This is a guest post by Ana Swanson, an analyst at JL Warren Capital LLC. Watch a video of Ana discussing the Alibaba IPO on CNBC here.
Working in the newest sectors of the Chinese economy is a high-risk, high-return business. That’s likely to be the takeaway from the Chinese central bank’s announcement Monday that it will limit the amount that Chinese can spend using smartphone payment services – potentially cutting off a multibillion dollar business for Chinese internet giants Alibaba and Tencent (0700.HK).
Alibaba, the Chinese e-commerce company that recently abandoned the Hong Kong exchange and is preparing for a U.S. initial public offering, has made big forays into internet finance over the past few years.
Since launching last June, its Yu’e Bao online investment platform has grabbed headlines by acquiring 80 million new users and $80 billion in funds, making it the fourth largest money market fund in the world. Alibaba also operates Alipay, China’s dominant online payments system, and a successful small business lending platform. Alibaba’s extensive knowledge of the online shopping habits and creditworthiness of Chinese consumers and businesses undoubtedly have given it an advantage in these ventures.
The field of internet finance offers almost endless opportunities, but some of Alibaba’s efforts are being stifled by regulation. On March 14, the Chinese central bank blocked efforts by Alibaba and Tencent to release virtual credit cards linked to their online payment tools and settle payments using Quick Response (QR) codes, citing security risks. On Tuesday, Industrial and Commercial
Whether these new regulations are motivated primarily by security risks or threats to well-connected business interests is unclear, though both factors likely play a role.
The risks of security breaches, identify theft, and money laundering are very real in the wild west of Chinese internet finance. But it’s also true that new developments like online investment platforms, virtual credit cards, and QR payments threaten powerful monopolies such as those held by China UnionPay, the country’s offline payment business, and China’s big four banks. Surging bad loans and more competition for profits are weighing heavily on Chinese banks:
This increasing regulation has sparked concerns over Alibaba’s upcoming IPO. Will regulations dent what could otherwise be an extremely high valuation?
Given China’s top-down, heavy-handed style of governance, businesses in China are constantly at the risk of unpredictable regulation. This new spate of regulations undoubtedly poses a risk to Alibaba’s business, especially in the medium and longer-term. Investors in the Alibaba IPO should keep other risks in mind as well: Fake products abound on Taobao and Tmall, and Alibaba faces increasing competitive pressure in a high-stakes and rapidly evolving sector.
Yet Alibaba’s IPO still seems likely to be well received. JL Warren Capital estimates Alibaba’s valuation at $150-200 billion, based on estimated 2015 earnings of around $6 billion and a conservative price-earnings ratio of 30. The key to this valuation is Alibaba’s core business: Taobao, Tmall and
That section of the business remains robust and inspires a dizzying array of superlatives. Alibaba is the largest and most profitable e-commerce company in China by every measure: It controls roughly 80% of China’s e-commerce market, a market that is larger and growing more rapidly than that of the US. Alibaba handles more goods than Amazon (AMZN.NASDAQ) and eBay (EBAY.NASDAQ) combined. On its busiest shopping day last year, Alibaba alone sold three times as many goods as were bought in the entire U.S. on Black Friday. Alibaba dwarfs China’s number two e-commerce company, JD.com, whose IPO roadshow in New York earlier this year was met with a lukewarm reception.
Alibaba is also likely to be attractive to investors because it provides a way to buy into China’s new economy. With stimulus measures slowing and non-performing loans on the rise, investors are not looking kindly on Chinese banking and property stocks, the traditional mainstays of the economy. The Chinese government has made repeated commitments to its goal of shifting the country from an economic model driven by investment to one driven by consumption and technology.
While the extent to which regulators will allow these new sectors to grow freely remains uncertain, Chinese e-commerce has gathered a momentum that will be hard to slow. If investors are looking to gain access to China’s new economy, Alibaba may be a good place to start.
Ana Swanson is an analyst for JL Warren Capital, an equity research firm focused on Chinese companies and the Chinese economy.
