Alibaba.com is China’s answer to Amazon.com, and its upcoming initial public offering has been one of the most hotly anticipated in years.
Rightly so, since it’s expected to be the biggest IPO ever.
You read that correctly. The biggest IPO ever.
Bigger than UPS, bigger than Facebook, bigger than Kraft Foods, bigger than GM, bigger than Visa.
Bigger than all of them, it’s expected to raise over $21 billion in funds with a launch price between $60 and $68. In this price range, the company’s value is around $170 billion, which would make it the 21st most valuable company in the United States.
In the tech sector, it would be the sixth most valuable company trading in the United States markets, behind Apple (NASDAQ: AAPL), Google (NASDAQ: GOOG), Facebook (NASDAQ: FB), IBM (NYSE: IBM), and Oracle (NYSE: ORCL).
The most amazing part about this valuation is that it was actually higher than this before a recent reduction. Before a couple of mid-summer delays to the IPO, analysts expected Alibaba to raise $198 billion. Then it was lowered by a little more than 22% to $154 billion.
But even its much more conservative $21 billion still tops the IPO list by a decent margin.
IPOs are risky, and persistently skeptical watchers call each new IPO the bellwether of an IPO bubble. Will this, the biggest IPO thus far, be the straw that breaks the camel’s back, crashing the trend?
I’m going to go not very far out on a limb and say no, it won’t.
If Alibaba has a hugely high valuation, it’s because it has a pretty damn high absolute value. Yes, you’re still in for a risk, but Alibaba promises to ride out the IPO hype.
How Alibaba Works
The Alibaba Group has 10 different sub-properties, and it can generally be said that they all make their money when items are sold online in different ways.
From Alibaba.com itself, money is earned with simple B2C online sales. With its sales platform Taobao Marketplace, it takes a percentage of sales between individuals, sort of like eBay. Aliyun, Alibaba’s cloud computing platform, provides services to support online and mobile commerce. Alimama is an online marketing platform for online sellers that Alibaba offers.
If it’s e-commerce in China, Alibaba does it. It commands nearly 80% of the Chinese e-commerce market.
According to Alibaba’s IPO prospectus filed last May, the three properties Taobao Marketplace, Tmail, and Juhuasuan (a Groupon-style service) generated a combined gross merchandise value of $248 billion from 231 million active buyers and 8 million active sellers.
All told, these services generated $6.5 billion of net income for Alibaba last year.
The Old China Growth Story
The United States is the leading e-commerce market in the world, but China is a close second. Alibaba said approximately 84% of its revenue comes from China and 12% comes from other countries.
Recent surveys from Bain and Company and PricewaterhouseCoopers showed that nearly 75% of Chinese citizens who shop online do so on a weekly basis, more than three times the rate of people in the United States.
And these are new buyers. In the Bain and Co. report, 63% of online shoppers in China said they had made their first online purchase some time in the last four years. In the U.S., this was just 22%.
The market has excellent growth potential, and with a population nearly five times that of the United States’, it has a higher growth ceiling. To use a racing metaphor, it has both great acceleration and a high top speed. It’s this potentiality that will drive BABA upward.
However, it also has the difficult regulatory system of China to deal with.
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Variable Interest Entities (VIE)
Complicated Chinese regulations were the main reason cited for the delay of the Alibaba IPO earlier this summer.
In order for Alibaba to skirt the Chinese government limitations on foreign investment in Chinese companies, it had to incorporate as a Cayman Islands holding company called Alibaba Group Holding Ltd. This variable interest entity (VIE) won’t exactly own any of Alibaba’s assets, but it will be contractually entitled to Alibaba’s profits.
That will be what you’re buying at the time of the IPO.
It’s a complicated structure that was designed some 14 years ago specifically so Chinese companies could list on the NYSE and NASDAQ. Today, there are more than 200 companies using this structure, including Baidu and JD.com.
It poses a continuous risk, though, because the VIE structure has never been vetted by Chinese courts, and previous incarnations of this workaround have been declared unlawful.
In 2011, China’s merger control authority prevented Chinese retailer Yihaodian from merging with Wal-Mart under a VIE structure, and in late 2012, the China Securities and Regulatory Commission fined brokerage firm Minsheng Securities for attempting to go public under a VIE structure.
Though it appears Alibaba is cleared for takeoff with this IPO, this workaround is going to continue to be a soft spot moving forward.
The Bottom Line
From a value perspective, I like to think of the Alibaba Group as a combination of Amazon and eBay. It offers not only B2C retail but also C2C, as well as all the related payment, marketing, and data management services in an end-to-end package.
Yesterday’s closing values of Amazon and eBay were:
AMZN: $327.76
EBAY: $51.61
The $60-$80 range for shares suggests that analysts see Alibaba’s value at about 10% to 15% higher than IPO cost. It’s a safe price.
Good Investing,
Tim Conneally
For the last seven years, Tim Conneally has covered the world of mobile and wireless technology, enterprise software, network hardware, and next generation consumer technology. Tim has previously written for long-running software news outlet Betanews and for financial media powerhouse Forbes.
