How to Play Tomorrow’s Massive Alibaba IPO
Since releasing my C.H.A.O.S. stock-screening strategy in April, I’ve covered 23 companies.
Some have notched quick gains – like FitLife Brands (FTLF), up 27% since I profiled it on June 26.
Others have graduated to major exchanges – like biometrics firm,NXT-ID (NXTD), which uplisted to the Nasdaq last Thursday.
And some were bought out – like PLX Technology (PLXT), which accepted an offer from Avago Technologies (AVGO) on June 23. This was just two months after I mentioned that PLX was a strong takeover candidate.
Indeed, we’ve seen many scenarios play out over the past six months. But this one is unprecedented…
The Biggest IPO of the Year
Today’s C.H.A.O.S. breakdown comes courtesy of this email from a subscriber…
I’ve got your back, E. And the timing is perfect, too, as e-commerce giant, Alibaba, hits the stock market tomorrow. So let’s dive in…
Business is booming for Alibaba. Here are a few key metrics, converted to U.S. dollars…
There’s no question that Alibaba is a strong company, with an even stronger balance sheet.
The most interesting metric? Gross profit.
For every $ 1 of revenue, it keeps around $ 0.43.
By comparison, Alibaba’s largest competitor, Amazon (AMZN), only notches $ 0.01 in profit for every dollar of revenue. Ugh!
And given that the Chinese government makes it very difficult for foreign companies to break into its domestic market, you can expect that growth to continue for Alibaba.
There are two negatives here, though:
- Stunted Growth? Alibaba has a lot of “one-time items.” In other words, a large chunk of its growth comes from non-recurring payments. This begs the question: Is its growth sustainable?
- Currency Inconsistency: Alibaba reports its numbers in Chinese yuan, while also converting them into U.S. dollars. However, the currency conversion is inconsistent. In one instance, for example, it used the monthly average exchange rate. Now, while monthly currency fluctuations aren’t usually too dramatic, it makes for non-exact figures.
C.H.A.O.S. Meter: 15/20
When Alibaba was founded on April 4, 1999, it was five years afterAmazon had already built its massive e-commerce platform.
Even though “e-commerce” was just a theory stemming from the emerging internet craze – and consumers’ willingness to “buy online” hadn’t yet been proven – Amazon quickly did prove that.
In other words, Alibaba didn’t create the e-commerce market. And it didn’t disrupt the online shopping industry. Amazon did.
Alibaba’s model is based on Amazon’s existing e-commerce market validation – and the company is piggy-backing off its success.
Particularly, in China.
In bringing its services to China’s enormous population, Alibaba has massively impacted China’s e-commerce market.
However, Alibaba doesn’t just target China’s growing middle class. Poorer regions are underscoring the high-impact nature of Alibaba’s services.
You see, while cities like Shanghai, Beijing, and Hong Kong are wealthy, many other parts of China remain underdeveloped.
That means Alibaba’s services are essential to consumers in these parts, whereas Amazon’s services in the United States are more of a convenient luxury.
C.H.A.O.S. Meter: 15/20
It goes without saying that Alibaba’s IPO tomorrow will be an immediate catalyst for shares.
It’s arguably the most anticipated IPO of 2014, and Alibaba originally set its launch price between $ 60 and $ 66 per share. However, overwhelming demand has boosted the range to $ 66 to $ 68.
Based on Alibaba’s expected FY 2015 earnings (set to jump by 50%, according to consensus estimates), shares will be priced at 29 times those forward earnings.
At that price, shares are attractive, relative to its competitors, which trade much higher. For example…
Baidu (BIDU) trades at 39 times its projected earnings.
Tencent Holdings (TCEHY) trades around 37 times its forward estimates.
In fact, the median multiple for Chinese and U.S. e-commerce firms is 43.
And Amazon shares trade at an astounding multiple of 135 times forward earnings.
So if Alibaba meets its projected consensus earnings of roughly $ 2.42 per share, and trades “conservatively” at Baidu’s multiple, it should be a $ 94 stock.
However, if Alibaba trades at Amazon’s multiple… well, shares could climb as high as $ 320.
There’s no reason why the market won’t value Alibaba at comparable multiples to its peers. Indeed, analysts project shares will settle in the $ 90 to $ 100 range over the next 12 months. So even if shares open in the $ 70 range, you’ll still be buying the stock 28% cheaper.
Share demand is very high, with nearly 40 large institutions submitting orders for $ 1 billion or more.
Already, the IPO is larger than all the year’s previous IPOs combined. Expect plenty of acceleration.
C.H.A.O.S. Meter: 19/20
Alibaba doesn’t engage in direct sales or hold any inventory. Rather, it operates as a platform for third parties.
Three segments make up Alibaba’s retail marketplace in China:
- Taobao Marketplace – China’s largest online shopping platform.
- Tmall – China’s largest third-party platform for retailers.
- Juhuasuan – China’s most popular group buying marketplace.
Combined, these segments generate gross merchandise volume (GMV) of $ 296 billion per year – and accounted for 81.6% of Alibaba’s revenue in fiscal 2014.
In addition, Alibaba also operates three other retail platforms:
- Alibaba.com – its global wholesale website.
- 1688.com – its China-based wholesale marketplace.
- AliExpress – its global consumer marketplace, AliExpress.
Here’s how it all breaks out…
Any way you slice it, Alibaba moves an extraordinary amount of product. In fact, CEO Jonathan Lu says, “We’re the largest online and mobile commerce company in the world.”
A bold statement. But it’s backed up by the fact that Lu has grown Alibaba’s customer base to a size that’s larger than entire nations…
For example, according to Alibaba’s recent F-1 SEC filing, it has just under 300 million customers. To put that in perspective, the only three countries with populations larger than that are the United States, China, and India.
The interactions between buyers and sellers create what’s called a “network effect.”
In other words, more merchants attract more customers. And more customers attract more merchants.
Additionally, buyers and sellers within one marketplace will often participate in or more of the other marketplaces, thus creating a “second-order network effect” that further strengthens Alibaba’s ecosystem.
This means that any rivals looking to penetrate China’s e-commerce market will find it incredibly difficult to steal the Chinese shoppers loyal to Alibaba’s services.
Which, by the way, accounts for 80% of China’s entire e-commerce industry.
In other words, Alibaba has the same transactional volume as twoAmazon.com websites. And it’s still growing.
C.H.A.O.S. Meter: 20/20
So, with roughly 300 million customers and 80% of China’s e-commerce market, how does an already mammoth organization like Alibaba grow its business even more in the years ahead? Like this…
Increased Penetration: At the end of 2013, there were 618 million active internet users in China – the largest online population in the world. But only 302 million of them shop online. So there’s plenty of room to grow that number.
Indeed, analysts project that China’s internet population will grow to 850 million in 2015, with a market value of $ 395 billion. At the current penetration rate, it means the number of online shoppers in China will increase to roughly 420 million.
As the number of Chinese online shoppers grows, so will Alibaba’s revenue. That’s even more important when you consider the next growth catalyst…
Consumption Growth as a Percentage of China’s GDP: One significant aspect of Alibaba’s business is the spending power of its Chinese consumers, matched against GDP.
In 2013, the personal consumption expenditure (PCE) was 35% of GDP. Compare that to the United States, where PCE was just under 67%. As China’s middle class grows, there’s plenty of room for China’s PCE number to grow, too – which will generate more revenue for Alibaba.
Easier Online Connectivity: China is a perfect example of the massive growth of mobile technology. Especially since Xioami is fueling competition with rivals like Apple (AAPL) by offering similar products at substantially lower prices.
As mobile adoption continues to surge in China, Alibaba will benefit from easier, “anywhere” access.
Decline of Brick-and-Mortar Retailers: Offline, China’s retail sector faces considerable challenges (more so outside of major cities).
For starters, China has an underdeveloped physical retail infrastructure, with a limited number of brick-and-mortar stores. In addition, manufacturing quality is inconsistent and there’s a limited selection of products.
This means more Chinese consumers are switching from physical retail stores to online.
International Expansion: As it stands, Alibaba’s business is centered on its domestic operations. Its international commerce only accounts for 9.3% of total revenue. Needless to say, it wants to expand globally and capitalize on powerful markets like the United States and India.
Alibaba’s IPO will give the company much more publicity, but it remains to be seen whether or not this will result in new business.
These five growth drivers are realistically attainable, both in the near term and long term.
C.H.A.O.S. Meter: 19/20
OVERALL C.H.A.O.S. RANKING: 88/100
Final Verdict: As you may know, a score of 85 or higher on the C.H.A.O.S. Meter signifies a “Buy.”
Unlike many of the other companies I’ve profiled, Alibaba is a mammoth outfit. It’s well-established, well-known, and boasts a proven business model.
Ahead of the IPO, demand for Alibaba shares is at historic levels. As such, with the hype surrounding the launch, you can expect a large gap between its launch price (between $ 66 and $ 68) and its actualopening price, which I anticipate will be in the mid-to-high $ 70s.
This happened when I profiled Mobileye (MBLY) before its IPO. The company set its launch price for $ 25… but the stock actually opened at $ 36.
Gaps like this are ranges that aren’t investable… unless you’re already invested in the stock.
However, even if Alibaba opens in the high $ 70s, you’re still buying it at a deep discount to its future earnings.
And if it opens above $ 80, you should only buy half your position. IPOs are volatile, so take advantage of selloffs – and remember: Alibaba’s future is much bigger than your IPO entry point.
Your eyes in the Pipeline,
P.S. Have a company you want to run through my C.H.A.O.S. screener? Then, simply post its name and ticker symbol below, and I’ll consider running it in a future issue.
Marty Biancuzzo’s technology research is already the most sought after in the industry. Since joining Wall Street Daily, he’s broken news on some of the biggest market-moving catalysts of the year, including the digitization of city infrastructures, neuroengineering breakthroughs and the Twitter IPO. Learn More >>