On Tuesday, the Chinese trade portal Alibaba will conduct an initial public offering on the Hong Kong market, and it seems to have set of an absolute feeding frenzy among institutional investors. The company has received an almost unbelievable $100 billion U.S. dollars in orders from investors, and many fund managers could get zero allocations when the initial public offering closes on Thursday. Alibaba has so far has raised more than 1.5 billion dollars from investors including at least $100 million from Yahoo, which owns 40 percent of the parent company. Demand for these shares has been so strong – exceeding share allocation by more than 150-fold, that the cash inflows caused the Hong Kong dollar to appreciate against the US dollar, forcing the Hong Kong Monetary Authority to sell its currency to keep it from rising beyond the official peg to the U.S. dollar.

On the surface, none of this makes any sense at all. While Alibaba has an impressive installed base- more than 24 million people have registered for the service, it’s technology is mediocre and it’s profits lackluster for a deal of this size. Alibaba made only $29 million in 2006, though this year it is forecast to make $83 million. Forbes pointed out that this works out to an “astronomical” price-to-earnings range of more than 100 times earnings.

So what got all these investors so incredibly excited? There are a couple of different theories. One is the salesmanship of their CEO Jack Ma – and he must be good if he convinced Yahoo to give away the store as they did in 2005. He skillfully sold global concepts like “China” and “manufacturing” and “the next Google” – downplaying his company’s many shortcomings. For example, in their launch prospectus they said “there are 42 million SMEs in China in 2006. Internet use has risen 23.4 percent annually since 2002, with 137 million users in 2006″. All this is true, but it has nothing at all to do with Alibaba- any company in China could have said the same thing. There may have been one more unspoken thing he sold, and that is the sense that the Chinese government will always be on Alibaba’s side. While Google is being blocked and having its traffic redirected to Chinese companies by Chinese authorities, Mr. Ma and his partners at Yahoo have made it clear that they will cooperate with the Chinese government. As the Financial Times put it, “Mr Ma has made no secret of his own willingness to co-operate closely with the Chinese authorities in any investigations into his company’s users. Clearly, a company with the support of the Chinese government, has far less financial risk then one whose business can be terminated by simply flipping a switch.

We are more than aware of the dangers here. In September, 2005 we wrote about Alibaba, and the billion dollar Investment Yahoo had just made. At the time, the Chinese Oil Company was trying to take over Unocal (since bought by Chevron) but I thought the Yahoo/Alibaba deal warranted much more attention than it was getting and expressed this concern:

I think the Alibaba takeover of Yahoo China is a big deal. Much bigger that CNOCC trying to pay too much for one of our little pissant oil companies. The Yahoo-Alibaba system could could evolve into a robust national trading platform- an export-driven engine that could help China become even more of an economic powerhouse. Since smaller countries would have to play by their rules they could even move towards a global trading platform that has domination of all major supply chains.

For writing this, this newsletter and portal was promptly blocked in China. Why would the Chinese government block an obscure little newsletter operating in a completely different part of the world, I wondered. Had I hit a nerve? In any event, my concerns about Alibaba dominating supply chains proved to be overblown and never happened- at least not yet. If anything, Alibaba proved to be rather bumbling, and there was talk in the financial community that Yahoo was greatly disappointed in Alibaba. When you pay a billion dollars for a minority share in a company that only makes $29 million a year, this is certainly understandable. Still, what if Alibaba became the “official” ecommerce system of China. Then the billion dollars Yahoo paid would be a fantastic bargain- maybe on a par with something like the Louisiana purchase. I think the possibility that Alibaba could gain some kind of quasi-official status in China is one reason for what I understand is called “wuli rexin” – or “irrational exuberance” among investors about this particular deal.

These investors should be careful of what they wish for. What do we have when you merge Government and Corporate interests? I’ll give you a hint- it is not “communism” and should the Chinese government get involved in “picking winners” – as they certainly seem to be doing, they could completely destroy Chinese entrepreneurship. Alibaba’s premium accounts cost a whopping 40,000 yuan, or $5,300 for Chinese customers, but far less for foreign customers. Isn’t it a possible that some of the Alibaba member base will begin to feel ripped off by these outrageous prices? Isn’t it also a possibility that some bright Chinese entrepreneur will figure out a way to offer the same- or much better services, at far less cost?

An interview in TechCrunch with the CEO of an American manufacturing portal had this take on the deal: “There is not a lot of depth in what their business is doing. They are basically a directory and that offers limited value beyond supplier discovery” said Mitch Free, CEO of MFG.com, “Alibaba has done a great job selling listings to suppliers in China. However, Alibaba is virtually unknown within the industrial community in North America and Europe. In order for their model not to implode”, he said, they will need to both “deliver value to their supplier customers in China” and also “build a brand and value proposition with the industrial-buying community in North America and Europe”. He concluded that, “those buyers have moved way past using directories and are looking for more transactional depth and process integration”.

There is already some indication that the smart money is getting out. Mr. Ma has even left two of his best companies out of the deal: its online shopping unit, Taobao.com, and its online payment services provider, Alipay. Why would the investors let him get away with this? Yahoo had a big run up on it shares as a result of news of this deal, but Terry Semel, Chairman of the board of Yahoo, made his largest trades of company stock in two years when he exercised options in late October to buy 2.1 million shares at $15 each and immediately sold them at prices ranging from $29 to $31.54. He walked away with a quick $32.8 million profit. If the Yahoo-Alibaba deal is so fantastic, why did buy and then immediately sell shares in his own company? Does he know something we don’t?

So the bottom line. With free and fair competition, Alibaba could be a good deal- but it probably isn’t. Without free and fair competition, however, Alibaba ironically could be a fantastic deal- but if that is the case, many people in the world may be turning to Yahoo and saying, “you created a monster”.

This does not bode well for either California or the administration of Arnold Schwarzenegger. Whenever an executive- in the government or private sector, makes “across the board cuts” it is a pretty good indication that they don’t have a handle on the situation. It is also likely that this will table efforts to provide health care for the uninsured, and will probably delay much needed water projects. As the San Francisco Chronicle reported:

The meltdown in the housing market and slowing California economy are likely to create a shortfall in the state budget next year of as much as $11 billion, according to estimates made Tuesday. In response, Gov. Arnold Schwarzenegger has asked department heads to stop spending what they can today and prepare for bigger cuts next year, according to legislative sources. Schwarzenegger won re-election in 2006 in part because of the perception that he had restored order to the state’s chronic spending problems. But the deepening slump in the real estate market, combined with risky assumptions from this year’s $145 billion spending plan, have resulted in a return of the big imbalance between what the state takes in and what it spends. The governor and Legislature will face yet another difficult budget in 2008 that will require either deep spending cuts across the board or perhaps consideration of new taxes – something the Republican governor has resisted in the past…

The current budget, adopted in August after a two-month impasse, was considered by many a victory for conservatives because of its austerity. The plan provided a record reserve of $4 billion and paid off $2.5 billion in bond debt early, while providing for all major services. But some of the plan’s assumptions have not been realized – such as $300 million in income from the expansion of Indian casinos and the $1 billion sale of the state’s EdFund, an agency that services student loans. There have also been unanticipated costs, such as health care and other expenses at state prisons ordered by the federal court. Meanwhile, collection of taxes from the state’s three major sources of income – personal income tax, sales taxes and corporate taxes – have been sliding downward since spring.

The state ended the 2006-2007 fiscal year more than $800 million below forecasts and started the first quarter of the 2007-2008 fiscal year another $770 million short. Administration officials said they are not ready to comment on how big the deficit will be next year except that it will be far higher than the $6.1 billion estimated in August. The meltdown in the housing market and slowing California economy are likely to create a shortfall in the state budget next year of as much as $11 billion, according to estimates made Tuesday. Administration officials said they are not ready to comment on how big the deficit will be next year except that it will be far higher than the $6.1 billion estimated in August.

Some experts, like Stephen Levy, senior economist for the Center for Continuing Study of the California Economy, a nonpartisan research group based in Palo Alto, said it could be as much as $11 billion. “The order that was restored was temporary,” said Levy, noting that the state was saved from similar troubles two years ago when billions of unanticipated tax revenue arrived as a result of capital gains taxes imposed on big tech stock holders who sold out. Insiders at Google Inc., for instance, sold a total of $3.7 billion worth of Google stock in 2006 and $4.3 billion worth in 2005. “We went through the reserves that were built up in the Google years,” Levy said. “And now with the housing market, we have all major tax forecasts going lower.”

The Sacramento Bee has reported how the California Chamber of Commerce has used the “job killer” label they coined to kill any legislation they don’t like, and how the label virtually ensures a Schwarzenegger veto. The Chamber broke a tradition of non-partisanship dating back more than 100 years when it endorsed Schwarzenegger in the 2003 recall election, and has been a reliably Republican institution ever since. The article also describes how this slogan has been used to advance the career of Allan Zaremberg, who has now hung out as Chamber President for more than a decade. It is good that the media finally reporting on this, as the Schwarzenegger administration has been in virtual lock step with the California Chamber and has never understood that being “pro-corporation” and being “pro-business” are vastly different things. What this simplistic bumper sticker slogan had really killed is serious debate on business development in California.

Today, calling a bill a “job killer” is the kiss of death for legislation the chamber deems unfriendly. Gov. Arnold Schwarzenegger has vetoed all but three of the chamber’s 41 job-killer bills on his watch. The chamber’s job-killer list, a compendium of a dozen or so Democratic bills that would rein in businesses, has become the unofficial score card that industry and trade groups use to measure their success in beating back unfriendly legislation. The chamber issues laudatory press releases – “From day one in office, Gov. Schwarzenegger has demonstrated his commitment to protecting California’s economy and encouraging job creation,” reads one dated Oct. 12 – and the governor takes a bow. “Since I took office, California’s business climate has dramatically improved,” the Republican governor said after vetoing all 12 of this year’s job-killer bills.

But critics charge the chamber simplistically tags as job killers all legislation that would improve environmental protections and consumer protection, including tort reform, insurance reform and landlord/tenant law. “I think it’s part of the whole movement by the free marketeers, extreme right-wing of the (Republican) party that has identified this as an effective phrase,” said former Democratic Assemblywoman Hannah-Beth Jackson. “Unfortunately, it resonates with people in way that takes the focus off the real legislation.”

Shasta Ventures closed a $250 million venture capital fund focused on early-stage technology companies, according to a report in the Silicon Valley / San Jose Business Journal. Menlo Park-based Shasta announced that limited partners in Shasta Ventures II LP are primarily returning investors from Shasta’s first fund, including endowments, foundations, pensions and family offices. Shasta Ventures, which began investing its first fund of $210 million in early 2005, has made 22 investments to date in early-stage companies spanning consumer and business Internet services, mobile and wireless, and software and infrastructure.

The University of California, Berkeley got a $2 million gift from the Dow Chemical Co. Foundation that will pay to start a new program providing teaching and research opportunities in the area of sustainable products and solutions. According to a report in San Francisco Business Times, the foundation intends to provide a total of $10 million over the next five years and to help the program find additional foundation and corporate sponsors. Based at the Center for Responsible Business at U.C. Berkeley’s Haas School of Business, the Sustainable Products and Solutions (SPS) Program is being established in partnership with Cal’s College of Chemistry. The program will focus on sustainability issues involving society, science, engineering, the environment and finance. A request for proposals will be issued later this fall seeking research and education ideas, primarily from master’s degree-level and doctoral students at Cal.

Cisco Systems, the giant San Jose, Calif., networking company, will invest a further $100 million in venture capital initiatives in India. VentureBeatWire reports that that tand he plan was mentioned by Chief Executive John Chambers and follows two years after Cisco announced a plan to invest $1.1 billion in India over two to three years, including $100 million in venture investments. This is an expansion of that plan.

Yahoo got absolutely lambasted in Congress last week for its role in helping the Chinese government arrest and imprison Chinese journalists. “While technologically and financially you are giants, morally you are pygmies,” House Foreign Affairs Committee Chairman, and holocaust survivor Tom Lantos, D-Calif., said in an angry statement at that hearing.

The case involved Shi Tao who was jailed for allegedly providing state secrets to foreigners after he sent an e-mail that contained notes about government media restrictions, and Wang Xiaoning who was arrested in 2002 in connection with anonymous e-mails and other political writings he posted online. Both journalists were arrested after Yahoo turned over information about their online activities and both were given harsh 10 year prison terms. Family members of Shi and Wang in April sued Yahoo and the Chinese company Alibaba.com, which took over Yahoo’s mainland China operations in 2005.

In a dramatic moment during the hearing, Yahoo Chief executive Jerry Yang and General Counsel Michael Callahaner were prompted to apologize to Shi’s mother, who was sitting behind them, and both turned to her and bowed deeply. “After meeting with the families, it was clear to me what we had to do to make this right for them, for Yahoo and for the future,” Yang said later in a statement. “We are committed to making sure our actions match our values around the world.” Yang also said the company also was establishing a “human rights fund to provide humanitarian and legal aid to dissidents who have been imprisoned for expressing their views online.”

Let’s hope that is sincere- it sounds like it is. Yahoo was born here in California- and while we wish them great success in all their foreign ventures, we hope they don’t forget that they are an American company Now it is up to the Chinese authorities to release Shi Tao and Wang Xiaoning, and anyone else who has been jailed on such ridiculous charges. This will be a thorn in U.S. China relations, and an unnecessary one that alienates the very people likely to be most friendly towards China.

California’s budget situation has deteriorated since the summer and the State is now facing a massive $10 billion revenue shortfall, according to state’s legislative analyst Elizabeth Hill. Her report, made to the legislature said the current fiscal year budget situation had worsened by $6 billion since its passage in August, wiping out a hoped-for $4.1 billion reserve and leaving a $1.9 billion deficit. Turmoil in housing markets and the slowing economy that caused a drop in property taxes, was the reason for the shortfall, but the report also noted that forecasted revenues from Indian casino compacts were over optimistic and would be delayed.

When Governor Schwarzenegger signed the state’s current spending plan in August, he called it “a balanced budget”. Even before then, however, the slumping housing and credit markets had begun cutting into state tax revenue and threatening to make next year’s budget even worse. Economists had warned that thedecline in new home sales and construction, layoffs and bankruptcies in the mortgage-lending industry, and a volatile stock market were erasing revenue that lawmakers thought would materialize to cover California’s $145 billion budget.

“Knowing the challenges that we face, throughout the fall, my administration has been examining a variety of options to close next year’s budget gap,” Governor Schwarzenegger said in a statement. ” I have not made any final decisions yet, but it’s clear that the decisions that will be involved will be tough.”

The situation continues to look bleak in the housing industry throughout California, but the Bay Area, with its high home prices faces special challenges. As reported in the San Francisco Chronicle:

Bay Area home sales limped along at a decades-low pace in October, as buyers continued to find few mortgage options. A total of 5,486 new and existing houses and condos changed hands last month, down 35.7 percent from October 2006 and the lowest sales count since at least 1988 Sales of existing, single-family homes in the nine counties that touch the bay slid 41.3 percent, from 5,761 last year to 3,384 in October, the firm reported Thursday. Although it was the 33rd month in a row of year-to-year sales declines, the market has been slammed in recent months by a tightening in the mortgage market, which is making home loans harder to come by and more expensive.

Of particular concern in the high-priced Bay Area housing market is that the number of jumbo loans, or those over $417,000, has slowed to a trickle. This summer, after higher defaults in the subprime sector – where mortgages were given to people with iffy credit – investors stopped buying jumbo mortgages, leading buyers to walk away from deals or avoid the market altogether. “We don’t have liquidity in the marketplace, and that’s creating a drop in market value because people can’t close on a purchase,” said San Francisco mortgage broker Leon Huntting.

The Los Angeles Police department has scrapped a plan to map the city’s Muslim population – a project they said was necessary to identify potential hotbeds of extremism. The mapping project set off howls of protest from Muslim groups and civil libertarians who called it “religious profiling”. Others noted that it would be almost impossible to create such a map, since the Muslim community is spread out and integrated through the area, and census data is forbidden by law from recording religious affiliation. In a statement, Mayor Antonio Villaraigosa said that “while I believe the department’s efforts to reach out to the Muslim communities were well intentioned, the mapping proposal has created a level of fear and apprehension that made it counterproductive.” LAPD officials stressed for that the mapping program was not a form of profiling or targeting but rather a way to better understand the Muslim community. They have subsequently been reaching out to Muslim activists, some of whom who said they would welcome greater involvement by the LAPD in their communities.

Venture capital investor Clearstone Venture Partners, which has two offices in California and one in Mumbai, plans to invest $30-40 million in companies focusing on India’s consumer market in fiscal 2008. According to a press release from the company, Clearstone, which has $650 million in committed capital under management, has invested a total of $21 million in three Indian companies with partners since 2006. Clearstone Venture Partners, which plans to focus on India’s high-growth, consumer-driven market, says the sector is not overcrowded with investors,”The market is still underplayed. It can take more investors.” said Clearstone Director Rahul Khanna.

Santa Clara-based security software vendor McAfee Inc. has issued a report claiming that government-affiliated hackers in China are aggressively working to crack Internet security in other nations and this could eventually provoke a global cyber war. McAfee said that in 2007, there were more attacks reported on critical national infrastructure than ever before. Targets included financial markets, utilities and air traffic control machinery, and the attacks were believed to have been launched by governments or government-allied groups. “Within two decades, according to McAfee, the scuffle could erupt into a worldwide conflict involving hundreds of countries attacking one another’s online networks with sophisticated software. The Chinese government has denied the allegations, “China has also been attacked by hackers of some countries, so the Chinese government attaches great importance to and participates in the international law enforcement cooperation in this area,” Foreign Ministry spokesman Liu Jianchao said at a briefing.