By Joseph Hogue, Street Authority
StreetAuthority expert Jimmy Butts made a prescient forecast in October 2014 when he warned investors about the perils of initial public offerings (IPOs).
In his report, Jimmy laid bare the process by which Wall Street creates fervor for upcoming share issues through "road shows" and media hype.
Investors buy the newly issued shares from company insiders and underwriters and get left holding the bag when they are unable to find the proverbial "greater fool."
Facebook, Inc. (Nasdaq: FB) is the prime example, with shares surging on the first day of trading, only to drop by more than 50% over the following three months of trading. But just as Facebook may be the poster child for not getting caught up in the IPO frenzy, it's also the perfect illustration of a stock that can turn itself around after the post-IPO swoon.
And one mega-IPO from last year may have just found its Facebook moment.
This Global Powerhouse Has Lost Its IPO-Shine
In his look at IPO froth, Jimmy took note of Alibaba Group Holding Ltd (NYSE: BABA) and for good reason. The Chinese behemoth broke records as the largest IPO in history and the market rewarded it with stunning enthusiasm. Shares jumped 38% on the first day of trading, valuing the company at $231 billion.
The IPO frenzy couldn't continue. After all, at their peak, shares were valued at 27 times 2014 sales. A subsequent pullback from those highs, which has erased $60 billion in market value, was seemingly inevitable.
But just as Facebook was able to regain investor interest after its post-IPO crash, investors might want to start looking at China's largest e-commerce company as well. The catalyst: some recent deals that position it for dominating growth.
Alibaba has recently begun expanding its reach into the United States with trial deals to handle Chinese sales for retailers like Neiman Marcus and Saks Incorporated. Daiwa Securities Group estimates that demand for U.S. consumer goods in China may rise 1,800% to $291 billion by 2020 from $15 billion today. International commerce is still just 7% of total revenue for Alibaba and presents a big opportunity for growth.
To help jumpstart the U.S. sales efforts, Alibaba has announced a deal with peer lending platform LendingClub Corp. (NYSE: LC) to offer loans to U.S. businesses that are planning to sell into the Chinese market. Loans for up to $300,000 will be available at a monthly rate of 0.5% to businesses under the program.
Ironically enough, I warned investors not to get caught in the LendingClub IPO frenzy last year when the stock pushed past my $25 target on the second day of trading. Shares have now settled into the low $20's.
Growth Is Catching Up To Alibaba's Value
Even after the post-IPO tumble, shares of Alibaba trade for 17.5 times expected 2015 sales, but recent quarterly reports reveal strong growth metrics, justifying the strong valuations. Gross merchandise volume (GMV) rose 49% (year-over-year ) in the December quarter, with mobile GMV surging 213% to more than a third of total volumes. Revenue increased 40% over the same quarter last year and earnings per ADS (the equivalent of earnings per share for and ADR) increased 35%.
Still, that revenue growth has disappointed some analysts. Mobile sales carry lower margins, and that category's growth is impacting gross margins company wide.
Still, Alibaba is building a huge base of users with 265 million monthly active users in mobile alone and 334 million active buyers overall. Management stated in the December quarter that it was managing the business for growth in gross merchandise volume and active buyers, not for monetization rates. This sounds a lot like Facebook after its sales failed to live up to expectations post-IPO.
Despite management's focus on growth, monetization is slowly improving. When the company does shift its focus to faster-rising monetization, revenue should surge higher.
Shares trade for roughly 40 times the fiscal (March) 2015 earnings per share forecast of around $2.20 a share. That is pricey, but not alarmingly, given the company's 30% annual growth rate in both sales and earnings. That multiple might be considered a bargain when you note that shares of Amazon.com, Inc. (Nasdaq: AMZN) trade for more than 1,000 times expected 2015 earnings.
A short-term catalyst may come in the form of market listings for the Alibaba affiliate Zhejiang Ant Small & Micro Financial Services Group. Ant Financial Services was formerly known as Alipay and is akin to Paypal.
The financial services group announced in early February that it would sell shares in Mainland China later this year and possibly in other markets in 2016. The division is estimated to be worth $50 billion. That's double the estimated value made back in September 2014 and represents more than a fifth of Alibaba's market cap.
Ant Financial Services unveiled China's first credit scoring system this year and could eventually be a powerhouse in its own right. Investing in Alibaba shares now could provide investors with the opportunity to profit from IPO fervor for Ant Financial toward the end of 2015 and into next year.
I have a one-year target of $108 per share based on a forward multiple of 38 times fiscal 2016 estimated earnings of 2.85 per share. While the shares offer a near-term opportunity in the selloff, the real potential is for long-term gains as the company becomes the leader in global e-commerce.
Risks To Consider: As a Chinese company, regulatory risk for Alibaba is a constant issue, but the company has done well working with the government so far. Shares may be volatile whenever concerns about regulatory oversight are voiced, but should trend higher over the long-run.
Action To Take --> Take advantage of the selloff and the long-term opportunity to position your portfolio in what could one day be a global powerhouse. Recent deals help Alibaba to open the U.S. market and a 2016 IPO could support the stock price this year.Courtesy Joseph Hogue at Street Authority (EconMatters archive here)
The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.
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