"Wait and See" for Alibaba

A number of our clients called last week to ask if we would buy Alibaba (BABA) stock for their accounts.  We told them, "No, we'll have plenty of time to buy Alibaba in the years to come, but meanwhile, to purchase the Initial Public Offering (IPO) is too risky."

Our reasons for concern are as follows:

1. Chinese company.  Even though Alibaba is going through a full SEC registration with accounting statements certified by US accounting firms and investment banks, we have to be skeptical about their numbers.

2. Even if the numbers are real, the valuations are ridiculous - a P/E greater than 200, Price/Sales greater than 60.  By comparison, Google, with 6X Alibaba's revenues, has a P/E of 22 and a P/S of 6.

3. Generally, companies decide to go public right BEFORE their stellar growth rates level off.  Alibaba has a fat operating margin of 80% right now, which is very likely to shrink as consumers shift from PC to mobile buying.  Why did management decide NOW was the best time to go public.  Could it be because the next few years look far less promising?

4. As we have seen in other "Web 2.0" IPO's over the last two years (including Facebook, Twitter, LinkedIn, Groupon), generally there is a 50% decline from the closing price on the first day's trading to some date in the future, which means we have PLENTY of time to buy this stock later.

Add these and more factors, and we conclude that the probability of making money at the IPO is low.  We did not buy Google at the 2004 IPO, and we were not concerned when that stock gained 7X in the next 4 years.  We were quite happy to buy Google in 2009 after the stock had declined 70% from the 2007 peak and the valuations made sense.  That investment was worth 4X over the next 5 years. 

Read the entire commentary here.