If we didn’t have the Fed FOMC meeting and the Scottish Independent vote, the only thing the financial media would be covering is the whopping Alibaba IPO. So should we buy it?
Courtesy of wikipedia
Should I BUY Alibaba IPO?
I have been asked several times this week by friends who know I work in the financial sector if they should buy Alibaba? My pat answer is, “If you are asking you probably shouldn’t be risking your money!” Ok, it was a curt answer, but I think my point is valid. When someone is usually asking this question, they are looking for instant wealth; it’s a flipping mentality, one of buying lotto tickets. They have no interest in earnings, growth, or even investing. These people are looking for a quick return, fast money, a sure-fire win. I usually follow-up my curt answer with a couple of more sarcastic jabs, which is usually not met with the humor it was intended to illicit. “If flipping IPOs was so easy, everyone would be doing it and we would all be millionaires!”, “How did that work for you on Facebook?”, “Why not short the stock, it’s 50:50, you have the same odds and better returns betting on Black on the roulette table”, “If you don’t play, you can’t win, or so the lottery motto says.” A few more zingers and they know not to ask me any more questions. I usually just can’t help myself and those that know me well, know my sledge hammer wit and sarcasm can be a little biting, and those that don’t usually means I am more likely not to be invited to their next dinner party.
Should I INVEST in Alibaba?
So lets move on to a more thoughtful and realistic question, is Alibaba a good investment based on its longer term growth potential? That is better question and comes with a longer and more detailed answer that most of my stock flipping / day-trading friends don’t want to hear.
Before buying any stock I find it far easier to decide if the company is a growth company (opportunity) or income company (seasoned and income).
Growth opportunity companies are simply characterized as a business that is still seeing organic growth and has a rather long way to go before their goods and services reach a maximum penetration level. These companies usually don’t pay dividends, as any profit is reinvested. They usually are seeing strong double digit year-over-year growth. They may not be profitable yet. The expectations for these companies are that the stock will continue to rally strongly and may not be solely economic dependent. They also tend to be higher volatile stocks.
Income and seasoned return companies have matured. They usually have seen maximum penetration on their goods and services. Growth for these companies usually comes from stealing customers from the competition, through replacements of existing products, and population growth. Any growth is usually in the single digits, they usually pay dividends, and the company’s product have usually become commoditized. These stocks move far more slowly, they are usually far less volatile, and are usually impacted by inflation and economic conditions.
There is nothing wrong with investing in either company, but before you invest it is important to understand these differences and also understand the expectations based on which type of company it is. There are some companies that fit into both of these categories, like Apple. Apple has released new distinct product lines that are new and have strong organic growth, which creates new revenue streams and they also have existing product lines that are more in common with a seasoned business. Apple is unique in that aspect, but for the most part it is easy to categorize a company.
So what is Alibaba? It is clearly a growth company and it has seen massive and amazing growth as it is nowhere near maximum penetration based on consumer levels in China and emerging markets. So that means we need to understand this company is going to be volatile as it battles against competitors and moves in fits and starts as it grows.
Not just any IPO.
Alibaba is not like a typical IPO, not even a high-tech or even Dot.com IPO. It has several complexities that bring some concern and uncertainty of how the company operates, its future, and even what its real value is.
First, this is a Chinese company and that brings a host of issues with it. Here are some questions that have been leveled at the company, which are all valid in some respect.
1 .Cayman Business:
Courtesy of wikipedia
Foreigners are NOT legally allowed to own a Chinese company, so how can Alibaba list stock in the U.S.? Alibaba re-formed their company in Grand Cayman so that it can list itself on the NYSE. This brings some serious questions to the table which are buried in the Grand Cayman business structure – so many that we can’t even begin to list them. Let’s just say my own well versed and experienced attorney in finance and business would take months to clearly understand ownership and what parts of the company are included or not included in the Grand Cayman structure and I would bet he would still walk away with more questions. There is another huge issue with this as the Chinese government has leveled criticism at Alibaba and this tactic to domicile in Cayman while Alibaba is actually a Chinese company. Sounds familiar? We have seen a recent rise in our own criticism of “tax inversions” in this country, I am sure China has similar concerns. This IPO and its longer term success or failure will be a test to see how / if the Chinese government responds. I am not implying that this has never been done before, it has many times, but this is a very high profile IPO and it is putting some pressure on the Chinese government to respond. Usually foreign companies are listed as ADRs in the US, AFTER they had already been listed in their own country. This is NOT the case with Alibaba.
2. Ownership Power:
Courtesy of wikipedia
Why not Hong Kong? Most Chinese companies are listed in Hong Kong and as previously mentioned it can also list in the US under an ADR program, so why didn’t Alibaba take this approach? Hong Kong stock exchange is far stricter in its voting rights and far simpler. Each share of stock equals one vote, no “ifs, thans, or buts” about it. In the US you can form far more complex companies and share classes, like Facebook in which Zuckerberg’s shares have voting rights more powerful than common shares. Most people don’t have a problem with that and Zuckerberg is a US citizen. The owners and founders of Alibaba didn’t want to be restricted by Hong Kong’s 1 share = 1 vote rule and thus decided to create different share classes and maintain control of the company, even when they are diluted by going IPO. Jack Ma (CEO) is also a Chinese National. This too has the perception of putting a little egg on the Chinese government’s face, as the world’s potentially biggest company is now listed in America on the NYSE.
3. Financial Reporting:
There have been significant questions about their actual numbers. Chinese companies have been notorious for questionable accounting and several private sector mergers in China have quickly turned sour as the truth surfaces. I am not critical of Alibaba per se, but the company exists in a questionable accounting environment that has proven that skepticism is wise. Alibaba is no doubt successful, how successful and the actual profit margins and revenue is probably correct, but one can’t help wonder a little. The accounting, cultural, and language barrier has made auditing difficult for many foreigners engaging in Chinese businesses.
4. Transparency of business:
Yahoo, an investor in Alibaba, has already faced a rather contentious battle with the company. Alibaba has created several side businesses under their umbrella and integrated into the core business. One was Alipay (like PayPal) – it was a needed service that was integrated into the core business. Alibaba, even though Alipay is part of the company, thought Yahoo should not receive or did not own any of the Alipay business. The fight lasted a year and eventually it was privately settled, rumored not to Yahoo’s satisfaction. This morning, Jack Ma (CEO of Alibaba) even said it was a painful and hard decision dealing with Yahoo. Alibaba has many side businesses, the question is will shareholders receive ownership or benefits of those businesses, what about future businesses under Alibaba? That is a big unknown and the Yahoo – Alibaba battle is proof that there is no guarantee. What if shareholders didn’t benefit when Apple launched iTunes or now Apple Pay – and said it was a NEW business and shareholders were not entitled? Ouch!
5. Chinese Government:
Courtesy of wikipedia
This is more conspiracy and conjecture. There is no supporting evidence, but I can’t simply dismiss the concerns that some have brought forth. This is a massive company, it is now listed on the NYSE, and it is a tech giant in; financial transactions, commerce, big data, email, and a host of things. As Alibaba further penetrates the US markets and now our financial markets, is there risk that some have mentioned that Alibaba could be used by the Chinese government for spying or more nefarious activities? If US Congressional members put a target on China and Alibaba, even make the accusation, how could it affect the stock and listing?
I have listed several broad concerns, many real and some only conjecture, yet one can’t simply ignore them as if they would not have an impact. These factors can certainly bring volatility to the stock.
Why Invest in Alibaba?
Ignoring all the issues I outlined above, there is an amazing business story. Many like to compare Alibaba with Amazon, but it is far more than just another Amazon. Let’s look at the upsides to investing.
1. Consumers: There are only 330 million people in the U.S.; there are over 1.3 billion in China. Alibaba already has more consumers than there are people living in our country. China is one of, if not the biggest potential consumer base in the world. Alibaba – being a Chinese company – has massive advantages over a US company entering their market, like an Amazon. It has a cultural alignment with its consumers, it understands the people, speaks the language, and understands the nuances that a US run company could never fully comprehend. The growth in their Chinese consumers is simple proof of this. Alibaba is expanding into neighboring countries as well.
2. Multitude of businesses: Unlike Amazon, which is frequently compared to, Alibaba, is not just an online retail business – it has many companies under its umbrella. While not all maybe profitable, they all do generate significant revenue.
a. Taobao is quickly becoming the world’s largest online market place.
b. Tmall is their online retail platform for third-party sellers
c. Juhuasuan is the online group buying market place.
d. AliExpress is their business retail portal that has expanded into BRIC nations, including the US.
e. 1688.com is their wholesale online market place.
f. Alimama is their online marketing company.
g. Aliyun is their cloud computing and data management company.
h. Alipay is their PayPal system.
i. Cainiao is their logistics company that works closely with delivery services.
j. Laiwang is their online chat company.
k. 11 Main is a U.S. online shopping site.
3. Profit Margins: Collectively the profit margins of this company and their group of companies are massive, bigger than Apple, running over 40%. It’s amazing and rare to see profit margins so massive.
4. Growth: This company is seeing year-over-year growth of 50% and expanding quickly into the BRIC nations. The numbers are massive and impressive. The diversity of the business is amazing. I looked at sales data, that dwarf Amazon and EBay combined. They had sold more on one shopping holiday in China than Amazon had sold the entire Holiday season. I can’t deny how impressive this massive company is and I am impressed at the company’s diversity and synergetic integration. It may be the world’s biggest company and Jack Ma could be the next Steve Jobs.
Future of Alibaba
The future of Alibaba will be interesting. It has one dark shadow,the Chinese government that looms over them, however if successful world wide – perhaps it can bring a further acceptance and embrace of capitalism, free markets, and entrepreneurism.
Perhaps today’s IPO will be the mark in history in which the world will remember when the torch was passed from the US to China as being the world’s largest consumer market.
I have mixed reservations about the IPO, this comes down to trust. Trusting a man and a business that has already had a contentious relationship with its US partner, Yahoo. It is trust in a Chinese government that will keep its hands off or not change the rules or the risk of political landscape that could lead to nationalization.
The math, the fundamentals, and the potential are huge – on that alone I would certainly be a long-term investor in this company.
What should give us all pause, is the structure of the company, China, accounting, and the economic/political risks.
My recommendations for investors interested in this company, if you have to buy today on the IPO, buy a very little (knowing you can’t hedge it and it would be volatile). Wait until earnings to access and volatility settle down, along with options listed, before you put on a larger position.
For those looking to flip an IPO, forget it – go buy a lottery ticket or put you money on black or red. There are just too many unknowns and if you do make money, it will be luck not keen insight or wise trading.
Support & Resistance
Welcome to the Dove rally into the mid-terms. There is one more FOMC meeting, but until then – the Fed will not let this market decline, by hook or by crook.
Alibaba + Doves = lift off!
Let’s get this party started. VIX will continue to drop.
OK, my above sarcasm aside – this market is rallying on the addiction and juice of cheap money and starting to get a little euphoric. Continue to watch the RUT strength and volume. For now flow will continue to the equity markets as long as the Fed keeps rates at zero and accommodating.
Shoe-shine Boy, Coffee Barista, and the Hair Dresser.
One of our traders said this morning, is Alibaba IPO today’s “shoe-shine boy”?
For those not familiar with the “shoe-shine boy” story, let me share it to offer some perspective. I believe it was JP Morgan who was arriving at the NY Stock Exchange one early morning before the stock market crash of the 1920s. The shoe-shine boy, who would shine his shoes every day proceeded to give him a stock tip. JP Morgan went into the exchange and proceeded to tell his staff to SELL everything and to GO SHORT the market! When asked why, he said the shoe-shine boy gave me a stock tip. They looked at him in bewilderment and said, so what? He retorted, when the shoe-shine boy is buying there is no one left to buy! The shoe-shine boy is at the bottom of the pyramid, who will the shoe-shine boy sell too when he wishes to get out. He was right, the market crashed and he made millions.
Courtesy of hyperallergic
I had my own experience back in 2006. I had visited a coffee shop every morning before heading to the exchange. Behind the counter the young man that made my espresso every morning was studying some books, I thought for college. I asked him what he was studying and he looked up and said, REAL ESTATE INVESTING! He then proceeded to give me real estate advice. When the 19 year old coffee barista is giving you real estate advice, it is time to sell. My friend looked at me and said “shoe-shine boy?!”, I nodded my head. My friend put his house up for sale and I too got out very shortly after and proceeded to rent until 2009. The shoe-shine boy and coffee barista is not the sole indicator, there were other signs, it was just the literal realization that we are getting to the bottom of the buyers in the pyramid of investing, which usually marks the top. Similar stories could be told during the dot.com bubble as well.
This week I had several calls from friends about the Alibaba IPO, and this morning the trader in our office said her friend (a hairdresser) was talking about buying Alibaba.
Is the hair-dresser another shoeshine boy?