|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Noon buying rate
|
|
Period
|
|
Period end
|
|
Average
(1)
|
|
Low
|
|
High
|
|
|
|
(RMB per US$1.00)
|
|
2012
|
|
|
6.2301
|
|
|
6.2990
|
|
|
6.3879
|
|
|
6.2221
|
|
2013
|
|
|
6.0537
|
|
|
6.1412
|
|
|
6.2438
|
|
|
6.0537
|
|
2014
|
|
|
6.2046
|
|
|
6.1704
|
|
|
6.2591
|
|
|
6.0402
|
|
2015
|
|
|
6.4778
|
|
|
6.2869
|
|
|
6.4896
|
|
|
6.1870
|
|
2016
|
|
|
6.9430
|
|
|
6.6400
|
|
|
6.9580
|
|
|
6.4480
|
|
December
|
|
|
6.9430
|
|
|
6.9198
|
|
|
6.9580
|
|
|
6.8771
|
|
2017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
January
|
|
|
6.8768
|
|
|
6.8907
|
|
|
6.9575
|
|
|
6.8360
|
|
February
|
|
|
6.8665
|
|
|
6.8694
|
|
|
6.8821
|
|
|
6.8517
|
|
March
|
|
|
6.8832
|
|
|
6.8940
|
|
|
6.9132
|
|
|
6.8687
|
|
April
|
|
|
6.8900
|
|
|
6.8876
|
|
|
6.8988
|
|
|
6.8778
|
|
May
|
|
|
6.8098
|
|
|
6.8843
|
|
|
6.9060
|
|
|
6.8098
|
|
June (through June 9)
|
|
|
6.7970
|
|
|
6.7998
|
|
|
6.8085
|
|
|
6.7935
|
|
-
(1)
-
Annual
averages are calculated using the average of the rates on the last business day of each month during the relevant year. Monthly averages are calculated using
the average of the daily rates during the relevant month.
B. Capitalization and Indebtedness
Not Applicable.
C. Reasons for the Offer and Use of Proceeds
Not Applicable.
D. Risk Factors
Risks Related to Our Business and Industry
Maintaining the trusted status of our ecosystem is critical to our success and future growth, and any failure
to do so could severely damage our reputation and brand, which would have a material adverse effect on our business, financial condition and results of operations.
We have established a strong brand name and reputation for our ecosystem. Any loss of trust in our ecosystem or platforms could harm our
reputation and the value of our brand and result in consumers, merchants, brands
8
Table of Contents
and
other participants reducing their activity level in our ecosystem, which could materially reduce our revenue and profitability. Our ability to maintain our position as a trusted platform is based
in large part upon:
-
-
the reliability and security of our platforms as well as the commitment to high levels of service, reliability, security and data protection by
the merchants, developers, logistics providers, service providers and other participants in our ecosystem;
-
-
the quality, breadth and functionality of products, services and functions and the quality, variety and appeal of content available through
our platforms;
-
-
the effectiveness and perceived fairness of rules governing our marketplaces and other platforms and overall ecosystem;
-
-
the strength of our consumer and intellectual property rights protection measures; and
-
-
our ability to provide reliable and trusted payment and escrow services through our arrangements with Alipay.
Increased investments in our business, strategic acquisitions and investments as well as our focus on
long-term performance and on maintaining the health of our ecosystem may negatively affect our margins and our net income.
We have experienced significant growth in our profit margins and net income. However, we cannot assure you that we will be able to maintain our
growth at these levels, or at all. Our operating profit grew 65% from fiscal year 2016 to fiscal year 2017 but our net income decreased by 42%. Consistent with our focus on the long-term interests of
our ecosystem participants, we may take actions that fail to generate positive short-term financial results, and we cannot assure you that these actions will produce long-term benefits. There can be
no assurance that we will be able to sustain our net income growth rates or our margins.
We
continue to increase our spending and investment in our business to support our future growth, including in expanding our core commerce offerings, such as our continuing efforts to
grow Tmall Supermarket, a supermarket category for high quality fresh produce, food products and fast moving consumer goods, or FMCG; improving our technological infrastructure and cloud computing
capacities; and investing in our digital media and entertainment business. All of these initiatives are crucial to the success of our business but will have the effect of increasing our costs and
lowering our margins and profit, and this effect may be significant, at least in the short term. Moreover, many of our business initiatives emphasize expanding our user base and enhancing user
experience, rather than initially prioritizing monetization or profitability.
Furthermore,
we have made, and intend to continue to make, strategic investments and acquisitions to expand our user base and geographic coverage and add complementary offerings and
technologies to further strengthen our ecosystem. For example, we expect to continue to make strategic investments and acquisitions relating to core commerce (including in connection with our new
retail strategy), cloud computing and big data, digital media and entertainment, international expansion, logistics services, local services, healthcare and new technologies, such as artificial
intelligence, or AI. Our strategic investments and acquisitions may adversely affect our future financial results, including by decreasing our margins and net income. For example, we believe that our
continuing expansion into the digital media and entertainment sectors, including our acquisition of Youku Tudou, our international expansion, including our acquisition of a controlling stake in
Lazada, and our investments and acquisitions to transform our core commerce business, such as our recent privatization of Intime, are important to our overall business but will have a negative effect
on our financial results, at least in the short term. In addition, the performance of minority investments we make that are accounted for under the equity method investments may also adversely affect
our net income.
We may not be able to maintain or grow our revenue or our business.
We have experienced significant growth in revenue in recent years. In particular, our revenue grew 45% from fiscal year 2014 to fiscal year
2015, 33% from fiscal year 2015 to fiscal year 2016 and 56% from fiscal year 2016 to
9
Table of Contents
fiscal
year 2017. Our ability to continue to generate and grow our revenue depends on a number of factors. For example, our marketing customers do not have long-term marketing commitments with us. If
our services do not generate the rate of return expected or offer prices that are competitive to alternatives, marketers may reduce their spending on the marketing services we offer. See
"Item 5. Operating and Financial Review and Prospects A. Operating Results Factors Affecting Our Results of
Operations Our Ability to Create Value for Our Users and Generate Revenue" and " Our Monetization Model."
Our
future revenue growth also depends on our ability to continue to grow our core commerce and other businesses, including our cloud computing business, digital media and entertainment
business, as well as the businesses we have acquired or invested in and new business initiatives we may explore in the future, including in industries in which we have limited or no experience. This
requires significant investments of time and resources, and our new businesses and initiatives may present new and difficult technological, operational and legal challenges. For example, as we expand
our digital media and entertainment business, we may be unable to produce or license quality content on commercially reasonable terms or at all, fail to anticipate or keep up with changes in user
preferences, user behavior and technological developments or fail to gain access to content distribution channels. In addition, as we expand into the online video industry we may not be able to
acquire and retain users, attract marketers to purchase online marketing services on our video platforms, obtain professionally produced content at competitive prices or at all, encourage more
user-generated content, or grow user acceptance and the popularity of our online video content. In addition, our expansion into new sectors will subject us to additional regulatory risks. We may also
fail to identify or anticipate industry trends and competitive conditions or fail to invest sufficient resources in new growth areas. If we are unable to successfully expand and monetize our
businesses, our future revenue growth may be adversely affected.
In
addition, our revenue growth may slow or our revenues may decline for other reasons, including decreasing consumer spending, increasing competition and slowing growth of the China
retail or China online retail industries and changes in government policies or general economic conditions. In addition, although our revenue grew at a faster rate in fiscal year 2017 than fiscal year
2016, as our revenue grows to a higher base level, our revenue growth rate may slow in the future.
If we are unable to compete effectively, our business, financial condition and results of operations would be
materially and adversely affected.
We face increasingly intense competition, mainly from established Chinese Internet companies, such as Tencent, Baidu and their respective
affiliates, global Internet companies, as well as certain offline retailers and e-commerce players, including those that specialize in a limited number of product categories, such as FMCG, global or
regional cloud computing service providers and digital media and entertainment providers. We compete to:
-
-
attract, engage and retain consumers based on the variety and value of products and services listed on our marketplaces, the engagement of
digital media and entertainment content available on our platforms, the overall user experience of our products and services and the effectiveness of our consumer protection measures;
-
-
attract and retain merchants and brands, based on our size, the size and the engagement of consumers on our platforms and the effectiveness of
our products and services to help them build brand awareness and engagement, acquire and retain customers, complete transactions, expand service capabilities, protect intellectual property rights and
enhance operating efficiency;
-
-
compete to attract and retain marketers, publishers and demand side platforms operated by agencies based on the reach and engagement of our
media properties, the depth of our consumer data insights and the effectiveness of our branding and marketing solutions;
10
Table of Contents
-
-
attract other participants of our ecosystem based on access to business opportunities created by the large scale of economic activity on our
platforms, the strength of the network effect of our ecosystem, as well as tools and technologies that help them operate and grow their businesses;
-
-
optimize the usefulness of the data and technologies we provide, including data-enabled customer relationship management tools, marketing data
and data science, media ecosystem for branding, cloud computing services, omni-channel solutions, the availability and quality of supporting services, including payment settlement and logistics
services, and the quality of our customer service;
-
-
thrive in new industries and sectors as we acquire new businesses and expand, bringing us into competition with major players in these and
other industries and sectors; and
-
-
attract motivated and capable employees, including engineers and product developers who serve critical functions in the development of our
products, services and our ecosystem.
Many
of our competitors generate significant traffic, have established brand recognition, significant technological capabilities and significant financial resources, and have built significant
ecosystems around their core businesses, such as e-commerce, social media and gaming.
In
addition, as we expand our various businesses and operations into an increasing number of international markets, including markets in which we have limited or no experience and in
which we may be less well-known, such as Southeast Asia, India and Russia, we increasingly face competition from domestic and international players operating in these markets.
Our
ability to compete depends on a number of other factors as well, some of which may be beyond our control, including:
-
-
the timely introduction and market acceptance of the products and services we offer, compared to those of our competitors;
-
-
our ability to innovate and develop new technologies;
-
-
our ability to maintain and enhance our leading position in retail commerce in China;
-
-
our ability to benefit from new business initiatives; and
-
-
alliances, acquisitions or consolidations within the Internet industry that may result in stronger competitors.
If
we are not able to compete effectively, the level of economic activity and user engagement on our platforms may decrease significantly, which could materially and adversely affect our
business, financial condition and results of operations as well as our brand.
We may not be able to maintain and improve the network effects of our ecosystem, which could negatively
affect our business and prospects.
Our ability to maintain a healthy and vibrant ecosystem that creates strong network effects among consumers, merchants and other participants is
critical to our success. The extent to which we are able to maintain and strengthen these network effects depends on our ability to:
-
-
offer secure and open platforms for all participants and balance the interests of these participants, including consumers, merchants, brands,
service providers and others;
-
-
provide tools and services that meet the evolving needs of consumers, merchants and brands;
-
-
provide a wide range of high-quality product, service and content offerings to consumers;
-
-
attract and retain merchants and brands of all sizes;
-
-
provide merchants and brands with a high level of traffic flow with strong commercial intent and effective online marketing services;
11
Table of Contents
-
-
further enhance the attractiveness of our mobile platforms;
-
-
arrange secure and trusted payment settlement and escrow services;
-
-
coordinate fulfillment and delivery services with third-party logistics service providers;
-
-
attract and retain third-party service providers that are able to provide quality services on commercially reasonable terms to
our merchants;
-
-
maintain the quality of our customer service; and
-
-
continue adapting to the changing demands of the market.
In
addition, changes we may make to enhance and improve our ecosystem and balance the needs and interests of the various participants on our ecosystem, or to comply with regulatory
requirements, may be viewed positively from one participant group's perspective, such as consumers, but may have negative effects from another group's perspective, such as merchants. If we fail to
balance the interests of all participants in our ecosystem, consumers, merchants, brands and other participants may spend less time, mind share and resources on our platforms and conduct fewer
transactions or use alternative platforms, any of which could result in a material decrease in our revenue and net income.
We may not be able to maintain our culture, which has been a key to our success.
Since our founding, our culture has been defined by our mission, vision and values, and we believe that our culture has been critical to our
success. In particular, our culture has helped us serve the long-term interests of our customers, attract, retain and motivate employees and create value for our shareholders. We face a number of
challenges that may affect our ability to sustain our corporate culture, including:
-
-
failure to identify, attract, promote and retain people in leadership positions in our organization who share our culture, values
and mission;
-
-
failure to execute an effective management succession plan to replace our current generation of management leaders;
-
-
the increasing size, complexity, geographic coverage and cultural diversity of our business and workforce;
-
-
the integration of new personnel and businesses as we expand our existing businesses and acquire new businesses;
-
-
challenges of effectively incentivizing and motivating employees, including members of senior management, and in particular those who have
gained a substantial amount of personal wealth related to share-based incentives;
-
-
competitive pressures to move in directions that may divert us from our mission, vision and values;
-
-
the continued challenges of an ever-changing business environment;
-
-
the pressure from the public markets to focus on short-term results instead of long-term value creation; and
-
-
the increasing need to develop expertise in new areas of business that affect us.
If
we are not able to maintain our culture or if our culture fails to deliver the long-term results we expect to achieve, our business, financial condition, results of operations and prospects could
be materially and adversely affected.
If we are not able to continue to innovate or if we fail to adapt to changes in our industry, our business,
financial condition and results of operations would be materially and adversely affected.
The Internet industry is characterized by rapidly changing technology, evolving industry standards, new mobile apps, protocols and technologies,
new service and product introductions, new media and entertainment content
12
Table of Contents
including
user-generated content and changing customer demands and trends. Furthermore, our competitors are constantly developing innovations in Internet
search, online marketing, communications, social networking, entertainment and other services, on both mobile devices and personal computers, to enhance users' online experience. We continue to invest
significant resources in our infrastructure, research and development and other areas in order to enhance our technology and our existing products and services as well as to explore new growth
strategies and introduce new high quality products and services to attract more participants to our platforms. The changes and developments taking place in our industry may also require us to
re-evaluate our business model and adopt significant changes to our long-term strategies and business plans. Our failure to innovate and adapt to these changes and developments would have a material
adverse effect on our business, financial condition and results of operations.
For
example, we derive significant revenue from mobile, and the ways users access content, interact and transact on our mobile platforms develop rapidly. We may fail to continue to offer
superior user experience in order to increase or maintain the level of mobile engagement on our platforms. The variety of technical and other configurations across different mobile devices and
platforms increases the challenges associated with this environment, and we may fail to develop and provide products and services that work effectively with this wide range of configurations. If we
are unable to continue to attract and retain significant numbers of mobile consumers and increase or maintain levels of mobile engagement on our platforms, our ability to maintain or grow our business
would be materially and adversely affected.
Our failure to manage the growth of our business and operations could harm us.
Our business has become increasingly complex as the scale, diversity and geographic coverage of our business and our workforce continue to grow.
We have also significantly expanded our headcount, office facilities and infrastructure, and we anticipate that further expansion in certain areas and geographies will be required. This expansion
increases the complexity of our operations and places a significant strain on our management, operational and financial resources. We must continue to hire, train and effectively manage new employees.
If our new hires perform poorly or if we are unsuccessful in hiring, training, managing and integrating new employees, our business, financial condition and results of operations may be materially
harmed.
Moreover,
our current and planned staffing, systems, policies, procedures and controls may not be adequate to support our future operations. To effectively manage the expected growth of
our operations and personnel, we will need to continue to improve our transaction processing, operational and financial systems, policies, procedures and controls, which could be particularly
challenging as we acquire new operations with different and incompatible systems in new industries or geographic areas. These efforts will require significant managerial, financial and human
resources. We cannot assure you that we will be able to effectively manage our growth or to implement all these systems, procedures and control measures successfully. If we are not able to manage our
growth effectively, our business and prospects may be materially and adversely affected.
We face risks relating to our acquisitions, investments and alliances.
We have acquired and invested in a large number and a diverse range of businesses, technologies, services and products in recent years,
including investments of varying sizes in equity investees and joint ventures, and we have a number of pending investments and acquisitions that are subject to closing conditions. See "Item 5.
Operating and Financial Review and Prospects A. Operating Results Recent Investment, Acquisition and Strategic Alliance
Activities." We expect to continue to evaluate and consider a wide array of potential strategic transactions as part of our overall business strategy, including business combinations, acquisitions and
dispositions of businesses, technologies, services, products and other assets, as well as strategic investments and alliances. At any given time
13
Table of Contents
we
may be engaged in discussing or negotiating a range of these types of transactions. These transactions involve significant challenges and risks,
including:
-
-
difficulties in integrating into our operations the diverse and large number of personnel, operations, products, services, technology, internal
controls and financial reporting of companies we acquire, and any unanticipated expenses relating to business integration;
-
-
disruption of our ongoing business, distraction of our management and employees and increase of our expenses;
-
-
departure of skilled professionals as well as the loss of established client relationships of the businesses we invest in or acquire;
-
-
for investments over which we may not obtain management and operational control, we may lack influence over the controlling partner or
shareholder, which may prevent us from achieving our strategic goals in these investments;
-
-
regulatory requirements and compliance risks as well as publicity risks that we may become subject to, including as a result of acquisitions of
businesses in new industries or geographic areas or otherwise, especially for acquisitions of companies which are subject to heightened regulatory requirements and scrutiny;
-
-
actual or alleged misconduct or non-compliance by us or any company we acquire or invest in (or by its affiliates), whether before,
during or after our acquisition or investment, which may lead to negative publicity, litigation, government inquiry or investigations against these companies or against us;
-
-
unforeseen or hidden liabilities or additional operating losses, costs and expenses that may adversely affect us following our acquisitions or
investments;
-
-
potential impairment charges or write-offs due to the changes in the fair value of our investments or acquired companies as a result of market
volatility or other reasons that we may or may not control, particularly with respect to public investee companies, such as Alibaba Pictures, the market value of which investment has been
significantly lower than its carrying value for an extended period of time; such that, if the fair value of our investment in this or other equity investee companies remains below its carrying value
for a significantly longer period of time, we may need to write down the carrying value to its fair value, which could have a material adverse effect on our financial results;
-
-
regulatory hurdles including in relation to the anti-monopoly and competition laws, rules and regulations of China and other jurisdictions in
connection with any proposed investments and acquisitions, including, in the case of the exercise of our option in the future to acquire an equity interest in Ant Financial Services, PRC regulations
pertaining to non-bank payment companies and other relevant financial services;
-
-
the risk that any of our pending or other future proposed acquisitions and investments fails to close, including as a result of political and
regulatory challenges and protectionist policies; and
-
-
challenges in maintaining or further growing our acquired businesses, or achieving the expected benefits of synergies and growth opportunities
in connection with these acquisitions and investments, such as our acquisition of Youku Tudou and a controlling stake in Lazada and our recent privatization of Intime.
We
have concluded a number of significant acquisitions and investments in recent years, and we have limited experience in integrating major acquisitions. As our acquisition and
investment activity continues at a rapid pace, with a large number and a diverse range of target companies, we and our management will continue to face significant challenges, including unanticipated
ones, in integrating these businesses into our existing businesses.
14
Table of Contents
We may face challenges in expanding our international and cross-border businesses and operations.
As we expand our international and cross-border businesses into an increasing number of international markets, such as Southeast Asia, India and
Russia, we will face risks associated with expanding into markets in which we have limited or no experience and in which we may be less well-known. We may be unable to attract a sufficient number of
customers and other participants, fail to anticipate competitive conditions or face difficulties in operating effectively in these new markets. The expansion of our international and cross-border
businesses will also expose us to risks inherent in operating businesses globally, including:
-
-
inability to recruit international and local talent and challenges in replicating or adapting our company policies and procedures to operating
environments different than that of China;
-
-
lack of acceptance of our product and service offerings;
-
-
challenges and increased expenses associated with staffing and managing international and cross-border operations and managing an organization
spread over multiple jurisdictions;
-
-
trade barriers, such as import and export restrictions, customs duties and other taxes, competition law regimes and other trade restrictions,
as well as other protectionist policies;
-
-
differing and potentially adverse tax consequences;
-
-
increased and conflicting regulatory compliance requirements;
-
-
challenges caused by distance, language and cultural differences;
-
-
increased costs to protect the security and stability of our information technology systems, intellectual property and personal data, including
compliance costs related to data localization laws;
-
-
availability and reliability of international and cross-border payment systems and logistics infrastructure;
-
-
exchange rate fluctuations; and
-
-
political instability and general economic or political conditions in particular countries or regions.
As
we expand further into new regions and markets, these risks could intensify, and efforts we make to expand our international and cross-border businesses and operations may not be
successful. Failure to expand our international and cross-border businesses and operations could materially and adversely affect our business, financial condition and results of operations.
Transactions
conducted through our international and cross-border platforms may be subject to different customs, taxes and rules and regulations, and we may be adversely affected by the
complexity of and developments in customs and import/export laws, rules and regulations in the PRC and other jurisdictions. For example, effective as of April 8, 2016, the Notice on Tax
Policies of Cross-Border E-Commerce Retail Importation, or the New Cross-Border E-commerce Tax Notice, replaced the previous system for taxing consumer goods imported into the PRC and
introduced a 17% value-added tax, or VAT, on most products sold through e-commerce platforms
and consumption tax on high-end cosmetics. See "Item 4. Information on the Company B. Business
Overview Regulation Tax Regulations."
In
addition, changes to trade policies, treaties and tariffs in the jurisdictions in which we operate, or the perception that these changes could occur, could adversely affect our
international and cross-border operations, our financial condition and results of operations. For example, the U.S. administration under President Donald Trump has advocated greater
restrictions on trade generally and significant increases on tariffs on goods imported into the United States, particularly from China.
15
Table of Contents
We rely on Alipay to conduct substantially all of the payment processing and all of the escrow services on
our marketplaces. If Alipay's services are limited, restricted, curtailed or degraded in any way or become unavailable to us or our users for any reason, our business may be materially and adversely
affected.
Given the significant transaction volume on our platforms, Alipay provides convenient payment processing and escrow services to us through
contractual arrangements on preferential terms. These services are critical to our platforms and the development of our ecosystem. In the twelve months ended March 31, 2017, approximately 72%
of GMV on our China retail marketplaces was settled through Alipay's escrow and payment processing services. We rely on the convenience and ease of use that Alipay provides to our users. If the
quality, utility, convenience or attractiveness of Alipay's services declines for any reason, the attractiveness of our marketplaces could be materially and adversely affected.
Alipay's
business is subject to a number of risks that could materially and adversely affect its ability to provide payment processing and escrow services to
us, including:
-
-
dissatisfaction with Alipay's services or lower use of Alipay by consumers and merchants;
-
-
increasing competition, including from other established Chinese Internet companies, payment service providers and companies engaged in other
financial technology services;
-
-
changes to rules or practices applicable to payment systems that link to Alipay;
-
-
breach of customers' personal information and concerns over the use and security of information collected from customers;
-
-
service outages, system failures or failure to effectively scale the system to handle large and growing transaction volumes;
-
-
increasing costs to Alipay, including fees charged by banks to process transactions through Alipay, which would also increase our cost
of revenues;
-
-
negative news about and social media coverage on Alipay, its business or its products and service offerings; and
-
-
failure to manage funds accurately or loss of funds, whether due to employee fraud, security breaches, technical errors or otherwise.
In
addition, certain commercial banks in China impose limits on the amounts that may be transferred by automated payment from customers' bank accounts to their linked accounts with
third-party payment services. Although we believe the impact of these restrictions has not been and will not be significant in terms of the overall volume of payments processed for our China retail
marketplaces, and automated payment services linked to bank accounts represent only one of many payment mechanisms that consumers may use to settle transactions, we
cannot predict whether these and any additional restrictions that could be put in place would have a material adverse effect on our marketplaces.
Alipay's
business is highly regulated and faces challenges in managing its regulatory risks. Alipay is required to comply with numerous complex and evolving laws, rules and regulations.
In particular, regulators and third parties in China have been increasing their focus on online and mobile payment services, and recent regulatory and other developments could reduce the convenience
or utility of Alipay users' accounts. In addition, as Alipay expands its businesses and operations into more international markets, it will become subject to additional legal and regulatory risks and
scrutiny. Furthermore, our commercial arrangements with Alipay may be subject to anti-competition challenges. See " We and Ant Financial Services are subject to a broad range
of laws and regulations, and future laws and regulations may impose additional requirements and other obligations on our business or otherwise that could materially and adversely affect our business,
financial condition and results of operations," and "Item 4. Information on the Company B. Business
Overview Regulation Regulation Applicable to Alipay."
16
Table of Contents
If we needed to migrate to another third-party payment service or significantly expand our relationship with other third-party payment services, the transition
would require significant time and management resources, and the third-party payment service may not be as effective, efficient or well-received by consumers and merchants on our marketplaces. These
third-party payment services also may not provide escrow services, and we may not be able to receive commissions based on GMV transacted through these systems. We would also receive less, or lose
entirely, the benefit of the commercial agreement with Ant Financial Services and Alipay, which provides us with preferential terms, and would likely be required to pay more for payment processing and
escrow services than we currently pay. There can be no assurance that we would be able to reach an agreement with an alternative online payment service on acceptable terms or at all.
We do not control Alipay or its parent entity, Ant Financial Services, over which Jack Ma effectively
controls a majority of the voting interests. If conflicts that could arise between us and Alipay or Ant Financial Services are not resolved in our favor, they could have a negative effect on our
ecosystem and materially and adversely affect our business, financial condition, results of operations and prospects.
Although we rely on Alipay to conduct substantially all of the payment processing and all of the escrow services on our marketplaces, we do not
have any control over Alipay. Alipay provides payment services to us on preferential terms pursuant to our long-term commercial agreement with Ant Financial Services and Alipay. Following the
divestment and subsequent equity holding restructuring related to Ant Financial Services, an entity controlled by Jack Ma, our executive chairman, became the general partner of Hangzhou Junhan Equity
Investment Partnership, or Junhan, a PRC limited partnership, and Junao Equity Investment Partnership, or Junao, a PRC limited partnership, which are two major equity holders of Alipay's parent, Ant
Financial Services. Accordingly, Jack has an economic interest in Ant Financial Services and is able to exercise the voting power of the equity interest in Ant Financial Services held by Junhan and
Junao. We understand that through the exercise of this voting power, Jack continues to control a substantial majority of the voting interests in Ant Financial Services.
If
Alipay were not able to successfully manage the risks relating to its business, its ability to continue to deliver payment services to us on preferential terms may be undermined.
Furthermore, if for any reason, Alipay sought to amend the terms of its agreements and arrangements with us, there is no assurance that Jack Ma, in light of his voting control over Alipay's parent,
Ant Financial Services, would act in our interest. If we were to lose the preferential terms with Alipay or if Alipay is unable to successfully manage its business, our ecosystem could be negatively
affected, and our business, financial condition, results of operations and prospects could be materially and adversely affected.
Ant
Financial Services also provides other financial services to participants in our ecosystem, including wealth management, lending, insurance and credit system, and may provide
additional services in the future. Other conflicts of interest between us, on the one hand, and Alipay and Ant Financial Services, on the other hand, may arise relating to commercial or strategic
opportunities or initiatives. Although we and Ant Financial Services have each agreed to certain non-competition undertakings, Ant Financial Services may provide services to our competitors from time
to time and we cannot assure you that Ant Financial Services would not pursue other opportunities that would conflict with our interests. Jack Ma may not resolve these conflicts in our favor.
Furthermore, our ability to explore alternative payment services other than Alipay for our marketplaces may be constrained due to Jack's relationship with Ant Financial Services.
In
addition, we grant share-based awards to employees of Ant Financial Services, and Junhan grants share-based awards tied to the value of Ant Financial Services to our employees. The
provision of awards to our employees tied to the value of Ant Financial Services is intended to enhance our strategic and financial relationship with Ant Financial Services. See "Item 7. Major
Shareholders and Related Party Transactions B. Related Party Transactions Agreements and Transactions Related to Ant Financial
Services and its Subsidiaries Equity-based Award Arrangements." The share-based awards granted by Junhan to our employees result in expenses that are recognized
by our company. Subject to the approval of our audit committee, Jack, through his role with us and his control over Junhan, could be in a position to propose and promote further share-
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grants that result in additional, and potentially significant, expenses to our company. Accordingly, these and other potential conflicts of interest between us and Ant Financial Services or
Alipay, and between us and Jack or Junhan or Junao, may not be resolved in our favor, which could have a material adverse effect on our business, financial condition, results of operations
and prospects.
Moreover,
because of our close association with Ant Financial Services and overlapping user base, events that negatively affect Ant Financial Services could also negatively affect
customers', regulators' and other third parties' perception of us. In addition, any actual or perceived conflict of interest between us and Ant Financial Services or any other company integral to the
functioning of our ecosystem could also materially harm our reputation as well as our business and prospects.
Our business generates and processes a large amount of data, and the improper use or disclosure of data could
harm our reputation as well as have a material adverse effect on our business and prospects.
Our business, including our cloud computing business, generates and processes a large quantity of personal, transaction, demographic and
behavioral data. We face risks inherent in handling and protecting large volumes of data. In particular, we face a number of challenges relating to data from transactions and other activities on our
platforms, including:
-
-
protecting the data in and hosted on our system, including against attacks on our system by outside parties or fraudulent behavior or improper
use by our employees;
-
-
addressing concerns related to privacy and sharing, safety, security and other factors; and
-
-
complying with applicable laws, rules and regulations relating to the collection, use, storage, transfer, disclosure and security of personal
information, including any requests from regulatory and government authorities relating to this data.
The
PRC regulatory and enforcement regime with regard to data security and data protection is evolving. According to the Cybersecurity Law, which was promulgated by the National People's
Congress Standing Committee on November 7, 2016 and took effect as of June 1, 2017, as network operators we are obligated to provide technical assistance and support for public security
and national security authorities to protect national security or assist with criminal investigations. In addition, the Cybersecurity Law provides that personal information and important data
collected and generated by an operator of critical information infrastructure in the course of its operations in the PRC must be stored in the PRC, and the law imposes additional data security and
privacy protection obligations on network operators. Further, on July 1, 2015, the National People's Congress Standing Committee promulgated the National Security Law, or the
New National Security Law, which took effect on the same date and replaced the former National Security Law promulgated in 1993 and covers various types of national security including
technology security and information security. See "Item 4. Information on the Company B. Business
Overview Regulation Regulation of Internet Security." Compliance with the Cybersecurity Law, the New National
Security Law, as well as additional laws and regulations that PRC regulatory bodies may enact in the future, may result in additional expenses to us and subject us to negative publicity which could
harm our reputation with users and negatively affect the trading price of our ADSs. There are also uncertainties with respect to how the Cybersecurity Law and the New National Security Law will
be implemented in practice. PRC regulators, including the Ministry of Industry and Information Technology, or the MIIT, and the Cyberspace Administration of China, or the Cyberspace Administration,
have been increasingly focused on regulation in the areas of data security and data protection. We expect that these areas will receive greater attention and focus from regulators, as well as attract
continued or greater public scrutiny and attention going forward, which could increase our compliance costs and subject us to heightened risks and challenges associated with data security and
protection. If we are unable to manage these risks, we could become subject to penalties, including fines, suspension of business and revocation of required licenses, and our reputation and results of
operations could be materially and adversely affected.
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In
addition, pursuant to our data sharing agreement with Ant Financial Services and Alipay, which sets forth data security and confidentiality protocols, and subject to relevant legal
requirements and limitations, we have agreed to a broad sharing of data with Ant Financial Services through a data sharing platform that we own and operate. Cainiao Network, Koubei and Alibaba
Pictures have also entered into agreements with us to participate in the data sharing platform. We also grant expressly limited access to specified data on our data platform to certain other
participants in our ecosystem that provide services to merchants and consumers, such as retail operating partners, logistics service providers, mobile app developers, independent software vendors, or
ISVs, cloud developers, marketing affiliates and various professional service providers. These ecosystem participants face the same challenges inherent in handling and protecting large volumes of
data. Any systems failure or security breach or lapse on our part or on the part of any of our ecosystem participants that results in the release of user data could harm our reputation and brand and,
consequently, our business, in addition to exposing us to potential legal liability.
As
we expand our operations into international markets, we will be subject to additional laws in other jurisdictions where we operate and where our merchants, consumers, users, customers
and other participants are located. The laws, rules and regulations of other jurisdictions, such as the United States and Europe, may be more comprehensive, detailed and nuanced in their scope,
and impose more stringent or conflicting requirements and penalties than those in China. Complying with laws and regulations for an increasing number of jurisdictions could require significant
resources and costs. Our continued expansion into cloud computing services, both within China and overseas, will also increase the number of users and the amount of data hosted on our system, as well
as increase the number of jurisdictions in which we have information technology systems. This, as well as the increasing number of new legal requirements in various jurisdictions, such as the Russian
Data Localization Law, which came into effect on September 1, 2015, and the European Union General Data Protection Regulation, which will come into effect in May 2018, present increased
challenges and risks in relation to policies and procedures relating to data collection, storage, transfer, disclosure, protection and privacy. Our privacy policies concerning the collection, use and
disclosure of personal data are posted on our websites. Any failure, or perceived failure, by us to comply with our posted privacy policies or with any regulatory requirements or privacy
protection-related laws, rules and regulations could result in adverse publicity or proceedings or actions against us by governmental entities or others. These proceedings or actions could subject us
to significant penalties and negative publicity, require us to change our business practices, increase our costs and severely disrupt our business.
Failure to maintain or improve our technology infrastructure could harm our business and prospects.
We are constantly upgrading our platforms to provide increased scale, improved performance and additional built-in functionality and additional
capacity. Adopting new products and maintaining and upgrading our technology infrastructure, including our data centers, cloud operating systems and big data analytics platform, require significant
investments of time and resources, including adding new hardware, updating software and recruiting and training new engineering personnel. Any failure to maintain and improve our technology
infrastructure could result in unanticipated system disruptions, slower response times, impaired quality of users' experiences and delays in reporting accurate operating and financial information. For
example, on Singles Day, there is significantly higher than normal activity on our marketplaces that our systems must handle. In addition, much of the software and interfaces we use are internally
developed and proprietary technology. If we experience problems with the functionality and effectiveness of our software or platforms, or are unable to maintain and constantly improve our technology
infrastructure to handle our business needs, our business, financial condition, results of operation and prospects, as well as our reputation, could be materially and adversely affected.
The successful operation of our business depends upon the performance and reliability of the Internet
infrastructure in China and other countries in which we operate.
Our business depends on the performance and reliability of the Internet infrastructure in China and other countries in which we operate.
Substantially all of our computer hardware and a majority of our cloud computing services are currently located in China. Almost all access to the Internet in China is maintained through state-
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telecommunication operators under the administrative control and regulatory supervision of the MIIT. In addition, the national networks in China are connected to the Internet through state-owned
international gateways, which are the only channels through which a domestic user can connect to the Internet outside of China. We may face similar or other limitations in other countries in which we
operate. We may not have access to alternative networks in the event of disruptions, failures or other problems with the Internet infrastructure in China or elsewhere. In addition, the Internet
infrastructure in the countries in which we operate may not support the demands associated with continued growth in Internet usage.
The
failure of telecommunications network operators to provide us with the requisite bandwidth could also interfere with the speed and availability of our websites and mobile
applications. We have no control over the costs of the services provided by the telecommunications operators. If the prices that we pay for telecommunications and Internet services rise significantly,
our gross margins could be adversely affected. In addition, if Internet access fees or other charges to Internet users increase, our user traffic may decrease, which in turn may significantly decrease
our revenues.
Our ecosystem could be disrupted by network interruptions.
Our ecosystem depends on the efficient and uninterrupted operation of our computer and communications systems. System interruptions and delays
may prevent us from efficiently processing the large volume of transactions on our marketplaces. In addition, a large number of merchants maintain their important systems, such as enterprise resource
planning, or ERP, and customer relationship management, or CRM, systems on our cloud computing platform, which contains substantial quantities of data relating to their accounts, transaction data,
consumer information and other data that enables merchants to operate and manage their businesses. Increasing media and entertainment content on our platforms also requires additional network capacity
and infrastructure to process. Consumers expect our media and entertainment content to be readily available online, and any disruptions or delay to the delivery of content could affect the
attractiveness and reputation of our media and entertainment platforms.
We
and other participants in our ecosystem, including Ant Financial Services and Cainiao Network, occasionally experience system interruptions and delays that make websites and services
temporarily unavailable or slow to respond. Although we have prepared for contingencies through redundancy measures and disaster recovery plans and also carry business interruption insurance, these
preparations and insurance coverage may not be sufficient. Despite any precautions we may take, the occurrence of a natural disaster, such as an earthquake, flood or fire, or other unanticipated
problems at our facilities or the facilities of Ant Financial Services, Cainiao Network and other participants in our ecosystem, including power outages, system failures, telecommunications delays or
failures, construction accidents, break-ins to information technology systems or computer viruses, could result in delays or
interruptions to our platforms, loss of our, consumers' and customers' data and business interruption for us and our customers. Any of these events could damage our reputation, significantly disrupt
our operations and the operations of the merchants and other participants in our ecosystem and subject us to liability, which could materially and adversely affect our business, financial condition
and results of operations.
If third-party logistics service providers used by our merchants fail to provide reliable logistics services,
or the logistics data platform operated by Cainiao Network were to malfunction, suffer an outage or otherwise fail, our business and prospects, as well as our financial condition and results of
operations, may be materially and adversely affected.
Our merchants use third-party logistics service providers to fulfill and deliver their orders. Cainiao Network cooperates with a number of
third-party logistics service providers to help merchants on our platforms fulfill orders and deliver their products to consumers. Cainiao Network operates a logistics data platform that links our
information system and those of logistics service providers. Interruptions to or failures in these third-parties' logistics services, or in Cainiao Network's logistics data platform, could prevent the
timely or proper delivery of products to consumers, which would harm the reputation of our marketplaces and our ecosystem. These interruptions or failures may be due to events that are beyond our
control or the control of Cainiao Network or these logistics service providers, such as inclement weather, natural disasters, transportation disruptions or labor
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unrest.
These logistics services could also be affected or interrupted by business disputes, industry consolidation, insolvency or government shut-downs. The merchants on our marketplaces may not be
able to find alternative logistics service providers to provide logistics services in a timely and reliable manner, or at all. We do not have agreements with logistics service providers that require
them to offer services to our merchants. If the logistics data platform operated by Cainiao Network were to fail for any reason, the logistics service providers would be severely hindered from or
unable to connect with our merchants, and their services and the functionality of our ecosystem could be severely affected. If the products sold on our marketplaces are not delivered in proper
condition, on a timely basis or at shipping rates that marketplace participants are willing to bear, our business and prospects, as well as our financial condition and results of operations could be
materially and adversely affected.
If other third-party service providers on our ecosystem fail to provide reliable or satisfactory services,
our business, financial condition and results of operations may be materially and adversely affected.
Ant Financial Services, Cainiao Network and a number of other third-party participants, including retail operating partners, logistics service
providers, mobile app developers, ISVs, cloud developers, marketing affiliates and various professional service providers, provide services to users on our platforms, including
merchants, brands, consumers and users of our cloud computing services. To the extent these service providers are unable to provide satisfactory services to our users on commercially acceptable terms
or at all or if we fail to retain existing or attract new quality service providers to our platforms, our ability to retain, attract or engage our users may be severely limited, which may have a
material and adverse effect on our business, financial condition and results of operations. In addition, certain of these third-party service providers on our ecosystem have access to our user data to
a limited extent in order to provide their services. These third-party service providers also engage in a broad range of other business activities outside of our platforms. If these third-party
participants engage in activities that are negligent, illegal or otherwise harm the trustworthiness and security of our ecosystem, including the leak or negligent use of data or failure to perform
their contractual obligations, or users are otherwise dissatisfied with their service quality on or off our platforms, we could suffer reputational harm, even if these activities are not related to,
attributable to or caused by us, or within our control.
We depend on key management as well as experienced and capable personnel generally, and any failure to
attract, motivate and retain our staff could severely hinder our ability to maintain and grow our business.
Our future success is significantly dependent upon the continued service of our key executives and other key employees. If we lose the services
of any member of management or key personnel, we may not be able to locate suitable or qualified replacements, and may incur additional expenses to recruit and train new staff, which could severely
disrupt our business and growth. In particular, Jack Ma, our lead founder, executive chairman and one of our principal shareholders, has been crucial to the development of our culture and strategic
direction.
As
our business develops and evolves, it may become difficult for us to continue to retain these employees. A number of our employees, including many members of management, may choose to
pursue other opportunities outside of our company. If we are unable to motivate or retain these employees, our business may be severely disrupted and our prospects could suffer.
The
size and scope of our ecosystem also require us to hire and retain a wide range of capable and experienced personnel who can adapt to a dynamic, competitive and challenging business
environment. We will need to continue to attract and retain experienced and capable personnel at all levels, including members of management, as we expand our business and operations. Competition for
talent in the PRC Internet industry is intense, and the availability of suitable and qualified candidates in China is limited. Competition for these individuals could cause us to offer higher
compensation and other benefits to attract and retain them. Even if we were to offer higher compensation and other benefits, there is no assurance that these individuals will choose to join or
continue to work for us. Any failure to attract or retain key management and personnel could severely disrupt our business and growth.
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Our revenue and net income may be materially and adversely affected by any economic slowdown in China as well
as globally.
The success of our business ultimately depends on consumer spending. We currently derive a substantial majority of our revenue from China and
are also expanding into international markets. As a result, our revenue and net income are impacted to a significant extent by economic conditions in China and globally, as well as economic conditions
specific to online and mobile commerce. The global economy, markets and levels of consumer spending are influenced by many factors beyond our control, including consumer perception of current and
future economic conditions, political uncertainty (including potential impact resulting from political and regulatory uncertainties in the United States and the proposed exit of the
United Kingdom from the European Union), levels of employment, inflation or deflation, real disposable income, interest rates, taxation and currency exchange rates.
The
growth of the PRC economy has slowed in recent years. According to the National Bureau of Statistics of China, China's GDP growth rate was 6.7% in 2016, down from 6.9% in 2015 and
7.4% in 2014. There have also been concerns on the relationships among China and other Asian countries as well as the relationship between China and the United States, which may result in or
intensify potential conflicts in relation to territorial, regional security and trade disputes. For instance, the United States has expressed a desire to reexamine the trade relationship
between China and the United States. Any continuing or worsening slowdown could significantly reduce domestic commerce in China, including through the Internet generally and within our
ecosystem. Although our financial performance is mainly affected by consumer spending, which may not be as adversely affected as other sectors of the economy, an economic downturn, whether actual or
perceived, a further decrease in economic growth rates or an otherwise uncertain economic outlook in China or any other market in which we may operate could have a material adverse effect on consumer
spending and therefore adversely affect our business, financial condition and results of operations.
Security breaches and attacks against our systems and network, and any potentially resulting breach or
failure to otherwise protect confidential and proprietary information, could damage our reputation and negatively impact our business, as well as materially and adversely affect our financial
condition and results of operations.
Although we have employed significant resources to develop our security measures against breaches, our cybersecurity measures may not detect,
prevent or control all attempts to compromise our systems, including distributed denial-of-service attacks, viruses, malicious software, break-ins, phishing attacks, social engineering, security
breaches or other attacks and similar disruptions that may jeopardize the security of information stored in and transmitted by our systems or that we otherwise maintain. Breaches of our cybersecurity
measures could result in unauthorized access to our systems, misappropriation of information or data, deletion or modification of user information, or a denial-of-service or other interruption to our
business operations. As techniques used to obtain unauthorized access to or sabotage systems change frequently and may not be known until launched against us or our third-party service providers, we
may be unable to anticipate, or implement adequate measures to protect against, these attacks.
We
have in the past and are likely again in the future to be subject to these types of attacks, although to date no attack has resulted in any material damages or remediation costs. If
we are unable to avert these attacks and security breaches, we could be subject to significant legal and financial liability, our reputation would be harmed and we could sustain substantial revenue
loss from lost sales and customer dissatisfaction. We may not have the resources or technical sophistication to anticipate or prevent rapidly evolving types of cyber-attacks. Cyber-attacks may target
us, our merchants, consumers, users, customers or other participants, or the communication infrastructure on which we depend. Actual or anticipated attacks and risks may cause us to incur
significantly higher costs, including costs to deploy additional personnel and network protection technologies, train employees, and engage third-party experts and consultants. Cybersecurity breaches
would not only harm our reputation and business, but also could materially decrease our revenue and net income. We do not carry cybersecurity insurance.
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We may not be able to acquire a direct equity ownership interest in Ant Financial Services.
In August 2014, we entered into a share and asset purchase agreement, or the 2014 SAPA, to restructure the economic terms of our
relationship with Alipay and Ant Financial Services. The 2014 SAPA provides for future potential equity issuances of up to 33% of equity interest in Ant Financial Services to us in the event that Ant
Financial Services applies for and receives certain PRC regulatory approvals in the future. In addition, in the event of a qualified IPO of Ant Financial Services or Alipay, if our total ownership of
equity interests in Ant Financial Services, if any, has not reached 33%, we would be entitled, at our election, to receive a one-time payment equal to 37.5% of the equity value, immediately prior to a
qualified IPO of Ant Financial Services, as a whole and not just of its subsidiary Alipay. If we acquire equity interests in Ant Financial Services in an aggregate amount less than the full 33% equity
interest, then the percentage of Ant Financial Services' equity value used to calculate the liquidity event payment will be reduced proportionately. If Ant Financial Services does not receive the
required PRC regulatory approvals mentioned above, we will not be able to acquire a direct equity ownership interest in Ant Financial Services, and we would fail to benefit from any appreciation in
its equity value beyond the date of a qualified IPO of Ant Financial Services or Alipay. Our inability to reap the benefits of any appreciation in equity value of Ant Financial Services, including in
connection with a qualified IPO of Ant Financial Services or Alipay, could represent a significant missed opportunity that is beyond our control. In addition, if we elect to receive a one-time payment
equal to 37.5% of the equity value, immediately prior to a qualified IPO of Ant Financial Services, it is possible that Ant Financial Services will not have sufficient funds to make the payment in a
timely manner or on a schedule acceptable to us. See "Item 7. Major Shareholders and Related Party Transactions B. Related Party
Transactions Agreements and Transactions Related to Ant Financial Services and its Subsidiaries 2014 Restructuring of
Our Relationship with Ant Financial Services and Alipay."
Tightening of tax compliance efforts that affect our merchants could materially and adversely affect our
business, financial condition and results of operations.
E-commerce in China is still developing, and the PRC government may require operators of marketplaces, such as our company, to assist in the
collection of taxes with respect to the revenue or profit generated by merchants from transactions conducted on their platforms. A significant number of small businesses and sole proprietors operating
businesses through storefronts on Taobao Marketplace may not have completed the required tax registration. PRC tax authorities may enforce registration requirements that target small businesses or
sole proprietors on Taobao Marketplace and may request our assistance in these efforts. As a result, these merchants may be subject to more stringent tax compliance requirements and liabilities and
their business on our marketplaces could suffer or they could decide to remove their storefronts from our marketplace rather than comply, which could in turn negatively affect us. We may also be
requested by tax authorities to supply information on our merchants, such as transaction records and bank account information, and assist in the enforcement of tax regulations, including the payment
and withholding obligations against our merchants, in which case, we may lose existing merchants and potential merchants might not be willing to open storefronts on our marketplaces. Stricter tax
enforcement by the PRC tax authorities may also reduce the activities by merchants on our platforms and result in liability to us. For example, as a result of recent stricter enforcement on VAT and
the payment of VAT refunds, we substantially increased our allowance for doubtful accounts for VAT receivables in relation to our VAT refund service in fiscal year 2017.
Potential
heightened enforcement against participants in our ecosystem (including imposition of reporting or withholding obligations on operators of marketplaces with respect to
value-added tax of merchants and stricter tax enforcement against merchants generally) could have a material adverse effect on our business, financial condition and results of operations.
We have been and may continue to be subject to allegations and lawsuits claiming that items listed and
content available on our marketplaces and websites are pirated, counterfeit or illegal.
We have received in the past, and we anticipate we will receive in the future, communications alleging that items offered, sold or made
available through our online marketplaces by third parties or that content we make
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through other services, such as our online video and music platforms, infringe third-party copyrights, trademarks and patents or other intellectual property rights. Although we have adopted
measures to proactively
verify the products sold on our marketplaces for infringement and to minimize potential infringement of third-party intellectual property rights through our intellectual property infringement
complaint and take-down procedures, these measures may not always be successful. In the event that alleged counterfeit or infringing products are listed or sold on our marketplaces or allegedly
infringing content are made available through our other services, we could face claims and negative publicity relating to these activities or for our alleged failure to act in a timely or effective
manner in response to infringement or to otherwise restrict or limit these activities. We may also choose to compensate consumers for any losses, although we are currently not legally obligated to do
so. If, as a result of regulatory developments, we are required to compensate consumers, we would incur additional expenses.
We
may implement further measures in an effort to strengthen our protection against these potential liabilities, including working with brands and government authorities to assist in
their offline investigations and taking legal actions against sellers of counterfeit goods on our marketplaces. These measures could require us to spend substantial additional resources and/or
experience reduced revenues. In addition, these measures may reduce the attractiveness of our marketplaces and other services to consumers, merchants, brands and other participants. A merchant or
online marketer whose content is removed or whose services are suspended or terminated by us, regardless of our compliance with the applicable laws, rules and regulations, may dispute our actions and
commence action against us for damages based on breach of contract or other causes of action, make public complaints or allegations or organize group protests and publicity campaigns against us or
seek compensation. Any costs incurred as a result of liability or asserted liability relating to the sale of unlawful goods or other infringement could harm our business.
We
also have been and may continue to be subject to allegations of civil or criminal liability based on allegedly unlawful activities or unauthorized distribution carried out by third
parties through our online marketplaces. In May 2015, we were named as a defendant in a lawsuit filed in the Southern District of New York by Kering S.A and other plaintiffs, which
asserts various claims based on, among other things, the sales of allegedly counterfeit or otherwise trademark infringing merchandise by merchants on certain of our marketplaces. We have also acquired
certain companies, such as Youku Tudou and a controlling stake in Lazada, which are from time to time subject to allegations and lawsuits regarding alleged infringement of third-party intellectual
property or other rights, and we may continue to acquire other companies which are subject to similar disputes.
In
addition, we have been and may continue to be subject to significant negative publicity in China and other countries. For example, in December 2016, the Office of the
U.S. Trade Representative, or USTR, identified Taobao Marketplace as a "notorious market" that, according to submissions to the USTR by certain brands and industry associations, facilitates
substantial copyright piracy and trademark counterfeiting. In January 2015, the State Administration for Industry and Commerce in China, or SAIC, released a report stating that Taobao
Marketplace had the highest percentage of counterfeit goods among the online marketplaces that it surveyed. Subsequently, in the same month, the SAIC released a self-described "white paper" discussing
perceived failures of our platforms, including an alleged failure to crack down on the sale of counterfeit goods and other alleged illegal activities on our China retail marketplaces. Although the
SAIC withdrew the so-called "white paper" the same day it was released, and later clarified that the document carried no legal force, there may be continued public perception that counterfeit or
pirated items are commonplace on our marketplaces or that we delay the process of removing these items. This perception, even if factually incorrect, and existing or new litigation and regulatory
pressure or action related to intellectual property rights protection could damage our reputation with consumers, harm our business, diminish the value of our brand name and negatively affect the
trading price of our ADSs.
Failure to deal effectively with any fraud perpetrated and fictitious transactions conducted on our
marketplaces and other sources of customer dissatisfaction would harm our business.
We face risks with respect to fraudulent activities on our marketplaces and periodically receive complaints from consumers who may not have
received the goods that they had purchased, as well as complaints from
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merchants
who have not received payment for the goods that a consumer had contracted to purchase. Although we have implemented various measures to detect and reduce the occurrence of fraudulent
activities on our marketplaces, there can be no assurance that these measures will be effective in combating fraudulent transactions or improving overall satisfaction among our merchants, consumers
and other participants. Additional measures that we take to address fraud could also negatively affect the attractiveness of our marketplaces to consumers or merchants. In addition, merchants on our
marketplaces contribute to a fund to provide consumer protection guarantees. If our merchants do not perform their obligations under these programs, then we may use funds that have been deposited by
merchants in a consumer protection fund to compensate consumers. If the amounts in the fund are not sufficient, we may choose to compensate consumers for losses although currently we are not legally
obligated to do so. If, as a result of regulatory developments, we are required to compensate consumers, we would incur additional expenses. Although we have recourse against our merchants for any
amounts we incur, there is no assurance that we would be able to collect from our merchants.
In
addition to fraudulent transactions with legitimate consumers, merchants may also engage in fictitious or "phantom" transactions with themselves or collaborators in order to
artificially inflate their own ratings on our marketplaces, reputation and search results rankings, an activity sometimes referred to as "brushing." This activity may harm other merchants by enabling
the perpetrating merchant to be favored over legitimate merchants, and may harm consumers by deceiving them into believing that a merchant is more reliable or trusted than the merchant
actually is.
Moreover,
illegal, fraudulent or collusive activities by our employees could also subject us to liability or negative publicity. We have discovered cases in which certain of our
employees had accepted payments from merchants or other service providers in order to receive preferential treatment on our marketplaces. Although we dismiss the employees responsible for these
incidents and have implemented internal controls and policies with regard to the review and approval of merchant accounts, sales activities and other relevant matters, we cannot assure you that our
controls and policies will prevent fraud or illegal activity by our employees or that similar incidents will not occur in the future. Any illegal, fraudulent or collusive activity could severely
damage our brand and reputation as an operator of trusted marketplaces, which could drive users and consumers away from our marketplaces, and materially and adversely affect our business, financial
condition and results of operations.
In
January 2015, the SAIC discussed alleged fraudulent and fictitious transactions on our China retail marketplaces in its self-described "white paper." Although the SAIC withdrew
the so-called "white paper" the same day it was released and later clarified that the document carried no legal force, the negative publicity and user sentiment generated as a result of this document
or other allegations of fraudulent or deceptive conduct on our platforms could severely diminish consumer confidence in and use of our services, reduce our ability to attract new or retain current
merchants, consumers and other participants, damage our reputation, result in shareholder or other litigation and diminish the value of our brand names, and materially and adversely affect our
business, financial condition and results of operations.
We may increasingly become a target for public scrutiny, including complaints to regulatory agencies,
negative media coverage, including social media and malicious reports, all of which could severely damage our reputation and materially and adversely affect our business and prospects.
We process an extremely large number of transactions on a daily basis on our marketplaces, and the high volume of transactions taking place on
our marketplaces and publicity about our business creates the possibility of heightened attention from the public, regulators, the media and our participants. Heightened regulatory and public concern
over consumer protection and consumer safety issues may subject us to additional legal and social responsibilities and increased scrutiny and negative publicity over these issues, due to the large
number of transactions that take place on our platforms and the increasing scope of our overall business operations. In addition, changes in our services or policies have resulted and could result in
objections by members of the public, the media, including social media, participants in our ecosystem or others. From time to time, these objections or allegations, regardless of their veracity, may
result in public protests or negative publicity, which could result in government inquiry or harm our reputation. Corporate transactions we or related parties undertake, such as our
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acquisition
of the media business of SCMP Group Limited, which includes the South China Morning Post newspaper, and our partnership with the International Olympic Committee, may also subject us to
increased media exposure and public scrutiny in Hong Kong, China and internationally. Moreover, as our business expands and grows, both organically and through acquisitions of and investments in other
businesses, domestically and internationally, we will be exposed to heightened regulatory scrutiny in jurisdictions where we already operate as well as in new jurisdictions in areas including consumer
safety, public health and public trust. There is no assurance that we would not become a target for regulatory or public scrutiny in the future or that scrutiny and public exposure would not severely
damage our reputation as well as our business and prospects.
In
addition, our directors and management have been, and continue to be, subject to scrutiny by the media and the public regarding their activities in and outside Alibaba Group, which
may result in unverified, inaccurate or
misleading information about them being reported by the press. Negative publicity about our executive chairman or other founders, directors or management, even if untrue or inaccurate, may harm
our reputation.
We and Ant Financial Services are subject to a broad range of laws and regulations, and future laws and
regulations may impose additional requirements and other obligations on our business or otherwise that could materially and adversely affect our business, financial condition and results
of operations.
The industries in which we and Ant Financial Services operate in the PRC and other countries, including online and mobile commerce and payments,
financial services, cloud computing and digital media and entertainment and other online content offerings, are highly regulated. As we and Ant Financial Services expand into new regions and markets,
we will become subject to additional regulatory compliance requirements, which may be complex and potentially conflicting. In particular, the PRC government authorities are likely to continue to issue
new laws, rules and regulations governing these industries, enhance enforcement of existing laws, rules and regulations and impose requirements relating to, among other things, new and additional
licenses, permits and approvals or governance or ownership structures on us, Ant Financial Services and our users. These laws, rules and regulations and their application could take a direction that
is adverse to our or Ant Financial Services' business at any time. In addition, there is no assurance that any required licenses, permits and approvals could be obtained or any new requirements can be
satisfied in a timely or cost-effective manner, and failure to obtain them could have a material adverse effect on our business, financial condition and results of operations. Changes in regulatory
enforcement as well as tax policy in the PRC and other countries could also result in additional compliance obligations and increased costs or place restrictions upon our current or future operations.
Any legislation or regulation of this kind could also severely disrupt and constrain our business and the payment services used on our marketplaces.
We
have from time to time been subject, and are likely again in the future to be subject, to PRC and foreign government inquiries and investigations, including those relating to website
content, alleged third-party intellectual property infringement and securities laws and regulations. We also face scrutiny, and have been subject and continue to be subject to inquiries and
investigations, from PRC and foreign governmental bodies that focus on cross-border trade, tax, intellectual property protection, our investment activities, human rights, user privacy and data
protection matters and fraudulent or other criminal transactions. We may also face protectionist policies and regulatory scrutiny on national security grounds in foreign countries in which we conduct
business or investment activities. None of these inquiries and investigations has resulted in significant restrictions on our business operations. However, as we continue to grow in scale and
significance, we expect to face increased scrutiny, which will, at a minimum, result in our having to increase our investment in compliance and related capabilities and systems.
The
increasing sophistication and development of our user base and our expansion into the mobile and entertainment business will also subject us to additional regulations and increase
the need for higher standards of user protection, privacy protection and dispute management. Any increased involvement in inquiries or investigations could result in significantly higher legal and
other costs, restraints on our ability to enforce the contracts we have entered into, loss of business and revenue, liability for breach of contracts with third parties,
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of management and other resources, as well as negative publicity, which could harm our business and reputation and materially reduce our revenue and net income.
Ant
Financial Services, which through Alipay provides the substantial majority of the payment processing services on our marketplaces as well as other financial and value-added services,
such as payment, wealth management, lending, insurance and credit system, is subject to various laws, rules and regulations in the PRC and other countries where it operates, including those governing
banking, privacy, cross-border and domestic money transmission, anti-money laundering, counter-terrorist financing and consumer protection laws, rules and regulations. In recent years, the PRC
government has increasingly focused on regulation of the financial industry, including laws, rules and regulations relating to the provision of payment services. See "Item 4. Information on the
Company B. Business Overview Regulation Regulation Applicable to Alipay." These
laws, rules and regulations are highly complex and could change or be reinterpreted to make it difficult or impossible for Ant Financial Services to comply. As Ant Financial Services expands into
international markets, it will increasingly become subject to additional legal and regulatory compliance requirements as well as political and regulatory challenges, including scrutiny on data privacy
and security, anti-money laundering compliance and national security grounds, to its business and investment activities in these markets. In addition, Alipay is required to maintain a payment business
license in the PRC as well as other applicable money transmitter or other licenses and approvals in other countries where it operates. In certain jurisdictions where Alipay currently does not have the
required licenses, Alipay provides payment processing and escrow services through third-party service providers. If Alipay or its partners fail to obtain and maintain all required licenses and
approvals or otherwise fails to comply with applicable laws, rules and regulations, if new laws, rules or regulations come into effect that impact Alipay or its partners' businesses, or if any of
Alipay's partners ceases to provide services to Alipay, its services could be suspended or severely disrupted, and our business, financial condition and results of operations would be materially and
adversely affected.
We may be accused of infringing intellectual property rights of third parties and content restrictions of
relevant laws.
Third parties may claim that the technology used in the operation of our platforms or our service offerings or the content on our platforms,
including content available through our digital media and entertainment business, search business, online reading platform and news feed features, infringe upon their intellectual property rights.
Although we have not in the past faced material litigation involving direct claims of infringement by us, the possibility of intellectual property claims against us, whether in China or other
jurisdictions, increases as we continue to grow, particularly internationally. We have also acquired businesses, such as Youku Tudou, that have been, and may continue to be, subject to liabilities for
infringement of third-party intellectual property rights or other allegations based on the content available on their websites or the services they provide. In addition, we expect our ecosystem to
involve more and more user-generated content, including the entertainment content on Youku Tudou, the interactive media content displayed on Taobao Marketplace and Tmall, including livestreams, as
well as the data generated, uploaded and saved by users of our cloud computing services, over which we have limited control and we may be subject to claims for infringement of third-party intellectual
property rights, or subject us to additional scrutiny by the relevant government authorities. These claims or scrutiny, whether or not having merit, may result in our expenditure of significant
financial and management resources, injunctions
against us or payment of damages. We may need to obtain licenses from third parties who allege that we have infringed their rights, but these licenses may not be available on terms acceptable to us or
at all. These risks have been amplified by the increase in the number of third parties whose sole or primary business is to assert these claims.
China
has enacted laws and regulations governing Internet access and the distribution of products, services, news, information, audio-video programs and other content through the
Internet. The PRC government has prohibited the distribution of information through the Internet that it deems to be in violation of PRC laws and regulations, impairs the national dignity of China or
the public interest, or is obscene, superstitious, fraudulent or defamatory. Users of certain of our websites and platforms, including Youku Tudou, can upload content, to these websites and platforms,
which is generally referred to as "user-generated content." Due to the significant amount of content uploaded by our users, we may not be able to identify all the videos or other content that may
violate
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relevant
laws and regulations. If any of the information disseminated through our marketplaces and websites, including videos and other content (including user-generated content) displayed on Youku
Tudou's or our other websites or on our Tmall set-top boxes and smart televisions powered by our YunOS that provide access to entertainment and e-commerce content, were deemed by the PRC government to
violate any content restrictions, we would not be able to continue to display these content and could become subject to penalties, including confiscation of income, fines, suspension of business and
revocation of required licenses, which could materially and adversely affect our business, financial condition and results of operations. The outcome of any claims, investigations and proceedings is
inherently uncertain, and in any event defending against these claims could be both costly and time-consuming, and could significantly divert the efforts and resources of our management and other
personnel. An adverse determination in any of these litigation matters or proceedings could cause us to pay damages, as well as legal and other costs, limit our ability to conduct business or require
us to change the manner in which we operate and harm our reputation. As we expand our operations internationally, we expect that we will become subject to similar laws and regulations in other
jurisdictions.
We may be subject to claims under consumer protection laws, including health and safety claims and product
liability claims, if property or people are harmed by the products and services sold on our marketplaces.
Due to several high-profile incidents involving food safety and consumer complaints that have occurred in China in recent years, the PRC
government, media outlets and public advocacy groups are increasingly focused on consumer protection. Government authorities in other countries where we operate also place high importance on consumer
protection. Moreover, as part of our growth strategy, we expect to increase our focus on food, food supplements and beverages, mother care, baby care and healthcare products and services, and
electronics products. For example, through Tmall Supermarket, we offer products that are frequently purchased by consumers, such as groceries and FMCG. We have also invested in companies involved in
these sectors. These activities could expose us to increasing liability associated with consumer protection laws in those areas. Operators
of e-commerce platforms are subject to certain provisions of consumer protection laws even where the operator is not the merchant of the product or service purchased by the consumer. For example,
under applicable consumer protection laws in China, e-commerce platform operators may be held liable for consumer claims relating to damage if they are unable to provide consumers with the true name,
address and contact details of merchants or service providers. In addition, if we do not take appropriate remedial action against merchants or service providers for actions they engage in that we
know, or should have known, would infringe upon the rights and interests of consumers, we may be held jointly liable for infringement alongside the merchant or service provider. Moreover, applicable
consumer protection laws in China hold that trading platforms will be held liable for failing to meet any undertakings that the platforms make to consumers with regard to products listed on their
websites. Furthermore, we are required to report to SAIC or its local branches any violation of applicable laws, regulations or SAIC rules by merchants or service providers, such as sales of goods
without proper license or authorization, and we are required to take appropriate remedial measures, including ceasing to provide services to the relevant merchants or service providers. We may also be
held jointly liable with merchants who do not possess the proper licenses or authorizations to sell goods or sell goods that do not meet product standards.
In
addition, we are facing increasing levels of activist litigation in China by plaintiffs claiming damages based on consumer protection laws. This type of activist litigation could
increase in the future, and if it does, we could face increased costs defending these suits and damages should we not prevail, which could materially and adversely affect our reputation and brand and
our results of operations.
As
our business expands outside of China, we may also face increasing scrutiny from consumer protection regulators, as well as increasingly become target for litigation, in the
United States, Europe and other jurisdictions. If claims are brought against us under any of these laws, we could be subject to damages and reputational damage as well as action by regulators,
which could have a material adverse effect on our business, financial condition and results of operations. We do not maintain product liability insurance for products and services transacted on our
marketplaces, and our rights of indemnity from the merchants on our marketplaces may not adequately cover us for any liability we may incur. Even unsuccessful claims could result in significant
expenditure of funds and
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of management time and resources, which could materially and adversely affect our business operations, net income and profitability.
We may be subject to liability for content available in our ecosystem that is alleged to be socially
destabilizing, obscene, defamatory, libelous or otherwise unlawful.
Under PRC law and the laws of certain other jurisdictions in which we operate, we are required to monitor our websites and the websites hosted
on our servers and mobile interfaces for items or content
deemed to be socially destabilizing, obscene, superstitious or defamatory, as well as for items, content or services that are illegal to sell online or otherwise in other jurisdictions in which we
operate our marketplaces, and promptly take appropriate action with respect to the relevant items, content or services. We may also be subject to potential liability in China or other jurisdictions
for any unlawful actions of our merchants, marketing customers or users of our websites or mobile interfaces, or for content we distribute or that is linked from our platforms that is deemed
inappropriate. It may be difficult to determine the type of content that may result in liability to us, our websites and platforms, such as our cloud computing services, which allow users to upload
and save massive data on our cloud data centers, or Youku Tudou, which allows users to upload videos and other content to our websites, may make this even more difficult. If we are found to be liable,
we may be subject to negative publicity, fines, have our relevant business operation licenses revoked, or be prevented from operating our websites or mobile interfaces in China or other jurisdictions.
In
addition, claims may be brought against us for defamation, libel, negligence, copyright, patent or trademark infringement, tort (including personal injury), other unlawful activity or
other theories and claims based on the nature and content of information posted on our platforms, including user-generated content, product reviews and message boards, by our consumers, merchants and
other participants.
Regardless
of the outcome of any dispute or lawsuit, we may suffer from negative publicity and reputational damage as a result of these actions.
We may become the target of anti-monopoly and unfair competition claims, which may result in our being
subject to fines as well as constraints on our business.
Although the PRC Anti-Monopoly Law is relatively recent, having taken effect on August 1, 2008, PRC anti-monopoly enforcement agencies,
namely the Ministry of Commerce, or the MOFCOM, the National Development and Reform Commission, or the NDRC, and the SAIC, have in recent years strengthened enforcement actions, including levying
significant fines, with respect to concentration of undertakings and cartel activity, mergers and acquisitions, as well as abusive behavior of companies having market dominance. The PRC Anti-Monopoly
Law also provides a private right of action for competitors or users to bring anti-monopoly claims against companies. In recent years, an increased number of companies have been exercising their right
to seek relief under the PRC Anti-Monopoly Law. As public awareness of the rights under the PRC Anti-Monopoly Law increases, more companies, including our competitors, business partners and customers
may resort to seeking the remedies available under the law, such as through complaints to regulators or as plaintiffs in private ligation, to improve their competition position, regardless of the
merits of their claims.
From
time to time, we may receive close scrutiny from government agencies under the PRC Anti-Monopoly Law in connection with our business practices, investments and acquisitions. Any
anti-monopoly lawsuit or administrative proceeding initiated against us may result in our being subject to profit disgorgement, heavy fines and various constraints on our business, or result in
negative publicity which could harm our reputation and negatively affect the trading price of our ADSs. These constraints could include forced termination of any agreements or arrangements that are
determined to be in violation of anti-monopoly laws, required divestitures and limitations on certain pricing and business practices, which may limit our ability to continue to innovate, diminish the
appeal of
our services and increase our operating costs. These constraints could also enable our competitors to develop websites, products and services that mimic the functionality of our services, which could
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the popularity of our marketplaces, products and services among merchants, consumers and other participants, and cause our revenue and net income to decrease materially.
Our brand name and our business may be harmed by aggressive marketing and communications strategies of our
competitors.
Due to intense competition in our industry, we have been and may be the target of incomplete, inaccurate and false statements about our company
and our products and services that could damage our and our management's reputation and our brand and materially deter consumers from making purchases on our marketplaces. Our ability to respond to
our competitors' misleading marketing efforts may be limited during our self-imposed quiet periods around quarter ends or due to legal prohibitions on permissible public communications by us during
certain other periods.
Our results of operations fluctuate significantly from quarter to quarter which may make it difficult to
predict our future performance.
Our results of operations fluctuate significantly from quarter to quarter. In addition, our business is characterized by seasonal fluctuations,
which may cause further fluctuations. The fourth quarter of each calendar year generally contributes the largest portion of our annual revenues due to a number of factors, such as merchants allocating
a significant portion of their online marketing budgets to the fourth calendar quarter, promotions, such as Singles Day on November 11 of each year and the impact of seasonal buying patterns in
respect of certain categories such as apparel. The first quarter of each calendar year generally contributes the smallest portion of our annual revenues, primarily due to a lower level of allocation
of online marketing budgets by merchants at the beginning of the calendar year and the Chinese New Year holiday, during which time consumers generally spend less and businesses in China are
generally closed. We may also introduce new promotions or change the timing of our promotions in ways that further cause our quarterly results to fluctuate and differ from historical patterns. In
addition, seasonal weather patterns may affect the timing of buying decisions. For example, unexpectedly long periods of warm weather could delay the purchase of heavier clothing items that have
higher average selling prices. The performance of our equity investees and of businesses in which we have made investments, may also result in fluctuations in our results of operations. Fluctuations
in our results of operations related to our investments may also result from the accounting implication of re-measurement of fair values of certain financial instruments, share-based awards and
previously held equity interests upon disposal or step acquisitions. Given that the fair value movements of the underlying equities of financial instruments,
share-based awards or equity interests are beyond the control of our management, the magnitude of the related accounting impact is unpredictable and may affect our results of operations significantly.
Our
results of operations will likely fluctuate due to these and other factors, some of which are beyond our control. In addition, our growth in the past may have masked the seasonality
that might otherwise be apparent in our results of operations. As the rate of growth of our business declines in comparison to prior periods, we expect that the seasonality in our business may become
more pronounced. Moreover, as our business grows, we expect that our fixed costs and expenses, such as payroll and benefits, bandwidth and co-location fees, will continue to increase, which will
result in operating leverage in seasonally strong quarters but can significantly pressure operating margins in seasonally weak quarters.
Our
quarterly and annual financial results will likely differ from our historical performance. To the extent our results of operations are below the expectations of public market
analysts and investors in the future, or if there are significant fluctuations in our financial results, the market price of our ADSs could decline materially.
We may not be able to protect our intellectual property rights.
We rely on a combination of trademark, fair trade practice, patent, copyright and trade secret protection laws in China and other jurisdictions,
as well as confidentiality procedures and contractual provisions, to protect our intellectual property rights. We also enter into confidentiality agreements with our employees and any third parties
who may access our proprietary information, and we rigorously control access to our proprietary technology and information.
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Intellectual property protection may not be sufficient in China or other countries in which we operate. Confidentiality agreements may be breached by
counterparties, and there may not be adequate remedies available to us for these breaches. Accordingly, we may not be able to effectively protect our intellectual property rights or to enforce our
contractual rights in China or elsewhere. In addition, policing any unauthorized use of our intellectual property is difficult, time-consuming and costly and the steps we have taken may be inadequate
to prevent the misappropriation of our intellectual property. In the event that we resort to litigation to enforce our intellectual property rights, the litigation could result in substantial costs
and a diversion of our managerial and financial resources. We can provide no assurance that we will prevail in any litigation. In addition, our trade secrets may be leaked or otherwise become
available to, or be independently discovered by, our competitors. Any failure in protecting or enforcing our intellectual property rights could have a material adverse effect on our business,
financial condition and results of operations.
We may be subject to material litigation and regulatory proceedings.
We have been involved in a high volume of litigation in China and a small volume of litigation outside China relating principally to third-party
and principal intellectual property infringement claims, contract disputes involving merchants and consumers on our platforms, consumer protection claims, employment related cases and other matters in
the ordinary course of our business. As our ecosystem expands, including across jurisdictions and through the addition of new businesses, we may face an increasing number of these claims, including
those involving higher amounts of alleged damages. We are subject to laws and regulations in China and the other jurisdictions where our merchants, consumers, users, customers and other participants
are located. These laws, rules and regulations may vary in their scope and impose requirements which are more stringent than, or which conflict with, those in China. We have acquired and may acquire
companies, such as Youku Tudou, that are subject to or may become subject to litigation, including shareholder class action lawsuits in the case of companies we acquire that are or were
publicly-listed companies, as well as regulatory proceedings.
As
publicly-listed companies, we and certain of our subsidiaries face additional exposure to claims and lawsuits inside and outside China. We will need to defend against these lawsuits,
including any appeals should our initial defense be successful. The litigation process may utilize a material portion of our cash resources and divert management's attention from the day-to-day
operations of our company, all of which could harm our business. There can be no assurance that we will prevail in any of these cases, and any adverse outcome of these cases could have a material
adverse effect on our reputation, business and results of operations. In particular, we have been named as a defendant in certain purported shareholder class action lawsuits described in
"Item 8. Financial Information A. Consolidated Statements and Other Financial Information Legal and
Administrative Proceedings." We are currently unable to estimate the possible loss or possible range of loss, if any, associated with the resolution of these lawsuits. An unfavorable outcome from the
lawsuits, including any plaintiff's appeal of the judgment in these lawsuits, could have a material adverse effect on our consolidated financial position, results of operations, or cash flows in the
future. In addition, although we have obtained directors and officers liability insurance, the insurance coverage may not be adequate to cover our obligations to indemnify our directors and officers,
fund a settlement of litigation in excess of insurance coverage or pay an adverse judgment in litigation.
In
early 2016, the U.S. Securities and Exchange Commission, or SEC, informed us that it was initiating an investigation into whether there have been any violations of the federal
securities laws. The SEC has requested that we voluntarily provide it with documents and information relating to, among other things: our consolidation policies and practices (including our accounting
for Cainiao Network as an equity method investee), our policies and practices applicable to related party transactions in general, and our reporting of operating data from Singles Day. We are
cooperating with the SEC and, through our legal counsel, have been providing the SEC with requested documents and information. The SEC advised us that the initiation of a request for information
should not be construed as an indication by the SEC or its staff that any violation of the federal securities laws has occurred. This matter is ongoing, and, as with any regulatory proceeding, we
cannot predict when it will be concluded.
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The
existence of litigation, claims, investigations and proceedings may harm our reputation and adversely affect the trading price of our ADSs. The outcome of any claims, investigations
and proceedings is inherently uncertain, and in any event defending against these claims could be both costly and time-consuming, and could significantly divert the efforts and resources of our
management and other personnel. An adverse determination in any litigation, investigation or proceeding could cause us to pay damages as well as legal and other costs, limit our ability to conduct
business or require us to change the manner in which we operate.
We may suffer reputational harm and the price of our ADSs may decrease significantly due to business dealings
by, or connections of, merchants or consumers on our marketplaces with sanctioned countries or persons.
The U.S. government imposes broad economic and trade restrictions on certain countries and regions, or the Sanctioned Countries,
including Cuba, Iran, North Korea and Syria, and numerous individuals and entities, including those designated as having engaged in activities relating to terrorism, drug trafficking, proliferation of
weapons of mass destruction or human rights violations, or the Sanctioned Persons. The United Nations, the European Union, or the EU, the United Kingdom, or the UK, and other countries also
impose economic and trade restrictions, including on certain Sanctioned Countries and Sanctioned Persons. We do not have employees or operations in the Sanctioned Countries, and, although our websites
are open and available worldwide, we do not actively solicit business from the Sanctioned Countries or Sanctioned Persons.
As
a Cayman Islands company, we are generally not required to comply with U.S., UK, and EU sanctions to the same extent as U.S., UK or EU entities. However, our U.S., UK, and EU
subsidiaries, our employees who are U.S. persons or UK or EU nationals, activities in the U.S., UK, or EU, activities involving U.S.-origin goods, technology or services, and certain
Iran-related activities, are subject to applicable sanctions requirements. In the case of Alibaba.com, our aggregate cash revenue from members in these Sanctioned Countries in fiscal year 2017
accounted for less than 0.002% of Alibaba.com's cash revenue. In the case of AliExpress and our China retail marketplaces, an insignificant percentage of orders have been placed by consumers from the
Sanctioned Countries, with an aggregate GMV settled of approximately US$9.3 million in the twelve months ended March 31, 2017. As all transaction fees on AliExpress and our China retail
marketplaces are paid by merchants, primarily based in China, we do not earn any fees or commission from consumers in Sanctioned Countries in respect of transactions conducted on these platforms.
We
cannot assure you that current or future economic and trade sanctions regulations or developments will not have a negative impact on our business or reputation. International economic
and trade sanctions are complex and subject to frequent change, including jurisdictional reach and the lists of countries, entities, and individuals subject to the sanctions. Hence, we may incur
significant costs related to current, new, or changing sanctions programs, as well as investigations, fines, fees or settlements, which may be difficult to predict. We also could face increased
sanctions-related compliance costs and risks as we expand globally and into additional businesses, such as cloud computing, hardware and data hosting. In addition, our expanding network of investee
companies, global business partners, joint venture partners or other parties that have collaborative relationships with us or our affiliates may engage in activities in or with Sanctioned Countries or
Sanctioned Persons, which might result in negative publicity, governmental investigations and reputational harm. Any of the above may cause the price of our ADSs to decline significantly, and thus
materially reduce the value of your investment in our ADSs.
Certain
institutional investors, including state and municipal governments in the United States and universities, as well as financial institutions, have proposed or adopted
divestment or similar initiatives regarding investments in companies that do business with Sanctioned Countries. Accordingly, as a result of activities on our marketplaces involving users based in the
Sanctioned Countries, certain investors may not wish to invest, and certain financial institutions may not wish to lend or extend credit and may divest their investment in, or seek early repayment of
loans to us. These divestment initiatives may negatively impact our reputation and investor sentiment with respect to our ADSs may be materially and adversely affected.
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Failure to comply with the terms of our indebtedness could result in acceleration of indebtedness, which
could have an adverse effect on our cash flow and liquidity.
We have issued an aggregate of US$8.0 billion unsecured senior notes. We have also entered into a five-year term loan facility of
US$4.0 billion. In addition, in April 2017, we replaced our US$3.0 billion revolving credit facility with a new US$5.15 billion revolving credit facility. Under the terms
of our unsecured senior notes and credit facilities and under any debt financing arrangement that we may enter into in the future, we are, and may be in the future, subject to covenants that could,
among other things, restrict our business and operations. If we breach any of these covenants, our lenders under our credit facilities and holders of our unsecured senior notes will be entitled to
accelerate our debt obligations. Any default under our credit facilities or unsecured senior notes could require that we repay these debts prior to maturity as well as limit our ability to obtain
additional financing, which in turn may have a material adverse effect on our cash flow and liquidity.
We may need additional capital but may not be able to obtain it on favorable terms or at all.
We may require additional cash resources due to future growth and development of our business, including any investments or acquisitions we may
decide to pursue. If our cash resources are insufficient to satisfy our cash requirements, we may seek to issue additional equity or debt securities or obtain new or
expanded credit facilities. Our ability to obtain external financing in the future is subject to a variety of uncertainties, including our future financial condition, results of operations, cash
flows, trading price of our ADSs, liquidity of international capital and lending markets and PRC governmental regulations over foreign investment and cross-border financing and the Internet industry
in the PRC. For example, although not explicitly required by statute, since May 2016, the NDRC has been requiring offshore incorporated companies directly or indirectly controlled by PRC
residents to complete filings with the NDRC before pricing and closing of any offshore debt issuance. In addition, incurring indebtedness would subject us to increased debt service obligations and
could result in operating and financial covenants that would restrict our operations. There can be no assurance that financing will be available in a timely manner or in amounts or on terms acceptable
to us, or at all. Any failure to raise needed funds on terms favorable to us, or at all, could severely restrict our liquidity as well as have a material adverse effect on our business, financial
condition and results of operations. Moreover, any issuance of equity or equity-linked securities could result in significant dilution to our existing shareholders.
We are subject to interest rate risk in connection with our indebtedness.
We are exposed to interest rate risk related to our indebtedness. The interest rates under our credit facilities and one tranche of our
unsecured senior notes with an aggregate principal amount of US$300 million are based on a spread over LIBOR. As a result, the interest expenses associated with our indebtedness will be subject
to the potential impact of any fluctuation in LIBOR. Any increase in LIBOR could impact our financing costs if not effectively hedged. Our RMB denominated bank borrowings are also subject to interest
rate risk. Although from time to time, we use hedging transactions in an effort to reduce our exposure to interest rate risk, these hedges may not be effective.
We may not have sufficient insurance coverage to cover our business risks.
We have obtained insurance to cover certain potential risks and liabilities, such as property damage, business interruptions and public
liabilities. However, insurance companies in China and other jurisdictions in which we operate may offer limited business insurance products. As a result, we may not be able to acquire any insurance
for all types of risks we face in our operations in China and elsewhere, and our coverage may not be adequate to compensate for all losses that may occur, particularly with respect to loss of business
or operations. We do not maintain product liability insurance, nor do we maintain key-man life insurance. This could leave us exposed to potential claims and losses. Any business disruption,
litigation, regulatory action, outbreak of epidemic disease or natural disaster could also expose us to substantial costs and diversion of resources. We cannot assure you that our insurance coverage
is sufficient to prevent us from any loss or that we will be able to successfully claim our losses under our current insurance policy on a timely basis, or at all. If we incur any loss that is not
covered by our
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insurance
policies, or the compensated amount is significantly less than our actual loss, our business, financial condition and results of operations could be materially and adversely affected.
An occurrence of a natural disaster, widespread health epidemic or other outbreaks could have a material
adverse effect on our business, financial condition and results of operations.
Our business could be materially and adversely affected by natural disasters, such as snowstorms, earthquakes, fires or floods, the outbreak of
a widespread health epidemic, such as swine flu, avian influenza, severe acute respiratory syndrome, or SARS, Ebola, Zika or other events, such as wars, acts of terrorism, environmental accidents,
power shortage or communication interruptions. The occurrence of a disaster or a prolonged outbreak of an epidemic illness or other adverse public health developments in China or elsewhere in the
world could materially disrupt our business and operations. These events could also significantly impact our industry and cause a temporary closure of the facilities we use for our operations, which
would severely disrupt our operations and have a material adverse effect on our business, financial condition and results of operations. Our operations could be disrupted if any of our employees or
employees of our business partners were suspected of having the swine flu, avian influenza, SARS, Ebola, Zika or other disease epidemics, since this could require us or our business partners to
quarantine some or all of these employees or disinfect the facilities used for our operations. In addition, our revenue and profitability could be materially reduced to the extent that a natural
disaster, health epidemic or other outbreak harms the global or PRC economy in general. Our operations could also be severely disrupted if our consumers, merchants or other participants were affected
by natural disasters, health epidemics or other outbreaks.
Risks Related to our Corporate Structure
The Alibaba Partnership and related voting agreements limit the ability of our shareholders to nominate and
elect directors.
Our articles of association allow the Alibaba Partnership to nominate or, in limited situations, appoint a simple majority of our board of
directors. If at any time our board of directors consists of less than a simple majority of directors nominated or appointed by the Alibaba Partnership for any reason, including because
a director previously nominated by the Alibaba Partnership ceases to be a member of our board of directors or because the Alibaba Partnership had previously not exercised its right to nominate or
appoint a simple majority of our board of directors, the Alibaba Partnership will be entitled (in its sole discretion) to nominate or appoint such number of additional directors to the board as
necessary to ensure that the directors nominated or appointed by the Alibaba Partnership comprise a simple majority of our board of directors.
In
addition, we have entered into a voting agreement pursuant to which SoftBank, Yahoo, Jack Ma and Joe Tsai have agreed to vote their shares in favor of the Alibaba Partnership director
nominees at each annual general shareholders meeting for so long as SoftBank owns at least 15% of our outstanding ordinary shares. Furthermore, the voting agreement provides that SoftBank has the
right to nominate one director to our board until SoftBank owns less than 15% of our outstanding ordinary shares, and that right is also reflected in our articles of association. In addition, pursuant
to the voting agreement, Yahoo, Jack Ma and Joe Tsai have agreed to vote their shares (including shares for which they have voting power) in favor of the election of the SoftBank director nominee at
each annual general shareholders meeting in which the SoftBank nominee stands for election. Moreover, subject to certain exceptions, pursuant to the voting agreement SoftBank and Yahoo have agreed to
give Jack and Joe a proxy over, with respect to SoftBank, any portion of its shareholdings exceeding 30% of our outstanding shares and, with respect to Yahoo, all of its shareholdings up to a maximum
of 121.5 million of our ordinary shares. These proxies will remain in effect until Jack Ma owns less than 1% of our ordinary shares on a fully-diluted basis or we materially breach the voting
agreement.
This
governance structure and contractual arrangement limit the ability of our shareholders to influence corporate matters, including any matters determined at the board level. In
addition, the nomination right granted to the Alibaba Partnership will remain in place for the life of the Alibaba Partnership unless our articles of association are amended to provide otherwise by a
vote of shareholders representing at least 95% of shares that
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vote
at a shareholders meeting. The nomination rights of the Alibaba Partnership will remain in place notwithstanding a change of control or merger of our company and, for so long as SoftBank and
Yahoo remain substantial shareholders, we expect the Alibaba Partnership nominees will receive a majority of votes cast at any meeting for the election of directors and will be elected as directors.
These provisions and agreements could have the effect of delaying, preventing or deterring a change in control and could limit the opportunity of our shareholders to receive a premium for their ADSs,
and could also materially decrease the price that some investors are willing to pay for our ADSs, As of the date of this annual report, the parties to the voting agreement and the partners of the
Alibaba Partnership held in the aggregate more than 50% of our outstanding ordinary shares (including unvested shares and shares underlying vested and unvested awards). See "Item 6. Directors,
Senior Management and Employees A. Directors and Senior Management Alibaba Partnership."
The interests of the Alibaba Partnership may conflict with the interests of our shareholders.
The nomination and appointment rights of the Alibaba Partnership limits the ability of our shareholders to influence corporate matters,
including any matters to be determined by our board of directors. The interests of the Alibaba Partnership may not coincide with the interests of our shareholders, and the Alibaba Partnership or its
director nominees may make decisions with which they disagree, including decisions on important topics such as compensation, management succession, acquisition strategy and our business and financial
strategy. For example, because the Alibaba Partnership will continue to be largely comprised of members of our management team, the Alibaba Partnership and its director nominees, consistent with our
operating philosophy, may focus on the long-term interests of our ecosystem participants at the expense of our short-term financial results, which may differ from the expectations and desires of
shareholders unaffiliated with the Alibaba Partnership. To the extent that the interests of the Alibaba Partnership differ from the interests of any of our shareholders, our shareholders may be
disadvantaged by any action that the Alibaba Partnership may seek to pursue.
Our articles of association contain anti-takeover provisions that could adversely affect the rights of
holders of our ordinary shares and ADSs.
Our articles of association contain certain provisions that could limit the ability of third parties to acquire control of our company,
including:
-
-
a provision that grants authority to our board of directors to establish from time to time one or more series of preferred shares without
action by our shareholders and to determine, with respect to any series of preferred shares, the terms and rights of that series;
-
-
a provision that grants the Alibaba Partnership the right to nominate a simple majority of our board of directors notwithstanding a change of
control or merger of our company; and
-
-
a classified board with staggered terms that will prevent the replacement of a majority of directors at one time.
These
provisions could have the effect of delaying, preventing or deterring a change in control, and could limit the opportunity for our shareholders to receive a premium for their ADSs,
and could also materially decrease the price that some investors are willing to pay for our ADSs.
SoftBank owns approximately 29% of our outstanding ordinary shares and its interests may differ from those of
our other shareholders.
As of March 31, 2017, SoftBank owned approximately 29% of our outstanding ordinary shares. Subject to certain exceptions, SoftBank has
agreed to grant the voting power of any portion of its shareholding exceeding 30% of our outstanding ordinary shares to Jack Ma and Joe Tsai by proxy. Under the terms of the voting agreement we
entered into with SoftBank, SoftBank also has the right to nominate one member of our board of directors, and Yahoo, Jack and Joe have agreed to vote their shares (including shares for which they have
voting power) in favor of the SoftBank director nominees at each annual general shareholders meeting in which the
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SoftBank
nominee stands for election until such time as SoftBank holds less than 15% of our outstanding ordinary shares. SoftBank's director nomination right is also reflected in our articles of
association. Except with regard to shareholder votes relating to the Alibaba Partnership director nominees, SoftBank will have significant influence over the outcome of matters that require
shareholder votes and accordingly over our business and corporate matters. SoftBank may exercise its shareholder rights in a way that it believes is in its own best interest, which may conflict with
the interest of our other shareholders. These actions may be taken even if SoftBank is opposed by our other shareholders.
For
more information, see "Item 7. Major Shareholders and Related Party Transactions B. Related Party
Transactions Transactions and Agreements with SoftBank and Yahoo Voting Agreement."
If the PRC government deems that the contractual arrangements in relation to our variable interest entities
do not comply with PRC governmental restrictions on foreign investment, or if these regulations or the interpretation of existing regulations changes in the future, we could be subject to penalties or
be forced to relinquish our interests in those operations.
Foreign ownership of certain types of Internet businesses, such as Internet information services, is subject to restrictions under applicable
PRC laws, rules and regulations. For example, foreign investors are generally not permitted to own more than 50% of the equity interests in a value-added telecommunication service provider. Any
foreign investor must also have experience and a good track record in providing value-added telecommunications services overseas. Although according to the Notice on Lifting the Restriction to Foreign
Shareholding Percentage in Online Data Processing and Transaction Processing Business (Operational E-commerce) promulgated by the MIIT on June 19, 2015, foreign investors are allowed to hold up
to 100% of all equity interests in the online data processing and transaction processing business (operational e-commerce) in China, other requirements provided by the Foreign Investment
Telecommunications Rules (such as the track record and experience requirement for a major foreign investor) still apply. It is unclear how this notice will be implemented and there exist high
uncertainties with respect to its interpretation and implementation by authorities.
While
the significant majority of our revenue was generated by our wholly-foreign owned enterprises in fiscal year 2017, we provide Internet information services in China, which are
critical to our business, through a number of PRC incorporated variable interest entities. The variable interest entities are owned by PRC citizens who are our founders or senior employees or by PRC
entities owned by these PRC citizens, or the variable interest entity equity holders, with whom we have contractual arrangements, or the contractual arrangements. The contractual arrangements give us
effective control over each of the variable interest entities and enable us to obtain substantially all of the economic benefits arising from the variable interest entities as well as consolidate the
financial results of the variable interest entities in our results of operations. Although the structure we have adopted is consistent with longstanding industry practice, and is commonly adopted by
comparable companies in China, the PRC government may not agree that these arrangements comply with PRC licensing, registration or other regulatory requirements, with existing policies or with
requirements or policies that may be adopted in the future.
In
the opinion of Fangda Partners, our PRC counsel, the ownership structures of our material wholly-foreign owned enterprises and our material variable interest entities in China do not
and will not violate any applicable PRC law, regulation or rule currently in effect; and the contractual arrangements between our material wholly-foreign owned enterprises, our material variable
interest entities and their respective equity holders governed by PRC law are valid, binding and enforceable in accordance with their terms and applicable PRC laws and regulations currently in effect
and will not violate any applicable PRC law, rule or regulation currently in effect. However, Fangda Partners has also advised us that there are substantial uncertainties regarding the interpretation
and application of current PRC laws, rules and regulations. Accordingly, the PRC regulatory authorities and PRC courts may in the future take a view that is contrary to the opinion of our PRC
legal counsel.
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It
is uncertain whether any new PRC laws, rules or regulations relating to variable interest entity structures will be adopted or if adopted, what they would provide. Please also see
" Substantial uncertainties exist with respect to the enactment timetable, interpretation and implementation of draft PRC Foreign Investment Law."
If
we or any of our variable interest entities are found to be in violation of any existing or future PRC laws, rules or regulations, or fail to obtain or maintain any of the required
permits or approvals, the relevant PRC regulatory authorities would have broad discretion to take action in dealing with these violations or failures, including revoking the business and operating
licenses of our PRC subsidiaries or the variable interest entities, requiring us to discontinue or restrict our operations, restricting our right to collect revenue, blocking one or more of our
websites, requiring us to restructure our operations or taking other regulatory or enforcement actions against us. The imposition of any of these measures could result in a material adverse effect on
our ability to conduct all or any portion of our business operations. In addition, it is unclear what impact the PRC government actions would have on us and on our ability to consolidate the financial
results of any of our variable interest entities in our consolidated financial statements, if the PRC government authorities were to find our legal structure and contractual arrangements to be in
violation of PRC laws, rules and regulations. If the imposition of any of these government actions causes us to lose our right to direct the activities of any of our material variable interest
entities or otherwise separate from any of these entities and if we are not able to restructure our ownership structure and operations in a satisfactory manner, we would no longer be able to
consolidate the financial results of our variable interest entities in our consolidated financial statements. Any of these events would have a material adverse effect on our business, financial
condition and results of operations.
Substantial uncertainties exist with respect to the enactment timetable, interpretation and implementation of
draft PRC Foreign Investment Law.
The MOFCOM published a discussion draft of the proposed Foreign Investment Law in January 2015 aiming to, upon its enactment, replace the
major existing laws and regulations governing foreign investment in China. The MOFCOM completed the solicitation of comments on this draft in February 2015, and indicated in March 2017
that it had revised the draft Foreign Investment Law based on public comments and is cooperating with the Legislative Affairs Office of the State Council and the Law Committee of National People's
Congress for the legislative deliberation of the revised draft Foreign Investment Law. However, the revised draft Foreign Investment Law has not been made available to the public, and there are still
substantial uncertainties with respect to the enactment timetable and the final content of the Foreign Investment Law.
Among
other things, the discussion draft of the Foreign Investment Law published by the MOFCOM purports to introduce the principle of "actual control" in determining whether a company is
considered a foreign invested enterprise, or an FIE. The discussion draft specifically provides that entities established in China but "controlled" by foreign investors will be treated as FIEs,
whereas an entity organized in a foreign jurisdiction, but cleared by the MOFCOM as "controlled" by PRC entities and/or citizens, would nonetheless be treated as a PRC domestic entity for investment
in the "restriction category" on the "negative list." In this connection, "control" is broadly defined in the draft law to cover any of the following summarized
categories:
-
-
holding 50% or more of the voting rights or similar rights and interests of the subject entity;
-
-
holding less than 50% of the voting rights or similar rights and interests of the subject entity but having the power to directly or indirectly
appoint or otherwise secure at least 50% of the seats on the board or other equivalent decision making bodies, or having the voting power to materially influence the board, the shareholders' meeting
or other equivalent decision making bodies; or
-
-
having the power to exert decisive influence, via contractual or trust arrangements, over the subject entity's operations, financial, staffing
and technology matters.
Once
an entity is determined to be an FIE, and its investment amount exceeds certain thresholds or its business operation falls within a "negative list" purported to be separately issued
by the State Council in the future, market entry clearance by the MOFCOM or its local counterparts would be required.
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The
"variable interest entity" structure, or VIE structure, has been adopted by many PRC-based companies, including us and certain of our equity investees such as Weibo, to obtain
necessary licenses and permits in the industries that are currently subject to foreign investment restrictions in China. Under the discussion draft of the Foreign Investment Law, variable interest
entities that are controlled via contractual arrangements would also be deemed as FIEs, if they are ultimately "controlled" by foreign investors. For any companies with a VIE structure in an industry
category that is in the "restriction category" on the "negative list," the existing VIE structure may be deemed legitimate only if the ultimate controlling person(s) is/are of PRC nationality (either
PRC state owned enterprises or agencies, or PRC citizens). Conversely, if the actual controlling person(s) is/are of foreign nationalities, then the variable interest entities will be treated as FIEs
and any operation in the industry category on the "negative list" without market entry clearance may be considered as illegal.
Based
on the definition of "control" in the discussion draft of the Foreign Investment Law, we believe that there are strong basis for a determination that we and our variable interest
entities are ultimately controlled by PRC citizens for the following reasons:
-
-
Alibaba Partnership has an exclusive right to nominate and appoint up to a simple majority of the members of our board of directors and
therefore it effectively controls the board and all management decisions of our company;
-
-
nearly all of the partners of Alibaba Partnership are PRC citizens; and
-
-
Alibaba Partnership exercises its nomination rights by a majority of votes of all its partners.
See
"Item 6. Directors, Senior Management and Employees A. Directors and Senior Management Alibaba
Partnership."
However,
there are significant uncertainties as to how the control status of our company, our variable interest entities and our equity investees with a VIE structure would be determined
under the enacted version of the Foreign Investment Law. In addition, it is uncertain whether any of the businesses that we currently operate or plan to operate in the future through our consolidated
entities and the businesses operated by our equity investees with a VIE structure would be on the to-be-issued "negative list" and therefore be subject to any foreign investment restrictions or
prohibitions. We also face uncertainties as to whether the enacted version of the Foreign Investment Law and the final "negative list" would mandate further actions, such as MOFCOM market entry
clearance, to be completed by companies with existing VIE structure and whether this clearance can be timely obtained, or at all. If we or our equity investees with a VIE structure were not considered
as ultimately controlled by PRC domestic investors under the enacted version of the Foreign Investment Law, further actions required to be taken by us or these equity investees under the enacted
Foreign Investment Law may materially and adversely affect our business and financial condition.
In
addition, our corporate governance practice may be materially impacted and our compliance costs could increase if we were not considered as ultimately controlled by PRC entities
and/or citizens under the enacted version of the Foreign Investment Law. For instance, the discussion draft of the Foreign Investment Law purports to impose stringent ad hoc and periodic information
reporting requirements on foreign investors and the applicable FIEs. Aside from investment implementation report and investment amendment report that would be required for
each investment and alteration of investment specifics, an annual report would be mandatory, and large foreign investors meeting certain criteria would be required to report on a quarterly basis. Any
company found to be non-compliant with these information reporting obligations could potentially be subject to fines and/or administrative or criminal liabilities, and the persons directly responsible
could be subject to criminal liabilities.
Our contractual arrangements may not be as effective in providing control over the variable interest entities
as direct ownership.
We rely on contractual arrangements with our variable interest entities to operate part of our Internet businesses in China and other businesses
in which foreign investment is restricted or prohibited. For a description of these contractual arrangements, see "Item 4. Information on the Company C.
Organizational Structure
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Contractual
Arrangements among Our Wholly-foreign Owned Enterprises, Variable Interest Entities and the Variable Interest Entity Equity Holders." These contractual arrangements may not be as effective
as direct ownership in providing us with control over our variable interest entities.
If
we had direct ownership of the variable interest entities, we would be able to exercise our rights as an equity holder directly to effect changes in the boards of directors of those
entities, which could effect changes at the management and operational level. Under our contractual arrangements, we may not be able to directly change the members of the boards of directors of these
entities and would have to rely on the variable interest entities and the variable interest entity equity holders to perform their obligations in order to exercise our control over the variable
interest entities. The variable interest entity equity holders may have conflicts of interest with us or our shareholders, and they may not act in the best interests of our company or may not perform
their obligations under these contracts. For example, our variable interest entities and their respective equity holders could breach their contractual arrangements with us by, among other things,
failing to conduct their operations, including maintaining our websites and using our domain names and trademarks which the relevant variable interest entities have exclusive rights to use, in an
acceptable manner or taking other actions that are detrimental to our interests. Pursuant to the call option, we may replace the equity holders of the variable interest entities at any time pursuant
to the contractual arrangements. However, if any equity holder is uncooperative and any dispute relating to these contracts or the replacement of the equity holders remains unresolved, we will have to
enforce our rights under the contractual arrangements through the operations of PRC law and arbitral or judicial agencies, which may be costly and time-consuming and will be subject to uncertainties
in the PRC legal system. See " Any failure by our variable interest entities or their equity holders to perform their obligations under the contractual arrangements would
have a material adverse effect on our business, financial condition and results of operations." Consequently, the contractual arrangements may not be as effective in ensuring our control over the
relevant portion of our business operations as direct ownership.
Any failure by our variable interest entities or their equity holders to perform their obligations under the
contractual arrangements would have a material adverse effect on our business, financial condition and results of operations.
If our variable interest entities or their equity holders fail to perform their respective obligations under the contractual arrangements, we
may have to incur substantial costs and expend additional resources to enforce the arrangements. Although we have entered into call option agreements in relation to each variable interest entity,
which provide that we may exercise an option to acquire, or nominate a person to acquire, ownership of the equity in that entity or, in some cases, its assets, to the extent permitted by applicable
PRC laws, rules and regulations, the exercise of these call options is subject to the review and approval of the relevant PRC governmental authorities. We have also entered into equity pledge
agreements with respect to each variable interest entity to secure certain obligations of such variable interest entity or its equity holders to us under the contractual arrangements. However, the
enforcement of these agreements through arbitral or judicial agencies may be costly and time-consuming and will be subject to uncertainties in the PRC legal system. Moreover, our remedies under the
equity pledge agreements are primarily intended to help us collect debts owed to us by the variable interest entities or the variable interest entity equity holders under the contractual arrangements
and may not help us in acquiring the assets or equity of the variable interest entities.
In
addition, although the terms of the contractual arrangements provide that they will be binding on the successors of the variable interest entity equity holders, as those successors
are not a party to the agreements, it is uncertain whether the successors in case of the death, bankruptcy or divorce of a variable interest entity equity holder will be subject to or will be willing
to honor the obligations of such variable interest entity equity holder under the contractual arrangements. If the relevant variable interest entity or its equity holder (or its successor), as
applicable, fails to transfer the shares of the variable interest entity according to the respective call option agreement or equity pledge agreement, we would need to enforce our rights under the
call option agreement or equity pledge agreement, which may be costly and time-consuming and may not be successful.
The
contractual arrangements are governed by PRC law and provide for the resolution of disputes through arbitration or court proceedings in China. Accordingly, these contracts would be
interpreted in accordance with
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PRC
law and any disputes would be resolved in accordance with PRC legal procedures. The legal system in the PRC is not as developed as in some other jurisdictions, such as the United States.
Moreover, there are very few precedents and little formal guidance as to how contractual arrangements in the context of a variable interest entity should be interpreted or enforced under PRC law, and
as a result it may be difficult to predict how an arbitration panel or court would view these contractual arrangements. As a result, uncertainties in the PRC legal system could limit our ability to
enforce the contractual arrangements. Under PRC law, if the losing parties fail to carry out the arbitration awards or court judgments within a prescribed time limit, the prevailing parties may only
enforce the arbitration awards or court judgments in PRC courts, which would require additional expense and
delay. In the event we are unable to enforce the contractual arrangements, we may not be able to exert effective control over the variable interest entities, and our ability to conduct our business,
as well as our financial condition and results of operations, may be materially and adversely affected.
We may lose the ability to use, or otherwise benefit from, the licenses, approvals and assets held by our
variable interest entities, which could severely disrupt our business, render us unable to conduct some or all of our business operations and constrain our growth.
Although the significant majority of our revenues are generated, and the significant majority of our operational assets are held, by our
wholly-foreign owned enterprises, which are our subsidiaries, our variable interest entities hold licenses and approvals and assets that are necessary for our business operations, as well as equity
interests in a series of our portfolio companies, to which foreign investments are typically restricted or prohibited under applicable PRC law. The contractual arrangements contain terms that
specifically obligate variable interest entity equity holders to ensure the valid existence of the variable interest entities and restrict the disposal of material assets of the variable interest
entities. However, in the event the variable interest entity equity holders breach the terms of these contractual arrangements and voluntarily liquidate our variable interest entities, or any of our
variable interest entities declares bankruptcy and all or part of its assets become subject to liens or rights of third-party creditors, or are otherwise disposed of without our consent, we may be
unable to conduct some or all of our business operations or otherwise benefit from the assets held by the variable interest entities, which could have a material adverse effect on our business,
financial condition and results of operations. Furthermore, if any of our variable interest entities undergoes a voluntary or involuntary liquidation proceeding, its equity holders or unrelated
third-party creditors may claim rights to some or all of the assets of the variable interest entity, thereby hindering our ability to operate our business as well as constrain our growth.
The equity holders, directors and executive officers of the variable interest entities may have potential
conflicts of interest with our company.
PRC laws provide that a director and an executive officer owes a fiduciary duty to the company he or she directs or manages. The directors and
executive officers of the variable interest entities, including Jack Ma, our lead founder and executive chairman, must act in good faith and in the best interests of the variable interest entities and
must not use their respective positions for personal gain. On the other hand, as a director of our company, Jack has a duty of care and loyalty to our company and to our shareholders as a whole under
Cayman Islands law. We control our variable interest entities through contractual arrangements and the business and operations of our variable interest entities are closely integrated with the
business and operations of our subsidiaries. Nonetheless, conflicts of interests for these individuals may arise due to dual roles both as directors and executive officers of the variable interest
entities and as directors or employees of our company, and may also arise due to dual roles both as variable interest entity equity holders and as directors or employees of our company.
We
cannot assure you that these individuals will always act in the best interests of our company should any conflicts of interest arise, or that any conflicts of interest will always be
resolved in our favor. We also cannot assure you that these individuals will ensure that the variable interest entities will not breach the existing contractual arrangements. If we cannot resolve any
of these conflicts of interest or any related disputes, we would have to rely on legal proceedings to resolve these disputes and/or take enforcement action under the contractual
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arrangements.
There is substantial uncertainty as to the outcome of any of these legal proceedings. See " Any failure by our variable interest entities or their equity
holders to perform their obligations under the contractual arrangements would have a material adverse effect on our business, financial condition and results of operations."
Furthermore,
a company controlled by Jack serves as one of the general partners of a PRC limited partnership that made a minority investment in Wasu. Yuzhu Shi, the founder, chairman and
a principal shareholder of Giant Interactive, a China-based online game company that was previously listed on the New York Stock Exchange, and an entrepreneur with significant experience in and
knowledge of the media industry in China, serves as the other general partner and the executive partner. The interest of the general partner controlled by Jack in the limited partnership is limited to
a return of its RMB10,000 capital contribution. In addition, Simon Xie, a former employee who is one of our founders and an equity holder in certain of our variable interest entities, is a
limited partner in this PRC limited partnership. To fund this investment, in April 2015 Simon was granted a financing with an aggregate principal of up to RMB6.9 billion by a major
financial institution in the PRC. The financing is secured by a pledge of the Wasu shares acquired by the PRC limited partnership, and a pledge of certain wealth management products we purchased. In
addition, we entered into a loan agreement for a principal amount of up to RMB2.0 billion with Simon in April 2015 to finance the repayment by Simon of the interest under the above
financing. We expect that these arrangements will strengthen our strategic business arrangements with Wasu to pursue our strategy of expanding entertainment offerings to consumers. See "Item 7.
Major Shareholders and Related Party Transactions B. Related Party Transactions Pledge for the Benefit of and Loan
Arrangement with a Related Party."
We
cannot assure you that Jack Ma will act in our interest given his ability to control one of the general partners of the PRC limited partnership invested in Wasu, nor can we assure you
that he will not breach his obligations to us as our director, including obligations not to compete with us. In addition, the interests of Mr. Shi, as an independent third-party, may not
coincide with those of Jack as the other general partner in the PRC limited partnership, or with our interests in pursuing our entertainment strategy. If any conflicts of this kind arise between Jack
and Mr. Shi in conducting the business of the PRC limited partnership, it could potentially have a material adverse effect on our relationship with the shareholder of Wasu and, consequently, on
our ability to achieve the strategic objectives of our alliance with Wasu. Furthermore, there is no assurance that Simon will have sufficient resources to repay the loans in a timely manner or at all.
The loan that we provided to Simon is secured by a pledge of Simon's limited partnership interest in the PRC limited partnership. However, if Simon fails to repay the loan, our enforcement of our
secured interests could be costly and time-consuming and would be subject to the uncertainties in the PRC legal system.
The contractual arrangements with our variable interest entities may be subject to scrutiny by the PRC tax
authorities. Any adjustment of related party transaction pricing could lead to additional taxes, and therefore substantially reduce our consolidated net income and the value of your investment.
The tax regime in China is rapidly evolving and there is significant uncertainty for taxpayers in China as PRC tax laws may be interpreted in
significantly different ways. The PRC tax authorities may assert that we or our subsidiaries or the variable interest entities or their equity holders are required to pay additional taxes on previous
or future revenue or income. In particular, under applicable PRC laws, rules and regulations, arrangements and transactions among related parties, such as the contractual arrangements with our
variable interest entities, may be subject to audit or challenge by the PRC tax authorities. If the PRC tax authorities determine that any contractual arrangements were not entered into on an arm's
length basis and therefore constitute a favorable transfer pricing, the PRC tax liabilities of the relevant subsidiaries and/or variable interest entities and/or variable interest entity equity
holders could be increased, which could increase our overall tax liabilities. In addition, the PRC tax authorities may impose late payment interest. Our net income may be materially reduced if our tax
liabilities increase.
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Risks Related to Doing Business in the People's Republic of China
Changes in the political and economic policies of the PRC government may materially and adversely affect our
business, financial condition and results of operations and may result in our inability to sustain our growth and expansion strategies.
Most of our operations are conducted in the PRC and a substantial majority of our revenue is sourced from the PRC. Accordingly, our financial
condition and results of operations are affected to a significant extent by economic, political and legal developments in the PRC.
The
PRC economy differs from the economies of most developed countries in many respects, including the extent of government involvement, level of development, growth rate, control of
foreign exchange and allocation of resources. Although the PRC government has implemented measures emphasizing the utilization of market forces for economic reform, the reduction of state ownership of
productive assets, and the establishment of improved corporate governance in business enterprises, a substantial portion of productive assets in China is still owned by the government. In addition,
the PRC government continues to play a significant role in regulating industry development by imposing industrial policies. The PRC government also exercises significant control over China's economic
growth by allocating resources, controlling payment of foreign currency-denominated obligations, setting monetary policy, regulating financial services and institutions and providing preferential
treatment to particular industries or companies.
While
the PRC economy has experienced significant growth in the past three decades, growth has been uneven, both geographically and among various sectors of the economy. The PRC
government has implemented various measures to encourage economic growth and guide the allocation of resources. Some of these measures may benefit the overall PRC economy, but may also have a negative
effect on us. Our financial condition and results of operation could be materially and adversely affected by government control over capital investments or changes in tax regulations that are
applicable to us. In addition, the PRC government has implemented in the past certain measures, including interest rate increases, to control the pace of economic growth. These measures may cause
decreased economic activity. While the PRC government maintained its expansionary monetary policy in 2016, there have been signs of continuing economic slowdown in China. Any prolonged slowdown in the
Chinese economy could lead to a reduction in demand for our services and consequently have a material adverse effect on our businesses, financial condition and results of operations.
There are uncertainties regarding the interpretation and enforcement of PRC laws, rules and regulations.
Most of our operations are conducted in the PRC, and are governed by PRC laws, rules and regulations. Our PRC subsidiaries are subject to laws,
rules and regulations applicable to foreign investment in China. The PRC legal system is a civil law system based on written statutes. Unlike the common law system, prior court decisions may be cited
for reference but have limited precedential value.
In
1979, the PRC government began to promulgate a comprehensive system of laws, rules and regulations governing economic matters in general. The overall effect of legislation over the
past three decades has significantly enhanced the protections afforded to various forms of foreign investment in China. However, China has not developed a fully integrated legal system, and recently
enacted laws, rules and regulations may not sufficiently cover all aspects of economic activities in China or may be subject to significant degree of interpretation by PRC regulatory agencies and
courts. In particular, because these laws, rules and regulations are relatively new, and because of the limited number of published decisions and the non-precedential nature of these decisions, and
because the laws, rules and regulations often give the relevant regulator significant discretion in how to enforce them, the interpretation and enforcement of these laws, rules and regulations involve
uncertainties and can be inconsistent and unpredictable. Therefore, it is possible that our existing operations may be found not to be in full compliance with relevant laws and regulations in the
future. In addition, the PRC legal system is based in part on government policies and internal rules, some of which are not published on a timely basis or at all, and which may have a retroactive
effect. As a result, we may not be aware of our violation of these policies and rules until after the occurrence of the violation.
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Any
administrative and court proceedings in China may be protracted, resulting in substantial costs and diversion of resources and management attention. Since PRC administrative and
court authorities have significant discretion in interpreting and implementing statutory and contractual terms, it may be more difficult to evaluate the outcome of administrative and court proceedings
and the level of legal protection we enjoy than in more developed legal systems. These uncertainties may impede our ability to enforce the contracts we have entered into and could materially and
adversely affect our business, financial condition and results of operations.
PRC regulations regarding acquisitions impose significant regulatory approval and review requirements, which
could make it more difficult for us to pursue growth through acquisitions.
Under the PRC Anti-Monopoly Law, companies undertaking acquisitions relating to businesses in China must notify MOFCOM, in advance of any
transaction where the parties' revenues in the China market exceed certain thresholds and the buyer would obtain control of, or decisive influence over, the other party. In addition, on
August 8, 2006, six PRC regulatory agencies, including the MOFCOM, the State-Owned Assets Supervision and Administration Commission, the State Administration of Taxation, the SAIC, the China
Securities Regulatory Commission, or the CSRC, and the State Administration of Foreign Exchange, or SAFE, jointly adopted the Regulations on Mergers and Acquisitions of Domestic Enterprises by Foreign
Investors, or the M&A Rules, which came into effect on September 8, 2006 and was amended on June 22, 2009. Under the M&A Rules, the approval of MOFCOM must be obtained in circumstances
where overseas companies established or controlled by PRC enterprises or residents acquire domestic companies affiliated with such PRC enterprises or residents. Applicable PRC laws, rules and
regulations also require certain merger and acquisition transactions to be subject to security review.
Due
to the level of our revenues, our proposed acquisition of control of, or decisive influence over, any company with revenues within China of more than RMB400 million in the
year prior to any proposed acquisition would be subject to MOFCOM merger control review. As a result of our size, many of the transactions we may undertake could be subject to MOFCOM merger review.
Complying with the requirements of the relevant regulations to complete these transactions could be time-consuming, and any required approval processes, including approval from MOFCOM, may delay or
inhibit our ability to complete these transactions, which could affect our ability to expand our business or maintain our market share. In addition, MOFCOM has not accepted antitrust filings for any
transaction involving parties that adopt a variable interest entity structure. Our ability to carry out our investment and acquisition strategy may be materially and adversely affected by MOFCOM's
current practice, which creates significant uncertainty as to whether transactions that we may undertake would subject us to fines or other administrative penalties and negative publicity and whether
we will be able to complete large acquisitions in the future in a timely manner or at all.
PRC regulations relating to investments in offshore companies by PRC residents may subject our PRC-resident
beneficial owners or our PRC subsidiaries to liability or penalties, limit our ability to inject capital into our PRC subsidiaries or limit our PRC subsidiaries' ability to increase their registered
capital or distribute profits.
SAFE promulgated the Circular on Relevant Issues Concerning Foreign Exchange Control on Domestic Residents' Offshore Investment and Financing
and Roundtrip Investment through Special Purpose Vehicles, or SAFE Circular 37, on July 4, 2014, which replaced the former circular commonly known as "SAFE Circular 75"
promulgated by SAFE on October 21, 2005. SAFE Circular 37 requires PRC residents to register with local branches of SAFE in connection with their direct establishment or indirect control
of an offshore entity, for the purpose of overseas investment and financing, with such PRC residents' legally owned assets or equity interests in domestic enterprises or offshore assets or interests,
referred to in SAFE Circular 37 as a "special purpose vehicle." SAFE Circular 37 further requires amendment to the registration in the event of any significant changes with respect to
the special purpose vehicle, such as increase or decrease of capital contributed by PRC individuals, share transfer or exchange, merger, division or other material event. In the event that a PRC
shareholder holding interests in a special purpose vehicle fails to fulfill the required SAFE registration, the PRC subsidiaries of that special purpose vehicle may be prohibited from making profit
distributions to the offshore parent and from
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carrying
out subsequent cross-border foreign exchange activities, and the special purpose vehicle may be restricted in its ability to contribute additional capital into its PRC subsidiary. Moreover,
failure to comply with the various SAFE registration requirements described above could result in liability under PRC law for evasion of foreign exchange controls.
We
have notified substantial beneficial owners of ordinary shares who we know are PRC residents of their filing obligation, and we have periodically filed SAFE Circular 75 reports
prior to the promulgation of SAFE Circular 37 on behalf of certain employee shareholders who we know are PRC residents. However, we may not be aware of the identities of all of our beneficial
owners who are PRC residents. We do not have control over our beneficial owners and cannot assure you that all of our PRC-resident beneficial owners will comply with SAFE Circular 37
and subsequent implementation rules. The failure of our beneficial owners who are PRC residents to register or amend their SAFE registrations in a timely manner pursuant to SAFE
Circular 37 and subsequent implementation rules, or the failure of future beneficial owners of our company who are PRC residents to comply with the registration procedures set forth in
SAFE Circular 37 and subsequent implementation rules, may subject the beneficial owners or our PRC subsidiaries to fines and legal sanctions. On February 13, 2015, SAFE
promulgated a Notice on Further Simplifying and Improving Foreign Exchange Administration Policy on Direct Investment, or SAFE Notice 13, which became effective on June 1, 2015. Pursuant to
SAFE Notice 13, entities and individuals are required to apply for foreign exchange registration of foreign direct investment and overseas direct investment, including those required under the SAFE
Circular 37, with qualified banks, instead of SAFE. The qualified banks, under the supervision of SAFE, will directly review the applications and conduct the registration.
Furthermore,
since it is unclear how those new SAFE regulations, and any future regulation concerning offshore or cross-border transactions, will be interpreted, amended and implemented
by the relevant PRC government authorities, we cannot predict how these regulations will affect our business operations or future strategy. Failure to register or comply with relevant requirements may
also limit our ability to contribute additional capital to our PRC subsidiaries and limit our PRC subsidiaries' ability to distribute dividends to our company. These risks may have a material adverse
effect on our business, financial condition and results of operations.
Any failure to comply with PRC regulations regarding our employee equity incentive plans may subject the PRC
participants in the plans, us or our overseas subsidiaries to fines and other legal or administrative sanctions.
Pursuant to SAFE Circular 37, PRC residents who participate in share incentive plans in overseas non-publicly-listed companies may submit
applications to SAFE or its local branches for the foreign exchange registration with respect to offshore special purpose companies. In the meantime, our directors, executive officers and other
employees who are PRC citizens or who are non-PRC residents residing in the PRC for a continuous period of not less than one year, subject to limited exceptions, and who have been granted restricted
shares, options or restricted share units, or RSUs, by us or our overseas listed subsidiaries may follow the Notice on Issues Concerning the Foreign Exchange Administration for Domestic Individuals
Participating in Stock Incentive Plan of Overseas Publicly Listed Company, issued by SAFE in February 2012, to apply for the foreign exchange registration. According to those regulations,
employees, directors, supervisors and other management members participating in any stock incentive plan of an overseas publicly listed company who are PRC citizens or who are non-PRC citizens
residing in China for a continuous period of not less than one year, subject to limited exceptions, are required to register with SAFE through a domestic qualified agent, which may be a PRC subsidiary
of the overseas listed company, and complete certain other procedures. Failure to complete the SAFE registrations may subject them to fines and legal sanctions and may also limit the ability to make
payment under the relevant equity incentive plans or receive dividends or sales proceeds related thereto, or our ability to contribute additional capital into our wholly-foreign owned enterprises in
China and limit our wholly-foreign owned enterprises' ability to distribute dividends to us. We also face regulatory uncertainties under PRC law that could restrict our ability or the ability of our
overseas listed subsidiaries to adopt additional equity incentive plans for our directors and employees who are PRC citizens or who are non-PRC residents residing in the PRC for a continuous period of
not less than one year, subject to limited exceptions.
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In addition, the State Administration for Taxation has issued circulars concerning employee share options, restricted shares or RSUs. Under these circulars,
employees working in the PRC who exercise share options, or whose restricted shares or RSUs vest, will be subject to PRC individual income tax. The PRC subsidiaries of an overseas listed company have
obligations to file documents related to employee share options or restricted shares with relevant tax authorities and to withhold individual income taxes of those employees related to their share
options, restricted shares or RSUs. Although we and our overseas listed subsidiaries currently withhold income tax from our PRC employees in connection with their exercise of options and the vesting
of their restricted shares and RSUs, if the employees fail to pay, or the PRC subsidiaries fail to withhold, their income taxes according to relevant laws, rules and regulations, the PRC subsidiaries
may face sanctions imposed by the tax authorities.
We rely to a significant extent on dividends, loans and other distributions on equity paid by our principal
operating subsidiaries in China and on remittances, including loans, from the variable interest entities in China to fund offshore cash and financing requirements.
We are a holding company and rely to a significant extent on dividends, loans and other distributions on equity paid by our principal operating
subsidiaries and on remittances, including loans, from the variable interest entities, for our offshore cash and financing requirements, including the funds necessary to pay dividends and other cash
distributions to our shareholders, fund inter-company loans, service any debt we may incur outside of China and pay our expenses. When our principal operating subsidiaries or the variable interest
entities incur additional debt, the instruments governing the debt may restrict their ability to pay dividends or make other distributions or remittances, including loans, to us. Furthermore, the
laws, rules and regulations applicable to our PRC subsidiaries and certain other subsidiaries permit payments of dividends only out of their retained earnings, if any, determined in accordance with
applicable accounting standards and regulations.
Under
PRC laws, rules and regulations, each of our subsidiaries incorporated in China is required to set aside a portion of its net income each year to fund certain statutory reserves.
These reserves, together with the registered equity, are not distributable as cash dividends. As a result of these laws, rules and regulations, our subsidiaries incorporated in China are restricted in
their ability to transfer a portion of their respective net assets to their shareholders as dividends. In addition, registered share capital and capital reserve accounts are also restricted from
withdrawal in the PRC, up to the amount of net assets held in each operating subsidiary. As of March 31, 2017, these restricted net assets totaled RMB45,472 million
(US$6,606 million).
Our pay-for-performance services constitute Internet advertisement, which subjects us to other laws, rules
and regulations as well as additional obligations.
We derive a significant amount of our revenue from pay-for-performance, or P4P, services and other related services. On July 4, 2016, the
SAIC promulgated the Interim Administrative Measures on Internet Advertising, or the Internet Advertising Measures, which came into effect as of September 1, 2016 and define Internet
advertisements as any commercial advertising that directly or indirectly promotes goods or services through Internet media in any form including paid-for search results. See "Item 4.
Information on the Company B. Business Overview Regulation Regulation of Advertising
Services." Under the Internet Advertising Measures, our P4P services and other related services constitute Internet advertisement.
Since
the Internet Advertising Measures came into effect recently, there exist substantial uncertainties with respect to its interpretation and implementation in practice by various
government authorities. We may face increased scrutiny from the tax authorities and may incur additional taxes in connection with our P4P and other related services. Moreover, PRC advertising laws,
rules and regulations require advertisers, advertising operators and advertising distributors to ensure that the content of the advertisements they prepare or distribute is fair and accurate and is in
full compliance with applicable law. Violation of these laws, rules or regulations may result in
penalties, including fines, confiscation of advertising fees and orders to cease dissemination of the advertisements. In circumstances involving serious violations, the PRC government may suspend or
revoke a violator's business license or license for operating an advertising business. In addition, the Internet Advertising Measures require paid-for search results to be obviously distinguished from
natural search results so that consumers will not
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misunderstand
the nature of these search results, therefore we are obligated to distinguish from others the merchants who purchase P4P and related services or the relevant listings by these merchants.
Complying with these requirements, including any penalties or fines for any failure to comply, may significantly reduce the attractiveness of our platforms and increase our costs and could have a
material adverse effect on our business, financial condition and results of operations.
In
addition, for advertising content related to specific types of products and services, advertisers, advertising operators and advertising distributors must confirm that the advertisers
have obtained requisite government approvals, including the advertiser's operating qualifications, proof of quality inspection of the advertised products, and, with respect to certain industries,
government approval of the content of the advertisement and filing with the local authorities. Pursuant to the Internet Advertising Measures, we are required to take steps to monitor the content of
advertisements displayed on our platforms. This requires considerable resources and time, and could significantly affect the operation of our business, while also subjecting us to increased liability
under the relevant laws, rules and regulations. The costs associated with complying with these laws, rules and regulations, including any penalties or fines for our failure to so comply if required,
could have a material adverse effect on our business, financial condition and results of operations. Any further change in the classification of our P4P and other related services by the PRC
government may also significantly disrupt our operations and materially and adversely affect our business and prospects.
We may be treated as a resident enterprise for PRC tax purposes under the PRC Enterprise Income Tax Law, and
we may therefore be subject to PRC income tax on our global income.
Under the PRC Enterprise Income Tax Law and its implementing rules, both of which came into effect on January 1, 2008, enterprises
established under the laws of jurisdictions outside of China with "de facto management bodies" located in China may be considered PRC tax resident enterprises for tax purposes and may be subject to
the PRC enterprise income tax at the rate of 25% on their global income. "De facto management body" refers to a managing body that exercises substantive and overall management and control over the
production and business, personnel, accounting books and assets of an enterprise. The State Administration of Taxation issued the Notice Regarding the Determination of Chinese-Controlled
Offshore-Incorporated Enterprises as PRC Tax Resident Enterprises on the Basis of De Facto Management Bodies, or Circular 82, on April 22, 2009. Circular 82 provides certain
specific criteria for determining whether the "de facto management body" of a Chinese-controlled offshore-incorporated enterprise is located in China. Although Circular 82 only applies to
offshore enterprises controlled by PRC enterprises, not those controlled by foreign enterprises or individuals, the
determining criteria set forth in Circular 82 may reflect the State Administration of Taxation's general position on how the "de facto management body" test should be applied in determining the
tax resident status of offshore enterprises, regardless of whether they are controlled by PRC enterprises. If we were to be considered a PRC resident enterprise, we would be subject to PRC enterprise
income tax at the rate of 25% on our global income. In such case, our profitability and cash flow may be materially reduced as a result of our global income being taxed under the Enterprise Income Tax
Law. We believe that none of our entities outside of China is a PRC resident enterprise for PRC tax purposes. However, the tax resident status of an enterprise is subject to determination by the PRC
tax authorities and uncertainties remain with respect to the interpretation of the term "de facto management body."
Dividends payable to foreign investors and gains on the sale of our ADSs or ordinary shares by our foreign
investors may become subject to PRC taxation.
Under the Enterprise Income Tax Law and its implementation regulations issued by the State Council, a 10% PRC withholding tax is applicable to
dividends payable by a resident enterprise to investors that are non-resident enterprises, which do not have an establishment or place of business in the PRC or which have such establishment or place
of business but the dividends are not effectively connected with such establishment or place of business, to the extent such dividends are derived from sources within the PRC, subject to any reduction
set forth in applicable tax treaties. Similarly, any gain realized on the transfer of shares of a resident enterprise by these investors is also
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to PRC tax at a current rate of 10%, subject to any exemption set forth in relevant tax treaties, if such gain is regarded as income derived from sources within the PRC. If we are deemed a PRC
resident enterprise, dividends paid on our ordinary shares or ADSs, and any gain realized by the investors from the transfer of our ordinary shares or ADSs, would be treated as income derived from
sources within the PRC and would as a result be subject to PRC taxation. See "Item 4. Information on the Company B. Business
Overview Regulation Tax Regulations." Furthermore, if we are deemed a PRC resident enterprise, dividends payable to
individual investors who are non-PRC residents and any gain realized on the transfer of ADSs or ordinary shares by these investors may be subject to PRC tax at a current rate of 20%, subject to any
reduction or exemption set forth in applicable tax treaties. It is unclear whether if we or any of our subsidiaries established outside China are considered a PRC resident enterprise, holders of our
ADSs or ordinary shares would be able to claim the benefit of income tax treaties or agreements entered into between China and other countries or areas and claim foreign tax credit if applicable. If
dividends payable to our non-PRC investors, or gains from the transfer of our ADSs or ordinary shares by these investors are subject to PRC tax, the value of your investment in our ADSs or ordinary
shares may decline significantly.
Discontinuation of preferential tax treatments we currently enjoy or other unfavorable changes in tax law
could result in additional compliance obligations and costs.
Chinese companies operating in the high-technology and software industry that meet relevant requirements may qualify for three main types of
preferential treatment, which are high and new technology enterprises, software enterprises and key software enterprises within the scope of the PRC national plan. For a qualified high and new
technology enterprise, the applicable enterprise income tax rate is 15%. The high and new technology enterprise qualification is re-assessed by the relevant authorities every three years. Moreover, a
qualified software enterprise is entitled to a tax holiday consisting of a two-year tax exemption beginning from the first profit-making calendar year and a 50% tax reduction for the subsequent three
calendar years. The software enterprise qualification is subject to an annual assessment. For a qualified key software enterprise within the scope of the PRC national plan, the applicable enterprise
tax rate for a calendar year is 10%. The key software enterprise qualification is subject to an annual assessment.
A
number of our China operating entities enjoy these preferential tax treatments. Our effective tax rate in fiscal year 2017 was 23%. The discontinuation of any of the various types of
preferential tax treatment we enjoy could materially and adversely affect our results of operations. See "Item 5. Operating and Financial Review and
Prospects A. Operating Results Taxation PRC Income Tax."
We and our shareholders face uncertainties with respect to indirect transfers of equity interests in PRC
resident enterprises or other assets attributed to a PRC establishment of a non-PRC company.
On February 3, 2015, the State Administration of Taxation issued the Bulletin on Issues of Enterprise Income Tax on Indirect Transfers of
Assets by Non-PRC Resident Enterprises, or Bulletin 7, which replaced or supplemented certain previous rules under the Notice on Strengthening Administration of Enterprise Income Tax for Share
Transfers by Non-PRC Resident Enterprises, or Circular 698, issued by the State Administration of Taxation, on December 10, 2009. Pursuant to this Bulletin, an "indirect transfer" of
assets, including equity interests in a PRC resident enterprise, by non-PRC resident enterprises may be recharacterized and treated as a direct transfer of PRC taxable assets, if the arrangement does
not have a reasonable commercial purpose and was established for the purpose of avoiding payment of PRC enterprise income tax. As a result, gains derived from this indirect transfer may be subject to
PRC enterprise income tax.
According
to Bulletin 7, "PRC taxable assets" include assets attributed to an establishment or a place of business in China, immoveable properties located in China, and equity
investments in PRC resident enterprises, in respect of which gains from their transfer by a direct holder, being a non-PRC resident enterprise, would be subject to PRC enterprise income taxes. When
determining whether there is a "reasonable commercial purpose" of the transaction arrangement, factors to be taken into consideration include: whether the main value of the equity interest of the
relevant offshore enterprise directly or indirectly derives from PRC taxable assets; whether the
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assets
of the relevant offshore enterprise mainly consists of direct or indirect investment in China or if its income mainly derives from China, directly or indirectly; whether the offshore enterprise
and its subsidiaries directly or indirectly holding PRC taxable assets have real commercial nature which is evidenced by their actual function and risk exposure; the duration of existence of the
business model and organizational structure; the foreign income tax liabilities arising from the indirect transfer of PRC taxable assets; the replicability of the transaction by direct transfer of PRC
taxable assets; and the applicable tax treaties or similar arrangements. In respect of an indirect offshore transfer of assets of a PRC establishment or place of business, the resulting gain is to be
included with the enterprise income tax filing of the PRC establishment or place of business being transferred, and would consequently be subject to PRC enterprise income tax at a rate of 25%. Where
the underlying transfer relates to the immoveable properties located in China or to equity investments in a PRC resident enterprise, which is not related to a PRC establishment or place of business of
a non-resident enterprise, a PRC enterprise income tax at 10% would apply, subject to available preferential tax treatment under applicable tax treaties or similar arrangements, and the party who is
obligated to make the transfer payments has the withholding obligation. Where the payor fails to withhold any or sufficient tax, the transferor shall declare and pay such tax to the tax authority by
itself within the statutory time limit. Late payment of applicable tax will subject the transferor to default interest. Bulletin 7 does not apply to transactions of sale of shares by investors
through a public stock exchange where the shares were acquired from a transaction through a public stock exchange.
There
are uncertainties as to the application of Bulletin 7. Bulletin 7 may be determined by the tax authorities to be applicable to some of our offshore restructuring
transactions or sale of the shares of our offshore subsidiaries or investments where PRC taxable assets are involved. The transferors and transferees may be subject to the tax filing and withholding
or tax payment obligation, while our PRC subsidiaries may be requested to assist in the filing. Furthermore, we, our non-resident enterprises and PRC subsidiaries may be required to spend valuable
resources to comply with Bulletin 7 or to establish that we and our non-resident enterprises should not be taxed under Bulletin 7, for our previous and future restructuring or disposal of shares of
our offshore subsidiaries, which may have a material adverse effect on our financial condition and results of operations.
The
PRC tax authorities have the discretion under Circular 698/Bulletin 7 to make adjustments to the taxable capital gains based on the difference between the fair value of the
taxable assets transferred and the cost of investment. If the PRC tax authorities make adjustments to the taxable income of the transactions under Circular 698/Bulletin 7, our income tax costs
associated with potential acquisitions or disposals will increase, which may have an adverse effect on our financial condition and results of operations.
Restrictions on currency exchange may limit our ability to utilize our PRC revenue effectively.
Substantially all of our revenue is denominated in Renminbi. The Renminbi is currently freely convertible under the "current account," which
includes dividends, trade and service-related foreign exchange
transactions, but requires approval from or registration with appropriate government authorities or designated banks under the "capital account," which includes foreign direct investment and loans,
including loans we may secure from our onshore subsidiaries or variable interest entities. Currently, our PRC subsidiaries, which are wholly-foreign owned enterprises, may purchase foreign currency
for settlement of "current account transactions," including payment of dividends to us, without the approval of SAFE by complying with certain procedural requirements. However, the relevant PRC
governmental authorities may limit or eliminate our ability to purchase foreign currencies in the future for current account transactions. In 2016, PRC governmental authorities began imposing more
stringent restrictions on outbound capital flows, including heightened scrutiny over "irrational" overseas investments for certain industries including real estate, hotel, cinema, entertainment and
sports clubs, as well as over four kinds of "abnormal" offshore investments, which are:
-
-
investments through enterprises established for only a few months without substantive operation;
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-
investments with amounts far exceeding the registered capital of onshore parent and not supported by its business performance shown on
financial statements;
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-
investments in targets which are unrelated to onshore parent's main business; and
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investments with abnormal sources of Renminbi funding suspected to be involved in illegal transfer of assets or illegal operation of
underground banking.
On
January 26, 2017, SAFE promulgated the Circular on Further Improving Reform of Foreign Exchange Administration and Optimizing Genuineness and Compliance Verification, which
tightened the authenticity and compliance verification of cross-border transactions and cross-border capital flow, including requiring banks to verify board resolutions, tax filing forms and audited
financial statements before wiring foreign invested enterprises'
foreign exchange dividend distribution of over US$50,000. See "Item 4. Information on the Company B. Business
Overview Regulation Regulation of Foreign Exchange and Dividend
Distribution Foreign Exchange Regulation." Since a significant amount of our PRC revenue is denominated in Renminbi, any existing and future restrictions
on currency exchange may limit our ability to utilize revenue generated in Renminbi to fund our business activities outside of the PRC, service any debt we may incur outside of China or pay dividends
in foreign currencies to our shareholders, including holders of our ADSs.
Fluctuations in exchange rates could result in foreign currency exchange losses and could materially reduce
the value of your investment.
The value of the Renminbi against the U.S. dollar and other currencies may fluctuate and is affected by, among other things, changes in
political and economic conditions and the foreign exchange policy adopted by the PRC government. For instance, in August 2015, the People's Bank of China, or PBOC, changed the way it calculates
the mid-point price of Renminbi against the U.S. dollar, requiring the market-makers who submit for reference rates to consider the previous day's closing spot rate, foreign-exchange demand and
supply as well as changes in major currency rates. In 2015 and 2016, the value of the Renminbi depreciated approximately 4.4% and 7.2% against the U.S. dollar, respectively. From the end of
2016 through the end of May 2017, the value of the Renminbi appreciated slightly by approximately 1.9% against the U.S. dollar. It is difficult to predict how market forces or PRC or
U.S. government policy, including any interest rate increases by the Federal Reserve, may impact the exchange rate between the Renminbi and the U.S. dollar in the future. There remains
significant international pressure on the PRC government to adopt a more flexible currency policy, including from the U.S. government, which has threatened to label China as a "currency
manipulator," which could result in greater fluctuation of the Renminbi against the U.S. dollar.
A
substantial percentage of our revenues and costs are denominated in Renminbi, and a significant portion of our financial assets are also denominated in Renminbi while substantially all
of our debt is denominated in U.S. dollars. We are a holding company and we rely on dividends, loans and other distributions on equity paid by our operating subsidiaries in China and on
remittances, including loans, from our variable interest entities in China for our cash needs. Any significant fluctuations in the value of the Renminbi may materially and adversely affect our
liquidity and cash flows. If we decide to convert our Renminbi into U.S. dollars for the purpose of repaying principal or interest expense on our outstanding U.S. dollar-denominated debt,
making payments for dividends on our ordinary shares or ADSs or other business purposes, appreciation of the U.S. dollar against the Renminbi would have a negative effect on the
U.S. dollar amount we would receive. Conversely, to the extent that we need to convert U.S. dollars into Renminbi for our operations, appreciation of the Renminbi against the
U.S. dollar would have an adverse effect on the Renminbi amount we would receive. From time to time we enter into hedging activities with regard to exchange rate risk. We cannot assure you that
our hedging activities will successfully mitigate these risks adequately or at all, and in addition hedging activities may result in greater volatility in our results of operations.
The audit report included in this annual report is prepared by auditors who are not inspected fully by the
Public Company Accounting Oversight Board and, as such, our shareholders are deprived of the benefits of inspection by it.
As an auditor of companies that are publicly traded in the United States and a firm registered with the Public Company Accounting
Oversight Board, or PCAOB, PricewaterhouseCoopers is required under the laws of the United States to undergo regular inspections by the PCAOB. However, because we have substantial operations
within the People's Republic of China, a jurisdiction where the PCAOB is currently unable to conduct inspections
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without
the approval of the Chinese government authorities, our auditor and its audit work is not currently inspected fully by the PCAOB.
Inspections
of other auditors conducted by the PCAOB outside of China have at times identified deficiencies in those auditors' audit procedures and quality control procedures, which may
be addressed as part of the inspection process to improve future audit quality. The lack of PCAOB inspections of audit work undertaken in China prevents the PCAOB from regularly evaluating our
auditor's audits and its quality control procedures. As a result, shareholders may be deprived of the benefits of PCAOB inspections, and may lose confidence in our reported financial information and
procedures and the quality of our financial statements.
Restrictions on the direct production of audit work papers to foreign regulators could result in our
financial statements being determined to not be in compliance with the requirements of the Exchange Act.
In late 2012, the SEC commenced administrative proceedings under Rule 102(e) of its Rules of Practice and also under the Sarbanes-Oxley
Act of 2002 against the mainland Chinese affiliates of the "big four" accounting firms, including the affiliate of our auditor, and also against Dahua, the former BDO affiliate in China. The
Rule 102(e) proceedings initiated by the SEC related to the failure of these firms to produce documents, including audit work papers, in response to the request of the SEC pursuant to
Section 106 of the Sarbanes-Oxley Act of 2002, as the auditors located in China are not in a position lawfully to produce documents directly to the SEC because of restrictions under PRC law and
specific directives issued by the CSRC. The issues raised by the proceedings are not specific to the Chinese affiliate of our auditor or to us, but potentially affect equally all PCAOB-registered
audit firms based in China and all businesses based in China (or with substantial operations in China) with securities listed in the United States. In addition, auditors based outside of
China are subject to similar restrictions under PRC law and CSRC directives in respect of audit work that is carried out in China which supports the audit opinions issued on financial statements of
entities with substantial China operations.
In
February 2015, each of the "big four" accounting firms agreed to a censure and to pay a fine to the SEC to settle the dispute with the SEC. The settlement stays the current
proceeding for four years, during which time the firms are required to follow detailed procedures to seek to provide the SEC with access to Chinese firms' audit documents via the CSRC. If a firm does
not follow the procedures, the SEC would impose penalties such as suspensions, or commence a new, expedited administrative proceeding against the non-compliant firm or it could restart the
administrative proceeding against all four firms. In addition, the limitations imposed by the PRC on the production of workpapers reflecting audit work performed in the PRC could likewise result in
the imposition of penalties on our independent registered accounting firm by the PCAOB or the SEC, such as suspensions of our audit firm's ability to practice before the SEC.
If
our independent registered public accounting firm, or the affiliate of our independent registered public accounting firm, were denied, even temporarily, the ability to practice before
the SEC, we would need to consider alternate support arrangements for the audit of our operations in China. If our auditor, or an affiliate of that firm, were unable to address issues related to the
production of documents, and we were unable to timely find another independent registered public accounting firm to audit and issue an opinion on our financial statements, our financial statements
could be determined to not be in compliance with the requirements of the Exchange Act. A determination of this type could ultimately lead to delisting of our ADSs from the New York Stock
Exchange or deregistration from the SEC, or both. This would materially and adversely affect the market price of our ADSs and substantially reduce or effectively terminate the trading of our ADSs in
the United States.
Risks Related to Our ADSs
The trading price of our ADSs has been and is likely to continue to be volatile, which could result in
substantial losses to our shareholders.
The trading price of our ADSs has been and is likely to continue to be volatile and could fluctuate widely in response to a variety of factors,
many of which are beyond our control. For example, the high and low sale prices of our ADSs in fiscal year 2017 were US$110.45 and US$73.30, respectively. In addition, the performance and
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fluctuation
of the market prices of other companies with business operations located mainly in China that have listed their securities in the United States may affect the volatility in the
price of and trading volumes for our ADSs. Some of these companies have experienced significant volatility, including significant price declines after their initial public offerings. The trading
performances of these PRC companies' securities at the time of or after their offerings may affect the overall investor sentiment towards other PRC companies listed in the United States and
consequently may impact the trading performance of our ADSs. In addition to market and industry factors, the price and trading volume for our ADSs may be highly volatile for specific business reasons,
including:
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variations in our results of operations;
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announcements about our earnings that are not in line with analyst expectations;
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publication of operating or industry metrics by third parties, including government statistical agencies, that differ from expectations of
industry or financial analysts;
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changes in financial estimates by securities research analysts;
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announcements made by us or our competitors of new product and service offerings, acquisitions, strategic relationships, joint ventures or
capital commitments;
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press and other reports, whether or not true, about our business;
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negative reports published by short sellers, regardless of their veracity or materiality to our company;
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changes or developments in the PRC or global regulatory environment;
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litigation and regulatory allegations or proceedings that involve us;
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changes in pricing we or our competitors adopt;
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conditions in our industries;
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additions to or departures of our management;
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actual or perceived general economic and business conditions and trends in China and globally;
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fluctuations of exchange rates between the Renminbi and the U.S. dollar;
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release or expiry of transfer restrictions on our outstanding ordinary shares or ADSs;
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sales or perceived potential sales or other disposition of existing or additional ordinary shares or ADSs or other equity or equity-linked
securities, including by our principal shareholders, directors officers and other affiliates; and
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the creation of vehicles that hold our ordinary shares, including by Yahoo, which has completed the sale of its core Internet business to
Verizon Communications Inc.
Any
of these factors may result in large and sudden changes in the volume and trading price of our ADSs. In addition, the stock market has from time to time experienced significant price
and volume fluctuations that are unrelated to the operating performance of particular companies and industries. These fluctuations may include a so-called "bubble market" in which investors
temporarily raise the price of the stocks of companies in certain industries, such as the e-commerce industry, to unsustainable levels. These market fluctuations may significantly affect the trading
price of our ADSs. In the past, following periods of volatility in the market price of a company's securities, shareholders have often instituted securities class action litigation against that
company. We have been named as a defendant in certain purported shareholder class action lawsuits described in "Item 8. Financial Information A.
Consolidated Statements and Other Financial Information Legal and Administrative Proceedings." The litigation process may utilize a material portion of our cash
resources and divert management's attention from the day-to-day operations of our company, all of which could harm our business. If adversely determined, the class action suits may have a material
adverse effect on our financial condition and results of operations.
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Substantial future sales or perceived potential sales of our ADSs, ordinary shares or other equity or
equity-linked securities in the public market could cause the price of our ADSs to decline significantly.
Sales of our ADSs, ordinary shares or other equity or equity-linked securities in the public market, or the perception that these sales could
occur, could cause the market price of our ADSs to decline significantly. As of March 31, 2017, we had 2,529,364,189 ordinary shares outstanding, and 1,251,592,493 of our ordinary shares
were represented by ADSs. All of our ordinary shares represented by ADSs were freely transferable by persons other than our affiliates without restriction or additional registration under the
Securities Act of 1933, or the Securities Act. The ordinary shares held by our affiliates are also available for sale, subject to volume and other restrictions as applicable under Rules 144
and 701 under the Securities Act, under sales plans adopted pursuant to Rule 10b5-1 or otherwise.
Certain
major holders of our ordinary shares will have the right to cause us to register under the Securities Act the sale of their shares. Registration of these shares under the
Securities Act would result in ADSs representing these shares becoming freely tradable without restriction under the Securities Act immediately upon the effectiveness of the registration. Sales of
these registered shares in the form of ADSs in the public market could cause the price of our ADSs to decline significantly.
If securities or industry analysts cease to publish research or publish inaccurate or unfavorable research
about our business, the market price for our ADSs and trading volume could decline.
The trading market for our ADSs will depend in part on the research and reports that securities or industry analysts publish about us or our
business. If one or more of the analysts who covers us downgrades our ADSs or publishes inaccurate or unfavorable research about our business, the market price for our ADSs would likely decline. If
one or more of these analysts cease coverage of our company or fail to publish reports on us regularly, we could lose visibility in the financial markets, which, in turn, could cause the market price
or trading volume for our ADSs to decline significantly.
As a foreign private issuer, we are permitted to and we will, rely on exemptions from certain New York
Stock Exchange corporate governance standards applicable to domestic U.S. issuers. This may afford less protection to holders of our ordinary shares and the ADSs.
We are exempted from certain corporate governance requirements of the New York Stock Exchange by virtue of being a foreign private
issuer. We are required to provide a brief description of the significant differences between our corporate governance practices and the corporate governance practices required to be followed by
domestic U.S. companies listed on the New York Stock Exchange. The standards applicable to us
are considerably different than the standards applied to domestic U.S. issuers. For instance, we are not required to:
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have a majority of the board be independent (although all of the members of the audit committee must be independent under the
U.S. Securities Exchange Act of 1934, as amended, or the Exchange Act);
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have a compensation committee or a nominating or corporate governance committee consisting entirely of independent directors;
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have regularly scheduled executive sessions for non-management directors; or
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have executive sessions of solely independent directors each year.
We
have relied on and intend to continue to rely on some of these exemptions. As a result, our shareholders may not be provided with the benefits of certain corporate governance
requirements of the New York Stock Exchange.
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As a foreign private issuer, we are exempt from certain disclosure requirements under the Exchange Act, which
may afford less protection to our shareholders than they would enjoy if we were a domestic U.S. company.
As a foreign private issuer, we are exempt from, among other things, the rules prescribing the furnishing and content of proxy statements under
the Exchange Act and the rules relating to selective disclosure of material nonpublic information under Regulation FD. In addition, our executive officers, directors and principal shareholders
are exempt from the reporting and short-swing profit and recovery provisions contained in Section 16 of the Exchange Act. We are also not required under the Exchange Act to file periodic
reports and financial statements with the SEC as frequently or as promptly as domestic U.S. companies with securities registered under the Exchange Act. As a result, our shareholders may be
afforded less protection than they would under the Exchange Act rules applicable to domestic U.S. companies.
If and when permitted by law, we may conduct a public offering and listing of our shares in China, which may
result in increased regulatory scrutiny and compliance costs as well as increased fluctuations in the prices of our ordinary shares and ADSs listed in overseas markets.
Although not currently allowed under PRC law, if and when permitted by law, we may conduct a public offering and/or listing of our shares on a
stock exchange in China in the future. We have not set a specific timetable or decided on any specific form for an offering in China. The precise timing of the offering and/or listing of our shares in
China would depend on a number of factors, including relevant regulatory developments and market conditions. If we complete a public offering or listing in China, we would become subject to the
applicable laws, rules and regulations governing public companies listed in China, in addition to the various laws, rules and regulations that we are subject to in the United States as a
reporting company. The listing and trading of our securities in multiple jurisdictions and multiple markets may lead to increased compliance costs for us, and we may face the risk of significant
intervention by regulatory authorities in these jurisdictions and markets.
In
addition, under current PRC laws, rules and regulations, our ordinary shares will not be interchangeable or fungible with any shares we may decide to list on a PRC stock exchange, and
there is no trading or settlement between these markets in the United States and mainland China. Furthermore, these two markets have different trading characteristics and investor bases,
including different levels of retail and institutional participation. As a result of these differences, the trading prices of our ADSs, accounting for the share-to-ADS ratio, may not be the same as
the trading prices of any shares we may decide to list on a PRC stock exchange. The issuance of a separate class of shares and fluctuations in its trading price may also lead to increased volatility
in, and may otherwise materially decrease, the prices of our ordinary shares and ADSs.
Our shareholders may face difficulties in protecting their interests, and their ability to protect their
rights through the U.S. federal courts may be limited because we are incorporated under Cayman Islands law, we conduct substantially all of our operations in China and most of our directors and
substantially all of our executive officers reside outside the United States.
We are incorporated in the Cayman Islands and conduct substantially all of our operations in China through our wholly-foreign owned enterprises
and the variable interest entities. Most of our directors and substantially all of our executive officers reside outside the United States and a substantial portion of their assets are located
outside of the United States. As a result, it may be difficult or impossible for our shareholders to bring an action against us or against these individuals in the Cayman Islands or in China in
the event that they believe that their rights have been infringed under the securities laws of the United States or otherwise. Even if shareholders are successful in bringing an action of this
kind, the laws of the Cayman Islands and China may render them unable to enforce a judgment against our assets or the assets of our directors and officers. There is no statutory recognition in the
Cayman Islands of judgments obtained in the United States or China, although the courts of the Cayman Islands will generally recognize and enforce a non-penal judgment of a foreign court of
competent jurisdiction without retrial on the merits.
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Our
corporate affairs are governed by our memorandum and articles of association, as amended and restated from time to time, and by the Companies Law (2016 Revision) and common law of
the Cayman Islands. The rights of shareholders to take legal action against us and our directors, actions by minority shareholders and the fiduciary duties of our directors are to a large extent
governed by the common law of the Cayman Islands. The common law of the Cayman Islands is derived in part from comparatively limited judicial precedent in the Cayman Islands as well as from English
common law, which provides persuasive, but not binding, authority in a court in the Cayman Islands. The rights of our shareholders and the fiduciary duties of our directors under Cayman Islands law
are not as clearly established as they would be under statutes or judicial precedents in the United States. In particular, the Cayman Islands has a less developed body of securities laws than
the United States and provides significantly less protection to investors. In addition, shareholders in Cayman Islands companies may not have standing to initiate a shareholder derivative
action in U.S. federal courts.
In
addition, our articles of association provide that in the event that any shareholder initiates or asserts any claim or counterclaim against us, or joins, offers substantial assistance
to or has a direct financial interest in any claim or counterclaim against us, and does not obtain a judgment on the merits in which the initiating or asserting party prevails, then the shareholder
will be obligated to reimburse us for all fees, costs and expenses (including, but not limited to, all reasonable attorneys' fees and other litigation expenses) that we may incur in connection with a
claim or counterclaim. These fees, costs and expenses that may be shifted to a shareholder under this provision are potentially significant and this fee-shifting provision is not limited to specific
types of actions, but is rather potentially applicable to the fullest extent permitted by law.
Our
fee-shifting provision may dissuade or discourage our shareholders (and their attorneys) from initiating lawsuits or claims against us or may impact the fees, contingency or
otherwise, required by attorneys to represent our shareholders. Fee-shifting provisions such as ours are relatively new and untested. We cannot assure you that we will or will not invoke our
fee-shifting provision in any particular dispute, or that we will be successful in obtaining fees if we choose to invoke the provision.
As
a result of the foregoing, our public shareholders may have more difficulty in protecting their interests through actions against us, our management, our directors or our major
shareholders than would shareholders of a corporation incorporated in a jurisdiction in the United States.
The voting rights of holders of our ADSs are limited by the terms of the deposit agreement.
Holders of our ADSs may exercise their voting rights with respect to the ordinary shares underlying their ADSs only in accordance with the
provisions of the deposit agreement. Upon receipt of voting instructions from them in the manner set forth in the deposit agreement, the depositary for our ADSs will endeavor to vote their underlying
ordinary shares in accordance with these instructions. Under our articles of association, the minimum notice period required for convening a general meeting is ten days. When a general meeting is
convened, holders of our ADSs may not receive sufficient notice of a shareholders' meeting to permit them to withdraw their ordinary shares to allow them to cast their votes with respect to any
specific matter at the meeting. In addition, the depositary and its agents may not be able to send voting instructions to holders of our ADSs or carry out their voting instructions in a timely manner.
We will make all reasonable efforts to cause the depositary to extend voting rights to holders of our ADSs in a timely manner, but they may not receive the voting materials in time to ensure that they
can instruct the depositary to vote the ordinary shares underlying their ADSs. Furthermore, the depositary and its agents will not be responsible for any failure to carry out any instructions to vote,
for the manner in which any vote is cast or for the effect of any such vote. As a result, holders of our ADSs may not be able to exercise their rights to vote and they may lack recourse if the
ordinary shares underlying their ADSs are not voted as they requested.
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The depositary for our ADSs will give us a discretionary proxy to vote our ordinary shares underlying the
ADSs if holders of these ADSs do not vote at shareholders' meetings, except in limited circumstances, which could adversely affect the interests of holders of our ADSs.
Under the deposit agreement for our ADSs, the depositary will give us a discretionary proxy to vote the ordinary shares underlying the ADSs at
shareholders' meetings if holders of these ADSs do not give voting instructions to the depositary, unless:
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we have failed to timely provide the depositary with our notice of meeting and related voting materials;
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we have instructed the depositary that we do not wish a discretionary proxy to be given;
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we have informed the depositary that there is substantial opposition as to a matter to be voted on at the meeting;
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a matter to be voted on at the meeting would have a material adverse impact on shareholders; or
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voting at the meeting is made on a show of hands.
The
effect of this discretionary proxy is that, if holders of our ADSs fail to give voting instructions to the depositary, they cannot prevent our ordinary shares underlying their ADSs
from being voted, absent the situations described above, and it may make it more difficult for shareholders to influence our management. Holders of our ordinary shares are not subject to this
discretionary proxy.
Holders of our ADSs may be subject to limitations on transfer of their ADSs.
ADSs are transferable on the books of the depositary. However, the depositary may close its transfer books at any time or from time to time when
it deems expedient in connection with the performance of its duties. In addition, the depositary may refuse to deliver, transfer or register transfers of ADSs generally when our books or the books of
the depositary are closed, or at any time if we or the depositary deems it advisable to do so because of any requirement of law or of any government or governmental body, or under any provision of the
deposit agreement, or for any other reason.
Holders of our ADSs may not receive distributions on our ordinary shares or any value for them if it is
illegal or impractical to make them available to them.
The depositary of our ADSs has agreed to pay holders of our ADSs the cash dividends or other distributions it or the custodian for our ADSs
receives on our ordinary shares or other deposited securities after deducting its fees and expenses. Holders of our ADSs will receive these distributions in proportion to the number of our ordinary
shares that their ADSs represent. However, the depositary is not responsible for making these payments or distributions if it is unlawful or impractical to make a distribution available to any holders
of ADSs. For example, it would be unlawful to make a distribution to a holder of ADSs if it consists of securities that require registration under the Securities Act but that are not properly
registered or distributed pursuant to an applicable exemption from registration. The depositary is not responsible for making a distribution available to any holders of ADSs if any government approval
or registration required for the distribution cannot be obtained after reasonable efforts made by the depositary. We have no obligation to take any other action to permit the distribution of our ADSs,
ordinary shares, rights or anything else to holders of our ADSs. This means that holders of our ADSs may not receive the distributions we make on our ordinary shares or any value for them if it is
illegal or impractical for us to make them available. These restrictions may materially reduce the value of the ADSs.
There could be adverse United States federal income tax consequences to United States investors
if we were or were to become a passive foreign investment company.
While we do not believe we are or will become a passive foreign investment company, or PFIC, there can be no assurance that we were not a PFIC
in the past and will not become a PFIC in the future. The determination of whether or not we are a PFIC is made on an annual basis and will depend on the composition of our income and
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assets
from time to time. Specifically, we will be classified as a PFIC for United States federal income tax purposes if either: (1) 75% or more of our gross income in a taxable year is
passive income, or (2) the average percentage of our assets by value in a taxable year which produce or are held for the production of passive income (which includes cash) is at least 50%. The
calculation of the value of our assets will be based, in part, on the quarterly market value of our ADSs, which is subject to change. See "Item 10. Additional
Information E. Taxation Material United States Federal Income Tax
Considerations Passive Foreign Investment Company."
Although
we do not believe we were or will become a PFIC, it is not entirely clear how the contractual arrangements between us and our variable interest entities will be treated for
purposes of the PFIC rules. If it were determined that we do not own the stock of our variable interest entities for United States federal income tax purposes (for instance, because the
relevant PRC authorities do not respect these arrangements), we may be treated as a PFIC. See "Item 10. Additional Information E.
Taxation Material United States Federal Income Tax Considerations Passive Foreign Investment Company."
If
we were or were to become a PFIC, adverse United States federal income tax consequences to our shareholders that are United States investors could result. For example,
if we are a PFIC, our United States investors will become subject to increased tax liabilities under United States federal income tax laws and regulations and will become subject to
burdensome reporting requirements. We cannot assure you that we were not or will not become a PFIC for any taxable year. You are urged to consult your own tax advisors concerning United States
federal income tax consequence on the application of the PFIC rules. See "Item 10. Additional Information E.
Taxation Material United States Federal Income Tax Considerations Passive Foreign Investment Company."