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Lessons From the Past: What Alibaba Can Learn From the Google IPO (Part 2)

This is a continuation of my previous blog post about the Google IPO. There has been a lot of talk in the media recently about the upcoming Alibaba IPO, so I thought it would be interesting to analyze another very publicized IPO that happened about ten years ago– the Google IPO. Tech IPOs as big as Alibaba’s or Google’s don’t happen often, so Alibaba could learn some valuable lessons by looking to the past. The previous blog post described the structure of the Google IPO and this blog post will discuss the result + some of the successes and shortcomings of the IPO.

The Result of the Google IPO

In traditional book-built IPOs, large financial service providers (usually banks) partner with the company wanting to pursue an IPO and assess its worth in order to determine a share price for the IPO. These banks (referred to as underwriters) have an incentive to underprice the IPO offering price in order to guarantee that all shares will be sold.

Google, at least within the public eye, wanted to eliminate this tendency to underprice by using the auction format (discussed in previous post). Some good evidence for this exists in Google’s initial S-1 filings which read, “Buyers hoping to capture profits shortly after our Class A common stock begins trading may be disappointed” (Google Form S-1, note 238).  Ultimately however, the results of the Google IPO auction were not analogous with Google’s stated goals. After uncertainty about the IPO grew due to concerns brought up by the SEC, Google adjusted its original price range of $108-$135 to $85-$95 per share, and later established a final price of $85 per share. Rather ironically, after the first day of trading had completed, Google’s share price rose from $85 to $100.34. Despite its unique structure, the results of the Google IPO seemed very similar to what would have occurred if Google had simply pursued a traditional book-built IPO.

Possible Alterations

After seeing the somewhat disappointing results of the Google IPO it is natural to ask what could have been done differently. Traditional game theory asserts that an auctioneer’s aims in an auction are five-fold: (1) to extract as much revenue as possible, (2) to allocate ‘prizes,’ or shares efficiently, (3) to gather accurate information about bidder’s valuations, (4) to encourage new bidders to participate in the auction, and (5) to attract attention to the auction. Based off of the results observed, it seems that Google only succeeded in achieving the fifth goal.

One possible improvement that could have been made is electing to enlist one experienced underwriter to lead the underwriting syndicate, rather than two inexperienced underwriters. Google chose Credit Suisse First Boston LLC and Morgan Stanley & Co. Inc., two of the leading investment banks in the U.S., to lead their underwriting syndicate. Unfortunately, neither of these banks had any experience with auction-based Internet IPOs. Electing one leading underwriter with more experience could have led to better communication between Google and the underwriter as well as increased efficiency in Google’s attempts to increase the pool of potential investors.

Conclusion: Same Result, More Hype

In conclusion, I think that Google’s goal for the IPO was to create more public excitement for the company. By using an untraditional IPO auction structure, Google was able to generate increased media attention and use its IPO as not only a catalyst for company revenue, but also as a largely effective marketing tool. Despite achieving similar results to traditional book-built IPOs, Google may have profited more from its IPO in the long run by generating new potential users and customers.

Furthermore, it is worth noting that Google did succeed in two of its initial goals: one, offering the shares to a larger group of people including private investors versus just financial institutions, and two, Google succeeded in paying a lower percentage to underwriters than experienced in traditional book-built IPOs. For a big tech company like Alibaba it may be wise to follow in some of Google’s footsteps as it prepares to hold its own IPO within the next month.

Lessons From the Past: What Alibaba Can Learn From the Google IPO (Part 1)

There has been a lot of talk in the media recently about the upcoming Alibaba IPO, so I thought it would be interesting to analyze another very publicized IPO that happened about ten years ago– the Google IPO. Tech IPOs as big as Alibaba’s or Google’s don’t happen often, so Alibaba could learn some valuable lessons by looking to the past. This blog post will be dedicated to describing the structure of the Google IPO and the next blog post will discuss the result + the things Alibaba can learn from the Google IPO.

Introduction and Context

Google filed for its initial public offering on April 29, 2004. The goal of going through with an IPO is the same for practically any company—to raise capital from the sale of shares in the company ownership. Google’s goal was no different, but after seeing how technology companies had faired using standard book-building IPOs, especially during the dot-com boom of the nineteen nineties, Google’s executives decided to change things up and use what is known as an auction IPO. In theory, an auction IPO is supposed to limit the underpricing of and restricted access to initial stocks typically experienced in a standard book-building IPO.

Structure of Google IPO Auction and Comparison to a Pure Dutch Auction

From the outside, the structure of the Google IPO auction seemed very similar to that of a standard pure Dutch auction. The general public had an opportunity to bid on shares in Google before the shares actually got released, and the auction format was used to determine which bidders actually got to buy the shares. Because an initial public offering is done once, this auction is an isolated occurrence. The auction is run once, allocating the company shares to specific bidders. After, these bidders can trade these shares amongst each other. Google can, in principle, sell more shares of its company in the future, however this sale would not be considered an IPO anymore.

In a standard Dutch auction (as related to an IPO) a company initially determines a price range and a maximum number of shares that can be sold during the IPO. Bidders then submit bids based on their localized demand, stating a price within the established price range and the number of shares they want to purchase at that price. The company then evaluates all the submitted bids and establishes what is known as a clearing price. The clearing price is the maximum price within the established price range at which all the designated amount of shares can be sold. After the clearing price is established, all winning bidders are sold their desired amount of shares at the clearing price. This bidding structure allows the company to maintain more control over price and allocation than in a standard book-built offering, in which the ‘clearing price’ is determined by an underwriter’s evaluation of the worth of company shares. It also is supposed to limit the underpricing of shares and establish a fairer offering price because the clearing price is a direct result of bidder competition. The larger the demand for the shares, the greater the clearing price, and vice versa.

There was one significant characteristic of the Google IPO auction that made it different from a traditional Dutch auction. Unlike the Dutch auction, in which the clearing price is determined solely by the bids submitted, Google executives maintained the option to rule out or ignore bids they deemed speculative. This essentially meant that the actual clearing price of the auction would not necessarily be the ultimate offering price. Google executives could adjust the price upwards or downwards depending on their own or their underwriter’s judgment. Thus, the main characteristic of the Dutch auction that allowed it to establish a more accurate or fair market price than the traditional book-building method was thoroughly undermined by Google.

The Challenges of Alibaba’s Yu’e Bao

In my previous post, I discussed the development of Yu’e Bao, a money market fund controlled by Alibaba. With the company’s leading position in e-commerce and the strong client base, the fund tripled in size during the first quarter with a total of 541.28 billion yuan under management in comparison with 185.34 billion yuan at the end of last year, making it the fourth largest in the world in terms of asset value.

Nevertheless, I think there are three main challenges behind the gorgeous achievement.

First, the yield is decreasing. Since the Chinese central bank has been engineering a decline in the Chinese yuan by purchasing the US dollar and increasing the daily trading band of the yuan, interest rates are expected to decrease in the near future. Although Alibaba is able to negotiate higher returns on deposits than what ordinary savors are obliged to accept, the declining interest rates would pose potential risk to the money-market fund. A signal is that the rate fell to around 5.5% now from its peak of 6.8%. Considering the fact that more than 90% of the fund is invested into bank deposits, further slides on return might be inevitable.

Second, traditional banks are fighting back with diversified wealth management products. Those state-owned banks fell behind Yu’e Bao in the competition for liquidity because the rate of a one-year deposit is capped at 3.3%. Nevertheless, they are bypassing the deposit requirement by offering the so-called “wealth management products”, which is just another channel of financing. Basically, they offer higher-than-deposit rates on financial products sold to the general public and then charge even higher rates on lending to government-led investment projects. The return in this scenario tends to be 5%, a level similar to Yu’e Bao’s.

Third, Yu’e Bao will have to face stricter regulation. There have been concerns that a significant portion of the fund flows into untested and unregulated investments eventually, threatening the stability of the overall financial system. People’s Bank of China Governor Zhou Xiaochuan said recently that while the central bank wouldn’t “crack down” on the products, it would improve regulations. Furthermore, since state-owned banks have dominated the nation’s financial sector for years with profoundly political influence, the regulatory authorities might be forced to curb any emerging power just like Yu’e Bao for protection of traditional banks’ profitability.

In terms of Yu’e Bao’s future, I believe there will still be great opportunities down the road because of its private capital nature and the ongoing financial reform in the country. Ordinary Chinese people have limited investment channels, so the promising Yu’e Bao could be a favorable complement to bank deposits and therefore increase their wealth level, an accomplishment in line with the government’s goal of boosting domestic consumption for economic growth.

The Development of Alibaba’s Yu’e Bao

Alibaba Group Holding Ltd., China’s Internet giant, has been diversifying its business exposure from a pure e-commerce provider. The company broke into the financial sector years ago by creating an affiliate called Small and Micro Lending Group, which offers loans mainly to China’s small and medium enterprises. Another attention-grabbing initiative was the inception of Yu’e Bao, which means “leftover treasure” in Chinese.

So what exactly is Yu’e Bao? It is a money-market fund originated from Alipay, Alibaba’s electronic payment system. With Alibaba’s leading position in e-commerce and the strong client base, the fund tripled in size during the first quarter with a total of 541.28 billion yuan under management in comparison with 185.34 billion yuan at the end of last year, making it the fourth largest in the world in terms of asset value. More surprisingly, the surge was done in just eight months.

Yu’e Bao was launched in June last year when China’s banking system was in the midst of a so-called “cash crunch”—state-owned banks were offering higher returns to attract funds and increase reserves after a surge of risky and untested credit growth. However, since the interest rate of a one-year fixed deposit was capped at 3.3% by China’s central bank and the Alibaba-backed fund initially offered around 6%, traditional bank deposits fell short of Yu’e Bao in the competition of liquidity.

Regarding the reason why it could offer higher yields than traditional deposits, it is attributed to Alibaba’s bargaining power with banks. According to the report of Tianhong, the third-party asset management firm in charge of the fund, more than 92% of the fund is invested into bank deposits because of its nature as a money-market fund. Since Alibaba is able to negotiate higher returns on deposits than what ordinary savors are obliged to accept, the yields for the fund’s investors are relatively higher.

Extensively speaking, Yu’e Bao’s popularity was derived from Alibaba’s credibility as a strong and trusted e-commerce provider. On the side of savors, the higher yielding fund offered better-than-deposit returns and convenience as well—savors can withdraw their funds whenever they like. On the side of Alibaba, the development of the fund would attract funds from online shoppers and ordinary savors, making it an extra money-making channel and a potential stimulus for consumption on the company’s online shopping sites, Tmall and Taobao.

In terms of the nation’s entire financial system, the fund has become an emerging power that is challenging those lumbering state-owned banks by pushing them to develop stronger risk management, diversify products offerings, and offer higher yields to savors in the process of interest rate liberalization.

Alibaba: Countdown to U.S. IPO

Alibaba Group Holding Ltd, China’s Internet giant, has decided to launch its IPO in the U.S. rather than in Hong Kong. The company is expected to raise as much as $15 billion in the listing, making it one of the largest ever in the U.S.

Currently, the two major U.S. stock exchanges, NYSE and Nasdaq, are competing for the high-profile listing by offering discounts on certain fees and increasing visibility. It is widely believed that the exchange that “wins Alibaba will have bragging rights and momentum” for other technology IPOs, leading to greater financial impact and trading revenues.

So here comes the question: Who is Alibaba?

The company is like as a mix of Amazon, eBay and PayPal, with a dash of Google thrown in, all with some uniquely Chinese characteristics.

Phase 1 – The Legendary Inception

Alibaba was created in 1999 by Jack Ma, an English teacher in the eastern Chinese city of Hangzhou. Internet was like a UFO to most Chinese at that time, so when Jack tried to promote Alibaba.com, a trading website that connected Chinese manufacturers with overseas buyers, many people considered him as a fraud. “How can you sell things in the virtual world of Internet? That is impossible!” Jack was rejected repeatedly. Instead of giving up, he was persistent and embraced a breakthrough by obtaining funds from Softbank, a major angel investor in Japan. Through Jack’s continuous concept pitch of Internet and online business, the company achieved profitability in late 2001.

Phase 2 – The Era of E-Commerce

Initially, Alibaba was focused on the B2B marketplace (Businesses to Businesses). Starting 2003, the company began to diversify its portfolio by creating Taobao.com, a C2C marketplace (Consumers to Consumers), and Tmall.com, a B2C marketplace (Businesses to Consumers).

Taobao is mostly for small businesses, on which they don’t pay to sell products. Instead, they pay Alibaba for advertising and other services to allow them to stand out from the crowd. Comparatively, Tmall was designed for bigger merchants, including many well-known brands such as Nike and Apple, on which they have to pay a deposit and an annual fee, as well as a commission on each transaction, for sales.

In 2012, the combined transaction volume of Taobao and Tmall topped one trillion yuan ($163 billion), more than Amazon and eBay combined.

Phase 3 – Go Beyond: A Conglomerate across Various Sectors

Alibaba’s huge success in e-commerce allowed it to break into sectors other than Internet for even larger impact on China’s economy.

1) Logistics

The company claimed that Taobao and Tmall account for more than half of all parcel deliveries in China. Following that, Jack has integrated the company’s advantage in transaction volume, data mining, and extensive networks to create a logistics firm called Cainiao. The vision is to facilitate infrastructure development by teaming up with other major players in the private sector as well as the Chinese government for more efficient online orderings and parcel deliveries.

2) Finance

One of the key determinants for the company’s success is the initiative of Alipay, an electronic payment system that protects buyers if sellers don’t deliver. This effective tool has been leveraged for the development of lending and financial products. On one hand, the company created an affiliate called Small and Micro Lending Group to address the financing problem facing China’s small and medium businesses. On the other hand, it launched a money-market fund for the general public, which became one of the world’s largest in just eight months. Furthermore, Alibaba was selected as one of the five private banks in a pilot program aimed at breaking the state-dominated banking monopoly in the country. As a result, the Internet giant will be capable of running businesses of corporate finance, investment management, venture capital, and even more.

Probably no one can accurately predict the size of Alibaba in the future, but what we can say for sure is, its magic will continue.

Alibaba V.S. Tencent

It’s big news recently the fancifully named Chinese e-commerce company Alibaba Group said Sunday it will begin the process of an initial public stock offering on the New York exchange soon. Analysts say it could raise $15 billion.  (Chinese e-commerce giant Alibaba sets U.S. IPO)

According to WSJ, Alibaba: A Mix of Amazon, eBay and PayPal With a Dash of Google, Alibaba Group Holding Ltd.— which is preparing to launch perhaps the largest U.S. stock listing ever of a Chinese company. It might be a little bit hard for Americans to understand the composition and functioning of Alibaba, perhaps the best way to understand Alibaba is as a mix of Amazon, eBay and PayPal, with a dash of Google thrown in, all with some uniquely Chinese characteristics. Alibaba’s revenue is about one-tenth of Amazon’s because the Chinese company doesn’t sell products on its site. But Alibaba is far more profitable. Alibaba’s third-quarter revenue rose 51% from a year earlier to $1.78 billion. Net profit was $792 million, giving the company a profit margin of 44.6%, according to shareholder Yahoo Inc., which owns a 24% stake in Alibaba. Amazon posted revenue of $17.09 billion and a loss of $41 million in the same quarter.

It seems really a success that Alibaba sets IPO in US. But in indeed, it might be a “desperate” choice for Alibaba. We have to mention another Chinese Giant company Tencent here. If we regard Alibaba as the mixture of Amazon, eBay and Paypal, Tencent is the mixture of Facebook、Twitter、Tumblr and Zynga. Isn’t it incredible?

Tencent is known as the first competitor of Alibaba in China. In this month, to further bolster its e-commerce capabilities, Tencent announced a deal to buy a 15% stake in JD.com Inc., China’s second-largest e-commerce firm (Which has 18.3 percent share in China while Alibaba has more than half). However, Alibaba lost to Tencent as smartphone and tablet usage surged over recent years. WeChat, known as Weixin in China, had 272 million monthly active users as of September and has quickly grown from a messaging app to a full-fledged platform, letting users play games, book taxis, make online payments and even invest in wealth management products. Smart marketing systems, like a gift-giving service that was rolled out for Chinese New Year, were highly successful in drawing new users onto the WeChat Payment system. (Tencent-JD.com partnership goes straight for Alibaba’s throat) The cooperation of Tencent and JD is really a threat to Alibaba since they now can both be in the Smartphone and Website markets in China.

We are guessing now, is the IPO in US as a fight back to Tencent?  Who’s the winner? Still unknown.

 

 

 

Alibaba: The Tech Company to Rule them All?

A recent article on canadianbusiness.com, “Why Alibaba’s IPO will make it the next global tech powerhouse,” discusses the strong potential of an online Chinese tech giant I had not heard of up until now- Alibaba. After reading the article, I couldn’t believe I had never heard of it before. Get this:

  • In 2012, two of Alibaba’s platforms processed more than US$160-billion worth of goods, more than Amazon and eBay combined.”
  • “Mark Mahaney, a tech analyst for RBC Capital Markets, recently pegged its worth at $150 billion. That makes it the third-most-valuable Internet company in the world, after Google and Amazon.”
  • “Consider that total U.S. sales on Cyber Monday in 2012 reached $1.5 billion, according to data from Bloomberg. Alibaba’s sales on Singles’ Day, a modern Chinese celebration held around the same time as Cyber Monday, totaled $3 billion.”

The company hasn’t even gone public yet and is already posting revenues bigger than practically all well-established U.S. tech companies.

The natural question to ask after seeing such dramatic figures is what is Alibaba and what is making it so successful? In short, Alibaba is an online retailer based in China that offers numerous platforms that connect buyers and sellers. Some of its more notable platforms include alibaba.com (connects small and mid-sized Chinese and international producers to international buyers), taobao.com (ebay-like platform that connects individual sellers to individual buyers), tmall.com (allows well-established, brand-name producers to sell directly to consumers and is set to surpass Amazon in 2015 as the biggest online retailer). The platform that I think has some of the most potential, though, is Alibaba’s payment program called Alipay, which, as the article states, now accounts for roughly half of China’s online payments market. Alipay has expanded its efforts from just offering a safe environment for transactions, and now offers loans to budding entrepreneurs and startups that eventually sell their products on Alibaba’s platforms. Additionally, Alipay is the likely candidate to become the dominant online payment system in emerging economies in Africa and Latin America. In so doing, Alibaba is slowly growing its influence over production, marketing, and selling of consumer products.

Furthermore, practically all of the world’s production of consumer products is done in China and Alibaba already has a firm link to Chinese manufacturers and wholesalers. With its IPO looming, its influence will grow far past the Chinese market, allowing it to connect Chinese producers to consumers worldwide. It will be very interesting to observe the development of impact of Alibaba on world markets in the coming years. With connections to a vast amount of producers and the largest population of consumers, Alibaba is heading for the top spot in the tech-giant rankings.