Wednesday, May 14, 2014

On Deck: Alibaba's IPO

Alibaba's IPO will be executed in the U.S.
Pay attention. Alibaba has made a landing on American soil in U.S. trading markets. Until recently, Alibaba was a far-flung concept, a fast-growing e-commerce business that had made technology splashes with torrent waves in China, where a stunted version of the Internet still languishes in its early rounds and still hasn't reached millions of households. (Or billions?)

Alibaba, we learned a few years ago, was China's version of Amazon with a business plan of peddling goods online to a Chinese market of tens of millions. Now Alibaba has made a virtual splash into the U.S., not by attempting to supplant Amazon, but in choosing to issue stock in an IPO in the U.S., of all places. Alibaba is on its way to becoming household-familiar in the way Amazon, eBay, and Google are.

Alibaba is planning to go public in one of the biggest stock offerings ever, upwards to $20 billion, selling goods online to the Chinese, but offering stock under American rules and protocol. (That very act is not unusual, as other Chinese corporations have issued stock here or are contemplating it.) And in finance circles, it figures.  From nowhere emerged a band of banks willing to lead that offering--whether stock will be offered in one big offering or in several stages. Banks have already assessed that the total market value of the company could reach $200 billion, rivaling many big-name companies in the U.S.

Alibaba, led by CEO and founder Jack Ma, portrays itself not as the Amazon of China, but as an Amazon with eBay, Google, and PayPal features. There is a Yahoo wrinkle, as well, as a struggling Yahoo made arguably its best strategic move ever by investing in a significant stake in Alibaba, when many weren't taking the Chinese company seriously. That stake will reap over $10 billion in cash for Yahoo, when the IPO occurs. 

Why would a Chinese company accustomed to Chinese markets, consumers and products choose to issue stock publicly in the U.S., subject to the rules and disclosure requirements of the S.E.C.? Alibaba claims it wanted to issue the new stock in Hong Kong, but regulations there wouldn't permit the founders to maintain a controlling interest in the company. U.S. laws and rules will permit company founders to retain controlling voting powers.

But there must be corollary reasons. A gravy train of benefits will inevitably come with Alibaba's decision to step onto U.S. soil. Let's first explain Alibaba's business model in a few sentences.

1. Alibaba is Amazon without the large, regional warehouses for product distribution and without the risks of financing and maintaining large amounts of inventory. Alibaba is like Amazon in that they are led by visionary founders (Ma at Alibaba and Jeff Bezos at Amazon), who tend to act as the corporate and long-term strategy department embodied in one being.

2.  Alibaba is eBay, because it allows individuals to sell whatever they choose in an electronic market, often in an auction environment. Alibaba also has an attached marketplace that allows companies to sell new, branded products directly to consumers.

3.  Alibaba is PayPal, because it, too, has a payments-systems affiliate.

4.  Alibaba is Google, because it runs a search engine to permit consumers to search products and product details and subjects them to product advertising, based on their searches.

It hasn't been articulated anywhere in glowing detail using the jargon of consultants--not in securities prospectuses, not in analysts reports, and not in media summaries. However, wouldn't Alibaba have plans to expand aggressively into U.S. markets with U.S. consumers? Does it envision consumers in Iowa benchmarking the website

Is it contemplating a wholesale transfer of a successful market strategy to the U.S.? Is an IPO a first step in global expansion? Will the U.S. also be the added source of growth shareholders will demand, as it they try to rationalize high stock-market values or high price-earnings ratios?

Perhaps an IPO in the U.S. is a "test the waters" step in a long-term strategy.  The IPO and the public trading of its stock (replete with analysts' commentary and continual coverage of the stock) are ways to promote a brand, a way to slip through the doors of a familiar club of technology companies Google-Amazon-Facebook-Apple. In some ways, Alibaba is already in this club in terms of market size, market valuation, and total revenues. The company will top $6 billion in sales this year, and it has been reported that it has profit margins that would cause Amazon to blush or Amazon executives to scratch their heads.

Alibaba, for now, is presenting a calculated growth strategy, focusing mostly on the potential for untapped markets in China and claiming it must manage fierce competition among companies in its own land that appear to be the Googles and eBays and PayPals of China.

On the banking side, underwriters have certainly swarmed the potential deal like locusts. Everybody wants a finger on this transaction, just as banks besieged Facebook and Twitter, when those companies prepared for IPO's. The bank roster includes the usual names for high-profile technology deals:  Morgan Stanley, Goldman Sachs, JPMorgan, et. al.

Alibaba indicated it wants to play fair and is not showing favorites, listing the banks in the SEC prospectus in alphabetical order (not in order of importance or in order of underwriting commitment) and convincing companies to accept a below-market IPO fee of 1%. It awarded underwriting roles, for the most part, to banks that have helped them in debt financing in the past (including those that  participate in an existing $8 billion facility).

Banks will earn their fees on this deal, because nobody wants to be associated with a fumbled, headline-blaring technology underwriting, similar to what happened with Facebook.  Furthermore, underwriters will need to explain clearly how growth will be achieved (although it has been taken for granted that China has only snipped a few layers of the surface of the potential for new consumers and Internet users). Underwriters will need to convince investors that reported profit margins (exceeding 30-40%) are real.

Banks, investors and research analysts--not just now, but on an ongoing basis--will need to grapple with an assortment of matters that aren't plain-vanilla, since they must tell a business story where the scenario is China, not Silicon Valley.  For example, stock-buyers will need to understand differences in reporting, business disclosures, and accounting methods.

Investors, analysts and banks will also need to understand or appreciate consumer behavior and trends in China. Don't discount at all, too, the impact of Chinese macroeconomics, political risks, and the patriarchal role of the Chinese government.

Banks and media reports estimate the value of the company, at the time of its offering in months to come, ranges from $135-200 billion, a range that is so wide that it suggests that much more due diligence and financial homework are necessary, but a range that considers the possibility of upcoming fluctuations in overall markets and sentiments for technology stocks.

Alibaba and banks will also have the opportunity to learn from the big stock roll-outs at Facebook and Twitter. There must binders of lessons learned in the past few years (not to mention countless lessons learned from the dot-com stock crumbles in the early 2000's).

Now if Alibaba is preparing for America, are Amazon, eBay and Google huddling to devise a counter-strategy?

Tracy Williams

See also:

CFN: Facebook's IPO:  What Went Wrong? 2012
CFN: Facebook IPO:  The Lucky Underwriters, 2012
CFN:  Now It's Twitter's Turn to Go Public, 2013
CFN:  What Can Morgan Stanley Do to Please Analysts? 2013

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