Alibaba IPO is a great investment

Alibaba.com which hit the Hong Kong Stock Exchange on Tuesday, Nov 6, had a large success with an increase over its initial offering price. The company is a spin off from Alibaba Group, the company that owns Taobao.com, Alipay and Yahoo China and is 40% owned by Yahoo. As of 3:40pm – 2:40am EST the trading price is at HK $39.50 ($5.09). I think an investment in this IPO would make sense for the long term and here’s why.

Alibaba is a B2B e-commerce company in China. According to iResearch, (China Internet Research Center), Alibaba is the largest B2B company in China for the year 2006 based on user registration and e-commerce user share. Alibaba operations take place in two markets, the China market and the international market. These are www.alibaba.com.cn and www.alibaba.com, respectively. In their S1 form, the company claims to operate one of the top trafficked websites in the world according to Alexa.com data for 2007. The core of the business is “Suppliers and buyers come to our marketplaces to establish their presence on the Internet, identify potential trading partners and interact with each other to conduct business online. For many suppliers wishing to market products and services through online channels, their listings on our marketplaces are their only presence on the Internet.” This is perhaps true today, but leaves room for change. However,  given the large established user base and growth, it would be difficult for a rival to take over in a short time frame. There are 2.4 million listings by suppliers. The users had 2.9 million new listings as a monthly average for the first half of 2007. This shows the market establishment and proven growth. There is also social features on the site, however I think it’s more important to focus on the market and why this is a business that will continue to thrive.

The business model lies in charging suppliers who purchase services. These are paying members. The user base has increased significantly, from 6 million in Dec 04 to 11 million in Dec 05 and 19.8 million as of Dec 06. The paying members as of 07 is 255,000 as of 07. The revenue generated is RMB957.7 million as of June 30, 2007. Also, it’s important to note that currently this is where the revenue comes from, but I would expect Alibaba to consider advertising as a revenue stream as well – as is very profitable by companies like Google.

China has 137 million of Internet users as of 2006 according to CNNIC (China Internet Network Information Center). The compounded annual growth rate of users is at 23.4%. This means that China will have more Internet users then the US. Also, SMEs (small and medium enterprises) have been a key driving force in China’s economic growth. According to research at the S1 form, Alibaba claims SMEs contribute 58% to China’s GDP and 48% of China’s tax revenue and employed over 75% of the work force in urban areas. Considering that so many manufacturers are operating in China and they are focusing on growth, Alibaba has a key success factor: They are helping their customers make even more money. There is no better recipe.

Alibaba’s management is focusing on the right thing, to keep suppliers on their site. This is a winner takes all market. If we look aside for a second and consider how Ebay operates in the US, this would be helpful. Ebay is the place to sell items. The reason is if it doesn’t sell on Ebay, it most likely will not sell anywhere else. Why is that the case? Because most of the sellers list their items on Ebay, which makes it the most compelling platform for buyers with the most variety of choice and availability of products. This is why when competitors launch their sites, it’s extremely hard to compete – with the key reason of not having enough sellers. Alibaba, it seems, has figured out this recipe and according to the S1, they intend to focus on the suppliers, which will bring in the buyers.

According to the risks, if the Chinese economy suffers, then Alibaba would suffer, which is from a risk point of view is not that significant – as all global companies operating in China would suffer the same fate. The other reasons at the S1 do not raise any alarms to me. Feel free to prove me wrong on this one.

Considering that more and more people will come online and China will have the most Internet users in the world, and throw into the mix that there are so many manufacturers looking to grow their services, this leaves a lot of room for Alibaba to grow – at least in it’s own domestic market. On the international front, this is unclear as domestic entrepreneurs would target their individual countries. This has yet to be seen.

It’s also interesting to note that Yahoo is a strategic investor along with Cisco Systems International B.V. The proceeds from the IPO would go to primarily for acquisitions. This would be targeted to complimentary products and services offered by other companies and technology companies. There is a strong management team in place, great growth possibility, and use of proceeds to continue growing the business with no concrete competitors in sight – according to the S1.

This is a buy and hold for long term in my view.