Alibaba's (NYSE:BABA) fintech affiliate Ant Financial could go public in Hong Kong soon, according to Reuters. The report, which cites two people familiar with the matter, claims Ant will sell 5% to 10% of its shares in the IPO, with a target valuation of over $200 billion.

Ant was previously valued at $150 billion after its last funding round in 2018, making it the world's most valuable start-up. Citing internal documents, Reuters claims Ant generated about 120 billion yuan ($17.1 billion) in revenue and nearly 17 billion yuan ($2.4 billion) in net profit last year.

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Ant said Reuters' claims regarding its IPO plans and financials were "incorrect", but didn't elaborate on the matter. Alibaba's stock popped after the report, but investors should clearly understand its relationship with Ant before classifying the potential IPO as a tailwind for the tech giant.

Untangling Ant Financial's ties with Alibaba

Back in 2003, Alibaba's Taobao marketplace launched a new online payment platform called Alipay. Alibaba restructured Alipay in two separate transactions in 2010 and 2011, which turned the subsidiary into a separate domestic company fully controlled by Alibaba co-founder Jack Ma.

Alibaba spun off Alipay to obtain a new digital payments license in China, which couldn't be obtained by companies with foreign investors. However, several of Alibaba's top investors -- including Yahoo and Softbank -- claim they weren't informed of the spin-off plans.

Alipay rebranded itself as Ant Financial in 2014, which distanced itself from Alibaba and established the foundations of a broader fintech ecosystem. To address investors' complaints about the prior spin-off, Alibaba forged a new agreement with Ant that entitled it to 37.5% of its pre-tax profits. Alibaba subsequently traded those rights for a formal 33% stake in Ant Financial last year.

Chinese regulators didn't block that investment, since Ant still operates as an independent company instead of a subsidiary of Alibaba. Alibaba can still retain its foreign investors, while its status as a Chinese company enables it to retain a stake in Ant Financial.

How fast is Ant Financial growing?

Ant Financial's Alipay holds a near-duopoly in China's digital payments market with Tencent's TenPay/WeChat Pay. Alipay controlled 54.5% of the market in the third quarter of 2019, according to iResearch, compared to a 39.5% share for Tencent's platforms.

Ant leverages the strength of Alibaba's Chinese marketplaces, which hit 726 million annual active consumers last quarter, to tether more users to AliPay. Tencent relies on WeChat, the most popular messaging app in China with over 1.2 billion monthly active users, to lock in its users.

AliPay and WeChat Pay are now widely used across China to buy goods at brick-and-mortar stores, pay bills, take public transportation, and access healthcare services. AliPay and WeChat also offer "Mini Programs" in their apps, which allow them to access common services -- including ride-hailing, e-commerce, and delivery services -- without ever leaving the app.

Ant and Tencent also offer a wide range of online banking, investment, and wealth management services through their platforms, and both companies have expanded aggressively overseas to serve Chinese tourists. The expansion of these walled gardens makes it tough for smaller challengers to gain any momentum.

How will Ant Financial's IPO affect Alibaba's investors?

If Reuters' report is accurate, Ant will only offer a small portion of its shares to Hong Kong investors. Moreover, smaller trades in the secondary market have already reportedly boosted Ant's private valuation to around $200 billion.

Alibaba won't be selling its own shares, and the rumored target valuation of Ant's IPO probably won't significantly change the value of its 33% stake right away. However, a fresh injection of cash could still help Ant expand its fintech ecosystem and shore up its defenses against Tencent.

Alibaba's 33% equity stake in Ant (which it acquired last September) generated 5.32 billion yuan ($752 million) in investment profits in fiscal 2020, which trickled down to 4% of its net income. It also generated platform and licensing fees from its prior profit-sharing arrangement with Ant in the first half of the year.

The bottom line

Alibaba probably won't reveal much more about Ant on its own, but an IPO filing in Hong Kong could finally part the veil. If the numbers impress investors, the value of Alibaba's stake in Ant could grow. If not, it could expose the costs of engaging in a prolonged war against Tencent in the cutthroat payments market.