Alibaba jumps in debut, impresses in first week

One week after the biggest IPO in history, Alibaba has delivered. Now the company must justify its $240 billion valuation.
Thumbs up for Jack Ma, so far
Thumbs up for Jack Ma, so far

It is one week after one of the most highly awaited IPOs in history, and Alibaba has not disappointed.

After pricing shares at $68 each on September 18 and raising a record $25 billion — the largest flotation ever — the company began the first day trading at $92.70. Shares soon spiked to just under $100 a unit before closing the day at $93.89, a 38% rise in its debut.

Shares hovered around the $90 mark in the first week of trading, dipping to a low of $87 at one point. But they rose again to $90.57 on September 24 at the New York close.

To say that Jack Ma, the former English teacher who founded Alibaba in his Hangzhou apartment in 1999 with just $60,000, has hit the jackpot is an understatement. This flotation has made Ma the richest man in China, who now has a net worth between $15 billion and $22 billion. He owns 7.9% of a company that’s valued at $240 billion. Only three technology companies in the world — Microsoft, Google and Apple — are bigger.

Ma was not the only winner from this landmark transaction. Investors who bought shares at the IPO price of $68 — which includes institutions such as Blackrock — are up 33% so far.

Sixty global accounts were selected during the pre-roadshow due diligence work. This left many funds clamouring to get a piece of the e-commerce giant, but the demand and the hype allowed Alibaba’s management to be selective during the allocation process.

Close to 1,800 institutions applied for stock, but half of them came up empty. Of the funds that received allocations, half received less than $1 million. The top 50 investors received 80% of the deal, and American funds made up 85% of the institutional allocation, leaving little room for Asian and European funds. US retail investors meanwhile were allocated $1 billion. While a large amount in dollar terms, it was small relative to the overall size of the deals.

Those who bought stock in the secondary market are less fortunate — they’re down 2%. Still, despite the slight dip in share price, investors are clearly keen on Alibaba and its enormous growth potential, truly remarkable for a company that already controls some 80% of China’s e-commerce market.

Past HK IPO
Although the performance numbers confirm demand for the company has been staggering, it still does not compare to the frenzy some Hong Kong IPOs have attracted in the past. Alibaba’s business-to-business portal, Alibaba.com, smashed a number of records in 2007, including receiving the highest valuation on record of 53.8 times, and the highest amount of retail subscription of $58 billion. Sheer momentum pushed the deal up 192% in its market debut.

But subsequent earnings failed to deliver against the overly aggressive valuation, and Alibaba.com was taken private five years later.

Yahoo, Tencent
One of the big questions leading up to the IPO would be the impact on its two largest pre-IPO investors, Yahoo and SoftBank.

Shares in both companies have dropped since mid-September, an indication that investors have sold their stakes and opted for direct exposure to Alibaba, instead of holding onto Yahoo or SoftBank stock, and hope both would benefit from Alibaba’s high valuation.

Yahoo’s share price is down 7% since September 12, while SoftBank shares have fallen 11% since September 15. Yahoo is trading at 28 times 2014 earnings, and SoftBank at 17 times 2015 earnings.

In fact, Yahoo has a market capitalisation of $39.5 billion and is worth close to nothing if you discount its $36.5 billion Alibaba stake (plus the after-tax cash it earned from cutting its holding to 16.3% from 22.4%, half of which it has promised to return to shareholders).

Other comps appear to have suffered sell-downs as a result of funds making room in their portfolio for Alibaba. Tencent, which was up until September 18 China’s largest company in terms of market cap at $155.7 billion, has dropped 12% since mid-August.

JD.com meanwhile, of which Tencent has a strategic stake in and is similar to Amazon, is down 17% since mid-August.

Is Alibaba overpriced?
It’s still early days, and while a 38% rise in its market debut suggests the syndicate got the correct price range, questions have already started about whether Alibaba’s shares are inflated. At $90 a share, the company is now trading at 40 times its 2015 earnings. Is Alibaba worth $240 billion?

It depends who you ask. Some bankers in Hong Kong said they wouldn’t be surprised if the stock was trading over $100 by year-end, pointing out that the company has historically blown through its conservative earnings estimates. In the most recent quarter Alibaba posted record profits of $2 billion and revenues of $2.54 billion.

Indeed, analysts say one of Alibaba’s greatest strengths is the fact that the company, which already controls 80% of the e-commerce market in China, still has tremendous room for growth.

China’s e-commerce market remains underpenetrated and online sales are gaining popularity. Bain & Co forecasts the mainland’s online market will grow by 32% each year until 2015. Of the 1.35 billion people living in China, 618 million currently use the internet, but only 302 million use it for shopping, according to the China Internet Network Information Centre.

It also has ambitious goes to becoming a global company. “We want to be bigger than Walmart,” Ma boldly told CNBC minutes after shares started trading on the New York Stock Exchange on September 19.

Some argue this is feasible. But the company has its fair share of risks as well, which almost certainly will come to light sooner or later.

Risks
Some are dubious about how much growth actually remains for a company that controls 80% of China’s e-commerce market, regardless of the fact it remains underpenetrated.

Competition is also increasing. Alibaba may be focused on the next frontier — securing customers’ mobile wallets by taking on the domestic banking sector — but so too are Tencent and Baidu, and others will surely come up.

Alibaba also remains linked to China, which is in the midst of an economic downturn. The staggering economy has dampened consumer sentiment and will almost certainly affect revenues in upcoming years.

In order to become the global company it aspires, some of its businesses, namely Alipay, will have to become successful in the US. Whether Americans will trust a cashless payments system owned by a Chinese company remains to be seen. Some polls conducted before the IPO suggested that 88% of Americans have never heard of Alibaba, and many remain suspicious over mainland companies after a few high-profile frauds, such as Sino-Forest.

Then there’s the company’s unconventional shareholder structure, a complex web that few understand and prevented Alibaba from listing in Hong Kong. Ma and executives in the controlling Alibaba Partnership have the power to nominate anyone they choose to the public company’s board. The structure effectively hands the partnership control over the makeup and control of the board — great when times are good, not so great if things sour.

Another sticking point is the fact that the company doesn’t own the licences to operate its website. Due to restrictions on foreign ownership of Chinese companies, Alibaba has set up a structure where Ma and other Chinese nationals own the licences through variable-interest entities.

VIEs have at best an uncertain legal framework in China and in the worst case may be deemed illegal under Chinese law. It could in theory force Alibaba to relinquish assets contained in VIEs.

These points aside, few deny Alibaba is an extremely powerful company with a huge customer base and incredible growth potential.

But its future success will very much depend on Ma, who, while charismatic, has been known to make some questionable decisions, such as his purchase of a Chinese soccer team.

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