How Alibaba Created History With Its IPO

by Sohini Bagchi    Sep 23, 2014

alibabama

Alibaba has officially become the largest public offering in history with its IPO valued at $25 billion, according to reports. This is a wakeup call about an emerging wave of technology giants in China’s state-dominated economy, believe experts. 

Under the ticker ”BABA” at the New York Stock Exchange, the e-commerce created history, having a market capitalization of roughly $219.8 billion, according to FactSet. That makes the company bigger than some of the U.S. technology industry’s most successful names, such as Facebook, eBay, and even Amazon.com. Moreover, if Alibaba’s investment banks were to exercise their option to sell an additional 48 million shares, it could make Alibaba’s IPO the biggest in the world, beating out the $22 billion IPO of Agricultural Bank of China in 2010.

History has been made

The e-commerce powerhouse, which was until recently nearly unknown to most Americans, always had ubiquitous roots in China. Founded by Jack Ma, who maintains strong control and large ownership over the company has often being compared with Steve Jobs, owing to his obsession with innovation, charm and spiritualism, has time and again proved his mettle in the online retailing space.

For example, it has used instant online micro-loans to grow its vendor base and get around inefficiencies in China’s financial markets. A blog post mentions “On Taobao, you find live scorpions, rental boyfriends or Tibetan Yak testicles and more bizarre…”

The company operates China’s largest Internet shopping destination, Taobao, and retail site Tmall.com, earned $3.7 billion in the 12 months ended March 31, 2014, up about $2 billion from the prior 12-month period. It has handled more than $248 billion in transactions last year, more than Amazon and eBay put together, mentions Bloomberg.

According to a MarketWatch report, analysts at MKM Partners see a number of positives in the IPO. The report says, the fact that Alibaba holds a dominant and consistent market position makes it stands out. Although there are many fast-growing competitors, Alibaba has maintained 50% to 90% market share in the retail categories it serves, and conducts about 70% of the overall ecommerce business in China.

Moreover, the Chinese economy is booming. “For an emerging economy, China has strong broadband and wireless infrastructure with weak brick-and-mortar retail infrastructure,” MKM analyst Rob Sanderson wrote in a note to clients.

The number of active buyers, at 279 million, is still growing, driven by the mobile business. And Sanderson pointed out that there were 1.3 billion wireless subscribers in China. He also pointed out that  Alibaba’s business model is highly profitable unlike its closest competitors Amazon et al. “The company takes no inventory risk, and does not bear the burden of building fulfillment capabilities.”

Not without risks

However, there are some potential concerns analysts point out given the complex ownership structure, which may raise questions about management credibility. Among those risks, buyers of the stock don’t own the underlying business, because Chinese government regulations restrict foreign ownership in the sector. They will have rights to revenue only through contracts that lawyers say may not be enforceable. Hence both the legal/regulatory and business risks continue to remain.

Originally designed to get around Chinese government regulations, the structure is vulnerable to Chinese regulatory risk, says a WSJ report. It is also vulnerable to U.S. regulatory risk. Senator Bob Casey of Pennsylvania urged the Securities and Exchange Commission to exercise more scrutiny in a recent letter that named Alibaba and its VIE, or variable interest entity structure, writing, “The sheer number of fraud cases involving China-based companies listed in the U.S. reveals systemic problems with many Chinese companies’ legal structures and accounting practices.”

The VIE structure, as expert note, also carries risk from potential conflicts of interest.  In some cases VIE owners have decided it’s in their interest to cut the foreign investors out, after they have the money.  In one case, a founder asked local officials to declare the VIE arrangement illegal, and they complied. In another case, a dispute between offshore investors and a VIE founder resulted in the loss of the VIE.

The WSJ report points out some VIE risks have already materialized at Alibaba. According to the prospectus, Jack Ma is majority owner of most of the VIEs. “These contractual arrangements collectively enable us to exercise effective control over, and realize substantially all of the economic risks and benefits arising from, the variable interest entities,” the prospectus reads. An investment in Alibaba, then, may depend largely on where Ma thinks his real interests lie.

However, investors and analysts continue to have high hopes on Alibaba, given the high ambition and enthusiasm of Jack Ma and his vision on expansion.  Many believe his interests seem aligned with those of investors in the IPO, which is going to be “pretty valuable.” In a statement, Jack Ma said that the company would “aggressively expand” into the U.S. and Europe. Increasingly that expansion would depend on mobile applications, according to Pamela Clark-Dickson, a senior analyst, with Ovum, especially with its recent buyout of Tango, Yahoo and other specialized firms in this space.

All said and done, amid hope, doubt and speculation, the entire financial and tech community is now keen to see what Alibaba does next.