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Alibaba U.S. IPO Filing Shows Risks of Bank Backlash to Alipay

Alipay's Application Displayed
The application for Alipay is displayed on an Apple Inc. iPhone 5s and iPad respectively, in an arranged photograph. Alipay, an online payment system like EBay Inc.’s PayPal, is owned by Alibaba founder Jack Ma and the company’s partners. Photographer: Brent Lewin/Bloomberg

Alibaba Group Holdings Ltd., which filed yesterday for what could be the biggest U.S. initial public offering ever, said one of the main risks it faces is tightening government oversight of its payments affiliate Alipay.

Alipay processes more than three-quarters of all transactions conducted on Alibaba’s Chinese online marketplaces, according to a 37-page section devoted to potential risks in its filing with the Securities and Exchange Commission.

China’s central bank in March blocked the issuance of virtual credit cards, in a move to tighten restrictions on online financial products. Alipay was among those planning to offer such cards. Its Yu’E Bao fund has also come under scrutiny as Chinese state-owned banks call for more regulation to stop the outflow of their cheapest source of funding.

“The greatest risk right now is in Alipay because of its movement into the banking sector,” said Paul Gillis, a professor of accounting at China’s Peking University. “It’s threatening the franchise of the big state-owned banks, and I don’t expect them to take that lying down. That’s probably the greatest risk here.”

The Hangzhou-based e-commerce giant also said China’s Internet infrastructure, slowing economic growth, regulatory oversight and comparatively obscure financial reporting requirements are among other factors that could potentially harm Alibaba’s business.

VIE Structure

Alibaba’s offering also shines a spotlight on a legal structure known as a variable interest entity, or VIE, intended to circumvent the Chinese government’s restrictions on foreign ownership of key industries.

The VIE format, first introduced when Internet portal Sina Corp. went public in 2000, gives overseas investors the gains and losses of the business through contracts rather than direct ownership. U.S. and Hong Kong regulators have raised concerns these contracts may not hold up in court.

While acknowledging that there remain “substantial uncertainties” regarding how the Chinese government interprets the current restrictions on foreign ownerships, Alibaba said in the filing it’s adopted safeguards to protect shareholders, including call options for individual holding companies.

Most of Alibaba’s business is generated by its wholly-owned foreign enterprises, with just 11.9 percent of revenue and 7.5 percent of assets contained within VIE structures, according to a blog post by Gillis. That compares with 28.3 percent and 10.1 percent respectively for Baidu Inc., Gillis wrote.

“Basically Alibaba is setting a new gold standard for VIEs,” Gillis said in an interview. “VIEs are a bad deal but this is the best one structured out there.”

Yahoo Dispute

Alipay, an online payment system like EBay Inc.’s PayPal, is owned by Alibaba founder Jack Ma and the company’s partners. Ma directly owns a “significant” minority stake and is general partner of another holding company, the IPO filing shows.

In 2010, Alibaba transferred ownership of Alipay to a company controlled by Ma. That move led to a dispute with shareholder Yahoo! Inc., which said it didn’t learn of the transfer until seven months later. At the time, Alibaba said the transfer was necessary because of Chinese restrictions on foreign ownership.

Alipay has more than 550 million registered users and processes about 8.5 million transactions a day, according to its website. Alibaba said its position as a “trusted platform for online and mobile commerce” depends upon its ability to provide reliable payment services through Alipay. The company is in talks to regain a stake in Alipay, a person familiar with the matter said last week.

Higher Returns

Alibaba licenses intellectual property and provides software technology services to Alipay in exchange for fees that amount to 49.9 percent of the affiliate’s pretax profit, the IPO filing showed.

Yu’E Bao, the fund pioneered by Alipay last year, competes with banks by offering deposits with higher returns. Yang Kaisheng, a former president of Industrial & Commercial Bank of China Ltd. and now an adviser to the China Banking Regulatory Commission, said in an interview in March that the country needs to step up regulation of Internet financing.

China’s central bank has proposed a cap on purchases of 5,000 yuan ($804) per single transaction done over Alipay, the filing showed. Some Chinese lenders are also targeting Alipay by imposing stricter limits on bank transfers than on other payment services, according to the document.

“There’s a bigger battle between the private sector and entrepreneurial class and China’s state-owned banks,” said Duncan Clark, the Beijing-based chairman of BDA China Ltd., which advises technology companies. “The bigger question is how far can Alipay can go into new areas in Internet finance.”

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