When the Alibaba Group starts trading on the New York Stock Exchange on Friday, many people may be asking, “Ali who?”
Professional investors, of course, already know that Alibaba is a fast-growing, hugely profitable Chinese company that is a combination of eBay and Amazon, with a little bit of Google thrown in. They like it so much that they have stampeded to Alibaba’s initial public offering, making it the largest ever on the United States stock market. The deal raised $21.8 billion for Alibaba and gives it an overall market value of $168 billion, two and a half times the size of eBay.
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Documents: Reports on Alibaba's I.P.O.
Graphic: Circle of FriendsStill, once the so-called smart money piles into a stock, it’s usually time to start asking dumb questions. And with Alibaba, there are many.
Can the company, which today dominates Chinese e-commerce, fend off competition forever? What about its odd corporate structure? Who, exactly, is checking the company’s books? And why did Alibaba recently spend more than a quarter’s worth of cash flow on what seemed like a grab bag of investments?
In many fundamental ways, investing in Alibaba is nothing like owning a slice of a typical American corporation. It requires far more trust. But as the rush into Alibaba’s public offering shows, mutual funds, hedge funds and pensions are falling over themselves to back the company. In a time of economic malaise, when few big companies are growing strongly, a business like Alibaba stands out brightly.
What Is Alibaba?
The e-commerce company has seized investor and public interest to an extent that is unusual for a company that does much of its business in China.
By Reem Makhoul and Sofia Perpetua on Publish Date May 6, 2014. Photo by Liangzhen/Chinatopix, via Associated Press.“You’ve got a world that is starved for growth, and this segment of the Chinese capital markets offers a high degree of growth,” said Brendan Ahern of KraneShares, a mutual fund firm that invests in Chinese companies.
For many, the allure of Alibaba is in its headline numbers.
Alibaba makes most of its revenue from fees and commissions that it receives from the two large Internet marketplaces that it operates in China. Taobao is a frenetic and eclectic online bazaar that offers a huge range of goods. Tmall, by contrast, is a more refined platform that established brands use to sell their goods. Together, Alibaba’s marketplaces sold $296 billion worth of goods in the 12 months through the end of June, which is estimated to be more than Amazon and eBay combined.
Facebook’s public offering faltered in 2012 when it became clear that the company did not yet have a strong footing in mobile devices. But Alibaba appears to be handling the retailing transition to mobile devices. In the second quarter of this year, mobile accounted for a third of the value of goods sold on Alibaba’s Chinese marketplaces, up from 12 percent in the same period a year earlier.
Alibaba is also reaping enormous profits from the torrent of commerce that takes place on its websites. In the second quarter, it made 43 cents of operating profits for every dollar of revenue, a staggering margin for a large, fast-growing company. Sometimes, outsize margins can be an indicator that a firm is somehow managing to overcharge — an advantage that might lessen as competition increases. But investors assert that the fees and commissions that Alibaba charges its sellers seem to be in line with those of its rivals.
“There is no evidence that it is gouging its customers, despite its dominance,” said Alistair Way, a fund manager at Standard Life Investments.
And even though consumers’ habits can change quickly, especially on the Internet, Alibaba’s fans expect it to remain dominant. Their argument: Alibaba’s marketplaces get so much traffic that sellers simply have to use them to reach consumers.
This sort of optimism has persuaded some analysts that Alibaba’s shares could trade well above its $68 offering price. James Cordwell of Atlantic Equities, for instance, says that Alibaba is worth about $100 a share, or 30 times the $3.35 a share that he estimates the company will make in profits in 2016. Alibaba, he contends, deserves a multiple of 30 times because that is in line with other Chinese Internet companies — and because he expects Alibaba’s earnings to grow at about 30 percent a year.
“Alibaba is highly profitable,” he said. “It is easier to value than Facebook and Twitter at their I.P.O.s.”
But even bullish analysts like Mr. Cordwell have their concerns.
A big one is whether Alibaba will eventually end up spending a lot of money to stockpile goods and distribute them, potentially depleting future profitability. Right now, a main attraction of Alibaba is that it does not consume large amounts of cash holding inventory, as is the custom for most retailers, including Amazon. Like eBay, Alibaba merely matches buyers and sellers. Nor has Alibaba used up cash building its own fully fledged distribution network. Given the size of the company’s business, such a network would most likely be punitively expensive. Alibaba has, however, invested in a joint venture with delivery companies to establish a logistics network.
But rivals that are building their own networks may do better in crucial parts of the market. JD.com, a Chinese online retailer that focuses on electronics, has its own logistics network — and analysts say that it appears to be notching up better electronics sales than Alibaba in China’s largest cities.
“It suggests that its fulfillment capacity is giving it a competitive edge in these cities,” Mr. Cordwell said.
Beyond its financial performance, Alibaba presents investors with other potential headaches. Its offering effectively asks investors to give up some basic rights and protections.
As is the case with any public company, outside investors have no real way of testing the accuracy of the Alibaba’s financial filings. Investors usually expect outside auditors to assess a company’s books. And American investors might take some comfort in the fact that the Public Company Accounting Oversight Board regulates audit firms, to help ensure they are doing their job. But the Chinese government does not allow the board to inspect Chinese audit firms. And the regulator has not inspected Alibaba’s auditor, PricewaterhouseCooper’s affiliate in Hong Kong.
Alibaba’s corporate structure is another reason to pause.
The actual entity that is going public, the Alibaba Group, is not based in the United States, but in the Cayman Islands. This entity also does not give investors a true ownership stake in Alibaba’s operating businesses. Instead, the Alibaba Group merely has contractual rights to profits from the businesses, an arrangement that allows foreign investors to effectively find a way around Chinese law that would otherwise ban such investment. Adding to concerns over control, Jack Ma, Alibaba’s executive chairman, has majority stakes in the company’s underlying Chinese entities.
Shareholders might find it hard to rein in Mr. Ma and his associates if they make decisions that outside shareholders disagree with. This fear arose a few years ago when Mr. Ma unexpectedly spun out Alipay, the company’s payments business, causing a rift with Yahoo, which has a big stake in Alibaba.
The questions about Mr. Ma’s latitude reasserted themselves after Alibaba made a string of deals that recently raised eyebrows. In April, the company lent $1 billion to Simon Xie, one of its founders, to finance an investment. Alibaba also took a stake in a Chinese soccer team this year. And after buying a movie production company, Alibaba said that it might have unearthed accounting irregularities at the firm, suggesting it did not do good due diligence.
The acquisition numbers are not insignificant: The $1.85 billion that Alibaba spent on acquisitions in the second quarter exceeded the $1.64 billion in cash flows from the company’s operations.
Still, for now, the issues of control and oversight may not be enough to derail Alibaba’s strong financial performance.
“If you are looking for growth, this company is offering that,” Mr. Ahern, the mutual fund manager, said.
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Alibaba Raises $21.8 Billion in Initial Public Offering
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