| CEO and founder of Alibaba.com, Jack Ma, left, is all smiles after his deal with Yahoo CEO Daniel Rosensweig. |
THE EFFORTLESS INSOUCIANCE with which a web browser surfs the globe makes it tempting to assume that the internet as a commercial operation is as disdainful of borders. The reality is quite different, as many big US online companies are finding to their cost. No more so than in China, where all the top web destinations remain homegrown.
The difficulty of cracking what has turned out to be an idiosyncratic and unpredictable market, despite the dollars available, is one reason for Yahoo’s deal with Alibaba, China’s leading e-commerce business.
The headlines boast that, for $1 billion cash, Yahoo will acquire a 40% stake in Alibaba. It sounds straightforward, but there is a lot more behind the investment, as John Chi, managing director of Seraphin Capital, a boutique merchant bank that advised Alibaba, explains. “Alibaba will acquire all of Yahoo’s businesses in China: that’s search, portal, email, instant messaging and downloads,” he says. “Plus, Alibaba gets the exclusive rights to Yahoo’s technology and brand name in China.”
So it is Alibaba that is doing the acquiring. Yahoo, in addition to selling all of its China businesses for some $700 million in Alibaba shares, is investing $1 billion of capital: $750 million to purchase existing shares from shareholder Softbank Corporation and other venture capital funds and $250 million in new shares. Yahoo will become the company’s largest shareholder, with some 40% of the economic interest in the new Alibaba group. Softbank and Alibaba management will each hold 30%.
Cashflow positive The deal values the existing Alibaba businesses at $3.3 billion. These comprise Alibaba International, the original B2B e-commerce platform; AliPay, Alibaba’s e-payment system; and TaoBao, its online auction business joint venture with Softbank that will be folded into Alibaba as part of the transaction. A valuation of that magnitude says a lot about how Yahoo regards the management of Alibaba and how keen it was to do a deal in China. Although group 2004 free cashflow amounted to $25 million on total revenues of $68 million, only Alibaba International is cashflow positive: AliPay and TaoBao are both loss-making, despite their rapid and impressive growth.
Another indication of Yahoo’s hunger for the deal is the shareholders’ agreement signed as part of the transaction. Although Yahoo holds 40% of the equity, it has agreed that it will vote with only 35% of its shares, says Seraphin’s Chi, with Alibaba founder, chairman and CEO Jack Ma permitted to vote with the remaining 5%. This means that on voting matters, management and Yahoo hold equal sway. That is not all. According to Chi, Ma also has final say on any change of control. “Jack has a personal poison pill,” Chi says. “A personal veto over anyone buying 50% [of Alibaba]. He’s definitely calling the shots.”
It might seem a somewhat lopsided deal but, Chi says, Yahoo also gets what it wants. “The main rationale for the deal was for Yahoo to get into bed with what they consider to be the best management team in China.”
According to Joseph Tsai, Alibaba’s CFO, Yahoo had a pressing need for a partner in China. “Yahoo realizes that they’re very strong globally but weak and undervalued in China. Everyone in China has heard of Yahoo: the recognition is definitely there, but their businesses [there] are relatively weak. The opportunity is to take that brand and revitalize it – it’s a turnaround opportunity for us.”
Plugging the gap The deal is not all one-way traffic, however, as Tsai admits. In addition to the obvious benefits of unfettered access to the Yahoo brand in China, the deal has plugged a gap in Alibaba’s product line that was clearly beginning to worry it.
“We’ve seen how search has changed things in e-commerce,” says Tsai, “and if we didn’t have a search engine, it could be a threat. The analogy is how Google has drawn away advertisers from eBay. We’ve seen the value shift from e-commerce to search and we felt we needed to hedge our bets.”
So Alibaba gets what it needs. Whether Yahoo does will become apparent only after some time, as China’s internet landscape becomes clearer. For now, Yahoo’s deal amounts to little more than a huge bet on the management team of Alibaba and its existing business e-commerce model, the price of which is giving up full control of its China growth strategy. That might seem like a big gamble, but there is an encouraging precedent for Yahoo in the form of its highly successful Japanese business, separately listed in Tokyo and managed in partnership with Japan’s Softbank Corporation.
“Yahoo Japan was very much a hand-in-hand cooperation between a very strong local partner and a technology leader and visionary,” says Chi. “[Alibaba and Yahoo] intend to replicate that.”
Turning a young company valued at $4.25 billion post Yahoo’s new money into a business worth $40 billion, Yahoo Japan’s approximate market value, will take some doing, but the market itself is certainly big enough to accommodate such a gorilla: China’s online population is growing at a prodigious rate. The key to Alibaba’s strategy of course will be to monetize that growth – while the internet is largely borderless for users, the same cannot be said when collecting the dollars and cents, or yuan and fen, that define the success of any online venture. “Like most internet businesses we divide our constituents into two groups – viewers and paying customers, that is, advertisers, a bit like TV,” says Tsai. “In terms of user generation, we’re agnostic on borders and geographic lines. When it comes to paying customers, you need a very strong on-the-ground network. We have a sales force of more than a thousand pounding the pavements seeking out advertisers among our client group – mainly small to medium-size enterprises.”
Internet business dynamics also affect consolidation opportunities among China’s online businesses, says Tsai. “If you’re in exactly the same business, it’s difficult to do an acquisition,” he says, “because you’re unable to integrate: you only have one website, one domain name through which you can acquire registered users. So consolidation tends to be across product lines.”
The road to IPO Even so, Tsai believes China’s internet sector will consolidate and expects Alibaba to be actively involved. “It’s a competitive field,” he says, “and the China portals are getting into the search business, so it’s going to get crowded. But search is one business where brand, technology and capital are critical. Are we going to be a consolidator? Yes: we have the size and the capability. But the next 12 to 18 months is about integrating the Yahoo businesses and rolling out the search product.”
With Yahoo’s cash added to Alibaba’s existing funds, Chi reckons Alibaba will be sitting on some $350 million of free cash by the end of calendar 2005. If any more is needed, Alibaba’s key shareholders have deep pockets. “We think we have as much money as anyone else in the market,” says Chi, “between us and our shareholders.”
If any more capital is needed, Alibaba can always go public, a strategy that Ma has assiduously avoided to date. No longer, apparently. Although there is no firm timetable for a listing, there is now a firm intention says Chi. “An IPO is the absolute intention of all the parties,” he says. “A lot of people thought Alibaba had given up full control to Yahoo, but that’s not the case. The shareholders’ agreement legislates that Yahoo, Softbank and the management team fully intend to undergo an IPO as soon as possible. That’s really a function of integrating the businesses and market conditions.”
“We don’t have a firm timetable for the IPO but it is the intention of the investors,” says Tsai. “The model is similar to Yahoo Japan, which has a separate listing.”
If Alibaba and Yahoo are successful in China the firm could surpass Yahoo Japan’s market value. The success of the deal will lie in Alibaba’s execution, in integrating the Alibaba and Yahoo businesses and in particular in maximizing revenues from Yahoo’s search technology and premium brand. The firm’s track record augurs well: Alibaba has successfully established China’s leading B2B e-commerce marketplace, which is already profitable and has taken on and is beating eBay’s China online auction site with TaoBao.
Going local The secret behind these achievements, claims Tsai, is that Alibaba is a Chinese business run by Chinese management. The need to think local and to react quickly to market trends and idiosyncrasies has placed foreign firms that tend to adopt multi-layer management structures at a disadvantage to Chinese competition.
“If you look at the market,” says Tsai, “no foreign company has been able to break into China: all the number-one players are locally grown. In the internet, decision-making needs to be very fast. If you come into the China market with a multinational structure, it won’t work.”
Yahoo’s deal with Alibaba means that Ma and his team enjoy complete management freedom in China, as Tsai is happy to explain. “Yahoo has realized that the way to do it right is to hand over a lot of operational flexibility to the local management team. We report to a board of directors of four people. That’s it: it’s operated as an independent company from Yahoo. We’ll only answer to our board and not to Yahoo’s management.”
Provided that Yahoo has backed the right team, its approach looks canny and likely to succeed. Yahoo, says Tsai, has learnt the lessons from its past mistakes; lessons that others have yet to heed.
“It is quite unusual for a major multinational corporation like Yahoo to accept a minority position in a country as significant as China,” he says. “It shows a lot of long-term thinking: they’ve been in the market seven or eight years and accumulated a lot of wisdom. Google and others will have to make their own mistakes before they can progress.”
If Alibaba fulfils its management promise and leads Yahoo to the number-one position in China, the rest of its competitors will also learn Yahoo’s China lessons. The risk to them is that the lessons get learned too late.
