Gigantic initial offering
Shopping is becoming more technology-driven and purchases easier than before. As e-commerce expands over the globe and gives a platform for buy-and-sell the traveling costs should become lower. Delivery of goods and transfer cash where needed is only a matter of a click. When billions of people are becoming shopping-spree why not some of them become supply-spree? The sum of all activities engaged in business that is taking place online is poised to be gigantic.
Alibaba group is one such big supplier who wants to get bigger. In May 2014, it filed its registration documents to go public in the US. With an estimated $20 b of capital raising it is touted to be one of the biggest IPOs in American history.
Will investors buy into the Alibaba story? To check that let's have some background about the business.
The tangled web of Alibaba
Alibaba group is a huge shopping complex, a fairly large internet search engine (competing with Google), and a not-so-small bank all bundled together.
The timeline:
- Taobao Marketplace - online shopping;
- Tmall - third-party platform for brands and retailers;
- Juhuasuan - group buying marketplace;
- Alibaba.com - online wholesale marketplace;
- AliExpress - global consumer marketplace;
- Alipay - payment and escrow services for buyers and services;
- Cloud computing services.
Alibaba and online China:
The players and the platform:
Logistics:
The story behind the pitch
Gross market value of merchandise sold on Alibaba's websites (GMV) is reported to be $248 b which is much higher than Amazon ($100 b) and eBay ($76 b) combined.
Of this, $37 b GMV came from mobile users.
That makes Alibaba the largest online and mobile commerce company in the world in terms of GMV. And the pitching does not stop.
The billionaires in the making
After the listing the current shareholders are likely to become wealthier by far.
It must have cost $280 m for Softbank to claim 34% ownership in Alibaba. For Yahoo it cost nothing to retain its shareholding because it collected much more from part sale of its stake than what it paid for the entire stake.
The tangled web of legal structure and contractual agreements
Because China has restrictions on direct foreign ownership the way is worked around such that laws are not compromised. These agreements in effect transfer most economic risks and rewards related to the business to the investors.
Composition of revenues
Alibaba primarily gets revenues from online advertisement and commissions; it also earns from fees, value-added services and cloud computing services.
A significant portion of revenues comes from online China.
A significant portion of revenues comes from online China.
Value of Alibaba
If Alibaba has to achieve what it aims to achieve success of this IPO is crucial. That means investors will have to buy into the story said so far.
Value of Alibaba is dependent upon its ability to monetize large online market and online consumer base of China in particular, and global in general. In effect it has the task on hand to convert market into market share, market share into revenues, revenues into operating profits, and finally operating profits into free cash flows. Can Alibaba pull it off?
The market for e-commerce has been enormous, and showing enormous potential for growth. If the following has to be believed, Alibaba had 83.76% (RMB 1,542 b) market share of the total China e-commerce of RMB 1,841 b in 2013.
Can online market grow as estimated? Specifically, can Alibaba continue to maintain its already dominant market share? Chances are lower on the latter, accordingly, we can expect the share to steadily come down in the years to come.
Operating margins
Alibaba's operating margins have improved from 25-30% range to the present margin of 48.1%. It is also unlikely that such a large operating margin can be sustained for long.
We can expect a few things going forward:
If Alibaba has to achieve what it aims to achieve success of this IPO is crucial. That means investors will have to buy into the story said so far.
Value of Alibaba is dependent upon its ability to monetize large online market and online consumer base of China in particular, and global in general. In effect it has the task on hand to convert market into market share, market share into revenues, revenues into operating profits, and finally operating profits into free cash flows. Can Alibaba pull it off?
The market for e-commerce has been enormous, and showing enormous potential for growth. If the following has to be believed, Alibaba had 83.76% (RMB 1,542 b) market share of the total China e-commerce of RMB 1,841 b in 2013.
Can online market grow as estimated? Specifically, can Alibaba continue to maintain its already dominant market share? Chances are lower on the latter, accordingly, we can expect the share to steadily come down in the years to come.
Operating margins
Alibaba's operating margins have improved from 25-30% range to the present margin of 48.1%. It is also unlikely that such a large operating margin can be sustained for long.
We can expect a few things going forward:
- China online market will continue to grow.
- Alibaba market share (GMV) will continue to slide from 84% to a lower, yet probably significant, share.
- Its gross margin (revenues as percent of GMV) is 2.6% at present; we cannot expect it to improve significantly.
- It will be difficult to sustain high operating margins for long; they will slide.
- No dividends will be in sight; Alibaba will have to spend lots in reinvestment each year.
- After a decade or so, it is more practicable to assume that both the total market and Alibaba will grow at a modest rate. In fact Alibaba should show signs of a mature firm. It could generate sustainable cash flows, pay dividends and do buy-backs, and have capacity to borrow more.
$200 b tech giant
Alibaba is soon likely to become one of the tech giants in the world.
However, there may be some gaps in this process of wealth creation.
I tried but concluded that to get to the value of $200 b Alibaba will have to do a lot of things - generate huge revenues and maintain margins.
The main issue is that we cannot attach high market share and high operating margins to Alibaba for too long. They will have to fall to a much reasonable and comfortable levels. And when we do that the result is a high implied growth rate to get to $200 b value of its common equity.
To know why consider this: Even when I let Alibaba enjoy reasonable excess returns until perpetuity (which I usually deter) during the stable growth period, I get year 10 revenues of $87 b. To get the right perspective we should translate those revenues into Alibaba's GMV and then into China GMV, and check whether the overall market (China GMV) appears to be achievable.
Two things to remember: There are caps on stable growth (perpetuity) period numbers; a firm cannot go on doing great things forever. Even during those great things period where growth is high it does not come free; the firm has to reinvest proportionately to achieve that growth. That reinvestment keeps a check on free cash flows.
Finally, it will be good to ask a few questions: how sustainable is this China story? Will there be any hiccups? For how long Tencent, Baidu, Amazon, eBay and others will let Alibaba keep those extraordinary returns? Are there any what if questions?
It has been thus so far: Jack Ma envisages and Joseph Tsai executes. Can these two make it to the next level?
However, there may be some gaps in this process of wealth creation.
I tried but concluded that to get to the value of $200 b Alibaba will have to do a lot of things - generate huge revenues and maintain margins.
The main issue is that we cannot attach high market share and high operating margins to Alibaba for too long. They will have to fall to a much reasonable and comfortable levels. And when we do that the result is a high implied growth rate to get to $200 b value of its common equity.
To know why consider this: Even when I let Alibaba enjoy reasonable excess returns until perpetuity (which I usually deter) during the stable growth period, I get year 10 revenues of $87 b. To get the right perspective we should translate those revenues into Alibaba's GMV and then into China GMV, and check whether the overall market (China GMV) appears to be achievable.
Two things to remember: There are caps on stable growth (perpetuity) period numbers; a firm cannot go on doing great things forever. Even during those great things period where growth is high it does not come free; the firm has to reinvest proportionately to achieve that growth. That reinvestment keeps a check on free cash flows.
Finally, it will be good to ask a few questions: how sustainable is this China story? Will there be any hiccups? For how long Tencent, Baidu, Amazon, eBay and others will let Alibaba keep those extraordinary returns? Are there any what if questions?
It has been thus so far: Jack Ma envisages and Joseph Tsai executes. Can these two make it to the next level?
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