FINANCE: Investment Ban Hobbles Ant, New Thinking Needed
Bottom line: Beijing needs to roll out new rules allowing limited foreign investment in sensitive areas or risk seeing private companies like Ant Financial suffer from slower growth and artificially low valuations.
Alibaba-affiliated (NYSE: BABA) Ant Financial has been on a financial roller coaster ride over the past month, as it tries to raise billions of dollar to fund its growth en route to an IPO that will offer Chinese investors one of their first plays into the private banking sector. Some reports have said the new funding could value Ant, whose largest asset is the Alipay electronic payments service, at up to $50 billion. But others have put the figure as low as $30 billion, reflecting the intense negotiations taking place.
While such discrepancies are common during high-stakes talks, one factor depressing Ant’s valuation is China’s ban on foreign ownership of electronic payments providers like Alipay. That ban has sharply limited who can invest in promising start-ups like Ant, giving domestic institutional investors far more leverage than they might have if foreign rivals could participate.
Such limitations could artificially undervalue some of China’s most promising private companies, ultimately hurting their ability to raise funds and limiting their growth.
In order to avoid that happening, China should consider implementing a two-tiered system that would allow foreign investment in sensitive areas, but only on the condition that management control remained in the hands of local Chinese. Such a system already exists informally for Internet companies, allowing names like Baidu (Nasdaq: BIDU) and Tencent (HKEx: 700) to list overseas despite formal bans on foreign ownership.
Ant Financial’s origins actually stem from Beijing’s ban on foreign ownership of electronic payment systems. The company’s core asset, Alipay, was once directly owned by Alibaba, whose investors included big overseas names like US search giant Yahoo (Nasdaq: YHOO) and Japan’s Softbank. But because of the foreign ownership ban, Alibaba founder Jack Ma spun Alipay into a separate company controlled by himself and other Chinese partners.
Since its formal launch last year with Alipay as its largest asset, Ant has moved quickly into a wide range of banking services to take advantage of reforms by Beijing to open up the sector to private money. Many of those moves require big investment, including Ant’s most recent plan to launch an online bank.
To help fund its rapid growth, Ant is in the process of making a private placement that would bring in several major Chinese institutional investors. Three names mentioned in recent reports are all massive state-owned entities, including the country’s Postal Savings Bank, China Development Bank and China’s social security fund. The group would collectively pay about $5 billion for around 10-15 percent of Ant, amounting to $1 billion or more each, the reports say. (English article)
Only a small number of Chinese institutional investors have such large sums of money, severely limiting Ant’s choices for funding partners. That has given those companies stronger leverage for getting bigger stakes than they might if they had to compete with big global investors like Russia’s Digital Sky Technologies and Softbank, which have shown a far greater willingness to pay more for smaller stakes in such high-growth companies.
China’s Internet companies faced a similar quandary a decade ago, when many needed big money to grow but faced difficulties getting those funds due to a prohibition on foreign investment and the underdeveloped state of China’s private equity industry. To solve that problem, foreign firms used a legal structure called variable interest entities (VIE), which were off-shore companies that held all the equity of companies like Baidu and Alibaba but had no voting power over their actual management.
While Beijing never officially confirmed its acceptance of the VIE structure, a lack of official objection has been interpreted as the government’s implicit acceptance of the system as a way for Internet companies to tap foreign capital markets. Ant Financial’s business is in the equally sensitive electronic payments sector, which so far has been limited to only Chinese investment though it is set to open up gradually to foreigner competition over the next few years.
To make sure companies like Ant get the funds they need and valuations they deserve, China should allow similar schemes like VIE to develop for other sensitive sectors. Beijing could allow foreigners to take the initiative once more to create a similar system and provide its tacit approval as it did with VIEs. But it could also consider becoming more actively involved in the process this time, helping to create an official government-backed system that will remove any legal uncertainty about such investment.
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