Alibaba, the Chinese e-commerce giant, sets off on global roadshows in New York on Monday, hoping to break all records with what could be a $22.1 billion to $24.3 billion flotation (post greenshoe).
The IPO is not only on course to surpass Facebook’s $18.4 billion deal as the tech sector’s largest but will almost certainly beat Agricultural Bank of China’s $22 billion offering as the largest of any company in the history of the financial markets.
Alibaba’s initial price range has been set at $60 to $66, although, like many US IPO’s, the company may be tempted to revise it upwards should demand prove overwhelming.
The base deal comprises 320.1 million ADS units. There is a split of 62% secondary units and 38% primary units, with one unit equalling one share.
Pre-greenshoe this means Alibaba is issuing 12.5% of its enlarged share capital, netting proceeds of $19.2 billion to $21.1 billion.
The greenshoe will add a further 15% to the deal, according to a term sheet seen by FinanceAsia. This comprises 48 million units, with a split of 54% primary units and 46% secondary units and will bring the deal up to 14.1% of the group’s enlarged share capital.
The biggest selling shareholders pre-shoe are Yahoo, which will divest 121.7 million shares to reduce its stake from 22.4% to 16.3%, followed by China Investment Corp offloading 14.28 million shares. Alibaba founders Jack Ma and Joe Tsai will also sell 12.75 million and 4.27 million shares, reducing their stakes to 7.8% and 3.2% respectively.
Assuming the greenshoe is exercised, Yahoo will sell a further 18.26 million shares, while Jack Ma will divest 2.7 million and Joe Tsai 902,782.
Based on its current issue price, Alibaba’s IPO is being marketed at about 24 to 27 times forecast 2015 earnings based on syndicate consensus figures of about $6.4 billion to $6.5 billion.
This pitches the deal at a discount to Alibaba’s closest Chinese comparable Tencent Holdings, on 30 times 2015 forecast earnings, but at a premium to both Baidu and eBay, which are trading at 26 times and 15 times respectively.
Price to earnings comparisons with two other key benchmarks, Amazon and China’s second largest e-commerce platform JD.com, are not possible however, since they do not currently generate profits. This lack of profitability is likely to be one of Alibaba’s chief selling points.
The young pretender to the world’s largest companies
Alibaba’s IPO will instantly propel it into the ranks of the world’s 30 largest companies by market capitalisation. Its current range spans $153.6 billion at the bottom end, pre greenshoe, to $172.31 billion at the top end, post shoe.
Yet its upper valuation may be just a jumping off point, given the possibility of an upwards revision in the price range, combined with the likelihood of frenetic secondary market activity by institutions, which do not get allocated and retail investors who pile in once Alibaba starts trading on the New York Stock Exchange.
At $172.31 billion, Alibaba will rank as China’s largest private sector company. Should it trade up through the $200 billion mark, it could well sweep past China’s largest bank ICBC ($215 billion), to rank third behind China’s largest oil company PetroChina ($245 billion), and China Mobile ($266 billion), once again the country’s biggest company due to accelerating 4G sales.
In 2009, Jack Ma told Alibaba's AGM: “I will regret it for the rest of my life if Alibaba cannot become a Microsoft or Walmart.” And his dream may soon come true as Wal-Mart is tantalisingly within reach at $249 billion.
But as Alibaba itself is showing, the global rankings can change quickly. Were Jack Ma asked the same question today, perhaps his answer might well be Apple ($592 billion) and Google ($400 billion). Neither featured in 2009’s top 10, but today sit in the number one and three slots.
Alibaba marks a coming of age for China’s first generation of private sector companies and their revolutionary founders. In many ways, the company is the ultimate representation and proxy for China Inc, not only in terms of country's high domestic growth trajectory, but its growing international presence and the likelihood that it will one day soon eclipse the US as the world's largest economy. Alibaba's profitability should track China’s growing wealth as the purchasing power of its existing customers increases and it spreads its tentacles deeper into China’s third and fourth tier cities, not to mention a rural hinterland, where 637 million people still reside.
In a broader sense, Alibaba is also a play on the way global technology is leading all of us to conduct our lives online and interconnect across national boundaries. Alibaba controls 80% of China’s e-commerce market and it wants to become ever more indispensable to the lives of the country's 1.3 billion people through the company’s ecosystem of buyers and sellers, digital content, banking and payments products, plus services such as location-based apps.
It had 279 million active buyers at the end of June but, since online shopping only accounts for 8% of Chinese consumption, Alibaba argues that it still has a long way to to to capture more of their wallet-share. And it intends to keep them in-house through its denial of access to outside web searches.
Investors weighing up the merits of the deal are likely to have two key questions.
Firstly, how much of Alibaba’s undisputed growth potential is already priced into the IPO valuation? And secondly how much momentum does the deal have behind it and what will this mean for the deal’s likely secondary market performance once it lists on the New York Stock Exchange?
Stock markets playing ball
In terms of momentum, the deal has hit a sweet spot in the global equity markets, although it appears to have the SEC lengthy approval process to largely thank for this. In an unusual misstep, Jack Ma and his team originally intended to launch roadshows a week ago, when many Western fund managers were still on their summer holidays.
They now find themselves presenting their case against the backdrop of rising markets. The tech-heavy Nasdaq-100 index, for example, has been on a strong rising trend since the beginning of August, up 6% since August 7 and 13.8% year-to-date.
China-related stocks have also been on a tear since the government embarked on a mini stimulus, with the Hang Seng China Enterprises Index up 23.5% since its mid-March low of 9,203.
The deal’s size is creating momentum all of its own, but one group of fund managers who will not participate are passive index trackers since Alibaba will not be represented in major indices due to its unique structure with no underlying security. This means it will not be included in the MSCI, S&P or FTSE indices.
Rivalry with Tencent
In the run up to the IPO, many commentators have cited Amazon and eBay as the main benchmarks since Alibaba is the Chinese version of the two combined. However, the one company Alibaba benchmarks itself against is run by another Ma - Pony Ma, the founder and CEO of Tencent Holdings, currently China’s largest internet company by market capitalisation.
Alibaba and Tencent were founded within months of each other in 1999 and initially forged separate paths. But they now find themselves pitted against one another in a battle to dominate China’s mobile internet sector, particularly mobile payments.
Jack Ma is likely to be very happy that Alibaba’s market capitalisation is on course to outpace Tencent’s $155.7 billion. Their fierce rivalry also means he would probably be overjoyed to see investors’ try to position themselves in Alibaba by selling out of Tencent.
Opinion is divided about Alibaba’s immediate impact on other Chinese tech stocks. If fund managers decide to maintain their overall Chinese tech exposure at current levels, then some selling pressure is likely.
However, it is also possible that the incredible hype surrounding Alibaba’s IPO could have a positive impact on the entire sector. In this scenario, it could be other China-related sectors that face downward pressure.
Year-to-date, Tencent is up 30%. Over the past decade, the stock has climbed a staggering 3,500% since its IPO in June 2004. Coming in so much later down the line, it seems highly unlikely that Alibaba’s IPO investors will reap the same financial rewards that Tencent’s have.
Likewise, Chinese search engine giant Baidu has richly rewarded investors, who purchased its IPO at $27 per unit in 2005. On Friday, the stock closed at $226.7, an eight-and-a-half fold increase in the intervening nine years.
Since its April low, Baidu has also performed well this year, up 57.9%.
Alibaba, Tencent and Baidu have all been on a dizzying whirlwind of acquisitions to consolidate and expand their market share in the $1.6 trillion e-commerce and mobile internet sector. For long-term investors, two more key questions concern their ability to absorb such a large number of takeovers and how the troika’s rivalry will play out as Tencent and Baidu try to eat into Alibaba’s dominant market share.
And overhanging them all is the Chinese government and whether it will also seek a slice of e-commerce profits following Chinese media reports that the State Administration of Taxation is studying just such a tax.
Recent jockeying for position between the three include an agreement between Tencent, Baidu and Chinese property company Dalian Wanda to launch a new online-to-offline venture at the end of August. This will leverage Tencent and Baidu’s online capabilities with goods and services available at Dalian Wanda’s 107 shopping malls.
This followed Alibaba’s investment this April in Intime Retail, which has 36 department stores.
Tencent also recently forged another online-to-offline deal with Sinopec, which has 30,000 petrol stations and convenience stores across China. Tencent also hopes customers will one day pay for their petrol with Weixin Payment, China’s most popular mobile payment service and part of WeChat, its messaging app with 438 million active users.
Early this year, Tencent and Alibaba received private sector banking licenses and both have far-reaching ambitions to use their internet platforms to by-pass the far less entrepreneurial state-owned banks. As Jack Ma said in 2008, “If banks don’t change, we will change banks.”
Alibaba is hoping to leverage its online payments service Alipay as consumers’ preferred online wallet and has also turned the investment products market on its head with its pioneering and highly successful money market fund Yu’E Bao. Alipay is not included in the IPO and most analysts have not included it in their valuations either.
However, Alibaba is entitled to 37.5% of its future profits as well as those of Small and Micro Financial Services Company (SMFSC), which it spun out into Alipay in August.
Amazon steps up its China presence
Alibaba’s main international e-commerce rivals are Amazon and eBay, although neither has made as much traction in China as they have in other overseas markets. However, in Amazon’s case this may now be changing following the recent announcement of a memorandum of understanding with the Shanghai Free Trade Zone (FTZ) and Shanghai Information Investment (SII).
The deal may turn out to be the game-changer if Amazon can finally maximize its key competitive advantage - unmatched international logistics experience.
The move will pitch it into fiercer battle with Alibaba and JD.com for domination of the Chinese cross-border e-commerce market, which Nielsen estimates will be worth $161 billion by 2018. Under the terms of the deal, Chinese shoppers should have access to Amazon’s US, UK, Germany and Japanese sites by the fourth quarter. Payments will be routed through the Chinese government’s e-commerce platform, kuajingtong.com (KJT) in return for a 2% fee – a rare instance in which a foreign company and the Chinese government’s interests are aligned.
This SII subsidiary will provide a Chinese-language interface for domestic shoppers and enable them to pay in Renminbi. Crucially it also means they will have direct access to international products at the same price as Amazon’s other overseas clients.
To date, many of China’s more affluent shoppers have tried to subvert import duties and domestic sales taxes by using Daigou (buying agents). The Chinese government hopes its officially sanctioned channel will progressively eliminate them.
International commerce accounts for about 9% of Alibaba’s total revenues and it recently positioned itself to capture more of the cross-border market by forging a partnership with US logistics firm ShopRunner in May. This will enable clients on its business-to-consumer site, Tmall, to directly purchase overseas orders for the first time.
And to reassure domestic customers that products are not fakes Alibaba also launched Tmall Global in February, with cast iron assurances.
Amazon is currently trading at $346.38 and in recent weeks has started to tick back up from its post interim results low. Since August 1, the stock is up 12.8%, although it remains down 13% year-to-date.
At current trading levels it is valued at 1.46 times on a 2015 price to sales basis. Its losses have been cited as the main reason for recent stock price weakness and have led a number of unfavourable comparisons with Alibaba’s business model.
Alibaba relies on third party providers to deliver its goods and therefore does not have the expensive infrastructure, which drains Amazon’s cash. It makes its money through advertising and charging sellers commission.
Like Alibaba, Amazon has also been on a spending spree, diversifying into other businesses such as consumer electronics and original content. In Alibaba’s case, investors have largely viewed its multiple acquisitions in a positive light because they help to consolidate its dominance. Where Amazon is concerned, investors have become increasingly impatient with the continual cash drain and lack of profits.
Alibaba’s business model and financials
This difference in their respective business models was very clearly demonstrated by their recent interim results. Amazon released its interim figures in late July recording a net loss of $126 million, up from $7 million the year before. Sales, were up 24% to $19.3 billion,
Alibaba, by contrast, recorded net profits of $2 billion in the three months to June backed by revenues of $2.54 billion, up 46.3% year-on-year. The net profit figures were distorted by equity revaluations, but both companies’ most recent full year results reveal the same picture.
In the year to December 2013, Amazon reported revenues of $74.5 billion and net profits of $274 million. In the year to March 2014, Alibaba recorded revenues of $8.46 billion and net profits of $3.77 billion.
In one of its recent filings, Alibaba split out the figures for Tmall (Amazon equivalent) and Taobao (eBay equivalent) for the first time. As of June 2014, these highlighted a two thirds/one third split in favour of Taobao.
However, Tmall is growing faster as it only accounted for one quarter of GMV (Gross Merchandise Value) at the same point in 2013. Alibaba prefers this metric, which tracks the value of goods sold across its sites, rather than revenues, which are much lower because they are derived from sales commissions.
In FY 2014, Tmall’s GMV stood at $82 billion making it similar in size to Amazon when compared with the latter's sales.
Taobao, on the other hand, is about two-and-a-half times larger than eBay, with GMV of $191 billion in the year to March 2014 compared with eBay’s $76.5 billion in the year to December 2013.
Alibaba’s nearest e-commerce benchmark in China is Tencent partner JD.com, which listed on the New York Stock Exchange this May and has a similar business model to Amazon. Unlike Alibaba, its $1.8 billion IPO came during difficult market conditions, but has since rewarded investors by shooting up 63% in the three months since then.
Pricing at $19 per unit represented a 2014 price to sales valuation of 1.35 times, based on forecast sales of $19.25 billion. As of Friday’s close, the stock stood at $29.03, a current valuation of 2.1 times.
JD.com’s IPO provided an important way marker for Alibaba, but the company is much smaller, with 19.6 million active customer accounts and GMV of $11.94 billion in the year to December 2013.
It is also still unprofitable because it has been building out its warehousing and distribution infrastructure. During its most recent results, management guided that losses will continue into 2015.
But JD.com is also becoming a more formidable competitor because of its relationship with Tencent. The latter took a 15% stake in May, boosted to 17.59% after JD.com’s IPO.
Alibaba’s lack of infrastructure in terms of warehouses and logistics has always been viewed as a potential weak spot since it makes it difficult to guarantee delivery times. The company recently moved to rectify this by signing a partnership agreement with state-owned China Post to create a fully-fledged internet trade and logistics platform.
Earlier this summer, it also signed a second agreement with SingPost to bolster its position in South East Asia and signal its intention to grow its Asian business.
For many commentators, one of the biggest risk factors concerns Alibaba’s corporate structure as a Variable Interest Entity (VIE). This enables Jack Ma to retain control of the company and leaves investors with no sway over board decisions.
It is ostensibly in place because foreign investors are not allowed to own Chinese internet companies, although the irony of Alibaba’s US listing means that neither can the Chinese retail investors, who power its profits.
Impact on Yahoo and SoftBank
One of the big unknowns surrounding Alibaba’s IPO will be its impact on its two big pre-IPO investors, Yahoo and SoftBank. In the run up to the listing, both companies have been used as proxies to gain indirect exposure to Alibaba and opinion is divided on what will happen to their share prices once it is listed.
Will investors continue to hold or buy into both stocks based on Alibaba’s implicit valuation, particularly if the latter’s share price tracks up? Or will they pare back their holdings in favour of direct exposure instead?
Yahoo has long been considered the most vulnerable to selling pressure. Its core business has been on a declining revenue trend and it no longer has the close relationship it once did with Alibaba following the 2008 departure of Jerry Yang, Yahoo’s founder and a close friend of Jack Ma.
In the IPO’s immediate aftermath, Yahoo’s share price may benefit from the company’s commitment to return at least 50% of its post tax gains on its Alibaba divestment back to shareholders. Some commentators also believe the tax implications of Yahoo’s Alibaba stake could provide an important prop for its share price if investors decide to punt on a potential take-over by Alibaba, particularly now that Jerry Yang is back on Alibaba’s board.
Rumours have surfaced because the theoretical tax due on Yahoo’s remaining stake is worth about $10 billion based on Alibaba’s current valuation range. Yahoo holds this stake through a Hong Kong subsidiary, but any future divestment proceeds would be subject to US capital gains tax of 38% since they would be considered passive income by the US tax authorities. The two companies could mitigate this tax demand if Yahoo were taken over by Alibaba, although that prospect becomes ever more attractive to Alibaba the lower Yahoo’s share price falls.
And some believe the US tech company’s share price could fall if investors decide to factor in uncertainty over the stub stake and apply a sum of the parts discount to its businesses instead.
Year-to-date Yahoo’s stock price is down about 2% and is trading at 28 times 2014 earnings. SoftBank, meanwhile, is down about 18% over the same time period and trading at 16.7 times forward earnings.
Roadshow timetable and syndicate
Alibaba’s management team has been split into orange and red teams.
An orange team will spend Monday in New York, Tuesday in Boston, Wednesday in Baltimore and New York, before heading to Denver and Los Angeles on Friday then San Francisco on Saturday. The following week will be spent in Hong Kong on Monday, Singapore on Tuesday and London on Wednesday before returning to New York for pricing on Thursday.
A red team will spend Monday in New York, before heading to Boston on Tuesday, back to New York on Wednesday, then Thursday in Los Angeles, Friday in San Francisco, before heading to Hong Kong the following Monday and Tuesday, London on Wednesday and Thursday in Kansas City and Chicago.
Bookrunners are Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs, JP Morgan and Morgan Stanley. A group of co-managers has also been added.
These comprise: BOCI, BNP Paribas, CICC, CLSA, DBS, Evercore, HSBC, Mizuho, Pacific Crest, Raymond Jonees, RBC, Stifel, SunTrust Robinson Humphrey and Wells Fargo.