Case Study – Alibaba’s Long, Strange Trip
Case Study – Alibaba’s Long, Strange Trip
Here we are, and nearly 10 years after going public, Alibaba’s stock today was for a short time under its IPO price...
This isn’t the first time it dipped below $68....
It did so in 2015, 2016 and again in 2022, and then today.
Today’s action was no doubt tied to news of China’s slumping economy... and a reminder that all booms are generally followed by busts, or a reasonable facsimile.
The stock’s sluggishness also reflects ongoing concerns over China’s new attitude toward business, which coincided with CEO Jack Ma’s disappearance in 2020 after criticizing China’s government… which, in turn, coincided with the beginning of a multi-year slide in Alibaba’s stock after first shooting past $300.
A Play on China
Ma resurfaced months later, with little explanation. But the whole ordeal was beyond bizarre, especially for Alibaba...
At the time of its public debut in 2014, Alibaba was not just another IPO or even another Chinese IPO. It was the biggest IPO ever.
Key to its popularity were its profit margins, which were in the 40% range. As Bloomberg put it at the time, those margins were “far higher than its U.S. rivals. Amazon.com, the world’s largest online retailer, had a net income margin of 0.51 percent in the March quarter, while EBay Inc., the biggest auction site, had a margin of 18.1 percent.”
Alibaba was the Chinese Amazon, only better... as if Alibaba simply did everything better than everybody else.
And at its public debut at the New York Stock Exchange, Jack Ma became an instant celebrity.
Investors big and small piled in....
The inspirational story of the company’s founding at Ma’s apartment kitchen table became legendary, as did its rapid growth, reflecting China’s explosive economy.
Alibaba became a public proxy for investing in China.
Way too Complicated
But under the surface, there were growing questions, starting with simply how complicated the company’s structure was.
As I wrote in a story that appeared at TheStreet.com 10 days before the actual IPO, referring to the company’s IPO prospectus....
Ignore the pictures of founder Jack Ma and the smiling people. Ignore the colorful charts and the tables showing how fast the company is growing and how big its potential market is.
They're all an effort to get you to gloss over just how complicated Alibaba really is, and complicated often equals trouble.
Any efforts to untangle this company require more than any old genie. They requires a forensic accounting genie.
I went on to say...
Alibaba is just too darn complicated, starting with the footnotes. Footnotes are common in financial filings, but when it comes to footnotes reconciling the various financial statements, Alibaba takes them to a new level, such as these below the consolidated financial statements.
As it turns out, what I wrote only scratched the surface...
Raising Red Flags
After its IPO, more than a few short-sellers – the most public, Jim Chanos – started raising red flags over Alibaba’s structure and accounting.
By then I had gone on to start Pacific Square Research with my former business partner, who was (and is) an exceptional forensic accountant. He confirmed what Chanos had found and went on to uncover numerous other inconsistencies and accounting issues... all of them suggesting that Alibaba’s IPO financials were as much of an illusion as was China’s real estate boom.
in 2015, the SEC had launched an informal investigation into whether the company had violated securities laws. The investigation turned formal in 2016, and the company has been disclosing it every year since... most recently last July.
Not that investors cared or paid attention...
‘They’re Wrong’
That was evident during CNBC’s annual Delivering Alpha conference in late 2016, when then-Vice Chairman Joe Tsai – now the company’s chairman – sat for an interview with Jim Cramer and David Faber.
Chanos had been a speaker earlier in the day, and Faber mentioned that the short-seller had “been going after Alibaba a bit.” Tsai responded that Chanos “doesn’t to try to understand the business and to appreciate the power of the digital economy in China.” (Which, of course, is irrelevant to the issues Chanos had been raising.)
Cramer then went on to mention the research, which I had shared with him. Turning to Tsai, mentioning me by name, he said...
He believes that you are buying your growth with these, and that if you actually disclosed all the equity investments – which he says you do not – you would have no idea what this company is really earning, other than the fact that the – most of the costs, like what you described, two million people, are off balance sheet, so you can't really figure out how well the company is actually doing.
Tsai responded (emphasis added)...
They're wrong. They never read our annual report. They never read our disclosures. We've made very clear disclosures about our equity investees, our affiliated companies. So that's just not right. And I hope that these guys will spend time and go to China and see what's going on, the power of consumption, the power of people – young people today in China are accessing the Internet through the mobile device.
We responded in a note to our subscribers, mostly hedge funds...
Hold on. Ding. Ding. Ding. Did he say we have not read the annual report and disclosures? (Yes he did, in black-and-white!) That’s absurd. And with more than 2,000-plus hours of forensic work, we can comfortably say that in addition to what BABA has disclosed, we know what it hasn’t disclosed… but we believe probably should have disclosed. Lack of disclosure is a big part of our thesis. It’s one thing to disagree with our analysis; it’s another to say we haven’t done our work. And as for his comment – “You can't just sit in the back room and read some balance sheet and draw conclusions about the business.” We beg to differ. That’s what analysts are supposed to do. And it’s what forensic accountants always do.
Surprise, surprise, without fanfare Alibaba went on to quietly restructure itself in ways that seemed to eliminate some of the issues we spotlighted.
Moral of This Story
Therein lies the moral of this story: Accounting issues don’t matter until they do, if ever. If everybody wants to own a stock, they will, regardless of any and every red flag.
Some companies transcend the concerns; others – especially if they’re highly levered or turn out to be complete frauds – don’t.
And if they do, it may be something else that gets them...
Like Jack Ma disappearing... and China cracking down on what it likely perceived as capitalists gone wild.
Funny how that works.
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DISCLAIMER: This is solely my opinion based on my observations and interpretations of events, based on published facts and filings, and should not be construed as personal investment advice. (Because it isn’t!)
Feel free to contact me at herb@herbgreenberg.com. You can follow me on Twitter (X) and Threads @herbgreenberg.
When Jack Ma disappeared I thought maybe he became like the doodah man or Sweet Jane living on reds, vitamin C and cocaine. Ain't it a shame.
Thanks Herb - great write up.. One thing I have wondered on BABA is why Charlie Munger (RIP) was a bull and owned a chunk - why didn’t this fall into his too complicated box or outside his circle of competence? Was it Li Lu’s influence? Tbh, I hadn’t followed the complexity of it, but when Ma went missing, that was the sign that either the company isn’t right or the Chinese gov is saying they’ve got too big for their boots... which was then reiterated by the ‘tax bills’ that Tencent had to pay..