benefit from sellers setting up their own websites and paying to show up on Internet queries, said Muzhi Li, an analyst at Mizuho Securities Asia Ltd. in Hong Kong.

Caroline Hsu, a spokeswoman for Google in Hong Kong and Taiwan, declined to comment on how the company’s business might benefit from the Alibaba fraud.

“A big direction for us is our display and export business and helping small- and medium-sized Chinese companies who want to go global and leverage the Google platform,” she said.

Another beneficiary may be Global Sources, a Shenzhen, China-based organizer of trade shows where buyers meet sellers of electronics, toys and lingerie, among other products, analysts said. It organizes 56 shows a year in locations including India, China, South Africa, Dubai and Miami.

“You can actually go to a trade show and see the products,” Wuh said. “I see them benefiting directly.”

Third-Party Checks

The company also operates a B2B site the competes against Alibaba. Online and other media services accounted for about 66 percent of Global Source’s $174.5 million in revenue in 2009, the last full year reported. Its stock is up 19 percent this year in New York trading.

Like Alibaba, Global Sources uses contractors to vet suppliers through factory visits and checks of business registrations and credit, Chief Executive Officer Merle Hinrichs said. The company has about 260,000 sellers, primarily in Asia, and about 970,000 buyers worldwide.

“Customers may want to consider the portals they use in light of this development,” Hinrichs said. “We do far more on the front end to avoid these problems.”

The strength of Alibaba’s model has been called into doubt, said Dane Chamorro, managing director for North Asia at Control Risks Group in Shanghai. His firm does background checks for companies.

‘Lost Their Way’

“They didn’t do their homework and weren’t monitoring their own platform,” he said. “You have to devote internal resources to verify that third parties using your platform are viable and legitimate.”

Although Alibaba tries to minimize the risks to buyers by vetting sellers, the system broke down because staff colluded with fraudulent sellers to bypass that verification process, said Elinor Leung, head of Internet research at CLSA Ltd. in Hong Kong. More than 2,300 vendors were involved, Alibaba said.

Alibaba CEO David Wei and COO Elvis Lee, who weren’t accused of wrongdoing, resigned to take responsibility for the “systemic breakdown” of integrity, the company said in a statement. About 100 salespeople were involved, the company said.

Jonathan Lu, 41, who heads the Taobao.com online retailing affiliate, China’s Ebay, replaced Wei.

“We had a small number of colleagues that may have lost their way and chose another path,” Lu said in an e-mail to employees on Feb. 23, two days after the scandal broke. “We must immediately fix these mistakes to prevent future detours.”

That’s no small task, Li said. As many as 35 percent of Alibaba’s registered sellers don’t renew their one-year contracts, meaning the company needs to add about 35,000 new suppliers a year to maintain current sales.

The turnover rate at Global Sources is about the same, Hinrichs said.

The entire B2B industry will suffer from the Alibaba scam, he said.

“This kind of situation is unfortunate for the industry but more unfortunate for Chinese manufacturers, most of whom have struggled to present their products, companies and brands and to do a good job for their international buyers,” Hinrichs said.

To contact the reporter on this story: Frederik Balfour in Hong Kong at fbalfour@bloomberg.net

To contact the editor responsible for this story: Young-Sam Cho at ycho2@bloomberg.net.

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