Alibaba lights IPO touch paper

The most highly anticipated IPO since Facebook looms closer. China’s internet industry offers enormous potential but also has its risks.

Alibaba Group has unveiled a few more details of its blockbuster US initial public offering, which could yet raise as much as $20 billion for the Chinese e-commerce giant and break all records. 

Founded 15 years ago by English teacher Jack Ma, Alibaba has since grown into the largest e-commerce company in the world’s most populated country. With a valuation anywhere between $150 billion and $250 billion, according to media reports citing analysts, it already dwarfs its US counterparts.

The potential fast growth of the company – part-Google, part-eBay, part-PayPal – coupled with a high price tag make it the most highly anticipated share offering since Facebook's $16 billion IPO in 2012.

Citi, Credit Suisse, Deutsche Bank, Goldman Sachs, JP Morgan and Morgan Stanley are joint bookrunners on the deal, which, depending on demand, could surpass Facebook in size when it lists on either the New York Stock Exchange or Nasdaq.

Tuesday’s filing with the US Securities and Exchange Commission did not disclose how much it really hopes to raise or how many shares it’s aiming to float. (The company said it would raise up to $1 billion, although this figure is widely seen as a placeholder.) It also didn't offer a timeline.

Investors, comparables

Alibaba’s filing comes at a time when investor demand for Chinese IPOs is waning – pork producer WH Group scrapped its IPO last week due to insufficient interest.

Meanwhile Weibo, China’s version of Twitter, last month priced is Nasdaq flotation at the bottom end of its range. Although shares in the microblogging service leapt 36% in price in the first four days of trading, they subsequently sank 24% in the following four days.

To avoid such after-market volatility, Alibaba and the syndicate of banks managing the IPO will doubtless be keen to lock up as many long-only institutional investors as possible. 

“People are definitely [erring] on the side of caution, particularly around technology,” Philip Lee, director of research firm S&P Capital IQ, said. “They’re waiting for the right market conditions to get enough institutional demand, plus [ensure] all investors are comfortable with the valuation levels.”

The fact that the company’s existing investor list is short may appeal to investors – Ma owns 8.9%, Joseph Tsai, co-founder and executive vice chairman, owns 3.6%, while Yahoo and SoftBank own 22.6% and 34.4%, respectively. Once the company goes public, Yahoo has agreed to sell 40% of its current stake in the company, or about 208 million shares.

Those evaluating Alibaba break down its business into two silos – e-commerce and social media. The closest e-commerce comparables include Amazon, Yahoo and eBay, while Facebook, Twitter and Tencent make up its social media peers.

All of the comps mentioned, barring Facebook, have seen their share prices fall sharply in recent months, with Amazon and Twitter losing 22% and 53%, respectively, so far this year. This sell-off has led investors and analysts to re-evaluate valuations for technology companies, which remain very high. Amazon is currently trading at a forward p/e ratio of 84.46 times, while Twitter is valued at 816.67 times forecast earnings, according to Bloomberg.

“One thing I would say that’s unique about Alibaba is it does have a significant advertising business model. Most of its revenues are generated from advertising, so that could command a premium to an Amazon or an Ebay based on that,” Lee told FinanceAsia.

Although no timeline has been given on when Alibaba will list, it will likely be in the second half of the year, as the company’s executives and bankers wait for more positive market conditions. Asian stock markets traded lower on May 7, following disappointing earnings reports, poor manufacturing data in China, and persistent worries about the crisis in Ukraine.

Simple mission

Alibaba’s mission statement – “to make it easy to do business anywhere” – sounds very simple for a company that is anything but.

Initially founded as an online platform to connect international businesses with Chinese suppliers, it has since grown into a behemoth company that boasts more inventory than eBay and Amazon combined and is involved in almost every aspect of online shopping. That includes three major online market places, search engines, payment systems (Alipay), micro-loans, delivery logistics and data collection.

It also operates a cloud-based mobile operating system and sells TV set-up boxes to bring online shopping into mainland living rooms. Alibaba's Taobao, meanwhile, acts as a sales platform for both individuals and small-scale entrepreneurs.

“Our founders started the company to champion small businesses, in the belief that the internet would level the playing field by enabling small enterprises to leverage innovation and technology to grow and compete more effectively in the domestic and global economies,” Alibaba said.

Its three major online marketplaces – Taobao, Tmall and Juhuasuan – handled Rmb1.54 trillion ($248 billion) worth of transactions from 231 million active buyers and 8 million active sellers last year, more than Amazon and Ebay combined.

Total revenue increased 72.4% to Rmb34.5 billion ($5.55 billion) in its fiscal year 2013 from Rmb20 billion in 2012. Over the same period, net income increased 85.4% to Rmb8.65 billion.

“On a financial basis, the growth numbers are off the charts,” Lee said. “The sheer scale of this company [is enormous], and the attraction to Chinese companies is the market growth opportunity. It’s significantly larger than what’s in the US and already bigger than Amazon in terms of its transaction model. That’s incredibly attractive.”  

Macro trends

Simply put Alibaba, like other internet and e-commerce companies on the mainland, is a play on China and its growth. The company’s future success is dependent on demographic trends in the country.

There are 1.35 billion people living in China, yet only 618 million use the internet, 500 million through their mobile phones. The real potential lies with online shopping – at the moment only 302 million Chinese use the internet for shopping, according to the China Internet Network Information Center.

Chinese consumers, Alibaba argues, are expanding the range of products and services they purchase online, which should increase online and mobile commerce activity and help support future growth.

The company also hopes to exploit China’s underdeveloped physical retail infrastructure, limited product selection and issues with inconsistent product quality. These shortfalls, which Alibaba believes are particularly acute outside of China's tier one and two cities, are causing consumers to “leapfrog the offline retail market in favour of online and mobile commerce,” the filing said.

Online shopping, which accounted for 7.9% of total Chinese consumption in 2013, is expected to grow at a compound annual growth rate of 27.2% from now to 2016, according to iResearch.


But some analysts argue Alibaba’s prospectus lacks certain key detail, namely on the financial metrics of Tmall, Taobao and Alipay.

This could prove to be a sticking point for some investors, particularly US investors that are not familiar with Alibaba’s business structure, save for those details garnered from Yahoo, which has been invested in the company since 2005 and has disclosed some information via its own public filings.

The huge scope and reach of Alibaba could also pose problems. For example, the company notes that “a significant number of small businesses and sole proprietors operating businesses through storefronts on Taobao Marketplace may not have completed the required tax registration. PRC tax authorities may enforce registration requirements that target small businesses or sole proprietors on Taobao Marketplace and may request our assistance in these efforts.”

The sellers, subject to more stringent tax requirements, could suffer and as a result remove their storefronts from Alibaba’s marketplace rather than comply.

Alibaba has also incurred “substantial indebtedness”, namely an $8 billion credit facility, and drew down $3 billion from that credit line in April.

Then there are concerns over Chinese censorship and regulation to take into consideration, issues that Alibaba has no control over and that are unlikely to change anytime soon. 

“Under PRC law, we are required to monitor our websites and the websites hosted on our servers and mobile interfaces for items or content deemed to be socially destabilising, obscene, superstitious or defamatory,” the filing said.

Alibaba is also responsible for “any unlawful actions” of its customers or users of its websites or mobile interfaces, with the company noting that “it may be difficult to determine the type of content that may result in liability to us, and if we are found to be libel, we may be subject to fines, have our relevant business operation licenses revoked, or be prevented from operating our websites or mobile interfaces in China.”

It’s no secret the government has a stranglehold on most of its sectors and the internet is no exception. What remains unclear to potential investors – and indeed the company itself – is how government intervention could impact its revenue streams, future growth and the company's business structure.

For example, the Chinese government has made it clear it is not comfortable with Alipay being part of the IPO, as they don't want a payment system being part of a US-listed company.

In filing, Alibaba noted the People’s Bank of China is currently considering a potential draft of regulations related to online and mobile payment services that could greatly reduce the size of individual transactions made via Alipay. The rules it is considering would cap the amount that a buyer could spend on Alipay at Rmb5,000 ($804) for a single transaction or Rmb10,000 ($1,609) in aggregate purchases per month. The rules, if implemented, would also limit transfers of money using Alipay to Rmb1,000 per transaction and Rmb10,000 in aggregate per year.

The government effectively has the power to change the business model of the company, which could trouble investors.

US over HK

Speculation had long been rife over where the company would choose to list its shares, with Hong Kong initially seen as the preferred location for China’s largest e-commerce company. But Alibaba’s insistence on maintaining its existing management structure – which allows for management to maintain control of its board of directors – was a sticking point for Hong Kong, as the city’s exchange prohibits dual-class share structures that give shareholders more than one vote per share.

So in mid-March Ma announced plans to take his brainchild to the US instead, saying at the time that a listing in America would make the company more global and enhance its transparency. 

Alibaba’s decision to go with the US was viewed as a blow to Hong Kong and has fuelled a debate about whether the Hong Kong Stock Exchange should allow dual-class structures. 

¬ Haymarket Media Limited. All rights reserved.
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