Ant Group, the Chinese payments giant, will float its initial public offering on the Hong Kong and Shanghai stock exchanges this year. That poses some issues for American-based investors who can’t access those markets. But there’s a solution: Buy Alibaba Stock (NYSE:BABA) instead.
Alibaba, the NYSE-listed Chinese e-commerce giant, holds a 33% stake in Ant Group. That means BABA stock acts as an Ant Financial IPO proxy.
But that’s not all. Alibaba also happens to be one of my top international stock picks. The e-commerce giant is even more dominant in China than Amazon is in the United States. And in logistics, it stands out thanks to its ground-up approach to building capacity. As investors look to Ant’s blockbuster IPO, here’s why Alibaba will benefit handsomely.
Alibaba Stock: A Proxy for Ant Group IPO
Ant Group started life as a side-project of Alibaba. Since very few Chinese had debit or credit cards in Alibaba’s early years, the company needed to create its own version. What it came up with was simple: Alipay. “The service would act as a trusted third party, holding money from buyers in escrow,” explained Sherisse Pham at CNN Business, “and only releasing it to sellers after the goods had been received and buyers confirmed they were happy with what they got.”
In 2011, Alibaba CEO Jack Ma spun off Alipay in a quite controversial deal. After much legal wrangling over ownership, Alibaba investors today own 33% of Alipay, now known as Ant Group. And the fledgling transaction payments startup has gone on to dominate Chinese financial services.
Jack Ma’s ‘Crown Jewel’
The company has transformed from its early escrow days. Today, Ant Group works as a “financial supermarket,” allowing people to buy insurance, pay bills, get loans, pay salaries, and even invest money. The company generated $17.7 billion in revenue in 2019, more than U.S.-based PayPal and Square. It’s also grown internationally, covering markets across Southeast Asia and beyond. And only Trump administration intervention scuttled its planned 2018 acquisition of MoneyGram.
“Ant Group really is the crown jewel of Jack Ma and … of China’s internet industry,” said Edith Yeung, general partner at Race Capital and creator of the China Internet Report. According to CNBC analysis, investors could value Ant Group at more than $200 billion, making Alibaba’s stake worth somewhere north of $67 billion.
What’s Ant Group Worth?
However, those estimates undervalue Ant Group. Alibaba’s holdings are worth far more, making the parent company a clear “buy.”
In 2019, Ant Group generated 24.0 billion RMB of operating profits ($3.5 billion) and a 40% top-line growth rate. That should make the Chinese financial giant worth far more than PayPal’s current $225 billion market capitalization.
Using a two-stage discounted cash flow model with:
- Market discount rate: Equal to PayPal’s 8.4%
- Growth rate: 40% in 2020, slowing to 15% by 2029
- EBITDA margin: 23% in 2020, rising to 27% by 2024 and shrinking back to 24% in 2029
Creates a fair value of $434 billion. That makes Alibaba’s stake worth $145 billion (or $53 per share)
But there’s a catch. Chinese stocks have notoriously high discount rates because of greater uncertainty. In a more conservative case, adjusting Ant’s discount rate to match Alibaba’s implied 11% rate puts fair value at $258 billion.
In reality, Ant Group will probably trade somewhere between the two goalposts. The Chinese government has pushed the Shanghai STAR Exchange (Shanghai Stock Exchange Science and Technology Innovation Board) as a U.S. NASDAQ alternative and will likely intervene to make sure Ant Group, it’s largest IPO yet, remains a resounding success.
Getting in on the Ground Floor
Investors might as well ride the wave. In 2020, the average IPO popped 36% on its first day, according to IPO tracker Renaissance Capital. Much of this has been led by tech, with companies like Lemonade (NYSE:LMND) up 139% and Snowflake (NYSE:SNOW) up 100% on their first trading day.
But how can Main Street investors get in? First-day pops only reward insiders who receive pre-IPO allocations. The moment the stock starts trading, those shares immediately rise and can’t be bought for the theoretical IPO price.
That’s where buying Alibaba comes in. Rather than fighting for Ant Group allocation, investors can buy BABA stock today and reap the gains. Every 3 shares of BABA stock gets you between 1-1.5 shares of Ant Group.
And the remaining shares in BABA gets you a strong e-commerce and cloud computing franchise too.
What’s Alibaba Worth?
According to research firm eMarketer, Alibaba captures a 55.9% share of all online retail sales in China. That’s far ahead of Amazon’s 37.7% share in the United States. Alibaba also holds a whopping 47.3% of China’s cloud computing market share, compared to Amazon’s 32.4% U.S. market share.
That makes Alibaba an exciting company to value. Using a that two-stage DCF model, Alibaba comes to a fair value of $316 per share without Ant Group. Adding in another $42 per share for Ant’s IPO brings fair value to $358, or a 24% upside from current levels
As Ant Group prepares to go public before year end, U.S. investors should buy into Alibaba to ride that wave of excitement.
On the date of publication, Tom Yeung did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Tom Yeung, CFA, is a registered investment advisor on a mission to bring simplicity to the world of investing.