Alibaba – great Chinese exposure on the US market

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How long have you held the stock?

Alibaba is due to list on the New York Stock Exchange on the 19th of September 2014. We are bidding for shares in the IPO process. Depending on our allocation of shares from the IPO, we may potentially buy more in the aftermarket, if the opening price is reasonable.

The K2 International Funds, however, have had some exposure to Alibaba primarily via our investments in Softbank and, more recently, Yahoo! Both Softbank and Yahoo! were early investors in Alibaba and they hold 34% and 22.4% of the company respectively. Yahoo! is expected to sell 6% of its holding in the IPO, whereas Softbank is expected to maintain its holding.

What do you like about it?

Alibaba is a company we are interested in, as it is positioned across a number of long-term structural growth drivers that we look for in a company.

The primary driver is rising internet penetration in China. Internet usage is surging, with China now having over 618 million internet users. However, this still represents only 46% of the population, compared to 87% of the population in the US. We expect that with growth in incomes, as well as increased access to PCs, tablets, smartphones, etc. that internet penetration rates will move up over time.

At the same time as this, we expect increasing take up of e-commerce by Chinese internet users. At present, China has 302 million e-commerce users (49% of internet users) and this compares to 61% of internet users in the US using e-commerce. As people become more comfortable with e-commerce, we again expect that the gap with the US will begin to close.

At 279 million active buyers, Alibaba has the dominant position in the Chinese e-commerce industry and hence is uniquely positioned to benefit from the structural growth drivers we’ve just mentioned.

How is it better than its competitors?

As mentioned, Alibaba has the dominant position in the Chinese e-commerce industry. In the technology space, we always invest in the dominant player. Whether in an incumbent area or as a disruptor technology, the largest company generally wins in tech due to network effects. Take Google as an example. If everybody is on Google, everyone will search with Google and hence everyone needs to be on Google.

What do you like about its management?

Alibaba is led by Jack Ma, executive chairman, who founded the company in 1999 from his apartment in Hangzhou. Ma is a former English teacher and started the company with a group of co-founders, including Joe Tsai, executive vice chairman, who has a background in private equity. The management team has done a terrific job building the company into the leading e-commerce player in China and, to date, management has executed on all growth initiatives and navigated all challenges.

One thing we will have to monitor is the M&A activity that management has been undertaking. Alibaba has been buying into businesses in adjacent industries, with the aim of gathering more data and increasing user engagement. This is a potential bear argument on the stock if concerns arise about management’s ability to make sensible acquisitions.

What is your target price?

We expect Alibaba to generate revenues of US$12.5 billion and a net income of US$7.3 billion for the 12 months to September 2015. Based on a peer comparative multiple of ~27.5x (simple average of Google, Baidu, Tencent and Facebook’s price-earnings multiples) we value Alibaba at approximately US$201 billion.

At what point would you sell it?

We would look to start selling our position as the share price starts to reflect our target price.

How much has it added to your overall portfolio over the last 12 months?

Given Alibaba hasn’t started trading yet, there has been no impact on performance.

Both the Softbank and Yahoo! investments have been positive contributors for our funds.

Is it a liquid stock?

We expect Alibaba to list at a market capitalisation of around US$155 billion. The stock won’t be as liquid as other companies of this size however, as the IPO is raising around US$20 billion and the majority of the equity will continue to be held by Alibaba management, as well as Softbank and Yahoo!.

Regardless, we expect the stock to be liquid enough for K2 to enter and exit with ease and we expect liquidity will improve once the lock-up on Jack Ma, Joe Tsai, Yahoo! and Softbank’s shares expires and they can sell their shares freely.

Where do you see the value?

Again, we see considerable value in the Alibaba business. It has a dominant market position in an industry that is supported by structural growth trends. In short, it is a fantastic business. However, we need to remain cognisant of valuations. We need to be prepared to sell shares if the price rises above our target valuation. Many tech companies look like exciting prospects, and most have strong growth ahead of them, but if you don’t buy them at the right price, then the inevitable bumps in the road on the way to success will have a disproportionate effect on those companies with huge valuations.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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