Is it a) funny, b) disturbing, or c) irrelevant that Alibaba went public at a sky-high valuation just at the point at which the red-hot economy which spawned it seems content to settle into a creaky middle age?
Few of the investors throwing money at Alibaba hand over fist last week seemed to notice, but China really is now presenting a new version of itself to the world. Rather than riding to the rescue when growth slows, as recent industrial production data, the worst since 2008, shows it most clearly is doing, China now is taking a more cautious, passive stance.
“China will not make major policy adjustments due to a change in any one economic indicator,” Finance Minister Lou Jiwei said on Sunday, adding that the country can’t rely on government spending to speed infrastructure investment.
However you cut it, this raises questions for investors in Alibaba, a Chinese e-commerce company which executed the biggest ever initial public offering totalling US$25bn and saw its shares surge 38% in their first day of trading.
Those who do back the Alibaba online marketplace will doubtless make an argument along the lines that it isn’t happening (China’s still booming! Well, comparatively.) and it doesn’t matter that it is (Alibaba can grow independent of China!), but of course financial markets aren’t simply about truth; they also involve the valuation of uncertainty.
Investors of a sceptical bent have thus far focused on two areas of potential vulnerability for outside stakeholders in Alibaba, which is run by Jack Ma, a charismatic (I use this word in its modern sense of billionaire) former teacher of English.
The first boils down to corporate governance and the second to politics.
Ma has been straightforward about where shareholders come in his estimation, saying they rank third behind customers and employees. While that might be a good strategy, of more detriment to investors is a corporate structure which effectively insulates executives from outside pressure. Combine this with the fact that the IPO was of a holding company in the Cayman Islands which only has a contract that entitles it to Alibaba’s profits, a matter about which there is some uncertainty in Chinese law.
That brings in the political angle, which is that companies in China, even globally famous ones, operate only at the pleasure of those in power. Laws can change, as can their enforcement. And while on the positive side Ma is China’s richest man, and clearly has enough influence to be where he is today, on the negative side Ma is, well, China’s richest man.
Leveraging growth
To be sure, Alibaba, which acts as a marketplace and therefore carries little inventory, unlike, say, Amazon.com, is fabulously capital-efficient and makes tremendous margins.
And while those margins aren’t dependent on growth, the valuation investors have placed on them, which is in a word enormous, is. Part of the way you get to a very large valuation is by discounting future growth, especially in Chinese e-commerce, which Alibaba dominates.
Part of that is a secular story: e-commerce is winning market share in a China without a great retail infrastructure, and China itself is rebalancing its economy more towards domestic consumption. All of that still holds true. Note too that part of the reason Alibaba has thrived, and been allowed to, is that it speeds this needed transition away from exports and investment and towards consumption.
The problem, and markets may be slow to recognise this, is that part of the expected growth of Alibaba is from growth in the Chinese economy itself. While China will surely grow quickly this year by developed world standards, perhaps 7%, that represents a quite rapid decline both from forecasts and from recent experience.
A look at the industrial production data shows a rapid slowing in investment-driven sectors, like concrete, steel and property. That is backed up by data on energy generation and consumption. China’s growth is slowing rapidly, and to judge by recent remarks from officials, they don’t intend to do very much about that.
It has to be stressed that both the slowdown and the sanguine response are a big surprise. My guess is that these twin surprises did not get much weighting in the minds of those selling and buying Alibaba’s IPO.
If we are looking at a slower-growing China run by officials less willing to lever up in order to support that growth, we may well see Alibaba having to operate in the kind of market and against the kind of backdrop of which it has no experience.
Alibaba investors may discover that high stock market valuations based on future growth are very much like any kind of leverage: it only takes a small change in assumptions about that growth to have a big impact.
(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at jamessaft@jamessaft.com)
