Alibaba IPO – The background

Alibaba is a Chinese e-commerce company, made up of various online outlets and functions. Their revenues are generated from a number of websites, such as and, which provide online marketplaces in which buyers and sellers can conduct business in wholesale or retail trade. These sites generate income through subscription and advertising fees, however the company has sought to expand vertically over recent years, and items bought on these sites may be delivered by another Alibaba business, Cainiao. Additionally, payments for these items are processed by Alipay, also an Alibaba business.

The company’s party piece, however, is not its service offering alone, but the economies of scale that it captures. Consider that in 2013 more than half of all parcels sent in China were Alibaba parcels and you get some idea of the scope of the company. For the 12 months ending in June 2014 Alibaba had orders of US$300bn worth of goods on its platforms according to the LA Times. This is more than Amazon and EBay combined.

Alibaba (ticker: BABA) is listing on the NYSE today, 19 September 2014, and has rapidly become the most talked about stock IPO since Facebook’s IPO in May 2012. Raising US$21.8bn, before underwriters have exercised options to sell more shares of the oversubscribed IPO, makes Alibaba the biggest IPO in US history. If underwriters exercise their options to sell additional shares that number could rise to US$25bn making it the biggest IPO ever. At US$68 a share Alibaba’s market cap will be approximately US$168bn making it the third biggest internet company in the world, behind Google and Facebook.

Speculation that Alibaba will be using the funds raised today to break into the US market may be misguided. Cultural differences as well as logistics have kept Alibaba more or less on the side-lines of the US market compared to Amazon or EBay. Thus, many analysts believe that the new cash inflow may be most useful in expanding the company’s grip on the Chinese market. The company faces strong competition in its core businesses from smaller players. With the Chinese market in general still being in a developmental phase there is a lot of room for growth. Only about half of the Chinese population currently has access to the internet and as this expands so will Alibaba’s potential customer base. Thus Alibaba has to cement its place in the marketplace through growing its distribution network and operating efficiencies. As such, it is likely that a generous portion of the capital raised should go towards these efforts.

Buying a share of Alibaba does not however give you ownership rights in the company. It gives you a right to the profits of the Alibaba Group which are held by a Variable Interest Entity registered in the Cayman Islands. This structure is due to Chinese government restrictions on foreign ownership of Chinese companies. This is however not a unique occurrence as similar Chinese companies such as Baidu have been listed in the US for a number of years under the same structure. The Hong Kong Stock Exchange rejected Alibaba’s application to list on the exchange due to Alibaba’s ownership structure which aims to give a small number of current owners the right to elect the majority of the board. This means that the current owners will still have the majority say in the future of the company. Nevertheless, by buying into Alibaba, what you are getting is exposure to a Chinese company larger and more diversified than Baidu, which has been the largest US listed Chinese technology company up to now.

Because of the ownership structure, Alibaba shares cannot be included in the Standard and Poor’s 500 index. This means that any institutional investor with a mandate to track the index will not be able to buy the stock. Thus volatility in Alibaba will not have the same impact on the broader market as say a large index included stock would. Volatility may be higher than with index included stocks as index tracking funds are not required to hold the stock during bad times and good. Larger swings can be expected at least initially for this reason.

In conclusion, Alibaba may the best way for investors to gain exposure to a large Chinese technology company with a strong hold on their market and strong growth opportunities. An understanding of the ownership structure is essential to evaluating the risks associated with an Alibaba share purchase. Enthusiasm seems to be the outlook at the moment. Providing trading goes smoothly at the open today the underwriters expect a decent jump in the share price by close of business in New York.