August 2014 Issue
China’s relationship with IPOs has been a difficult one. In 2012 the country enacted a moratorium on companies filing for IPO as it attempted to carry out a reform of its markets. The ban was predicated on a regulatory guided pricing system which had led to consistently excessive offering prices. Under the old systems, shares in IPOs tended to fall in value after listing.
Earlier this year Chinese firms also had to endure a four month sabbatical from domestic IPOs. They returned to the IPO market in mid June with the listing of seven firms on the Shanghai and Shenzhen stock exchanges. The offerings came after the China Securities Regulatory Commission granted approval for up to 10 firms to seek listings. China hopes to transform its IPO market, transitioning toward a registration-based system similar to that used in the United States. Many analysts expect the reorganisation of the Chinese IPO market to lead to a glut of filings through the remainder of 2014. Filings made by notable technology firms including Guangdong Ellington Electronics Technology, Shanghai Beite Technology and Shanghai Lianming Machinery on the Shanghai and Shenzhen exchanges reinforce the notion that China is about to firmly embrace the IPO market.
Although such domestic listings will garner headlines in China, the filing of domestic e-commerce giant Alibaba Group Holding Ltd in the US is markedly more significant. In May the firm filed for its IPO, putting the company on the path to what could eventually be the largest technology debut in history, surpassing Facebook Inc’s $16bn listing in 2012. According to data from Dealogic, Alibaba’s valuation following a $15bn to $20bn IPO would likely be in the region of $150bn. However some analysts and shareholders have suggested that the firm may be undervalued at that level, especially as Alibaba’s customers spent nearly $250bn on the firm’s group of e-commerce sites in 2013, a figure which exceeded the value of both Amazon and eBay’s transactions for the same period combined. Furthermore, the company saw its number of monthly active buyers increase by 44 percent to 231 million across its three marketplaces – Taobao, Tmall and Juhuasuan – in the last fiscal year. Alibaba has predicted that figure will continue to rise in the near future as the rapid development of Chinese society continues and the remaining half of the Chinese population eventually goes online.
As a result of Alibaba’s strong performance, the company’s revenues surged by more than half, and its net income in the first nine months of the 2013 fiscal year stood at $2.9bn. This is equivalent to 44 percent of all revenue – a profit margin far in excess of any other US or Chinese online company. In light of these very strong numbers, a valuation of the company at or around the $200bn mark has been mooted. 2013’s full-year free cash flow figure of around $5.2bn has led many analysts to predict a higher valuation for the firm. By way of comparison, Amazon is expected to generate $3.2bn in free cash flow in 2014, and its market capitalisation is around $137bn.
“Although it appears that Alibaba’s offering will prove immensely popular, it is unlikely that many of those companies hoping to ride Alibaba’s coat-tails will be anywhere near as successful in the short term.”
Alibaba’s forthcoming IPO, which is expected to come at some point in August depending on market conditions, will either take place on the New York Stock Exchange or the NASDAQ. The launch of the firm on either of those markets is expected to presage a flood of Chinese firms filing in the US in the coming years, particularly technology and e-commerce companies. There is already a cache of Chinese firms waiting to list in the US. Although it appears that Alibaba’s offering will prove immensely popular, it is unlikely that many of those companies hoping to ride Alibaba’s coat-tails will be anywhere near as successful in the short term.
The firm’s rise to prominence since it was founded in 1999 has been striking. Launching from an apartment in the city of Hangzhou, Alibaba now owns 80 percent of all online commerce in the world’s second largest economy. While there are currently no plans for Alibaba to expand its operations into American markets, it seems unlikely that the firm’s IPO filing will be the extent of its overseas ambitions. Alibaba’s relative autonomy when it comes to the Chinese government is one of the most important facets of its meteoric rise thus far in China, and will ultimately help the firm should it choose to expand into Western markets like the US. Further, the firm has been on something of an acquisition spree of late. Alibaba has either bought outright or purchased stakes in a number of local Chinese firms, including Youku Tudou, the country’s equivalent of YouTube, Weibo, the local Twitter-like micro-blogging site, and ChinaVision, a leading television-and-film production firm, among others. The company has also been pursuing investments in US firms. In light of the company’s recent forays, it may soon look to extend its core operations into that market as well.
Many Chinese firms in the US seem to operate almost anonymously, however this is unlikely to continue much longer. With China the US’ third largest trading partner, it is only a matter of time before Chinese firms and their brands make more of an impact on US markets. Whether Alibaba falls foul of US legislators, however, remains to be seen. Other prominent Chinese firms, such as telecommunications company Huawei Technologies Co Ltd, have seen their expansion hopes in the US hindered by their links to the Chinese government. In 2013 there were calls for Huawei to be banned from applying for network contracts in the US over fears that the company’s systems could have ‘back doors’ providing access for state sponsored hackers in the future.
Although Alibaba’s filing in the US is the most eye catching potential offering of a Chinese firm, it will not be the last. Some analysts have suggested that anywhere up to 30 Chinese companies may seek a listing in the US during 2014 if Alibaba’s offering is successful. By comparison, just eight Chinese firms filed for a US based IPO in 2013; however, those firms that did list performed admirably. According to data from EY, newly listed Chinese firms in the US saw their value rocket throughout 2013. On average, those firms’ valuations increased by 53 percent over debut price last year.
Not only have valuations grown impressively for Chinese companies listing in the US, operating in the American market itself provides Chinese firms with a number of benefits unavailable at home. Listing in the US exposes Chinese firms to features such as dual-class structures and an ability to list without having previously turned a profit. These options are not available in Hong Kong, for example. Further, the US market offers firms greater liquidity than the mainland Chinese IPO market.
Alibaba is not the only Chinese e-commerce firm applying for an IPO in the US. JD.com, backed by Saudi billionaire Prince Alwaleed bin Talal’s Kingdom Holding Co, also priced its own US IPO in May, just days after Alibaba listed. JD priced itself above the marketing range as it hoped to raise in the region of $1.78bn via its offering. The company, China’s number two ranked e-commerce company, priced its American Depositary Shares (ADS) at $19 per share, above the $16 to $18 per ADS indicated range. Accordingly the company has been valued at more than $25bn. The success or otherwise of JD is being watched intently by many would-be investors in Alibaba, who are hoping to see indicators of how the bigger firm will perform when it floats later this year. Through its offering, JD.com, which has forged a close partnership with Alibaba arch-rival Tencent Holdings Ltd, will raise $1.31bn from the sale of 69 million ADS. The firm also hopes to raise another $1.31bn by issuing shares to Tencent. The two companies agreed to merge their e-commerce operations in March 2014 and under the terms of that deal, Tencent agreed to subscribe to JD.com shares.
Although there are great expectations for Chinese firms listing in the US, there are still a number of challenges for those firms to overcome. The majority of Chinese firms utilise a controversial ownership structure known as variable interest entities (VIEs), which circumnavigates China’s rules against foreign ownership of Chinese businesses in sectors such as online retail and e-commerce. VIEs provide investors with access to a company’s profits but do not provide them any outright ownership of the firm. By utilising VIEs, foreign companies have amassed substantial holdings in Chinese firms including Tencent, Baidu and Alibaba in recent years. In this manner, US internet group Yahoo has been able to take a 24 percent ownership stake in Alibaba, a stake that is believed to be worth at least $42bn – more than Yahoo itself. As part of Alibaba’s IPO, Yahoo will be required to sell its outstanding stake in the firm.
VIEs have been remarkably popular. Since 1999 more than 200 Chinese companies have opted to list in the US and it is believed that roughly half of those firms used VIEs. However, any potential investors in Alibaba or any other Chinese firm utilising VIEs will take on a significant amount of risk should they opt to acquire shares.
Chinese laws prohibit foreign ownership of a majority of Alibaba’s Chinese assets. According to Alibaba’s filing, the firm will retain full ownership of its non-Chinese assets, and it is those assets which provide the bulk of the firm’s revenue. Under the terms of Alibaba’s offering, investors in the US will not be buying shares in Alibaba China; instead, they will be acquiring shares in a Cayman Islands entity named Alibaba Group Holding Limited. Rather than owning the company’s assets, the Cayman Islands firm instead has contractual rights to the profits of Alibaba China, but it retains no economic interest in that group. In its filing, Alibaba has recognised the risk involved in engaging in such an activity, noting that the company’s VIE structure may not be legal under Chinese law. Though it seems unlikely that the Chinese government would put a stop to Alibaba’s US offering, the possibility remains.
Should Alibaba’s IPO launch successfully and generate the sort of figures which have been suggested, the firm may take its place at the top of the global e-commerce table, while opening the door to the US IPO market for other Chinese firms to pour through.
© Financier Worldwide
BY
Richard Summerfield