Chinese tech giant Alibaba is on track to complete the single largest IPO in history. According to the S-1 filing submitted on the 6th of May, the fast-growing online retail conglomerate is expecting to fetch from $15bn to $20bn in exchange for a 12% stake, making it potentially larger then Visa’s $18bn IPO back in 2008.
Bigger than both Chinese Internet competitors Tencent and Baidu, Alibaba was founded by a 34 year-old English teacher, Jack Ma, in 1999. Operating out of Hangzhou with only 17 employees, Alibaba simplified import and export for small and medium sized companies, connecting business directly to one another (B2B).
By 2003 Ma launched Taobao.com, which acted similarly to Ebay, directly connecting consumers (C2C) rather than one business to another. As proof of the success of these ventures, Alipay, an offshoot of Taobao and analogue of PayPal handled $519bn in payments last year alone.
The third main pillar of the e-commerce giant is Tmall.com. Acting as a complement to Taobao, Tmall allows international brands to reach the growing Chinese middle and upper-middle class by providing a virtual storefront where only accredited brands can list (B2C). This has the result of maintaining a high level of quality control and reliability.
Alibaba also has many smaller businesses such as cloud-computing services, mobile messaging, search engine services (etao.com), and navigation solutions. In a recent spree it has aggressively bought both minority and majority stakes in many tech-related companies in China and abroad (Germany, United States and so on). Despite this, the management insists the focus of its business remains squarely in China and in e-commerce. Alibaba now holds shares in Lyft, Tango, Youku Toudo, ChinaVision and many other firms.
By betting on the rise of the Chinese middle class and on the increase of citizens with Internet access, Mr Ma has taken a different approach to the e-commerce market. Rather than hoping to redefine the industry as Amazon is trying with drones and Google with Google Wallet, he has focused on solving simple customer problems by employing simple solutions. One such example is Alipay’s use of an escrow system to overcome low consumer protection and has thus removed one of the biggest hindrances of growth to the Chinese e-commerce market.
So far this strategy has proven extremely successful. In 2005 Alibaba was estimated to be worth $2.5bn, by 2011 $32bn (a CAGR of 52.94%), and it is now estimated to be in a range of $130-235bn (CAGR of 55.12- 65.67% since 2005). Last year, the total value of goods sold through the e-commerce goliath exceeded $248bn, more than Amazon and EBay combined. As of December 31, 2013, Alibaba has 20,884 full-time employees.
According to a McKinsey research this extreme growth still has room to continue; only 30% of China’s population has access to broadband Internet, and the Chinese economy continues to steadily grow as a whole.
One of the more controversial subjects relating to the Alibaba IPO is the company’s decision to list on the New York Stock Exchange instead of Hong Kong. Since Hong Kong authorities could not agree to soften regulations and allow Alibaba to employ a unique governance structure, or to make use of a variable interest entity structure (V.I.E.) to circumvent foreign investment blocks, the e-commerce giant has opted to float in New York, where both of these will be possible. The structure would allow for a self-selecting partnership of managers and founders who would nominate a majority of board members. Many investors in Hong Kong voiced that they would not support such a system, as it would allow for the founders to sell equity in their company without giving up any degree of control. Such dual-class share systems are common in tech companies in the United States (Google and Facebook are two prominent examples) yet are not allowed in Hong Kong, where a strict one-share-one-vote rule is enforced. It appears that to the Hong Kong Stock Exchange the loss of the IPO is worth the cost of adhering to its core values and protecting shareholders. As for Ma, adhering to the Hong Kong voting regulations would have meant losing clear control of the company, something out of the question for the entrepreneur.
Just to provide some figures, right now about 8% of China’ shopping is taking place online, and Alibaba itself estimates this percentage to go up to 30% in the future. Alibaba currently accounts for 4/5 of the Chinese e-commerce market, and even though at a first glance 30% seems like a crazy growth, this number is explained by middle class people’s inclination of doing shopping online; in fact in China most of the shops are either cheap and low-quality goods, or extremely expensive and luxury ones.
From the filings, we find that the company values itself between $96.9bn and $121bn, according to calculations based on the number of shares and its own valuation per share in April. This result is much more conservative than the $200bn IPO valuation made by some analysts. However, since the actual pricing of the offer will take place in a few months, the final valuation could still be influenced by external market swings and investor reaction to a road show reaching out three continents.
Although Alibaba hasn’t specified its intention with the proceeds, one of the most likely uses is to reach other markets. In fact, the IPO is expected to provide Alibaba with the financial firepower to continue its forays into other markets. Alibaba recently bought digital mapping service AutoNavi Holdings Ltd. for $1.5bn and acquired a 16.5 per cent stake in video website Youku Tudou in a $1.2bn deal. Alibaba also just invested $215mm in Silicon Valley startup Tango to gain a toehold in the mobile messaging market.
The main problems in comparing Alibaba to its peers are the lack of information on the company itself and a shortage of truly comparable companies. The most famous examples that we can think of are Facebook, Tencent, Amazon and Ebay. Facebook is the least similar business, but like Alibaba it is a kind of “phenomenon”. Using Tencent as a comparable company works only if investors believe that all big Chinese internet companies are similar. Amazon, like Alibaba, actually sells goods online too but it uses a different model, while eBay is based on the same idea of the Chinese giant: both platforms, in fact, let buyers and sellers meet and agree on price. Rakuten, the Japanese online retailer, is another very close peer since it operates a marketplace in which it charges fees, rather than selling directly its own goods. It does, however, own a baseball team. The only information investors had on Alibaba until its S-1filing with the US Securities and Exchange Commission came from the quarterly updates of Yahoo, which has a 22.6% stake in the Chinese giant. Only basic profit details were reported: recently, it showed that Alibaba had a bumper end to 2013, producing $3.5bn in profits.
At the moment of writing, Facebook trades on 100 times last year’s earnings. Amazon is trading at a whopping 500 times, but this is mostly due to the very peculiar reinvestment policy of the company, whereby almost all of the operating income is plowed back into R&D. Tencent and Rakuten are on 50 and 40 times, respectively. EBay is the most conservative of the selection, with a P/E ratio standing at 21.4. Applying those multiples to Alibaba’s 2013 earnings makes it worth between $74.9bn and $350bn (Amazon has obviously been excluded for the above mentioned reason). However, comparing Alibaba just to Rakuten and Tencent produces $141bn and $176bn, which is the range that many analysts have bandied about.
The Chinese e-commerce profits dwarf those of eBay. The Chinese giant earned $3.5bn in its last fiscal year (which ends in March), while EBay’s reported $2.86bn. It is indeed the profitability of this company which really attracts investors to participate in the action: just to make an example, Ma’s company is not only growing faster than Facebook, but it’s also much more profitable (it can be argued that the businesses are different, however they are both internet companies for the sake of portfolio allocation and are among the most hyped companies around at the moment).
EBay has a Year-on-Year growth in net income of 9.46%, Alibaba instead pulls an incredible Y-o-Y income growth of 126% for the fiscal year ended in March. More recent results for Alibaba are to be released in successive filings but they are poised to be even greater.
Particularly interesting is to look at what the major shareholders plan on doing, as it can provide us with a strong signal of how much they believe in their company or, sometimes, how eager they are to cash out and leave the “hot potato” to the shareholders. Softbank with 34.4% is Alibaba’s biggest shareholder. Softbank executives have said the company plans to retain the stake, whose value could be worth more than $40bn depending on Alibaba’s final pricing.
Yahoo holds 22.6% of the company. In 2005 Jerry Yang (Yahoo’s co-founder and chief executive) invested $1bn in Alibabaas well as adding Yahoo China to the conglomerate, but in 2012 Yahoo sold back about half of its stake for $7.1bn. Its remaining stake is now worth ca. $27bn, making Marissa Mayer the second largest shareholder in the Chinese group. Yahoo agreed to sell part of its stake once Alibaba goes public, and its current representative on Alibaba’s board, Jeckie Reses, will step down after the IPO. Ms Mayer states that her company will use the proceeds from the IPO to do other deals but some analysts question the value of Yahoo’s core business ex-Alibaba.
The founder Jack Ma holds 8.9%, while the vice-president Joseph Tsai has 3.6%.
Other major shareholders, although not listed in the filing, are Temasek, DTS, Silver Lake Partners and Yunfeng Capital.
Bloomberg News recently valued Alibaba at $168bn, which would make Alibaba the most valuable Internet company after Google as well as giving it a larger market capitalization than most Dow Jones Industrial Average components. Just to make a comparison, Amazon’s market cap was last reported at $136.8bn while eBAy was just $64.6bn. We provide you with a chart made of selected IPOs of tech companies, which can help put into perspective the size of this equity listing. Moreover, apart from Zynga and Groupon, all the companies in the chart have grown incredibly their capitalization, strongly rewarding their early investors.
The preliminary filing of Alibaba still leaves many questions to be answered and doubtless there will be interesting developments in the months to come before the shares hit the market. However, one thing is certain: the IPO of the Chinese giant is going to be one of the most important financial events of the year.
The filing indicates that Credit Suisse, Deutsche Bank, Goldman, Sachs & Co., J.P. Morgan, Morgan Stanley and Citigroup will underwrite the IPO and act as joint bookrunners. Rothschild Inc. acted as Alibaba’s independent financial advisor, according to the filing, but it is not acting as an underwriter or distributing the deal.
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