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Investors love a good story. They lined up hundreds deep at the Waldorf-Astoria hotel in New York earlier this month to hear Alibaba's executive chairman, Jack Ma, promote the Chinese Internet retailer's initial public offering. "It was a zoo," said Vincent Rivers, senior portfolio manager for the London-based investment firm J O Hambro Capital Management. "There must have been 400 people waiting in line. Everybody was there. It was like a social event." The shy, somewhat awkward Ma opened by saying that he'd first come to the US 15 years ago looking for about $2 million in capital. "Now," he said, "I'm asking for slightly more."
The line drew a knowing laugh from the crowd - Alibaba was asking for nearly $22 billion, the biggest IPO ever in the US - but Ma should probably keep his day job. What the crowd really wanted to hear about was Alibaba's growth, and Ma didn't disappoint them. A few vivid charts and statistics told the story. Alibaba is already the world's largest Internet commerce company, with 231 million active buyers using its site, 11.3 billion annual orders and $296 billion in annual merchandise sales, a measure Alibaba uses instead of revenue.
To put this in perspective, Amazon has less than $82 billion in revenue. EBay has just over $17 billion. But what excites Alibaba's potential investors isn't only its size, but its prospects for getting bigger. China currently has 302 million Internet shoppers. That's less than half the country's 618 million Internet users. And Internet penetration in China is less than half the country's population of about 1.35 billion. Competition from brick-and-mortar retailers in China is far less than in the United States, which should also drive increases in Internet shopping.
"The potential is absolutely massive," Rivers said. "The real question isn't whether they'll have more users. It's how much will they spend." Chinese Internet shoppers spend far less per person than in the United States. "If you look long term and they can close that gap, you can get to some huge numbers," he said.
Alibaba also has enviably high profit margins of more than 40 percent, which even by Internet standards, let alone retail, is extraordinary. Amazon has struggled for decades to eke out a slender profit. EBay has an operating margin of 20 per cent and Google 23 per cent.
Alibaba is the dominant e-commerce company in China by far, which, along with the high margins, suggests that it's the kind of natural monopoly beloved by investors. Alibaba itself attributes this to the so-called network effect. "The interactions between buyers and sellers create network effects in that more merchants attract more consumers, and more consumers attract more merchants," the company asserts in its prospectus. And, Alibaba keeps profits large by dispensing with the high-cost, low-margin businesses that have dogged Internet retailers in the United States. Alibaba is simply a platform for connecting buyers and sellers. "We do not engage in direct sales, compete with our merchants or hold inventory," the prospectus notes. I was on the floor of the New York Stock Exchange on Friday morning, where the excitement of newly minted billions was palpable. The Alibaba trading station occupied the center of the floor, where it was surrounded by a throng of "V.I.P. guests" squeezed behind velvet ropes. The street outside was packed, the balconies were crowded with onlookers and cheers went up every time the indicated opening price was adjusted upward. Mr. Ma rang the opening bell and dropped in on the on-floor set of CNBC.
Perhaps some stocks should reflect what I'll call an "excitement premium," which in Alibaba's case is surely significant. That's fine until the excitement wears off. For a more sobering view, I turned to Bruce Greenwald, co-author of "Competition Demystified" and "Value Investing," and a finance professor at Columbia Business School. Value investors like Professor Greenwald, by nature, tend to be skeptical of stories, especially when those stories are as rosy as Alibaba's. Still, Professor Greenwald said he agreed with much of the Alibaba thesis. "There's no doubt they benefit from a network effect and they have growth potential," he said.
But value investors tend to prefer numbers to words, and Alibaba's numbers, impressive as they are, may give some investors pause. At $68 a share, Alibaba's market capitalisation is about $168 billion. It's hard to find a United States company that's directly comparable, but Professor Greenwald said eBay comes the closest. Like Alibaba, it has an auction site that benefits from a powerful network effect, it offers a vast e-commerce site and it has a pay system, PayPal. (While Alibaba spun off its payment system, Alipay, Alibaba will get a share of the proceeds from any sale or public offering of Alipay.) EBay's market capitalisation is about $65 billion.
Of course, eBay doesn't dominate e-commerce in the US to the degree that Alibaba does in China. But is it reasonable to assume such dominance will persist as the Chinese market matures? No one company dominates e-commerce in the US or in Europe, and none are as large as old-economy Walmart. China may now be undeserved by national brick-and-mortar chains, but that could change. Professor Greenwald said he believed that Alibaba deserved a premium to eBay - perhaps twice eBay's market capitalisation. "But three times? That's really pushing it," he said.
No Chinese Internet company is quite like Alibaba, so comparisons with Chinese stocks are difficult. But Baidu, China's version of Google, which also benefits from network effects and the growth in Chinese Internet use, has a market capitalisation of about $80 billion, and a P/E ratio of 45. Tencent Holdings, which is classified as social media rather than e-commerce, although it has elements of both, is even further afield. Its market capitalisation of $147 billion is also smaller than Alibaba's, although its P/E ratio is a steep 51.
Alibaba's valuation may not be outrageous, but to Professor Greenwald, these comparisons are "pretty scary." He added, "There's a lot of hype in Alibaba, and that's what you're seeing in the price."
That doesn't change the Alibaba story, and sometimes a story is enough. Amazon is the leading example, a company that barely earns a profit and drives value investors crazy. Its market capitalisation is $150 billion, nearly as big as Alibaba's, and its P/E ratio is over 500. Investors buy the Amazon story, which is that Internet commerce dominance is just over the horizon, along with huge profits.
After Alibaba's presentation in New York, "I'd say the mood was excitement," Mr. Rivers said. "There really wasn't much new, but there was significant buzz that this is a great growth opportunity."
Investors, Mr. Rivers added, "want to be able to say they'd been there."
© 2014 The New York Times News Service
TECHNOLOGY REVOLUTION: NETSCAPE TO ALIBABA
ALIBABA
SEPTEMBER 2014
$168 bn**
SEPTEMBER 18, 2014
$231 bn#
NOVEMBER 2013
$18 bn*
SEPTEMBER 18, 2014
$31 bn#
FEBRUARY 2012
$105 bn*
SEPTEMBER 18, 2014
$198 bn#
ZYNGA
DECEMBER 2011
$6.6 bn*
SEPTEMBER 18, 2014
$2.8 bn#
GROUPON
NOVEMBER 2011
$16.5 bn*
SEPTEMBER 18, 2014
$4.6 bn#
MAY 2011
$9.0 bn*
SEPTEMBER 18, 2014
$26.0 bn#
AUGUST 2004
$27.2 bn*
SEPTEMBER 18, 2014
$398 bn#
eBAY
SEPTEMBER 1998
$1.9 bn*
SEPTEMBER 18, 2014
$64 bn#
AMAZON
MAY 1997
$0.56 bn*
SEPTEMBER 18, 2014
$150 bn#
YAHOO!
April 1996
$0.85 bn*
SEPTEMBER 18, 2014
$42 bn#
NETSCAPE
AUGUST 1995
$2.2 bn*
SEPTEMBER 18, 2014
-#
