Forget the Alibaba flotation – Yahoo looks like a much more tempting investment

Alibaba dominates Chinese e-commerce

China’s biggest internet company is set to float on the stock market.

The company is called Alibaba, and it’s expected to list with a market value of at least $100bn.

Alibaba is a very attractive business, and I’d be happy to invest at the right price.

However, I don’t have to wait for the flotation to invest in Alibaba. All I need do is buy shares in Yahoo instead. That’s because Yahoo owns a 24% stake in Alibaba.

And as an added bonus, I think Yahoo’s core business has real turnaround potential.

Alibaba has an 80% share of China’s e-commerce market

Let’s start by looking at Alibaba.

The company is effectively the Chinese version of Amazon and eBay. It also has a stake in a Twitter-style messaging service and is even attempting to be the Chinese version of Hargreaves Lansdown.

The really impressive thing about Alibaba is its dominant market share in Chinese e-commerce. The FT says that roughly 80% of Chinese e-commerce goes through one of Alibaba’s platforms.

The company was founded by Jack Ma in 1999. The original business was an online platform that helped small Chinese businesses to sell their products to companies outside China.

Then in 2003, Ma launched Taobao. This is a marketplace where individuals and businesses can sell to Chinese consumers.

It’s been hugely successful and has absolutely thrashed eBay in the Chinese market. Prior to Taobao’s launch, eBay had an 80% market share in e-commerce. By 2007, eBay’s share had fallen to 8% while Taobao had captured an 84% market share.

As well as Taobao, Alibaba operates the Tmall platform, which is more akin to the main Amazon offering here in the UK. It’s also done very well.

Alibaba has also expanded into lots of other areas. Just like Amazon, Alibaba has a cloud computing business. It also owns an 18% stake in Weibo, a twitter-style social media site that has already listed on the US stock market.

I’m also excited by Alibaba’s new investment fund platform where Chinese investors will be able to select from a wide range of third-party funds. If Alibaba can achieve the kind of margins that Hargreaves Lansdown has in the UK – roughly 65% – this will be another great business.


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Are there any downsides to Alibaba?

Well, the biggest worry is corporate governance. Back in 2010, Alibaba sold one of its businesses, called Alipay, to Jack Ma for a nominal sum. This was a really dodgy deal and definitely wasn’t in the interests of Alibaba’s shareholders – apart from Ma.

Two big Alibaba shareholders, Yahoo and Softbank, kicked up a fuss, and eventually Ma agreed to pay more for Alipay. But with that history, you do worry that Ma might try and do something similar in future.

What’s more, after the flotation, Ma will have the power to nominate the majority of Alibaba’s directors, even though he won’t own anything like the majority of the shares. Indeed, the Hong Kong stock market refused to list Alibaba due to concerns about Ma’s power over the board.

As a result, Alibaba will list in New York where regulation is more relaxed.

This issue of corporate governance is a worry, but I’d still be tempted to invest thanks to Alibaba’s strong market position in China.

Lex in the FT thinks that Alibaba could make profits of $4.3bn this year, so if you put that on a multiple of 25 – not at all expensive for a fast-growing ecommerce company – and you get a market value of $107bn.

Some observers think the valuation could be much higher. Bernstein, a broker, reportedly thinks the valuation could be as high as $190bn.

Alibaba makes Yahoo look like a very attractive investment

Now if Bernstein is right, Yahoo looks like a very attractive investment right now. Yahoo’s current market value is $37bn, and it has a stake in Yahoo Japan that is worth $11bn.

Then if Alibaba is really worth $190bn, Yahoo’s stake is worth about $47bn, way more than Yahoo’s market cap. Even if Alibaba only lists at a more conservative $100bn, Yahoo’s stake is worth $25bn.

Yahoo’s stake in Alibaba will fall to 15% when Alibaba lists, and it will have to pay tax on the proceeds of its share sale. Even so, Yahoo’s valuation looks very tempting.

I believe that Yahoo’s core business is at the beginning of a turnaround with rising traffic on its websites. Website traffic is up 30% since March 2013, while mobile traffic has jumped 50% over the same period.

Granted, the latest financial results from Yahoo revealed falling revenue and profits– earnings per share came in at $1.30. But  I think the rising traffic figures will lead to rising profits before too long. Yahoo’s boss, Marisa Mayer, has a clear strategy and she’s executing it well. I wrote more about Mayer’s strategy last year.

Mayer’s next big challenge is to spend the proceeds of the Alibaba share sale wisely. She will probably do some share buybacks, and she may make some acquisitions. Both moves are fine as long as Mayer doesn’t pay too much.

So for me, Alibaba’s flotation is definitely worth keeping an eye on, and Yahoo looks like an interesting play on Alibaba as well as rising traffic at its core websites.

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