The best way for investors to buy in to Alibaba

Alibaba, the Chinese internet giant, will list on the New York stock market later this month.

It’s going to be one of the largest stock market listings ever, and it looks like the offer price will be reasonable. There’s a good chance that the share price will bounce in the first day’s trading.

Sadly, private investors in the UK won’t be able to get in at the very beginning, but that’s not a disaster. There’s another way for the likes of you and me to play the Alibaba story.

What does Alibaba do?

Alibaba is basically a Chinese Amazon, eBay and Paypal wrapped up in one company. 80% of China’s online retail purchases are transacted on one of Alibaba’s sites. On top of these consumer websites, Alibaba also operates a business-to-business platform that enables small Chinese businesses to sell to customers around the world.

Alibaba is also broadening out from e-commerce. Last year it launched a money market fund called Yu’e Bao which has been a phenomenal success. The fund pays a higher interest rate than conventional Chinese savings accounts and has already pulled in more than $90bn. And Alibaba also has a stake in a Twitter-style service called Weibo.

What’s the valuation?

Alibaba is expected to list with a share price somewhere between $60 and $66. (If demand for the shares is unexpectedly high, then the listing price might be higher.) At $63, Alibaba would be valued at around $155bn. That would put Alibaba on a multiple of 18 times sales which looks very high at first glance. (Last year’s sales were $8.5bn.)

However, the company doesn’t look so expensive if you focus on profits – it will open on a price/earnings ratio of 41. That’s obviously very high for most companies, but for a fast-growing tech company, it’s not so unreasonable. Remember there’s plenty of potential for further internet growth in China. You could also argue that the Alibaba sales figure understates the true scale of the company. Sales represents commissions and fees that Alibaba receives – total sales by all the different vendors on the Alibaba network came in at $248bn last year. That’s twice as much as Amazon.

Are there any downsides?

Don’t get me wrong though, Alibaba does have a couple of downsides.

The big issue is governance. Alibaba already has a rotten reputation in this area. Back in 2010, it sold its payments business, Alipay, to Alibaba’s founder, Jack Ma, for far too low a sum. After a huge fuss, Alibaba did backtrack on this, but it’s still a worry that Alibaba and Ma might try a similar trick in future. Shareholders will have limited control over the board, which will really be run by ‘partners’ in the business.

There are also concerns about what non-Chinese Alibaba shareholders will actually own. Because Alibaba is seen as a ‘strategic asset’ in China, overseas shareholders can’t directly own shares. Instead they buy a stake in a ‘variable interest entity’ that will receive some of the profits that Alibaba will make. There are no guarantees that Chinese courts will uphold the rights of the variable interest entities. So there is a fair bit of risk here.

That said, given the growth potential, I think there’s a good case for taking the risk and investing in Alibaba. Indeed I think the proposed $155bn valuation undervalues the company a little. And Wall Street analysts seem to agree – Bloomberg has polled 11 analysts and their average valuation for the company is $187bn. Yes, of course, analysts are often very wrong, but their positive stance suggests that, at the very least, we’ll see a short-term spike in the share price.

Yahoo is a great proxy

If you’re tempted to invest in Alibaba, you may prefer to invest in Yahoo rather than try to buy Alibaba shares in the days after the listing. I highlighted Yahoo as a potential proxy for Alibaba back in March, and I still think the company looks attractive.

Yahoo currently has a 22% stake in Alibaba and will sell 121 million Alibaba shares in the listing, which will raise around $7bn. It will then retain a 16.3% stake, which should be worth around $24bn when Alibaba lists. Yahoo also owns a stake in Yahoo Japan which is worth around $7bn. Yahoo will have to pay some tax when it sells shares, and there’s a fair amount of uncertainty about what the final tax bill will be.

Still, even after a recent rise in the share price, Yahoo’s total market cap is only $41bn, so it’s pretty obvious that the market isn’t ascribing much value to Yahoo’s core business. Now I can understand that – Google has completely eclipsed Yahoo when it comes to internet search, and Yahoo still hasn’t really found a role for itself. What’s more the recent financial results were disappointing – adjusted operating profit fell 7% year-on-year.

However, the relatively new CEO, Marisa Mayer, has been making the right strategic moves. Her emphasis on mobile and developing exclusive proprietary content makes a lot of sense to me. More and more people are visiting Yahoo’s mobile sites and I still think that will deliver a boost to Yahoo’s financial performance eventually.

So for me, Alibaba looks like a good way to play the long-term China growth story, and Yahoo is a simple way to give you access to Alibaba.

• This article is taken from our free daily investment email, Money Morning. Sign up to Money Morning here.

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