Online sesame

IFR Top 250 2014
10 min read
Jonathan Rogers

China’s online retailing giant Alibaba is one of the country’s most conspicuous corporate success stories, having grown from a modest start-up to the world’s biggest online retailer in just 15 years.

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Whether the company is simply basking in the “second honeymoon” being enjoyed by dotcom or its enterprise value is justified is the big question as its IPO looms.

Alibaba is an extraordinary cash cow. Its Ebitda last year was around the US$3bn-equivalent mark on the back of US$248bn of sales and its net income doubled to US$1.4bn in the last quarter of 2013.

Much of that revenue came from Alibaba’s 231m regular users in China, which is its sole market. That customer base grew at a heady 44% from the previous year and Alibaba boasts a like number for profit margins.

Small wonder then that as the company appears as promising a growth story as any in Asia with seemingly limitless cash-generating capability, bankers in the region have been falling over themselves to get a slice of Alibaba’s business.

This for a company that made its capital markets debut as recently as 2012. That borrowing emerged in July 2012 in the shape of a US$1bn four-year loan, with proceeds earmarked to help buy back a 20% stake Yahoo had bought in Alibaba in 2005 for US$1bn.

The price tag for the buyback, agreed in May that year, was a whopping US$7.1bn and closure of the deal would see Yahoo book a 700% profit.

Not a bad return for what seemed at the time a punt on the unproven skills of Alibaba founder, former English teacher, Jack Ma, with a bit of random dotcom madness thrown in. Yahoo continues to hold a 22.6% stake in the company, while Alibaba’s biggest shareholder with 34.4% is Japan’s SoftBank.

Internet-focused investment company SoftBank, founded by the enigmatic Masayoshi Son, holds one of the four board membership seats of Alibaba and is expected to have increased representation when the board is increased to nine, as flagged in the IPO filing.

That perhaps raises the possibility that Alibaba could aim to tap Japan’s capital markets once it has gone public and sought a rating. Assuming the company is rated in the upper reaches of the investment-grade credit curve, it would have little problem in tapping the Samurai market, according to DCM bankers in Tokyo.

“Alibaba could tap the Samurai market in size, at long tenor and at tight pricing given its link to SoftBank, its blue-chip status and rarity value,” said a syndicate head at a Japanese bank in Tokyo.

Seldom has an IPO been as eagerly awaited as that planned by Alibaba. Hong Kong was to have been the venue for the IPO, but Alibaba broke off talks late last year with the SAR’s financial regulators following disagreements about a partnership structure the company hoped to put in place before the listing.

In early May, Alibaba filed for a US listing that could be the biggest in the US market’s history, surpassing Facebook’s US$16bn debut last year. Alibaba’s IPO is expected to raise between US$15bn and US$20bn later this year.

It is of course easy to understand the crazed rush of the investment banking community for a slice of the Alibaba pie. The reason is not just that Alibaba has immense room to grow its business in China, but that it is seeking to establish a foothold in the US as well through its 11 Main online marketplace and through the purchase of selected start-ups.

Alibaba is spending a tiny fraction of its domestic revenue on these enterprises but is apparently determined to get plugged into the nous of Silicon Valley and has hired ex-eBay, Gap and Walmart staffers as part of this effort.

For now, though, in its limited history in the offshore capital markets, Alibaba has limited its presence to the loan arena, albeit in colossal size. The US$8bn three-year and five-year loan it raised in July last year attracted 22 participants in general syndication and paid Libor plus 225bp and 275bp respectively, a healthy pay-day for the banks.

Assuming the IPO is a success and that Ebitda continues to grow, those margins will probably fall given their tie-in to a leverage grid.

Should the company’s leverage fall below 1.5 times, the margins on both loans will fall by 50bp. And it seems likely that as the company’s profile is raised, banks will be falling over themselves to lend at ever tighter margins, with the promise of bond business hovering on the horizon.

Until now though, Alibaba has certainly been a nice little earner for the banks. Those involved in the US$8bn loan earned more fees from Alibaba late last year when the company sought to extend from January to December the drawdown period on the loan. Some US$5bn had already been drawn and banks earned a tidy 40% of the initial margin on the loan for signing up to the extension early.

The loan market has clearly had Alibaba on a re-rating dynamic since its 2012 loan debut, with that four-year paper paying Libor plus 325bp and again tied to a ratings grid that would see the margin going as high as Libor plus 475bp if leverage at the offshore group level exceeded three times.

Despite exercising restraint with leverage, Alibaba has been on an acquisition trail, having closed deals this year worth Rmb24bn (US$3.8bn), and there is a perception in the China e-commerce market that a three-way race is happening between Alibaba, Tencent – Asia’s largest listed internet company – and online search engine Baidu.

Tencent established in April a US$5bn MTN programme through Deutsche Bank, with many seeing the chunky size as a piece of grandstanding by Tencent ahead of Alibaba’s IPO.

Whatever that call, somewhat remarkably for an internet company, Tencent has recently obtained regulatory approval to operate a private bank, having established Qianhai Bank with Shenzen-based Baiyeyuan Investment.

Following the establishment of the MTN programme, Tencent quickly tapped the market for a US$2.5bn two-tranche 144A/Reg S bond issue, which was unusually timed to hit the early US trading session at launch and that eventually went 70% to US investors after building a hefty US$13.1bn global book.

The deal represented the largest bond issue from Asia’s technology sector and will surely be a template in terms of structure and execution for any offshore debt deal that is brought by Alibaba.

“Tencent’s trade showed the way in terms of what is do-able in the offshore dollar market for a Chinese e-commerce name. Given the US IPO plan, and the take-up of Tencent’s paper by US investors, I would expect Alibaba could tap that investor base in extremely large size,” said the head of Asia- Pacific DCM at a European bank in Hong Kong.

Despite a story that seems almost too good to be true, there is caution in some sectors with regards to Alibaba’s potential to grow too fast, initiating a high level of gearing, and the risks inherent in the company’s dependence on the largesse of the Chinese authorities to continue its rise.

“There is cut-throat competition in the e-commerce business in China and it might be that some of the leading companies grow too fast, acquire too many contingent liabilities and over-reach with their business models. And all the while they are really at the whim of the financial authorities, which creates an aura of uncertainty.

”This despite the seemingly miraculous performances of companies such as Alibaba, performances that in some ways symbolise the concurrent economic boom of China since their inception 15 years ago,” said a Singapore-based DCM head.

Still, despite the risks of Alibaba’s dependence on government, it could also be argued that the Chinese government has a stake in the ongoing success of Alibaba and is not about to find ways of tarnishing what is the jewel in the crown of corporate China, and the new paradigm it represents for an economy that has for too long relied on heavy industry, government-sponsored infrastructure development and export-driven manufacturing.

It might therefore not be music to the ears of would-be investors in Alibaba’s IPO that Ma’s slogan is “Customers first, employees second and shareholders third”

Concerns were also raised after Alibaba’s May 6 IPO filing documentation about the company’s Variable Investment Entity structure and fears that the corporate governance issues that have dogged many of the US stock market listings of Chinese companies will also hang over Alibaba post-listing.

“Alibaba will undoubtedly be confronted with unprecedented challenges and pressure due to the scale [of the listing], expectations, national boundaries, culture clashes, and regional politics and economics,” wrote Jack Ma in a letter to employees on May 6.

Indeed, it will be the sheer scale of the IPO that will create vast expectations for Alibaba, much as Facebook’s IPO did.

The plunge in Facebook’s stock after listing did little to aid the US internet giant’s reputation and clearly demonstrated just how becoming a publicly listed company changes the rules of the game.

It might therefore not be music to the ears of would-be investors in Alibaba’s IPO that Ma’s slogan is “Customers first, employees second and shareholders third”.