Courtesy Thomas Lombard/Wikicommons
Alibaba Headquarters

Alibaba’s $20b Magic Carpet Ride

Steve Russell

Readers who follow this column will recall I said I don’t invest in China, but I will trade anything. I am toying with breaking that rule this week when Alibaba goes public, but I run hot and cold. Maybe writing about it will help me make up my mind.

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My reason for not investing in China is the same one for staying away from Russia (even before it invaded Ukraine and got sanctioned, which made their stock less available): lack of a reliable rule of law. The bottom line is that you can’t trust their courts. Every legal system has ambient corruption, but some systems deal with it as bad behavior and some institutionalize it.

China still practices “socialist legality,” meaning that it is always the duty of the courts to rule in the interests of the Chinese people, which are identical to the interests of the Communist Party of China (CPC). What could possibly go wrong?

On paper, the government is one of “democratic centralism.” It would be wrong to say all power flows from the top down, but that is how it works on the big questions. A business operating in China needs to get right with the provincial bureaucrats. Failure to do so might mean obstacles to utilities, transportation, a long-term lease where you can’t own property and even a reliable labor force. You know, like New Jersey.

My theory is that Alibaba may be insulated from the need to stroke provincial bureaucrats because it does business primarily in cyberspace.

The Chinese invasion of cyberspace has made a lot of people a lot of money while I sat it out. Google (GOOGL) refused to censor their search results and got crosswise with the CPC, and Baidu (BIDU) came to lead the search engine pack in China and to coin money for investors in the U.S.

Baidu was one of those cases where my morals got in the way of making money. I support Google in the fight for a free Internet and therefore I will not invest on the other side of Google in a censorship fight.

Alibaba is a Chinese combination of ebay (EBAY) and Amazon (AMZN), except that it grows faster than the two put together and, unlike Amazon, Alibaba shows a profit.

Alibaba’s initial public offering (IPO) will be listed on the New York Stock Exchange (NYSE), allegedly because Facebook’s (FB) IPO turned into a $16 billion fiasco when demand for the stock crashed NASDAQ’s system. Alibaba is expected to raise $21 billion, the most lucrative IPO ever.

My history with IPOs is mixed. I think of the remark attributed to Daniel Drew, one of the original robber baron capitalists: “Anybody who plays the stock market not as an insider is like a man buying cows in the moonlight.” IPOs are the ultimate insiders game.

An IPO – Initial Public Offering – is the process by which a private company becomes a public company and founders get the first allocation of stock. The IPO is organized by an underwriting syndicate with deep enough pockets to buy up the stock within the price range announced and resell it to the public. The underwriters, in consultation with the company, decide how many shares will be allocated among potential buyers. There is a strong bias in favor of institutions, which can buy in bulk, and fabulously wealthy individuals, whose participation almost amounts to “branding,” or a seal of approval.

Shares are sometimes allotted to brokerages not part of the underwriting syndicate, but within those brokerages, the same game plays out. The “best” customers get first in line. By the time all the piggies are fed, there’s little left for the home gamer trading on his personal computer.

If your discount brokerage was allotted shares, you can make a statement of interest and you might be offered the opportunity to pick up a few. But probably not. Your chances go up with the cash balance in your account and an active trading history.

IPO shares from hot companies usually spike at the open, steeply. As the feeding frenzy drives the price upward, there comes a time when the traders begin to take profit. The higher the price goes, the more traders bail, and at some point nobody is left but investors. The stock has found its level, except for what the insiders might do.

The company insiders, the ones at the very front of the IPO line, are normally subject to a “lock-up period” between 90 and 180 days, during which they cannot sell their shares. The purpose is to let the “beta coefficient,” the volatility of the stock, settle down if it’s going to and avoid the downward pressure from massive insider profit-taking. If you are an investor, you are not home free until after the lock-up period, after which you will know whether the insiders are with you or against you.


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