INTERNET: Alibaba Finds New Can of Worms at Youku

Bottom line: An internal review that netted a Youku Tudou executive for suspected abuse of position was likely linked to the company’s pending purchase by Alibaba, and could be followed by more similar internal actions by China’s big tech companies this year.

Internal probe nets Youku VP

E-commerce leader Alibaba (NYSE: BABA) is quickly learning that major M&A can be a tricky business, as 2 of its largest purchases deliver headaches with the exposure of problems at acquired companies. First there were a series of accounting irregularities and a criminal investigation against an official at its Alibaba Pictures (HKEx: 1060) unit purchased in 2014, and now newly acquired online video unit Youku Tudou (NYSE: YOKU) is providing yet more headaches.

The latest problems are related to a single executive, with reports that a company vice president named Lu Fanxi has been taken away for questioning by police on suspicion of using his position for personal gain. This kind of activity is quite common in smaller Chinese companies, and Alibaba itself uncovered similarly inappropriate behavior by salespeople and fraudulent merchants at its B2B marketplace unit in 2011.

Uncovering problems like this after a major acquisition isn’t all that uncommon, and to an extent reflects a lack of strong internal controls at many younger and smaller Chinese companies. It’s only after an acquisition that such problems are often uncovered, and big names like Alibaba have shown a willingness to quickly address such issues after they are exposed.

This latest corruption case comes just 3 months after Alibaba offered to buy the remaining shares of Youku Tudou it didn’t already own for $3.7 billion. (previous post) That deal marked the largest purchase to date for the cash-rich Alibaba, easily trumping its $800 million purchase of a majority stake in ChinaVision Media Group in 2014, which it later renamed as Alibaba Pictures.

According to the latest reports, Lu was snagged during a comprehensive review of Youku Tudou’s books following the Alibaba purchase, aimed at laying the groundwork for the unit’s healthy future development. (Chinese article) Lu worked in Youku Tudou’s in-house production unit, part of a trend that has seen online video companies increasingly produce their own movies and series to give them more exclusive content.

Lu joined the company in 2009, and was responsible for making some of its most popular self-produced series. There’s no specifics on what exactly he was suspected of doing besides using his position for personal advantage. But such practice regularly occurs at Chinese companies of all sizes, and other big names that have netted executives in similar internal probes include telecoms giant Huawei, online search leader Baidu (Nasdaq: BIDU) and most recently real estate services leader SouFun (NYSE: SFUN).

It’s not completely clear from the reports if this latest review is related to Alibaba’s purchase, which has yet to close as Youku Tudou’s New York-listed shares remain publicly traded. But I suspect the review is probably similar to the one Alibaba conducted shortly after its 2014 purchase of a controlling stake of ChinaVision. That review led Alibaba to uncover accounting irregularities, and later the unit was forced to restate some of its asset values and take losses of nearly $50 million to correct the problem.

Company Official Arrested

Alibaba Pictures went on to cause more headaches for Alibaba after police later arrested one of the company’s executive directors, Patrick Liu, also known as Liu Chunning. In that instance Liu wasn’t arrested for any illegal behavior at Alibaba Pictures, but rather over allegations of inappropriate behavior during and after his earlier tenure at former employer Tencent (HKEx: 700). (previous post)

This kind of clean-up is sorely needed in China’s corruption-ridden corporate culture. And in many ways President Xi Jinping’s 2-year-old anti-corruption campaign is part of a much bigger national effort to clean up such practices in the Chinese government and at big state-owned companies.

Alibaba has also suffered similar headaches from negative publicity related to the rampant trafficking in pirated goods on some of its most popular e-commerce sites. Such trade in copyright- and patent-protected goods is also still quite common on China’s Internet, and Baidu has also been sued a number of times in the past for illegal trafficking of copyright protected songs on some of its sites.

At the end of the day, the uncovering of this kind of problem is inevitable at the big majority of Chinese companies, and it’s good to see big names like Alibaba trying to be more proactive in tackling the problem. We can probably expect to see a lot more similar internal probes and related actions in the year ahead, resulting in headline-grabbing criminal accusations as  big names like Huawei, Alibaba and Baidu take more steps to clean up their shops.

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