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(SEE UPDATES BELOW)

Having struggled to build a viable auction business with China’s largest Internet portal Sina, Yahoo is reportedly now negotiating to buy a 35 percent stake in Alibaba, owner of Taobao, according to Forbes. Taobao is the auction site that is supposedly giving eBay fits in China. Depending upon which numbers you look at – and which company you talk to – Taobao is either ahead of eBay in the auction market, or a respectable second.

Yahoo jumped into the Chinese online auction market last year, partnering with Sina Corp. to form 1pai.com. But despite’s Sina’s stature in China, 1Pai has been a distant third in the auction market. 1Pai general manager Zhen Zhaodong resigned recently, reportedly because Yahoo CEO Jerry Yang was unhappy with 1Pai’s slow growth.

Forbes says Yahoo wants a 35 percent stake in Alibaba for a cool $1 billion. Alibaba also operates a well-established business-to-business trading platform, but presumbaly Yahoo is more interested in the consumer auction site. If this is all true, it should make things doubly interesting for eBay – and harder for analysts and other observers to dismiss the threat that Alibaba poses.

UPDATE: We spoke with Paul Waide tonight from Pacific Epoch in China. He says the rumors there are that Alibaba is about to make a big announcement, and he expects official word of the deal by Monday morning, U.S. time.

Waide said the deal would appear to be more valuable to Yahoo than Alibaba. Alibaba has been generating cash for years now, and doesn’t appear to need the investment. And it’s already in a marketing dogfight with eBay-EachNet. “What else can Taobao do to crush eBay? What’s he (Alibaba CEO Jack Ma) going to do with a billion dollars? Unless he’s going to start giving money away, there’s not much he can do.” Yahoo, on the other hand, immediately becomes a player in one of the most important e-commerce battles in China.

UPDATE: This article from Wharton provides a good overview of Alibaba, the company, for those wanting to know more.