Tech companies are now the de facto leaders of the stock market. Names like Apple and Google are worth many billions of dollars and dominate headlines daily with new products and earnings reports. Meanwhile, Wall Street hangs on to every snippet of information in its never ending search for an edge. Other investors are looking for the next up-and-coming tech giant and the flood of internet company IPOs are feeding into those desires.
The dorm-room dreams of tech-savvy college students have become legitimate businesses. Since 2011, LinkedIn, Facebook, and Twitter have gone from social networking sites to multi-billion dollar companies that are changing the world.
The current big thing investors have their eye on: Alibaba.
The Chinese marketplace has been fertile soil for tech company growth. Since the introduction of Baidu (BIDU), a Chinese internet search engine similar to Google (GOOG), investors have kept a close watch on Asian tech companies. Alibaba’s IPO has many investors looking back at Baidu and other internet companies to see what history has taught us and what we can take away from this next offering.
A Closer Look At Internet Companies
Before we can analyze what Alibaba is and what it might mean for investors, it might help to get a sense of what other internet companies have done to help us get a better picture of what we can expect. Four companies, three of which have begun trading in just the last three years, are close examples to Alibaba that we can find to compare to: Baidu (BIDU), LinkedIn (LNKD), Facebook (FB), and Twitter (TWTR).
- Baidu (BIDU)
This Chinese web services company entered the U.S. market in early August 2005 at an expected IPO price of $27. By the time it started trading, the price rocketed up to $66 and continued to $122 by the end of its first trading day. Taking into account stock splits, Baidu has risen over 1,600% between 2005 and 2014.
Today, Baidu has a market cap of over $79 billion while revenue (TTM) is around $6.5 billion. Fundamentally, the stock is a classic growth story with long-term EPS growth of 36% and a P/E ratio of 44.85. This gives it a PEG ratio of 1.05, meaning that it could be currently undervalued. Operating margins are high at 30% and its return on equity is similarly high at 30%. Performance YTD is an impressive gain of 18.5%.
- LinkedIn (LNKD)
In mid-May of 2011, this stock opened at $83 and ended the day at $94, well above the expected price of $45. The professional social media company only made $15.4 million in 2010 and yet was valued at $4.25 billion. This seemingly outrageous valuation hasn’t hurt the stock though – since its IPO, the stock has risen over 350%.
Another growth stock, LinkedIn has a forward P/E of 75 and a long term EPS growth rate of nearly 38%. Like most internet companies, it has no long term liabilities but it hasn’t performed well so far this year — the stock is down 4% YTD.
- Facebook (FB)
Almost exactly one year after LinkedIn went public, Facebook launched its own IPO. Its expected price was $38 a share which valued Facebook at a jaw-dropping $104 billion. Due to the success of Google and LinkedIn, many investors had faith in the valuation despite controversy surrounding its actual worth.
Like its predecessors, Facebook has performed quite well since its IPO. Its stock has doubled since that time and the stock’s underlying fundamentals continue to point to higher growth. It has a P/E of 82 and a long term EPS growth rate of 38%. It has negligible long term debt liabilities combined with a high operating margin of 43%, allowing the company to make acquisitions and investments to expand it from social media network to tech giant.
- Twitter (TWTR)
Last year, Twitter announced its highly awaited IPO with a set price of $26. It opened at $45 following a trend established by Facebook and LinkedIn, but then closed the day at $44. This opening day dip caused many investors to rethink internet-based company valuations.
Looking back to opening day, Twitter’s stock has only gained 13%. YTD, the stock is down 20%. A look at the company’s fundamentals reveal a difference between Twitter and its competitors. Forward P/E is 138 and next year’s EPS growth is expected to be an astounding 275%, however, such large growth is unsustainable over the long term. Operating margins are poor at negative 87%, implying that the company is losing cash quickly.
In order for Twitter to correct the imbalance, it will need to grow at a much faster pace in a short period of time. It recently announced a plan to borrow $1.8 billion for investment and acquisition purposes, but only time will tell if these efforts will be enough to right the ship.
Alibaba’s IPO trading under the ticker symbol “BABA” is big news and investors are scrambling to get a piece of the action. Like the previously mentioned companies, its target price keeps being lifted – finally settling at $68 per share. At this price point, the company would be valued at nearly $168 billion and its P/E should be around 40. This fits in nicely with Baidu’s P/E of 38 putting Alibaba’s valuation at a fair estimate.
This Chinese tech conglomerate is a little different from its competitors though. It’s the world’s largest online commerce company with ties to search engines, retailers, banking services, and a host of other businesses. Its e-commerce business transactions totaled more than $248 billion last year and 80% of all Chinese online retail takes place through Alibaba. By 2017, the company estimates that the Chinese marketplace will grow from $248 billion to $713 billion.
The company has three main segments: Alibaba.com, Taobao, and Tmall. Alibaba.com connects exporters with companies around the globe, Taobao is a shopping site with over seven million merchants, and Tmall focuses on the Chinese middle class and name-brand goods. The size of the company’s $25 billion IPO listing makes it the largest tech IPO in U.S. history, beating out Facebook by $8 billion.
On the surface, it looks as if these companies are losing momentum and popularity. One of the biggest issues investors have with these types of companies is how to properly value them. How do they actually earn money?
Most internet-based companies make money through marketing and advertising. Google, Baidu, Facebook, and Twitter all share similar revenue generating strategies that focus primarily on selling advertising space and promoting online marketing. LinkedIn varies a little in the fact that it relies on company promoters and recruiters who are looking for employment as a primary revenue source instead of broad ad campaigns.
96% of Google’s revenue stems from advertising, but it has been actively seeking to diversify its revenue source. Facebook similarly is actively making acquisitions that seem to be heading in the direction of an internet provider in addition to its eponymous website.
The difference is what makes Alibaba so unique. As an e-commerce online company, it generates revenue from a diversified base, making it more resistant to economic difficulties. It may be more accurate to compare the company to the likes of Ebay (EBAY) and Amazon (AMZN) to get an idea of how it will grow.
From that perspective, Alibaba looks like it has plenty of room to grow, even considering its limited Chinese marketplace. Amazon’s revenue over the last year was over $81 billion versus Alibaba’s $8.5 billion. A small fraction comparatively which means Alibaba has a lot of potential for growth.
The Investor’s Playbook
Investors are clamoring for the opportunity to buy a piece of Alibaba, and that action could be a reason to take a look at Baidu, Facebook, and Twitter.
In order to purchase the expected $25 billion worth of shares that the Alibaba IPO will generate, investors will need to get the money from somewhere. The most appropriate place to look is at other tech stocks already owned by investors that might be considered inferior to Alibaba. Even genuinely in-demand stocks could be sold as investors flock to the new company.
Leading up to Alibaba’s IPO, investors have been selling shares of stocks they own in order to make room for the new publicly traded company. While Twitter’s longevity is in question due to weakness in the fundamentals, LinkedIn and Facebook both look to have been sold off ahead of Alibaba’s issuance creating a value gap that savvy investors can buy into.
Alibaba itself is a great Chinese growth story, but investors should be aware of other buying opportunities created by its IPO. The same fundamental reasons that make Alibaba a good buy are some of the same that make Baidu, Facebook, and Linked a good deal as well.
The saying “a rising tide lifts all ships” is particularly applicable to Baidu’s case. The Chinese marketplace is ruled by an Oligopoly and Baidu’s fortunes will rise along with Alibaba’s. Any selling action that occurs around Alibaba’s issuance could be a buying opportunity for investors to get in while the stock is temporarily undervalued.
CEO, Elite Wealth Management
Full Disclosures: http://elitewm.com/disclosures/
This article is not intended as investment advice. Elite Wealth Management or its subsidiaries may hold long or short positions in the companies mentioned through stocks, options or other securities.