Alibaba vs JD IPO Deluge

20 May 2014   CNBC.com

Alibaba vs. JD.com: which one will investors choose to own?

The announcement that GoPro has filed for an initial public offering (IPO) caused a flutter of excitement after the close yesterday (they’re profitable!). However, a more heavyweight IPO battle is shaping up between two Chinese e-commerce giants.

While everyone is waiting for Alibaba to announce pricing terms (more on that below), its rival JD.com is set to go public this week.

Compare and contrast

When Alibaba may go public: CNBC’s Kayla Tausche reports Alibaba expects to hear back from the SEC around June 7th with questions or comments about its business model and reveals when the e-commerce giant could go public.
The latter is looking to price Wednesday night on the NASDAQ, and it’s a big fish: JD is the largest online direct sales company in China. The market cap is roughly $23 billion, and they’re looking to price 93.7 million shares at $16—$18, the midpoint of which is a $1.6 billion offering. Most IPOs are in the $100-$200 million range.

It would be the third biggest IPO of the year, after Ally Financial’s $2.375 billion and Santander Consumer USA at $1.8 billion. This is not a pleasant rivalry between Alibaba and JD.com. They are bitter enemies.

How bitter? Here’s a list of JD.com’s underwriters: Bank of America/Merrill Lynch & UBS. Meanwhile, Alibaba’s enlisted the following list of Wall Street luminaries: Credit Suisse, Deutsche Bank, Goldman Sachs, JPMorgan, Morgan Stanley.

Notice something: there’s no overlap. Every major underwriter is represented, but you are either on one team or the other — not both. That’s not a coincidence.

So which one do you want to own? Though both are Chinese e-commerce companies, there are notable differences between the two, even on a superficial level.

JD.com is a more Amazon-like. They have built out a very sophisticated fulfillment infrastructure. They take possession of much of the merchandise and ship it out. They don’t just sell other people’s stuff, they sell goods themselves to customers. This involves big inventory risks, of course.

Alibaba doesn’t do it that way: they have a marketing platform for many different companies. Their revenue comes from fees they charge companies to have products on their platform.

JD.com’s revenue pool is also much narrower. Roughly 82 percent is from electronics and appliances, according to Renaissance Capital. That is a very low margin business!

Another difference between the two is that Alibaba has its own payment system, while JD does not.

The profit picture is also very different. JD has $11 billion in revenues, and is roughly break-even in profits (they’re supposed to make money this year). In this way, it’s very similar to its American rival Amazon, which is also barely breaks even. And we are not talking about a startup: JD has been around since 2004. By contrast, Alibaba appears to have roughly $8 billion in revenues on a yearly basis, and nearly $4 billion net profit. That’s a nearly 50 percent profit margin.

Here’s my point: what would you rather own, a company that is growing revenues with nearly zero profit margins, or a company that’s also growing revenues fast with a 50 percent profit margin? Now you understand the level of excitement over Alibaba.

There’s another problem for JD.com, and to a lesser extent for Alibaba: it will have to fit into a portfolio manager’s portfolio, and investors already have plenty of technology sector names. Investors only have room for so much tech, and this is a very crowded sub-space: tech e-commerce.

My point is that investors will not only have to decide if they want to own JD.com with Alibaba, they may also have to decide if they want to sell other e-commerce holdings.

Of course, there is room for expansion of tech holdings, but it’s not infinite. Many investors are weighted at the same levels that Russell weights sectors. There is a re-balancing this in June, where all their indexes will be overhauled; that will likely reflect the higher market weights of technology. Still, Alibaba will not be in the Russell by then; it won’t go in until September at the earliest, possibly December.

The bulls say yes, there’s room for plenty of investors, particularly hedge funds who may not worry as much about sector holdings. They may be right: indications are that JD is already several times oversubscribed. Yet that doesn’t mean it’s going to have a big pop on the first day.

Bottom line: there is an awful lot of Chinese paper that is coming to market relatively soon. There is always a price at which deals can get done, but for these two the question is, what is that price?

While I’m on the Alibaba topic, there’s been a lot of questions about when they will go public. Much of this is speculation, because there is a crucial issue that is not answerable right now: how much scrutiny will the Securities and Exchange Commission (SEC) give the company?

Normally, for a company of Alibaba’s size (over $1 billion in revenues), the time frame for going public is typically two to three months from the time they file until they set pricing terms. At that point, they will do a road show, and if the reception is favorable, go public a week to a couple weeks after that.

Alibaba filed on May 6th. Two to three months would be early July to mid August, which is the time frame most people are going with. But the path isn’t always so smooth. Look at JD.com: they filed in January, and didn’t announce terms until May 9th—that’s four months.

The SEC is reviewing the Alibaba prospectus now. The company will have to get SEC approval before they can announce terms. When will that happen? While the company has provided some financials, they will likely update them. Once they do, the SEC will review them.

CNBC’s Courtney Reagan reports GoPro has filed for its IPO and will trade on the Nasdaq under the ticker GPRO. CNBC’s Kayla Tausche weighs in.

The betting is, the SEC has quite a lot of questions. Here’s a few that are likely:

1) Provide more detail on revenue sources. Alibaba does not break down their revenue contribution with much granularity. So they talk about their consumer-to-consumer portal, Taobao, but don’t provide a lot of numbers.

2) Who’s controlling the company? There is a partnership that is controlling the board, we know that some of them are original partners. However, tthere are also other people in the partnership and little, if anything, is known about these people. The SEC will likely want to know more.

3) What else do they own? Alibaba also is a minority investor in many companies in China, like Weibo, the Twitter of China, as well as other companies. They will likely ask for more specifics.

Finally, not to make this more complicated than it already is, but the ultimate decision of when Alibaba should go public may be dictated by the stock market and the reception of IPOs, as well as the economic news out of China…and so far the news is not great.

The Renaissance Capital IPO ETF (IPO), a basket of roughly 60 recent IPOs, is just off the lows for the year.

There are seven Chinese IPOs this year, and the returns are not encouraging. All seven were up on their first day of trading (about 10 percent on average), but six of the seven are still below their close on the first day, according to Renaissance.

Take Jumei, the largest online beauty products retailer in China, which went public May 15th at $22, now trading at $19.55.

Not encouraging!