By Peter Garnry
Alibaba's IPO was finally announced last Friday in what will be a rare event in public markets. The size, brand recognition among institutional investors, the growth rates and profitability are staggering. It does not get any bigger than this. After several months of IPO drought we expect this one to be massive as investors will want to bet on China's transformation into a consumer economy over the next three decades.
Ma's everything platform
Already back in March, when it was announced that Alibaba was intending to IPO, we wrote about the fast growing Chinese e-commerce giant that few knew about in the developed world. That has certainly changed and the awareness will explode further over the coming weeks.
So what is Alibaba? It is the all dominating Chinese e-commerce company co-founded by Jack Ma in 1999. The company is a mix between Amazon and eBay as it facilitates buyers and sellers of goods but without the auction model. Its two biggest websites, Taobao and Tmall, account for more than half of all parcel deliveries in China and the transaction volume is larger than Amazon and eBay combined.
Over the coming weeks we will write more research notes on the Alibaba business but the graph above gives a quick overview.
Money machine
What is extraordinary about Alibaba is not only its revenue growth rate printing 46% year-on-year in its 2015 fiscal first quarter (ending June 30), but also its ability to churn out huge profits.
The EBITDA margin has exploded from 21% in fiscal year 2010 to 58% in the last 12 months highlighting that the company has surpassed its inflection point where the operational size of its business creates huge economics of scale. With fiscal year 2015 revenue expected to be around RMB 77 billion, the annual compounded growth since 2010 will be 63%.
Judging from the numbers it also seems that the company is able to sustain its high growth
rate with a decent decay in its annual revenue growth rate. That will be a big selling point on the roadshow.
The ultimate bet on future China
Buying shares in Alibaba will be the ultimate on China as the economy transforms itself into a consumer-driven economy in the age of connectivity and e-commerce. The graphs below shows the current growth in consumption and its percentage of GDP. Alone from increased consumption, penetration over the coming years for Alibaba will see huge growth potential.
The number of Chinese internet users were 618 million in 2013 and is expected to grow to 790 million in 2016. The current Internet penetration is only 46% in China compared to 88% in the US. Again plenty of opportunities for Alibaba as the the Chinese economy evolves.
Online shopping in China was a RMB 1.892 trillion market in 2013 and is expected to grow to RMB 4.772 trillion in 2016. The online shopping penetration was 8% in 2013 and is expected to grow to 14.5% in 2016. Over the coming decades, online shopping will only grow further as mobile and the Internet make it more convenient for consumers to shop than going to physical retailers. This trend will only accelerate and benefit e-commerce companies such as Alibaba.
We cannot cover all aspects of the Alibaba business and opportunities in this initial IPO research note, but we publish more analyses over the next two weeks ahead of the IPO.
$155 billion valuation
Alibaba is offering 123,076,931 new shares to the public in the price range $60-66 per share. At the mid price the company will raise $7.75 billion in new capital. In addition existing shareholders will be selling 197,029,169 shares and the underwriters will have an option of 48,015,900 shares. In total 368,122,000 shares will be available for the public translating into a free float of around 15%
The total number of outstanding shares immediately after the IPO will be 2,457,339,231 translating into a total market value of $155 billion based on the mid price of $63 per share.
The IPO proceeds will bring the combined cash and short-term investments to $14.8 billion. With interest-bearing debt around $7.9 billion, the total enterprise value will be $148 billion.
It has now been confirmed in the f-1 filing that the pricing date is set on September 18 with trading on the following day.
The battle between value and growth
Alibaba's IPO will get a lot of attention in the media because of the recent IPO drought but also because of the sheer numbers that Alibaba goes public with. We expect most big institutional investors with global equity products will add exposure to Alibaba.
We also expect a lot of debate about the valuation and bears will likely come out signalling this IPO as evidence of the bubble both in equity markets but also in China. Value investors will stay away from the IPO, pointing out the high expectations and valuation premium to the market, and then going back to buying depressed steel and mining stocks.
So what is the valuation multiple? In the last 12 month Alibaba generated $9.4 billion in revenue and $5.4 billion in EBITDA. These figures we expect to grow to $13.1 billion and $7.9 billion respectively over the next 12 months. Based on the enterprise value of $148 billion this translates into a trailing EV/EBITDA multiple of 27.3x and a 12-month forward multiple of 18.8x
The table below shows the trailing and 12-month forward EV/EBITDA multiple on a range of well-known Internet companies. Especially Alibaba's two biggest competitors in China, Tencent and Baidu, are interesting to compare, and the numbers show that Alibaba looks conservatively priced going on the roadshow.
Given the sharp decline in Facebook's share price following their IPO in 2012, Alibaba does not want to repeat the same mistake of pricing its shares too high. But this valuation actually looks too conservative. Our view is that Alibaba wants to go on the roadshow with an attractive valuation and sell all its shares first, and then begin to increase the offering price range as momentum is building up to the pricing date. That would give it a bullish story to create excitement and demand for the shares when trading begins.
Many investors and analysts will likely say the stock is overvalued. Our view is clear on this IPO. Everyone can figure out the return on invested capital and the cost of capital including the current valuation multiple. These things often check out and are the predominant driver of near-term pricing. The third dimension that few get right is the future growth rate. As we wrote a month ago, our expectations for Facebook's growth post IPO, which back then were aggressive in most eyes, have exceeded even our wildest imagination.
We believe few will be able to comprehend the compounding effect of Alibaba over the coming three decades as China transforms itself into a full-blown consumer economy. Many investors said Google, Facebook, LinkedIn etc. were overpriced but the thing most missed was the third dimension: the future growth rate. Our view is that investors with a long-term investing horizon should buy Alibaba shares at this valuation and bet on China and global e-commerce over the next couple of decades.
Play Alibaba IPO through Yahoo
Back in early July we recommended investors that wanted to play the Alibaba IPO to buy Yahoo shares as the prevailing estimates of Alibaba's IPO valuation suggested that Yahoo's stake was worth more than its market value even after subtracting a size discount. In other words, buying Yahoo shares should be 1:1 with the underlying expectations for Alibaba's market value. Our argument back then was that euphoria would build up towards the IPO. The share price is up 12% since our call (see chart). The opportunity to play the Alibaba IPO through Yahoo is still valid.
Yahoo share price the past year
Peter Garnry, Equity Strategist
Peter Garnry is an Equity Strategist at Saxo Bank. Originally from Denmark, he graduated from Copenhagen Business School in 2007. Peter writes daily equity updates on the US and European markets, as well as regular strategy pieces on various topics such as M&A activity, earnings season, profit margin expansion and sector valuations. He is also a regular commentator on television, including CNBC and Bloomberg. Before joining Saxo Bank in October 2010, Peter co-founded software firm UPSIDO which delivered an equity research platform for retail investors in the Nordic region. Peter Garnry is available to comment on global equities on a broad basis.
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