Alibaba Seeking Control Leaves HK Bourse in IPO Quandary

Hong Kong has a choice: grant Alibaba Group Holding Ltd. a shareholder structure that mirrors the world’s largest Internet companies, or stick to rules meant to protect ordinary investors and risk losing the largest initial public offering since Facebook Inc.

China’s biggest e-commerce company asked Hong Kong’s stock exchange to allow a partnership of more than 20 executives and shareholders to nominate a majority of board members, a person with knowledge of the matter said last week. That would enable founder Jack Ma, who owns just a 7.4 percent stake, and his management team to maintain control after an IPO.

Alibaba’s proposal would be a way around the Hong Kong exchange’s ban on IPOs with different classes of shares, a structure frequently used by U.S. technology companies including Facebook and Google Inc. Granting the request leaves the bourse open to criticism that it’s putting the company’s interests ahead of shareholders, the Asian Corporate Governance Association said.

“We are pretty certain that it won’t fly,” said Jamie Allen, the Hong Kong-based ACGA’s secretary general, in an interview. “The right to nominate directors is a basic right, so we don’t believe that the exchange will accept this.”

An IPO by Alibaba would be a coup for Hong Kong, home to only one other major Internet company: Tencent Holdings Ltd., the operator of the WeChat service.

Biggest IPO

Hangzhou-based Alibaba, which connects businesses and consumers to each other across China, has a value of about $87 billion, according to the average of 11 analyst estimates released last month. It could raise about HK$100 billion ($12.9 billion) in an IPO, Ernst & Young LLP said in June.

That would be the world’s biggest since Facebook raised $16 billion in May of last year, and the city’s largest since AIA Group Ltd.’s $20 billion offering in October 2010, according to data compiled by Bloomberg.

Under Alibaba’s proposal, all shareholders would still vote on the company’s nominees with partners being able to nominate an alternate board member if shareholders reject a candidate, the person familiar with Alibaba’s thinking said. No other investor rights would be changed, the person said. Deals involving company executives, major expenses and compensation would be voted on by all shareholders, according to the person.

The proposal will have to be approved by the Hong Kong stock exchange’s listing committee. The Hong Kong’s Securities and Futures Commission, or SFC, has the power to object to a listing application on “certain grounds,” according to a 2011 report by the regulator.

‘Exceptional Circumstances’

Under Hong Kong’s listing rules, new applicants must not include shares whose voting power doesn’t bear a “reasonable relationship” to the equity interest. Exemptions can be granted for stock that was already listed with a dual class and “exceptional circumstances agreed with the exchange.”

Florence Shih, a Hong Kong-based spokeswoman for Alibaba, and officials at Hong Kong Exchanges & Clearing Ltd. and the SFC declined to comment.

“Alibaba seems to see this process as negotiation with the exchange rather than the listing process being fairly set in stone,” said Allen of the ACGA. “There is a degree of negotiation but usually on more peripheral things, not on something quite as fundamental as the right of shareholders to nominate directors.”

Interests Aligned

While Alibaba’s proposal may draw criticism, the company’s partnership itself has benefits, including aligning management interests with those of the company, said Richard Ji, a former Morgan Stanley technology analyst now raising his own fund to focus on Internet companies.

“The partnership structure also allows the heads of different parts of the group to care about each other’s business,” he said.

Alibaba’s partnership includes Ma, co-founder Joseph Tsai, Chief Executive Officer Jonathan Lu and at least five women, the person said. Those partners will vote annually on adding new members and eligibility is limited to employees who have been with the company for at least five years, the person said.

Maintaining control of the board would give Alibaba’s partners the chance to anticipate and respond to rapid changes and advances in technology as the company competes for online and mobile spending. Ma is expanding Alibaba’s reach into financial services, logistics networks and smart TV. Limiting a majority of board nominations to the partners would also keep any activist investors at bay.

Ma, who founded Alibaba in 1999, also wants to ensure executives don’t lose control to activist investors such as Carl Icahn and Daniel Loeb, who have tried to push their own candidates onto company boards as they sought a new strategy.

Google, Facebook

While an IPO on the New York Stock Exchange or Nasdaq Stock Market would allow Ma to use a dual-class structure to maintain control, the proposal to Hong Kong suggests it would prefer to do an IPO closer to its fast-growing customer base.

Google founders Larry Page and Sergey Brin control 81 percent of the company’s Class B shares, which carry 10 times the voting power of shares owned by ordinary investors, data compiled by Bloomberg show. Facebook founder Mark Zuckerberg controls 69 percent of the company’s Class B shares.

According to the Hong Kong exchange’s corporate governance code, companies should set up board nomination committees where a majority are independent non-executive directors. Listed companies that deviate from the guidelines must give “considered reasons” for doing so in their annual and interim reports, according to the exchange.

Reputational Risk

A listing in Hong Kong would also give Alibaba less exposure to the risks of shareholder litigation, a phenomenon most common in the U.S., according to Andy Pitts, a partner at Cravath, Swaine & Moore LLP in New York.

“There is still a great anxiety about liability under the U.S. securities laws,” Pitts said. “If a non-U.S. company thinks that there’s a sufficiently large investor base to raise the capital that they need, then listing somewhere closer to home can be a very desirable option.”

Hong Kong is the fourth biggest equity market in the world with companies trading there worth a combined $3.2 trillion in market value, according to data compiled by Bloomberg. An IPO there would give both Alibaba’s customers and global investors a chance to invest in the company.

At the same time, making an exception for Alibaba risks putting the exchange’s reputation at risk, said Erik Gordon, a professor at the University of Michigan’s Ross School of Business and Michigan Law School.

“The Hong Kong exchange is well respected and you can raise a lot of capital,” he said. “If they go for this, no one is going to be fooled. Everybody is going to say ‘the H.K. exchange is one of these exchanges that has its integrity unless you’re big and powerful enough.’”

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