The topic of hedge funds financing the film industry and accounting in Chinese companies has generated the same basic thought in certain trading circles: Such speculative investments are not only dependent on the venture gaining popular favor to succeed, but if successful they require significant accounting attention to make sure investors are properly compensated.

Alibaba

Alibaba internally reviews “suspicious” accounting

That old school wisdom is getting a workout today as Chinese e-commerce giant Alibaba internally reviews “suspicious” accounting from a Hong Kong film production it acquired for $800 million.  According to a report in the New York Times, the news may hinder Alibaba’s $20 billion initial public offering, the largest in American history.

The issue at Alibaba Pictures Group, formerly ChinaVision Media Group, is the same issue that befalls many film-based investments: the valuation of film rights on a balance sheet.

Movie rights are a significant asset on a film company’s balance sheet, and valuation of those assets, which should be based on an accurate look at forward earnings, can be easily manipulated, say sources who have been involved in structuring film deals. This along with costs of production and marketing, and related party transactions, are two issues typically closely watched. Investment sources outside the Hollywood film industry typically avoid such deals as the risk factors can be too numerous.

Alibaba may have skipped due diligence

It is unclear exactly what was done in this situation, but it is clear Alibaba may have not conducted due diligence on the deal to the same rigorous specifications that are expected in Western financial circles.

“The big question is whether Alibaba did proper accounting due diligence,” Paul Gillis, a professor at Peking University’s Guanghua School of Management, was quoted as saying.

The Times reports that the deal to purchase the film company was concluded in a matter of a few short days and questions are being raised relative to Alibaba’s due diligence process, or lack thereof.

Jack Ma flying loose

Jack Ma, Alibaba’s chairman, appears to have a track record of flying loose and fast, a gun-slinger attitude that isn’t often appreciated in Western financial circles.   After mentioning the due diligence issue, The Times article notes that Ma agreed to lay down a $200 million investment for a 50 percent stake in a Chinese soccer team after having drinks with the team’s billionaire owner.

For its part Alibaba stands by its investment in the film company.

Alibaba “fully supports the new management of Ali Pictures as they thoroughly review and rectify the possible financial noncompliance they have found with the former ChinaVision,” an Alibaba spokeswoman told the New York Times in a statement. “The new management team has a firm commitment to transparency, good corporate governance and investor protection, and the actions they have taken are consistent with this commitment.”

Click to read the full New York Times article.