Alibaba, the currently private and soon-to-be public internet giant that has captivated Wall Street, is valued at as much as $200 billion by some tech experts.
But is the upcoming Alibaba IPO a sign of a bubble about to pop in tech?
One major investor scoffs at the bubble talk surrounding the Alibaba IPO. Masayoshi Son, a big Alibaba investor and the founder of Japanese Internet company Softbank (SFTBF),spoke at the recent Re/code Code Conference this week in California, saying, “Back then there was a vision and so on, but no profit. This time there is a big profit. I would say this time people got smarter on the investor side. This time I wouldn’t call it bubble.”
I wouldn’t be so sure.
For starters, Son has a vested interest in the Alibaba IPO, so it’s logical for him to say that talk of $200 billion valuations is justified. Softbank is Alibaba’s largest shareholder with a 35% stake — far more than the roughly 23% stake that Yahoo (YHOO) owns, and Yahoo gets a heck of a lot more press for its position.
Secondly, the beef with the Alibaba IPO doesn’t surround the company’s profitability, but rather the valuation multiple that is being placed on those profits.
For instance, Alibaba recorded $5.6 billion in revenue for fiscal 2013 and is tracking roughly $8 billion for fiscal 2014; Net income totaled $1.6 billion last year, or 28.6% of total revenue, and is tracking between $2.3 and $4 billion in profits for fiscal 2014.
That means an Alibaba IPO that values the company at $200 billion would mean the stock would trade at 25 times sales and 50 times earnings — presuming everything goes well, that is.
Alibaba IPO Has Big Risks
Now, those multiples aren’t unheard of in tech. Amazon (AMZN) has famously reinvested most of its profits into growth … and the stock managed to tack on 300% gains over the last five years to outperform even the impressive gains for the S&P 500 in the same period. And even though AMZN stock has suffered in 2014, giving up about 21% since Jan. 1, the tech giant still trades for a forward price-to-earnings ratio pushing 100 right now.
Of course, the 21% decline also speaks volumes of how Wall Street thinks right now. After years of giving AMZN a pass on its massive earnings multiple in pursuit of top-line growth, investors are finally holding Amazon’s feet to the fire.
Could the same happen after the Alibaba IPO? I certainly think so. And not just because of Amazon, but also because of the crash and burn of Mercadolibre (MELI) — a company that has long been billed as the Amazon.com of Latin America. This emerging-market stock that was supposed to capitalize on a fast-growing consumer class is down 25% in the past year. Furthermore, MELI stock is flat since 2012 … while the S&P 500 is up more than 60% in the same period.
Throw in eBay (EBAY) with its 8% loss in the last 12 months vs. 16% gains for the S&P 500, and it’s clear e-commerce isn’t all its cracked up to be, based on the struggles of these major players.
The reason things could be moving far beyond just trouble for e-commerce players and into tech bubble territory, however, is that underperformance has plagued a host of Internet stocks. Online content giant Yahoo (YHOO), social media darling LinkedIn (LNKD), daily deals player Groupon (GRPN) and even China internet darling Baidu (BIDU) are all sitting on losses of varying sizes in the past six months while the S&P 500 has gained more than 6% in the same period.
The question that investors should ask themselves, then, is what makes the Alibaba IPO all that much different, and what can justify the massive valuations that many on Wall Street are talking about right now.
Because based on the trouble of Internet stocks broadly and specifically Alibaba’s peers in e-commerce, it will be awfully hard to justify a massive earnings multiple for long after this China stock goes public.
And when it falls?
Well, it could be the exclamation point on what is already shaping up to be quite an ugly year for tech stocks.
Jeff Reeves is the editor of InvestorPlace.com and the author of The Frugal Investor’s Guide to Finding Great Stocks. As of this writing, he did not hold a position in any of the aforementioned securities. Write him at firstname.lastname@example.org or follow him on Twitter via @JeffReevesIP.