Time to Cash Out of China?

China has a credibility problem.

Anyone thinking that the standoff between Yahoo! (Nasdaq: YHOO  ) and Alibaba over a sneaky asset transfer is an isolated ownership and disclosure issue didn't watch the ticker tape last week. Many of China's growth stock darlings got clobbered.

Why did this happen? Are Chinese stocks down for the count with stateside investors?

Hop on for a wild ride to the past -- and the future.

The new asset stress test
Yahoo!'s 43% stake in Alibaba Group -- one of China's most successful Internet companies -- has been viewed as the shining star in Yahoo!'s otherwise ho-hum operations.

Alibaba Group does a bit of everything. Its Taobao site is a consumer-facing marketplace. Alibaba.com -- which was spun off as a public company a couple of years ago -- is the country's leading B2B platform.

Then we get to Alipay, a popular electronic transaction service that is aptly described as China's PayPal.

Alipay was handed over to a new company headed up by Alibaba CEO Jack Ma last summer. Yahoo! claims it wasn't made aware of the asset transfer until the end of March.

There are two thorny issues here. The first bone of contention is obviously the faulty dissemination of critical information. Alibaba doesn't see it that way. It claims that Yahoo! did know about this, since Alibaba's directors have been discussing this since 2009. Yahoo! has a seat on Alibaba's board. However, it does seem as if Yahoo! and fellow minority stakeholder Softbank were blindsided by the news.

The bigger problem here is that it seems as if Alipay was carved out without any compensation for Yahoo!.

Given China's protective nature, it's easy to fathom Alibaba Group wanting to reposition a fast-growing financial transaction platform as an entirely Chinese-owned endeavor so it doesn't run afoul of any Chinese ownership restrictions.

However, last week's Yahoo! filing doesn't seem to indicate that it will be compensated for an asset transfer that is likely valued in the billions of dollars. This is what's spooking the bejeezus out of investors. If any Chinese company can transfer valuable assets without recourse, aren't we all just buying mystery meat?

The two companies claim that they are now in discussions over the transaction, but it's bothersome to see Alibaba get into this now -- and not before it actually completed the transfer last summer.

Shares of Yahoo! took an 11% hit last week. If you think that it's the biggest dot-com loser in this mess, check out last week's bloodshed at some of China's once high-flying Internet stocks.

Company

5/13/11 Close

Weekly Loss

Renren (Nasdaq: RENN  ) $13.16 (22%)
Bitauto (Nasdaq: BITA  ) $7.79 (18%)
Youku.com (Nasdaq: YOKU  ) $48.54 (18%)
SINA (Nasdaq: SINA  ) $106.88 (15%)
SouFun (Nasdaq: SFUN  ) $23.00 (12%)

Source: Capital IQ, a division of Standard & Poor's.

Ouch! They unknowingly paid the price for Alipay.

Taking the wheels off a revolution
It isn't a surprise to see Renren as the biggest loser. The company behind China's popular Renren.com social networking site has had a rocky run since going public this month. Its curious structure -- set up as a Cayman Islands company that merely has contractual rights to the economic benefits of the social network, which is 99% owned by a Chinese citizen -- raised enough eyebrows before the Alipay-gate news broke. How sure are Renren investors now of what they're buying?

Investors have been loading up on SINA given the success of its Twitter-esque Weibo in recent months. Youku runs China's leading video-sharing website. Bitauto and SouFun operate fast-growing websites specializing in automotive and homeownership, respectively. These companies are unlikely to stiff investors, but if Alibaba can get away with it, why take that risk elsewhere?  

Were there other factors? Sure. Bitauto and SouFun didn't fare too well after posting quarterly results. However, it's not as if the numbers were shabby on either front. Revenue at Bitauto and SouFun climbed 57% and 54%, respectively. Earnings grew even faster!

The onus is on Alibaba Group to make things right. If it doesn't find a way to make Yahoo! and Softbank whole, we may have seen the last Chinese dot-com go public in this country.

If Google's (Nasdaq: GOOG  ) principled retreat from China last year was enough to get U.S. Secretary of State Hillary Clinton in attack mode, just imagine what this might turn into. After all, if Chinese companies can quietly replace valuable assets with clouds of vapor, can we return the favor? Can we swap all of the U.S. debt that China's buying for Blockbuster stores, "Lakers Three-peat Again" T-shirts, and David Hasselhoff CDs?

The upside potential of Chinese stocks given the booming economy of the world's most populous nation is too juicy to ignore, but Alibaba and the thorny thieves are making it hard to wax bullish. If this is how a Chinese company can treat its billionaire investors, what kind of chance do the little folks like you and me have?

Did last week's double-digit plunge on China's dot-com darlings create the mother of all buying opportunities or is caution warranted? Share your thoughts in the comment box below.

The Fool owns shares of Google and Yahoo!. Motley Fool newsletter services have recommended Google, Sina, and Yahoo!. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

Longtime Fool contributor Rick Munarriz still believes in China and has recommended several Chinese growth stocks to Rule Breakers newsletter service subscribers. He does not personally own shares in any stocks mentioned in this article. The Fool has a disclosure policy, and it's got mail.


Read/Post Comments (3) | Recommend This Article (7)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 16, 2011, at 10:47 AM, Supersyd wrote:

    Your points are well-taken, Rick, and underscore how nervous I get about investing overseas, where laws (if any) are not the same as here. But why not go about it another way? Instead of buying Chinese companies and their attendant risks, why not buy Chinese exposure with a good solid American company like Veeco or YUM!?

  • Report this Comment On May 16, 2011, at 11:42 AM, BabyBeluga2 wrote:

    Cramer would have it that AAPL, YUM and CAT are good China plays safely housed in the U.S., of course. The idea of gaining Chinese exposure with less risk is certainly a reasonable one. For scarier cases, just review the recent history of CAGC and mull over statements to the effect that every company in China tends toward fraud in its reporting practices. Scary! Scary!

    Yet the credibility problem in China is not new, and the market is overselling the entire Chinese internet sector, which is an opportunity for stock pickers who know that the Alibaba-Yahoo scandal will pass eventually, while the growth in the Chinese internet sector will continue to grow on a very, very large scale.

    Could it be that the additional uncertainty about the data in China gives the retail investor an even chance against the professionals such as Goldman Sachs? I suspect that demographics and economic growth in China will in the end be more decisive than the conventions Wall Street upholds but regularly violates in its own right. Yes, the Chinese have noticed Western hypocrisy before. . . .

  • Report this Comment On May 16, 2011, at 12:04 PM, pogicraft wrote:

    This has been the argument from the very beginning... which I caught wind of when Youku went public -- when buying Chinese companies, what exactly are you buying, especially as many of them come with zero dividends and have no voting rights (not to mention even if you bought all the shares afloat, you'd still own less than 10% of the company)

    so this certificate that stakes a claim to a offshore holdings company with minority stake in a property firm which oversees assets including the one you're interested in... it might as well be vapor

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