- Alibaba’s equity interest in Alipay has potentially increased to 33%, upon Alipay’s IPO.
- However, if Alibaba cannot secure regulatory approval to own any equity interest in Alipay, Alibaba will earn a royalty stream that’s equivalent to 37.5% of Alipay’s pre-tax earnings.
- Alibaba valuations will get a boost and investors can gain more upside if Alibaba can secure 33% equity interest in Alipay.
Alibaba has restructured the agreement it had with Alipay, and in this process of restructuring the equity interest, Alibaba investors will either gain 37.5% pre-tax income from Alipay for perpetuity, or they will receive a one-time payment equaling 33% equity interest upon Alipay’s IPO. Assuming Alipay goes with equity interest, the benefit to Alibaba shareholders will be more immediate, but if it goes with the perpetual profit share, the cumulative profit will take a while to accrue.
The upside from Alipay has improved significantly, which helps to alleviate the concerns major equity owners in Alibaba have had (Yahoo! (YHOO) and SoftBank).
Assuming Alipay goes public (under Small and Micro Financial Services) Alibaba will earn $9.38 billion from a liquidity event payment (basically gain 33% equity interest in Alipay).
This new agreement is a significant improvement from the original, as the minimum guarantee from an Alipay IPO was equity valued at $2 billion, and the maximum Alibaba would get in terms of equity value at IPO was $6 billion. The equity interest that Alibaba was entitled to was increased significantly.
Under the new deal, If Alibaba does receive 33% equity interest following PRC (Peoples Republic of China) approval, the 37.5% profit share will cease. Therefore, Alibaba investors will either get equity, or they will get a perpetual stream of royalty that’s equivalent to 37.5% of Alipay’s pre-tax earnings.
However, Alibaba investors should prefer the equity interest as it carries long-term upside and can boost Alibaba valuation further, as Alipay could potentially trade at a significantly higher value following the IPO. If in the event the PRC blocks Alibaba from gaining significant equity interest in Alipay, the on-going 37.5% pre-tax earnings stream is the next best remuneration that Alibaba shareholders can expect to receive.