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Mellody Hobson is President of Ariel investments, a Chicago-based money management firm that serves individual investors and retirement plans through its no-load mutual funds and separate accounts. Additionally, she is a regular financial contributor and analyst for CBS news.
Mellody: This morning I think we should cover the biggest stock news we have seen in the last few months, and that is the Alibaba IPO.
Tom: That sounds great. First things first: what, exactly, does Alibaba do?
Mellody: Great question. So this company is made up of a number of subsidiary companies, but they all focus on e-commerce. You can think of Alibaba as the Chinese version of amazon, PayPal and eBay rolled into one, with one big difference – they have a much larger market share. A full 80% of online shopping in china occurs on the company’s platforms! In other words, the company has a near monopoly in Chinese e-commerce, the world’s fastest growing e-commerce market. This is a company deeply ingrained in the lives of china’s emerging middle class. The sites have hundreds of millions of users, host millions of merchants and businesses, and handle more business than any other e-commerce company on earth.
Tom: Now I am beginning to understand all of the buzz about the IPO last week!
Mellody: I hope so! Tom, these numbers are eye-popping, and they keep going. When you look at the company’s profit margin, and compare it to other tech giants, it is staggering! Alibaba had $2.5 billion in revenues in the second quarter, compared to Google’s $16 billion in the same period. That means this company had $2 billion in net profits during the same period – 85% of its revenue – compared to Google’s $3.5 billion in profits, just 20% of its revenue. And these numbers are only expected to grow as Chinese consumers make and spend more money! All of this explains why this IPO was the biggest IPO in us history, raising $21.8 billion dollars, making it the one of the largest tech company in the world terms of market capitalization. Right now, it is larger than Facebook.
Tom: With those numbers, should we be jumping in on this IPO?
Mellody: As with every big IPO like this that gets tons of attention – and has numbers like those i just mentioned – the temptation to jump on the Alibaba bandwagon is going to be very hard to resist for many retail investors. However, i am always wary of hype around any stock, particularly IPO’s, and this one is no exception. This stock jumped from $68 on offering to over $90 dollars in its first day of trading! The expectations for this company’s performance are so high that anything but success is going to be considered a subpar. I don’t think that individual investors should get ahead of themselves on this one. Investors have to do their homework, because there are a number of questions that surround this deal, and a large helping of risk.
What makes me think there is considerable risk? The first is governance. Alibaba has very opaque governance’s structure, and there are not a lot of avenues for regular stockholder to have a voice. Control of the company is locked up by a group of insiders that have exclusive rights to nominate candidates for a majority of the board seats. So regardless of how the company is being run, common investors have no mechanism to weigh in. another concern is where the funds raised during the IPO go. Just over 61% of the expected proceeds will go to company executives and early investors. Less than 40% will go into the company’s operational coffers, according to Alabama’s latest IPO filing. At the initial price point of $68 a share, the Alibaba offering raised a ton of money – $8.5 billion for the Chinese firm’s coffers and $13.3 billion for insiders. And the stock soared in its first day of trading to over $90 a share!
This is not to say that investors won’t benefit from it – it may have been a very great buy – but advise everyone to wait and let the dust settle on this one. Some of these concerns mean that investors who got in too early have accepted a greater risk here than in other stocks out there. In the end, if the stock stumbles, it will have a long way to fall.
Tom: Are these challenges for all companies from developing countries?
Mellody: Not all companies, but certainly it is much more common for companies coming from emerging markets to list on us indices. However, companies from some countries are more risky than others. For example, corporate governance practices in Brazil or South Africa are much more similar to those of in the U.S., due to the fact that the legal structures here are based on European legal traditions. China is a different story, and represents some of the biggest challenges for investors looking to invest in companies based in emerging markets.
In recent years, Chinese companies listed on us exchanges have developed a reputation for conflict with the sec, particularly on transparency and disclosure requirements. an ABC news investigation found more than 100 china-based companies have been delisted, have left NASDAQ and new york stock exchanges, have been denied listing, or have withdrawn applications, all following allegations of fraud or accounting irregularities. By itself, this lack of transparency should make investors nervous. But there are also some big questions that remain to be answered when it comes to the legal conflicts between us and Chinese legal jurisdiction, particularly as they relate to Chinese companies and their financial obligations, right down to cash-flow rights.
Tom: Will the IPO have a ripple effect for our portfolios, Mellody?
Mellody: Absolutely. We have already seen the markets buoyed by the buzz around the IPO, and we could very likely see the tech sector get a boost over the next week or two. In terms of specific companies that might be impacted, and therefore could impact your portfolio, keep your eye on yahoo. Yahoo is expected to own around 16% of Alibaba. Since Alibaba was a private company until last week, when investors wanted to be exposed to Alibaba’s success, they would purchase yahoo stock. That’s now over, and yahoo has lost this status as a tracking stock. I think we can expect to see two impacts here. First, you will see yahoo stock being sold off. And second, we can expect people to go back and reexamine yahoo’s core business model and its fundamentals. If you subtract yahoo’s holdings of Alibaba, which were worth over $35 billion last week – and its holdings of yahoo japan – also worth several billion dollars, you are left with a much smaller value, perhaps even a negative number! So in the coming days we will see how investors value yahoo in the coming weeks and months. If they pass harsh judgment, we might see this push the yahoo to go private.
You may also want to keep an eye on your portfolio if you hold any amazon stock. When Alibaba launches in the U.S., they will directly compete with amazon. Alibaba founder jack ma has said they would look to expand aggressively in the us and Europe following the IPO to become what he described “a truly global company.” they would be starting from scratch, and that could be a challenge, but when you look at the numbers, they clearly know how to compete in the e-commerce space, they have deep experience doing it in a market that is arguably more challenging in terms of logistics, and they are wildly profitable – especially compared to amazon and its loss-leader model. As these two companies start competing in the same markets, or globally in the e-commerce sphere, you can expect a bloodbath, and it will only make it more difficult for amazon to send money back to their investors.