What is Alibaba really worth?

Financial Times

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In weeks or perhaps days, investors will have an answer to the most popular guessing game in the world's markets right now: just what is Alibaba really worth and on what basis are those numbers calculated? The Chinese e-commerce giant is expected soon to file its initial documents for a public offering in the U.S., revealing for the first time what goes on inside a company estimated to control 80 percent of China's e-commerce market.

Unusually for such a large and visible company, current estimates of its value range from the $80 billion implied by some synthetic securities to the $150 billion-plus suggested by optimistic analysts comparing it to other highly valued internet stocks - and come in spite of the drubbing tech stocks have suffered in the past month.

Synthetic securities

Impatient for the initial public offering, some hedge funds in Hong Kong have taken to buying certificates from investment banks designed to mimic the performance of Alibaba shares, or have simply created their own.

It works by taking long positions in Alibaba's main listed shareholders - Japan's SoftBank and Yahoo of the U.S. - and then trying to isolate their stake in Alibaba through short positions. For example, SoftBank, which holds more than a third of Alibaba, also owns a sizeable chunk of U.S. mobile operator Sprint as well as online gaming companies GungHo and Supercell.

For unlisted businesses - such as SoftBank's main telecoms unit - investors short out a similar publicly traded entity, such at Japanese rival KDDI. The process is part art, part science, and ultimately educated guess work.

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The value implied by at least one version of these certificates was just over $80 billion when Alibaba finally announced its intention to list in the U.S. last month, according to a simple index put together by Bank of America Merrill Lynch. However, analysts at the bank believe there to be a roughly 20 percent discount to the true value of an Alibaba holding company, which would bring the valuation closer to $100 billion.

Either way, the instrument is highly volatile. In the past year, the yen-denominated index has been almost double the current level, and almost half it - largely due to swings in the Japanese stock market rather than expectations over Alibaba's true size. But thanks to the mix of long and short positions it has not tumbled in line with global tech sector stocks over the past two months.

Even after recent falls, both SoftBank and Yahoo have both enjoyed share price rallies of around 130 percent since Alibaba sold its convertible bond in September 2012.

Convertible bonds

Would-be buyers of Alibaba's unlisted shares and convertible bonds have recently been making offers that value the group at $120 billion-$150 billion, according to bondholders and others involved in the market.

That is a sharp contrast to 2012, when Alibaba issued the $1.6 billion convertible bond to a small group of investors including Singapore's Temasek and GIC.

At the time, Alibaba was valued at less than $40 billion, two people with direct knowledge of the situation said. Under the terms of the deal, the bond will convert into equity upon completion of an IPO.

One share sale in February showed how dramatically its valuation has already changed. U.S. investment fund Tiger Global bought a stake in Alibaba from Giant Interactive Group, a Chinese games developer. The sale valued Alibaba at around $128 billion, according to calculations by Reuters. Investors with knowledge of the transaction say the actual valuation was slightly higher after accounting for fees and the structure of the deal, which went in part through Yunfeng Capital, a private equity fund co-founded by Alibaba's founder Jack Ma.

However, the valuation reflected by such share sales is complicated by the fact that the market is highly illiquid. Investors say many hedge funds trying to buy shares are unable to find a seller, even at valuations close to $150 billion.

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Still, the implied threefold gain in Alibaba's valuation follows a substantial rise in the share prices of its publicly traded rivals such as Tencent and Baidu. Much of those gains, equity analysts say, are because investors are increasingly confident that tech companies in the U.S. and elsewhere have proven that they can profit from smartphone users.

Multiples

Comparing Alibaba to its peers is in theory the most simple and reliable form of valuation. The problem is the lack of information on Alibaba - and a dearth of truly comparable companies.

The most cited examples are Facebook, Tencent and Amazon. The first is the least similar business but like Alibaba it is something of a phenomenon, the second works if investors believe that all big Chinese internet companies are similar and the last actually sells goods but using a very different model to Alibaba. Rakuten, the Japanese online retailer, is probably the straightest comparison since, like Alibaba, it operates a marketplace in which it charges fees, rather than selling its own goods - the model that makes up the bulk of Amazon's business. It does, however, own a baseball team.

The only information investors have on Alibaba, until it files with the U.S. Securities and Exchange Commission, come from the quarterly updates of Yahoo, its one-quarter owner. These give basic profit details. Yahoo's latest update, last week, showed that Alibaba had a bumper end to 2013, a year in which it produced $3.5 billion in profits.

Facebook trades on 100 times last year's earnings while Amazon is valued at a dizzying 500 times. Tencent and Rakuten are on 50 and 40 times, respectively. Applying those multiples to Alibaba's 2013 earnings makes it worth between $141 billion and $1.76 trillion. That last number is ridiculous. But comparing Alibaba to Rakuten produces $141 billion and $176 billion - bang in the range that the more optimistic analysts have bandied about.