Alibaba Files for an IPO: What You Need to Know

Alibaba Group, the largest e-commerce company in China, filed for its eagerly anticipated IPO on May 6, paving the way to what could be the largest tech IPO in history later this year.

Alibaba is the parent company of Taobao, which controls 95% of China's consumer-to-consumer (C2C) market, and Tmall.com, which controls 51% of China's business-to-consumer (B2C) market. Alibaba also owns Juhuasuan, a Groupon-like site that offers group discounts. Those three services, along with Alibaba's other Internet holdings, fuel 80% of all online commerce in China.

Alibaba's main site. Source: Author's screenshot.

Simply put, Alibaba is a beefed-up combination of eBay (EBAY 0.31%) and Amazon (AMZN -1.65%), handling 1.5 trillion yuan ($248 billion) in online transactions for 231 million active users last year -- more than Amazon and eBay combined.

Is Alibaba's growth sustainable?
Alibaba's top-line growth indicates that it could soon be bigger than Amazon or eBay in terms of annual revenue as well:

Source: Company annual reports.

Alibaba's net income also doubled to 8.27 billion yuan ($1.33 billion) for the quarter, thanks to its 45% profit margin. That growth is far more impressive than Amazon, which reported a 32% increase in net income to $108 million last quarter, and eBay, which finished last quarter with a GAAP net loss of $2.3 billion.

But the big question about Alibaba is whether that growth is sustainable. Although Alibaba has maintained a dominant position in the C2C market with Taobao, Tmall has steadily lost market share in the B2C market to Jingdong (formerly known as 360buy), a growing online marketplace that claimed 17% of the B2C market last year.

Alibaba's biggest competitor in B2C -- Jingdong, aka JD.com. Source: Author's screenshot.

To make matters worse, Jingdong merged its e-commerce operations with Internet giant Tencent's B2C (QQ Wangguo) and C2C (Pai Pai) platforms in March, which could accelerate Jingdong's e-commerce growth at Alibaba's expense.

Mobile and inorganic growth
Last quarter, approximately a fifth of all purchases on Alibaba sites were made on mobile devices, up from 7.4% a year earlier.

However, Alibaba's mobile growth could run into problems with Jingdong and Tencent's alliance. Tencent's WeChat is currently the second most popular mobile messaging in the world, growing from 195 million active users in the first quarter of 2013 to 355 million by the end of the year. Tencent is blending WeChat, its desktop messaging app QQ, its online games, and e-commerce platforms into one cohesive ecosystem.

To counter Tencent's growth, Alibaba made a string of acquisitions worth $3.5 billion this year, including stakes in department store operator Intime, movie production company ChinaVision Media, streaming video provider China's Wasu Media Holding, online video company Youku Tudou, and mapping company Autonavi. It's unclear just how Alibaba plans to put all those pieces together, however.

Macro growth factors and smaller rivals
Looking beyond Alibaba's near-term challenges, there are plenty of macro signs that indicate the company could grow substantially over the next few years. According to industry forecasts, the number of online shoppers in China will grow 53% between 2013 and 2016, thanks to a more affluent middle class and increased Internet connections across the country.

Compiled by author from data on Go-Globe.com and ChinaInternetwatch.com

Although Alibaba is certainly the largest player in this growing industry, several smaller players could also benefit from the rise of online shopping in China.

E Commerce China Dangdang (DANG), for example, is usually referred to as the "Amazon of China", since it was originally an online bookstore that expanded its inventory to include electronics, household products, and other items. Taking a cue from Amazon's Kindle, Dangdang also released its own e-reader, the DuoCon, last July.

Vipshop (VIPS -0.44%), a rapidly growing name in Chinese e-commerce, is a popular online retailer of discount name brands, similar to Overstock.com.

Both Dangdang and Vipshop have benefited from renewed interest in China's e-commerce market -- Dangdang is up nearly 160% over the past 12 months, while Vipshop has rallied nearly 320%. Of these two companies, Vipshop's growth is far more impressive -- last quarter, its revenue rose 117% year-over-year while its earnings soared 300%.

Valuation questions
The big question now is just how much Alibaba will be worth when it goes public. Current forecasts claim that Alibaba's IPO could raise at least $15 billion and possibly eclipse the $16 billion Facebook raised during its IPO in 2012.

Alibaba valued itself at $109 billion in April, significantly lower than analyst estimates of $150 billion to $200 billion. A $109 billion valuation would put Alibaba squarely between Amazon's market cap of $135 billion and eBay's market cap of $64 billion.

That revelation caused shares of Yahoo! (NASDAQ: YHOO), which owns 22.6% of Alibaba's shares, to fall nearly 7%. Yahoo!, which has relied heavily on its stake in Alibaba to offset slumping advertising revenues, will sell a third of its shares when Alibaba goes public.

Investors should also remember that Alibaba spun off Alipay, its PayPal-like service, to a separate company, Zhejiang Alibaba E-Commerce, in 2011. If Alipay is ever sold or spun off into its own IPO, Zhejiang Alibaba could pay Alibaba Group $2 billion to $6 billion. Since Alipay is required to remain under Chinese ownership, it could go public later in China and allow Alibaba's overseas shareholders to reap the benefits.

The bottom line
In conclusion, investors are excited about Alibaba's past growth, but it's unclear if major rivals like Tencent and Jingdong, or minor ones like Dangdang and Vipshop will throttle its growth in the C2C and B2C markets.

We'll know more about the Alibaba's proper valuation when it finally prices its IPO, but interested investors should do their due diligence and research China's e-commerce market, its relationship to mobile devices, and the comparable growth of Alibaba's chief rivals before jumping in.