News & Our Thinking

(St. Louis Post Dispatch)

““It’s not a pie-in-the-sky share price,” says Ying Ko, a senior analyst at Argent Capital Management in Clayton. “On the surface, it looks like a legitimate company, and their business model makes sense.”

September 26, 2014  (David Nicklaus)

If you were daydreaming last week when Alibaba Group Holdings made its IPO, you might have imagined for a moment that you were back in 1999.

The Chinese e-commerce company raised its price at the last minute, making it the largest initial public offering in world stock market history. Then a buying frenzy sent Alibaba’s shares up 38 percent in their first day of trading.

This invited all sorts of comparisons implying that investors had lost their senses. Alibaba raised $25 billion, more than 13 times the size of Google’s IPO a decade ago. Its market value, at $220 billion, is bigger than Facebook’s and about the same as that of JPMorgan Chase, one of the world’s largest banks. Amazon and eBay would have to merge to equal the market heft of the Chinese newcomer.

There’s a lot more to this IPO party than flavor-of-the-month fascination, however. Alibaba has a lucrative business that it runs through a variety of websites. Its profit margins are mouth-watering, and its revenue growth has averaged 85 percent in the last five years.

By some estimates, it handles four-fifths of all Chinese online shopping.

Alibaba has ambitions of expanding into other countries, but even if it doesn’t, it will benefit from a Chinese middle class that’s growing rapidly and has barely begun to shop online.

“It’s not a pie-in-the-sky share price,” says Ying Ko, a senior analyst at Argent Capital Management in Clayton. “On the surface, it looks like a legitimate company, and their business model makes sense.”

By technology-stock standards, Alibaba’s share price actually looks reasonable. Based on analysts’ forecast for next year’s earnings, Alibaba trades at a price-earnings ratio of 34, which is double the ratio for a broad index like the Standard & Poor’s 500.

Facebook, though, has a P/E ratio above 40. Amazon is at 85. If you’re looking to call something overpriced, those U.S. companies might be better candidates than the Chinese one.

David Ott, chief investment officer at Acropolis Investment Management in Chesterfield, notes that Alibaba is growing faster than Amazon and has much fatter profit margins, partly because it doesn’t operate its own warehouses.

“I think Amazon is pretty rich,” he said. “At this point, I think Alibaba is probably overvalued, but not radically because it is growing so quickly.”

To be sure, there are reasons to value a relatively young Chinese company less richly than a well-understood business like Amazon. Some investors are concerned about a governance structure that gives founder Jack Ma ironclad control over Alibaba and its payments company, Alipay. MSCI, a stock index provider, called the firms’ governance “worst in class.”

The company also has to stay in the good graces of China’s Communist Party. “The government is always a risk factor when you talk about China,” Ko said. “As Alibaba becomes bigger and bigger, will the government come in and start meddling?”

Even with such questions looming, it’s easy to see why investors are tempted by Alibaba’s eye-popping growth numbers, and it’s hard to make a case that the company is vastly overvalued.

Ott isn’t buying Alibaba at these prices, but he doesn’t see the IPO as a sign of a new stock-market bubble. “Technology is not in that flashing red-light zone that we were in during the 1990s,” he says.

A yellow caution light, maybe. We may not be replaying 1999, but exuberance is certainly back in style.