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Several high-profile companies, including Valeant Pharmaceuticals International (NYSE: VRX) and Alibaba Group (NYSE: BABA), have had their accounting practices called into question in recent weeks.
It goes without saying that any time accounting methods come under scrutiny, it can have a devastating effect on a company. Valeant’s stock price has collapsed over the past year. At $30, it is well off its 52-week high of $263.
Alibaba is the latest to be taken under a microscope. On May 25, news broke that the Securities and Exchange Commission is looking into the company’s consolidation practices, related-party transactions and other data pertaining to Alibaba’s huge Singles’ Day event last year.
Alibaba’s stock price sunk on the news, and one can hardly blame investors for thinking Alibaba could be the next Valeant. But after looking closer, the two situations don’t seem to be quite the same.
Alibaba Under Fire
Singles’ Day is a big event in China. It is a nationwide celebration of single people, held on Nov. 11 because of the relationship between “single” and the number one. The celebration includes festivals and it is commonplace for single people to have parties on this day.
While Singles’ Day is a huge social event, it’s also big business. What started out mostly on college campuses has turned into a near holiday in China. Singles’ Day is one of the biggest online shopping days of the year.
Not surprisingly, Alibaba rakes in cash on Singles’ Day through its online platforms Tmall and Taobao. Last year, Singles’ Day resulted in $24 billion of sales for Alibaba in a 24-hour period.
At issue is that the SEC is questioning how Alibaba consolidates results across its various affiliates. But there are key differences that separate Valeant’s accounting scandal from the situation Alibaba finds itself in. Importantly, Valeant’s accounting questions are inherently more serious. The company delayed filing its annual report by two months to correct a number of issues. The situation eventually cost CEO Michael Pearson his job.
Valeant’s delayed 10-K filing could have triggered accelerated debt payments, which in theory threatened to put the company into default. Valeant reported a $385 million loss in the fourth quarter alone.
Alibaba owns a minority stake in a company called Cainiao, which provides a centralized information system for transportation companies in areas like trucking. Because it owns less than half of the company, Alibaba only reports a percentage of losses incurred from its investment. The SEC may push for Alibaba to include 100% of any losses incurred.
Moreover, the SEC probe involves how Alibaba accounts for its Singles’ Day transactions. Presently, the company reports gross merchandise volume, a non-GAAP measure that does not remove fake orders. That may potentially inflate sales figures.
Final Thoughts
It is always scary when a company’s accounting practices are called into question. But ultimately, Alibaba does not look like another Valeant.
Alibaba said it’s fully cooperating with the probe and is providing all necessary documentation. While the results remain to be seen, it appears that the SEC inquiry is designed to improve Alibaba’s transparency regarding its affiliates, rather than expose fraud or misconduct.
In a statement, Alibaba said, “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.”
Alibaba shares sunk 6% after the news broke, but they quickly recovered the loss. It appears investors are comfortable with the company’s accounting practices, and may view Alibaba more favorably going forward if the SEC inquiry results in greater transparency.
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