On September 18th, Alibaba is expected to complete its IPO process and officially become a listed company on the New York Stock Exchange. If the company’s stock price remains in its expected range by the time it is listed, the IPO is expected to raise approximately $21 billion; the largest in US history following Visa’s $19.6 billion IPO in 2008. Before I proceed to discuss the IPO, there may be those of you who have never heard of Alibaba before and think that I’m talking about a Middle Eastern restaurant. No, Alibaba isn’t raising $21 billion to open up a new shwarma stand so let me start off by explaining what Alibaba is.
Alibaba is a Chinese e-commerce firm that was founded in 1999 by Jack Ma, who was previously an English teacher. Similar to Amazon, Alibaba operates a business-to-consumer retail website named Tmall where established companies sell directly to customers. Additionally, Alibaba also runs a website called Taobao.com, which is a consumer-to-consumer e-commerce site where individuals and small businesses sell goods to one another. Finally, Alibaba offers an electronic payment system called Alipay, just like Ebay’s Paypal. Thus, Alibaba is somewhat of a combination of Amazon and Ebay.
The biggest difference between Alibaba and Amazon is that whereas Amazon facilitates the sale of merchandise between companies and consumers by handling the shipping, Alibaba merely brings the two parties together in an online marketplace. So it doesn’t ship anything. Amazon’s main source of revenue is the commission it charges to companies on every transaction completed through its website. However, Alibaba does not charge any commissions on Taobao. Instead, it charges sellers to advertise on the website in order to stand out among the millions of other sellers on the website and increase their chances of selling their product.
Since its founding, Alibaba has been growing at a rapid pace and has gained control of 80% of the Chinese e-commerce sector. Currently, the company is extremely profitable and nearly unchallenged in its hegemony in China. In the 3 months ended June, the company’s net income increased to $1.1 billion, 42% more than the net incomes of Amazon and Ebay combined. To look at a statistic further up the income statement, Alibaba’s EBITDA margin in the latest quarter was 54% compared to Ebay’s 26.7% and Amazon’s meager 5.7% Currently, the company is owned by Jack Ma, Joe Tsai, who is the vice president of Alibaba, and various other investors including Yahoo who made a very profitable investment in the company by purchasing a 40% stake back in 2005 for only $1 billion.
Here is a short video by the New York Times that gives some more information on the company.
Besides efficient management and a determined vision, Alibaba’s success can be traced to two important factors present in the Chinese economy. First off is the rise of the Chinese middle class. While Chinese income per capita may still be lower than other developed economies due to its large rural population, it can’t be denied that the Chinese are getting richer. As the graph below shows, disposable income has been growing at a steady pace in line with the nation’s economic growth. In January of this year, disposable income rose 9.7% on an annual basis and reached 26,955 yuan. Thats about $4400.
Yes you’ve probably heard stories and read on this blog that the growth in Chinese economy has been slowing down when compared to its past pace. However, incomes in China continue to rise and the middle class continues to mature. That means that the Chinese are willing to spend more, especially on higher quality retail goods that can be found on Alibaba. The rise of the middle class in China also means that internet usage is increasing rapidly, something that is vital to Alibaba’s business. As more of China’s 1.3 billion population gain access to the internet, the more that Alibaba’s revenues are likely to increase. Here’s an infograph provided by the China Information Network Center that depicts the increase in internet usage across China. As you can see, although internet usage is frequent in China’s large coastal cities, it is rapidly spreading to the Chinese countryside. With a consumer base that is already unmatched in size, Alibaba can expect to be even more profitable as more people in China gain access to the internet.
The other reason why Alibaba and e-commerce has been so successful in China is because of the lack in the physical retail market. Despite being greatly populous, China’s less developed cities do not have the large shopping malls and well known brands that larger cities such as Beijing has. This is where Alibaba steps in. The company creates a bridge between the hundreds of millions of Chinese who want to spend their money but want to purchase something other than cheap replaceable products.
As the video stated, Alibaba is set to be valued at approximately $167 billion if it is listed at the expected share price between $60-65. Here is a graph provided by Bloomberg that compares the expected IPO valuation of Alibaba to other tech companies.
Although $162.7 billion is a lot of money, analyst actually believe that Alibaba is set undervalued and set to enter the market at a discount. Market capitalization (a means of measuring the market value of a company) is calculated as share price multiplied by the number of shares outstanding. Thus, it can change as soon as the company becomes public and starts to trade. However, experts had expected Alibaba to enter with a market value closer to $180 billion. The reason why Alibaba wishes to enter the market at a relatively undervalued price is because Jack Ma wants to avoid the Facebook pitfall. Facebook was valued at $200 billion at the time of its IPO. This was an overvalued price for the company as its price plummeted after the IPO and didn’t reach its IPO price until a year later.
So should you buy into Alibaba as soon as it hits the stock markets? Is it worth committing your retirement money into an e-commerce company run by the Chinese Steve Jobs? As successful as Alibaba is and is set to be, I maintain the same opinion about IPOs as I did at the time of Twitter’s IPO. While you can check out the video below that explains why Alibaba would make a great investment, it is wise to stay weary of IPOs for the first few months. That is because generally, many institutional investors and preferred shareholders make deals with companies to hold their stock for a certain period of time following the IPO. After that period passes by, many of them dump their shares, lowering the price of the stock. So, as you listen to the following video about why Alibaba is a great buy, I recommend that you give the stock time to find itself in the market. If the fundamentals of the company are strong, you can still make a buck off of it if for the next several years even if you enter a couple months late.
“I’m not a tech guy. I’m looking at the technology with the eyes of my customers, normal people’s eyes.”