The Genie and the Giant

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The Citic / Bear Stearns fall-out is one example of many where proposed or actual tie-ups in China have changed as of late. Another prominent one is Yahoo and their arrangement with Alibaba, the largest B2B website in China. In August 2005, Yahoo invested US$1B for a 39 percent stake in Alibaba, who then agreed to run the Chinese operations of Yahoo. Now with Microsoft on the hunt for Yahoo, Alibaba wants to buy out the Yahoo stake and is looking for financing to do so.

One might think that actually sticking with the investment might be valuable for Alibaba as they would have the expertise of Microsoft, which has a relatively strong financial and strategic position in the market. The rub is that Yahoo, over time, relied heavily on Alibaba for their assistance getting into the market and as a result, Yahoo had very little control of the day-to-day management of the company or the operations in China – giving Alibaba relative autonomy and freedom to do as it wished.

Microsoft on the other hand, has a very solid position in the market, good relations with the government and would more than likely ‘interfere’ with the autonomy over the Yahoo stake that Alibaba has enjoyed in the past few years. As well, Alibaba is keen to take control of the Yahoo stake for political reasons; namely to allay Beijing’s fears that Microsoft's plan would increase foreign influence over China's leading Internet firms.

Alibaba plans to leverage a clause in the 2005 deal buy out Yahoo's stake. Financing would come from two lead investors and a group of others, including large Chinese institutions according to news reports. This activity has only intensified in the past few days as Microsoft announced its threat of a proxy battle. Yahoo China is actually one of the key sticking points in the deal, as Yahoo management sees it as a key strategic asset.

However, rounding up the money isn’t as easy as it was a few months ago. Even Softbank, who owns 33% of Alibaba has balked at raising funding. An anonymous source told the press "There's no way we could raise funds in this environment. We bought Vodafone (Japan) just in the nick of time. We were lucky." The more likely scenario is that funding will come from a Chinese pension fund or even another state-owned enterprise looking to get into the internet sector.

To make the situation even more complicated. Lawyers are now arguing what the clause in the 2005 deal means. Some interpret it to mean that Microsoft will simply “step into Yahoo’s shoes” in the venture. Others are saying that it gives Microsoft ownership of Yahoo's stock and not Yahoo's ownership in Alibaba. Regardless of the legal outcome, there’s likely to be intense government scrutiny of the deal whichever way it goes.

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