Going gaga over Alibaba

What do Midland Railway and IBM have in common? The answer is they were the largest companies by market capitalisation in the UK and the US when each country reached the apex of its economic dominance in 1914 and 1967 respectively.

Both firms were emblematic of their era. Midland Railway was the biggest coal hauler in the country that had ushered in the industrial revolution. IBM was the leading hardware manufacturer at the dawn of the computer age when American consumers were the envy of the world.

But the two examples also highlight how fleeting global hegemony can be.

Few now remember the railway firm, which lost its independence after the First World War thanks to the Railways Act. IBM may still be a colossus, but it no longer ranks in the top 20 global companies in market cap terms.

In fact, when the New York Stock Exchange opens later today, IBM is also likely to be eclipsed by Alibaba, the company now best symbolising China’s ascendance on the world stage. The e-commerce giant priced its IPO in New York last night at $68 per share to the thunderous applause of global investors.

How gigantic is the deal?

Should the greenshoe be exercised, Alibaba’s flotation will raise $25 billion and rank as the world’s largest, beating Agricultural Bank of China’s $22.1 billion debut in 2010. When founder Jack Ma rings the opening bell, Alibaba’s market cap will be $177.5 billion, similar in size to Samsung Electronics. However, the stock price is expected to be much higher by closing on its first day, fuelled by newspaper hype and insistent demand from investors. Enthusiasm for the deal has been overwhelming, notwithstanding the fact that many investors have placed inflated orders to try to get some kind of allocation. The frustrated purchasing power of unallocated institutions, combined with the mass of retail investors who were unable to get into the IPO at all, could easily push the stock up into the stratosphere over the coming few days.

Should Alibaba trade up 10%, it will overtake IBM (market capitalisation of $191 billion) and Facebook ($193 billion) to become the world’s fourth largest tech stock behind Apple ($601 billion), Google ($396 billion) and Microsoft ($385 billion).

Should it trade up 20%, it will pass HSBC ($206 billion) and China’s largest bank, ICBC, on $209 billion.

At this point, it would also rank as China’s third largest company behind PetroChina and China Mobile.

How is it likely to perform?

What happens to Alibaba after the initial fanfare dies down depends on what investors believe about its prospects for growth. Shareholders are unlikely to reap the same upside as investors in rivals Tencent and Baidu, which both listed a decade ago when they were less than five years old. Tencent has risen 150-fold since its June 2004 IPO, for example.

Alibaba is now 15 years old, so can we expect similar growth? There are numerous jumbo IPOs of companies with relatively mature business models which have still done well for investors. The most famous is Visa, which listed in March 2008 and still ranks as the largest IPO on record by a US firm. It rose 28% on its first day of trading and has quintupled since then.

Yet for every Visa there is an NTT DoCoMo. When it listed in 1998, the Japanese mobile operator was also the world’s largest IPO, with investors riding a wave of enthusiasm for telecom and tech firms. NTT DoCoMo seemed to symbolise the beginning of the digital era and the stock made a promising start. Within a year, it was one of the three largest companies in the world, with a market capitalisation of $366 billion. Today the Japanese firm’s shares trade at a fraction of their IPO price.

A century of upside?

Jack Ma has no such qualms about Alibaba’s future. In the company’s pre-roadshow filing, he wrote a letter to prospective investors explaining how the company is only at the beginning of a 102-year journey, that will span three separate centuries from its inception in 1999.

Alibaba is not a mature business, its management says. Rather, its digital ecosystem will disrupt and transform all that it touches to the benefit of its Chinese customers and, increasingly, its global ones too.

A few years ago, Alibaba identified three pillar industries. In many respects it has only made inroads into the first one – e-commerce.

Alibaba has an 80% share of the domestic e-commerce market through its two main websites Taobao (where consumers can buy from a host of online sellers, and where Alibaba generates revenues from ads) and Tmall (more of a platform for merchants, who pay fees for virtual storefronts).

Alibaba had 279 million active buyers at the end of June. However, during roadshow presentations, its management pointed out that online shopping still accounts for just 8% of Chinese consumption (and that consumption, in turn, is only 36% of GDP compared to 70% in the US, suggesting a lot of room for growth). American research firm IHS even predicts this month that consumer spending will lift the Chinese economy above the US by 2024.

The second pillar of Alibaba’s business strategy, finance, feeds from the first, but is at a much earlier stage of development. Alibaba’s payment system Alipay is not directly included in the IPO vehicle. But investors will be entitled to 37.5% of the profits of the group’s financial services holding company, SMFSC (Small and Micro Financial Services Company), which contains Alipay, alongside other financial assets such as Alibaba’s pioneering money market fund, Yu’E Bao (see WiC225).

As WiC has written extensively in the past, Alibaba is battling Tencent and latterly Baidu for control of Chinese consumers’ mobile wallet. Jack Ma and Tencent founder Ma Huateng are now arch enemies, although the Tencent boss must be regretting the day he turned down Ma’s invitation to invest in Taobao when it first launched in 2003. According to NetEase Finance, he was offered 15%, but held out, hoping for 50%.

Tencent has since become a formidable competitor to Alibaba using the phenomenal success of its WeChat messaging infrastructure to build up a user base of 438 million people. It hopes they will start to use its own online payment system to pay for everything from petrol to restaurant bills.

Some of the headlines that greeted the launch of Apple Pay at the beginning of this week further underscore the ambitions of global tech companies in the financial services sector. In one editorial, the Financial Times wondered whether this was an “iPod moment for cash and credit cards”.

Alibaba’s third pillar, data mining is, potentially its trump card. While Baidu collects search data and Tencent collects social networking stats, Alibaba controls a valuable trove of transaction and credit information yielded by its e-commerce dominance. So far, it has been able to use the transaction profiles to build up a picture of customer preferences and also leverage its credit data to assist its nascent financial services ambitions. But it will have far wider potential as the digital world infiltrates other areas such as health and education.

In a sign of things to come, China’s National Bureau of Statistics has also started to use data from 11 tech companies including Alibaba to improve the agency’s oft-derided figures. During phase one of the trial, which began earlier this year, the bureau began using online information to help compile the national Consumer Price Index.

And outside China?

For many Chinese companies, their hallmark of success comes from going global. Alibaba has not really spent too much energy overseas yet, although it has made a number of smaller acquisitions. This is likely to change.

As Jack Ma put it in his recent investor letter: “In the past decade, we measured ourselves by how much we changed China. In the future, we will be judged by how much progress we bring to the world.”

Sohu Finance says one upshot of the IPO is the way it is shaping new perceptions of China’s internet firms. It notes that past listings tended to reinforce the view on Wall Street that China’s online giants were copycats of business models born in Silicon Valley. Thus Baidu was referred to as China’s Google, Renren as China’s Facebook and Sina Weibo as China’s Twitter.

“Of course, there are still many people calling Alibaba China’s Amazon,” writes Sohu Finance. “But this time there are a growing number of Wall Street investors realising that this title is not accurate.” In fact, many have given up trying to apply a simile to Ma’s creation.

In this respect, Sohu Finance thinks that Alibaba will herald a coming of age in China’s tech industry and raise awareness too in the West that Chinese firms are fostering unique and indigenous business models. With its sophisticated approach, Alibaba may also achieve a wider reputational milestone, reshaping the way China is seen in the world, and reducing the perception that its main advantages are cheaper labour and unfair subsidies.

On the other hand, a less welcome perception that some investors might glean is that buying China stocks continues to come loaded with corporate governance risk. In a list of five risks facing new shareholders, NetEase Finance says a key one is the absolute power Ma and his 29 partners have over decisionmaking and their control of the board. One day some of these investors might even rue the limited rights Alibaba’s VIE structure gives foreign investors too (for more on this see our related Talking Point in issue 237).

Oh yes, so why didn’t it list domestically?

Some wonder why Alibaba didn’t list in Shanghai – where enthusiasm for buying into the IPO would have been intense.

But Doug Young, who writes the Young China Biz blog, says that this was never a realistic option since Alibaba is incorporated outside China (a common practice among Chinese venture-backed tech firms).

“Such overseas incorporation has not only barred internet giants like Tencent and Baidu from listing in China, but has also locked out other major names like China Mobile and Lenovo, which are also technically incorporated outside China for historical reasons,” he notes.

Young continues: “Realising it was losing some of the nation’s best companies to overseas listings, China’s securities regulator began discussing plans more than five years ago for an international board in Shanghai where overseas-based firms could list and make their shares available to local investors. But that plan has been repeatedly been put on hold due to the anaemic performance of China’s domestic stock markets, which also resulted in a freeze on new IPOs last year and for most of the first half of 2014.”

WiC also suggests there’s another valid reason for electing to list in New York. It relates to Yahoo, which is selling down its Alibaba stake in the IPO. Had the deal been done locally in renminbi Yahoo would have had problems getting its cash out of China because of the country’s capital controls. That also helps to explain why Ma’s choices came down to Hong Kong or New York: he needed the IPO to be priced in a currency that is freely convertible.

Of course, that also means that the customer base which powers almost all of the company’s profits have had no chance to invest themselves.

Alibaba may be promising a pot of gold to its new shareholders, but there will be very few Chinese nationals among them. Only a small minority of China-domiciled investors have a US trading account and Chinese retail investors that can purchase American stocks have been deterred by the need to place an IPO order of at least $1 million for the stock.

As China.com writes, “They have lost one of the best investment opportunities in the capital markets, ‘selflessly and generously’ presenting it to American and Western investors.”

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