An employee walks behind a glass wall with the logo of Alibaba at the company's headquarters on the outskirts of Hangzhou, Zhejiang province, China. Picture: REUTERS/CHANCE CHAN
An employee walks behind a glass wall with the logo of Alibaba at the company's headquarters on the outskirts of Hangzhou, Zhejiang province, China. Picture: REUTERS/CHANCE CHAN
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Hong Kong — Alibaba Group Holding will buy 33% of Ant Financial, helping to clear the way for an initial public offering of the Chinese payments giant.

China’s biggest e-commerce operator will acquire new shares in its finance affiliate in exchange for certain intellectual property rights, the company said Thursday. While no cash is changing hands, Ant Financial will end royalty payments to Alibaba that were worth more than $300m last fiscal year. Alibaba also raised its annual forecast after posting third-quarter sales that topped estimates.

Alibaba has not held a stake in the owner of Alipay since founder Jack Ma controversially spun out the business in 2011. Ant Financial has had a string of recent setbacks, with its US expansion thwarted by the collapse of a deal for MoneyGram International while its Chinese business faces greater scrutiny from regulators and increased competition from Tencent Holdings.

"This acquisition of Ant Financial’s stake could be a preparation for its potential IPO," said Steven Zhu, a Shanghai-based analyst with Pacific Epoch. "Alibaba was able to improve revenue growth because performance-based ads were able to generate better revenue on mobile apps and its catered user pages drove more sales."

Alibaba said revenue in the 12 months ending March would rise 55% to 56%, up from a range of 49% to 53% previously. Ma is pushing deeper into brick and mortar retailers, including supermarkets and department stories, as the company also took control of the Cainiao logistics business.

That has come at a cost to profitability, with the operating margin shrinking to 31% in the quarter from 39% a year earlier.

Shares of Alibaba fell 4.4%, to $195.41 at 9.56am in New York.

Formally known as Zhejiang Ant Small & Micro Financial Services Group, Ant Financial operates Alipay as well as money market funds and credit scoring. It is based in Hangzhou, China, the same hometown as Alibaba.

Alibaba vice-chairman Joe Tsai said Ant was profitable in three key businesses of payments, wealth management and lending to consumers and small and medium-sized businesses. No decision on an IPO venue has been made, chief financial officer Maggie Wu said on a conference call.

Ant Financial paid Alibaba about 2.09-billion yuan ($332m) in royalty and technology fees in fiscal 2017, up about 86% from the previous year, according to a 2017 Alibaba filing.

Once dominant in China, Alipay’s share of online payments in the country has slumped to 54% as of the end of September amid the rise of Tencent’s WeChat platform, according to research firm Analysys International.

Ant Financial was valued at $74.5bn in 2016 by CLSA and the company almost doubled earnings in fiscal 2017 as it expanded its footprint in wealth management and overseas markets.

Thursday’s announcement comes just a few months after China took a major step towards opening its financial system by relaxing some of the rules on foreign ownership. The deal will likely be subject to regulatory approval.

Third-quarter revenue rose 56% to 83.03-billion yuan ($13.2 billion), topping estimates for 79.7-billion yuan. Adjusted earnings-per-share were 10.61 yuan, surpassed projections for 10.53 yuan.

Revenue from the company’s core e-commerce business jumped 57% to $11.3bn while cloud computing more than doubled to $553m.

Wu said investors should not equate lower margins with lower profits, as the overall business is growing.

"We are making the pie much bigger," she said. "Sixty percent of an apple compared with 40% of a watermelon, which one do you want?"

Credit Suisse Group acted as a financial adviser for the Alibaba Independent Committee in the Ant Financial transaction.

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