Major Tian Authors

Jack Ma Picked an “Excellent Time” for the Alibaba IPO

September 25, 2014

The Alibaba IPO, which debuted on the NYSE last week, has broken all sorts of records. What are its prospects going forward?

The long wait is finally over—Alibaba’s New York Stock Exchange (NYSE) debut last Friday has officially become the world’s largest IPO ever. With an initial offer price of $68, the company raised a whopping $21.8 billion; and since the underwriters of the deal later executed the “Greenshoe option”, which allowed them to buy an additional 15% of Alibaba’s shares at the offer price. The IPO then swelled up to $25 billion, surpassing Agriculture Bank of China’s sale of $22.1 billion in 2010 and taking the title of the world’s largest IPO.

Fueled by strong demand from the secondary market, the opening price on NYSE jumped 36% to $92.70: and by the end of the day, it went up to $93.89. The 38% overall climb on the first day is the biggest for any IPO larger than $10 billion, according to Bloomberg’s data.

While the underwriters walked away with hefty paychecks—more than $300 million in total, investors now face real, hard choices. After the third day of trading, the stock price dipped to $87.17; the price recouped 3.9% to $90.57 on the fourth day but is still below the opening price. Although Wall Street remains bullish in general on Alibaba’s stock price (some predicted that it would double in a year), in the short term, the price could continue to fluctuate and react to various indicators of the company’s growth potential.

“Jack Ma has picked an excellent time to take his company public,” said Lubos Pastor, the Charles P. McQuaid Professor of Finance at the University of Chicago’s Booth School of Business, during a recent interview with CKGSB Knowledge. “The flipside of it is that it’s not a very good time to be bullish (on the broader market).”

Thanks to loose monetary policies by central banks around the world, Pastor said, investors have a huge appetite for risk, which is pushing asset prices high and potentially diminishing future returns. And for growth companies, their stocks have historically tended to underperform the market by an average of 20% in the three-to-five year period after they went public, Pastor said, adding that Alibaba might not be the “average IPO”, given its unprecedented size.

In this interview, Pastor shares his thoughts on the e-commerce company’s future growth and risks that Alibaba and the market may face down the road.

Q. Did you expect such a huge jump in Alibaba’s stock price on the first day?

A. I expected the price to go up, but I was surprised by the magnitude of the jump. Thirty-eight percent is a big jump. Historically in the US, IPOs have jumped about 18% on the first day. So I think it suggests that market is very confident in the company’s future. That’s good news for Jack Ma and his friends. I guess the flipside is that they left about $9 billion on the table, maybe a bit more than what was necessary to grab the headlines.

Q. Where do you think the price will go in the short term?

A. In the short term, it’s virtually impossible to predict stock price movements. The only thing I can say with certainty is that the price will fluctuate.

But if you look at a slightly longer-term horizon, say three to five years, we have some historical academic research that suggests that IPOs tend to underperform the broader market. On average, in the US, averaging across all IPOs, we see underperformance of about 20% relative to the broad market index. But Alibaba may not be the average IPO—it’s a large company, which tends to do somewhat better down the road.

Q. What does the strong demand for Alibaba shares say about the broad US market? Is it a bullish sign?

A. It’s pretty clear to me that Jack Ma has picked an excellent time to take his company public. Right now, in the US, there’s a lot of appetite for risk, of precisely the kind that Jack Ma is bringing to the market. This is an environment with rock-bottom interest rates with very low bond yields, so investors go out of their way to find investment with more than just trivial rates of return. So this is a great time to be raising money in the market.

The flipside of it is that it’s not a very good time to be bullish—I’m certainly not bullish. In the time when investors have such huge appetite for risk, prices tend to be very high and future returns tend to be lower.

Q. Is the Federal Reserve’s action still a risk to the market?

A. There are two big things that the Federal Reserve has been doing: one is keeping interest rates low, and they’re planning to do that for a considerable time; they’re also buying bonds—the famous quantitative easing (QE).

It’s very well-known that QE is about to end next month—the Fed has been very good at communicating its intentions to the public. So the market has known for a long time that the QE is being wound down. I’m a bit surprised that the market is as rich as it is despite QE being wound down.

And in terms of interest rates—based on the official communications from the Fed, [raising rates] certainly is not going to happen this year. It could happen in the second half of next year. The Fed is not going to do anything unexpected.

Q. Given the size of Alibaba’s IPO, will it have any impact on other Chinese technology stocks in the US since it could draw a lot of capital from other places?

A. I don’t think so. I think there’s so much money around. There’s so much capital that’s looking for home that I don’t believe that there’s been much of a negative impact on other technology firms.

Q. Investors may have already factored in the risk associated with Alibaba’s variable interest entity (VIE) structure. Are there other China-related risks that they should look out for?

A. In addition to the one that you mentioned, there are two basic kinds of risks. One is corporate governance. People have pointed out that Jack Ma and his friends will have a lot of control over the company, despite owning a relative small fraction of shares. If he decides to buy another soccer team, and then another soccer team… there’s nothing small shareholders could do. So that could be a concern, although he has tried to overcome that concern with public statements.

The bigger concern, in my opinion, is the Chinese economy. The success of Alibaba hinges to a large extent on the success of the Chinese economy. We’ve seen a slowdown in China—industrial production growth has slowed down markedly in the summer; the housing market is not healthy—there’s an overhang of unsold homes on the market.

So there’s some potential for slow growth in the future, and the Chinese central bank seems aware of that and taking action.

Q. Do you think competition is also a concern here? Other Chinese e-commerce companies are very aggressive, especially on the mobile front?

A, One thing in favor of Alibaba in this regard is that the Chinese market is far from saturated, and there’s room for multiple big players in such a big and growing market.

In terms of the international market, this IPO could easily be a stepping-stone towards an expansion into the US. It could spur their future growth potentially. I don’t know what Jack Ma’s plans are. He once said that as a “crocodile”, he prefers to fight with “sharks”, or those global players like eBay and Amazon, in the Yangtze river; but given its size and recent success, I think Alibaba could move from the river into the ocean and put up a decent fight with the sharks.

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