The highly anticipated initial public offering (IPO) for the Chinese e-commerce website Alibaba debuted at the New York Stock Exchange on Friday. Alibaba appeared to have learned a lesson from Facebook, keeping the IPO price well below what the anticipated demand would dictate. They were subsequently rewarded with a solid stock debut.
The initial IPO price of $68 per share ballooned to $92.70 at the opening, which was delayed over two hours because of the trading imbalance of buyers swamping sellers. The peak hit $99.70 per share before ending the day at $93.89. Alibaba’s market capitalization grew from the expected $168 billion to $231.4 billion at closing, outstripping that of Wall Street stalwarts such as GE and IBM.
Overall, the IPO raised $21.8 billion, a record figure for U.S. IPOs and one falling just short of the worldwide record of $22 billion.
Alibaba is frequently compared to a combined Amazon, eBay, and PayPal, and with good reason. Approximately $300 billion in transactions take place on Alibaba, with a format similar to eBay and supported by the Alipay payment system that provides safety for consumers through escrow accounts that protect purchases. Currently, Alibaba is larger than all three companies combined.
Alibaba’s business model is closer to that of eBay, but with a healthy profit margin compared to the above companies. They receive income from businesses listing on their site, as well as from advertising revenue.
So is Alibaba stock overpriced at $93.89 per share? Perhaps a little, according to analysts. S&P Capital IQ reports an 18-month price target of $88.67. If correct, that figure suggest the market has already corrected for the intentionally underpriced offering, and that while the stock is relatively solid, growth may be relatively slow.
Investors did not buy ownership in Alibaba per se, but in Alibaba Group Holding, Ltd. (NYSE: BABA). The very reason for the NYSE offering is that it is illegal for foreign entities to invest directly in Chinese Internet services. Thus, the investment is in a variable interest entity (VIE) – essentially owning shares in a holding company in the Cayman Islands with a direct contractual claim on the profits of Alibaba.
And what significant profits they are: $2.3 billion through the second quarter of 2014, and nearly $7 billion predicted for 2015. This is why investors are clamoring for Alibaba despite potential risks that are more political in nature than economic.
Investors are at the whim of a small group of controlling interests as well as the Chinese government. In addition, in 2011, Alibaba’s chairman Jack Ma split Alipay off from Alibaba, claiming he was forced to do so by Chinese regulatory requirements. The claim was that foreign investors – in this case Softpay and Yahoo (NASDAQ: YHOO) – were banned from investing in Chinese-owned third-party payment services.
That scenario is quite similar to the Alibaba IPO situation, scaring off some investors. However, the majority of investors believed that the combination of growth potential, demonstrated profits, and low price were worth the risk.
The risk involved in Alibaba is increased by its very structure. Since shareholders do not own Alibaba directly, they have virtually no control in the direction of the company. With the direction in the hands of a few individuals (primarily Jack Ma and co-founder Simon Xie), investors have limited legal recourse in case something goes awry or the “rules” suddenly change. Chinese courts are unlikely to provide any relief to outside investors, given that direct foreign investment is already prohibited.
During these heady times of growth and a new beginning for Alibaba, everyone is happy. But hard times must eventually come, as it does to all companies. What happens then?
Friday was undoubtedly a success for Alibaba, but let’s see what happens over the next few weeks.
It appears that there is still plenty of unmet demand for the stock, based on Wall Street Journal information. They quoted sources as saying that more than 1,700 investment groups around the world placed Alibaba stock orders, with only half of those orders fulfilled and others receiving only partial shares.
With the new price level, it’s unclear whether investors still want to get in early or will wait until the first set of post-IPO performance metrics are available on Alibaba. The trading volume over the next few weeks will determine how well Alibaba stock maintains the price level.
Meanwhile, investors will be looking for any signs that the Chinese government or Jack Ma may pull the rug out from under foreign investment in Alibaba. Certainly, they have the tools to do so, and have shown little hesitation to use them when it suits their needs. Right now, it does not seem to.
Alibaba may be a worthwhile stock to own, but we would suggest treating it as a higher risk component of your portfolio – and if you didn’t get in on the initial IPO, wait a bit to see how the price reacts and get a feel for the volatility.