Can the Alibaba IPO Kick-start the Chinese Stock Market?

U.S. investors have lost a lot of money betting on the “China Miracle” since the market peaked in the fall of 2008.

But after more than five years of suffering disappointingly poor returns, the Chinese stock market just might be making a comeback.

Over the past three months, the iShares China Large Cap (FXI) — the major Chinese ETF that tracks an index of 25 Chinese large-cap stocks — has soared 15.53%. That makes the Chinese stock market the single-best-performing stock market over that time period among the 46 that I track at my firm, Global Guru Capital.

Dig a bit deeper, and you’ll find that the Chinese technology sector — and within that, the Internet sector — has shown even more strength than the overall Chinese market.

That’s why the renewed focus on Chinese Internet stocks — thanks to the upcoming listing of Chinese e-commerce giant Alibaba — could make Chinese Internet stocks one of the hottest sectors in the coming months.

Alibaba: The Biggest IPO in History?

If the investor relations firms are doing their jobs, you’ll be hearing a lot more about Alibaba in the coming days. A hodgepodge of various online marketplaces for consumers and businesses, Alibaba is minting a fortune by charging fees to 8.5 million businesses advertising on its sites.

As with all things Chinese, the numbers associated with Alibaba are all about superlatives.

Alibaba is already the largest e-commerce company in the world in terms of value of merchandise sold. Alibaba’s transaction volumes already surpass eBay Inc. and Amazon.com, combined. It boasts 279 million active buyers. That already trounces Amazon.com’s global user base of 244 million.

Just yesterday, Alibaba’s senior management hit the road, hat in hand, looking to raise $20-$24 billion for the company’s upcoming initial public offering (IPO). That puts the Alibaba offering on track to become the biggest-ever IPO, topping the $22 billion raised by Agricultural Bank of China Ltd. in 2010.

To put those numbers in perspective, Twitter raised about $2 billion in 2013 and Facebook generated $16 billion in 2012.

The IPO is expected to value Alibaba at roughly $155 billion. At that market valuation, Alibaba would instantly become one of the largest companies listed in the United States. It also would match Amazon.com’s valuation on Day One.

At that level, Alibaba would trade at 41 times 2013 earnings. If that sounds expensive, consider that Amazon is valued closer to 600 times its 2013 earnings. Alibaba is far more profitable than Amazon, generating 43% operating profit margins. Amazon’s margins are, well, pretty much 0%, as it barely breaks even.

The Fertile Fields of China’s Internet

For all the comparisons with its U.S. rivals, Alibaba is still largely focused on China. And that’s not such a bad thing.

The growth in Internet users, growing e-commerce and growth in services all combine to make the Internet in China one of the most powerful “big picture” investment themes around.

Today, China boasts more than 630 million Internet and mobile Internet users. That compares with just 94 million over a decade ago. In 2014, China is already home to by far the largest number of Internet users in the world. Yet, Internet penetration in China is just 47%, compared to 87% in the United States.

Sure as day follows night, the Internet will become an ever-larger part of Chinese citizens’ consumption and social lives — just as it has in the United States.

China is already home to more fixed broadband lines than any other single market. It already has more than one billion wireless subscribers, even as most of these consumers have yet to use their first smartphone. Last year, China also surpassed the United States to become the world’s largest e-commerce market. By 2020, McKinsey estimates China’s e-tail market will be worth $420-650 billion. That will match the combined size of the e-commerce markets in the United States, Japan, United Kingdom, Germany and France.

China’s 12th Five Year Plan aims to ensure that the technology sector will contribute 8% of gross domestic product (GDP) in 2015 and 15% by 2020. The government also clearly is committed to protecting its “national champions” at the expense of foreign competition. Google, Facebook and Twitter already are all blocked in mainland China. A whole cadre of Chinese Internet companies has evolved to essentially mimic and reproduce the U.S. Internet service sector.

How To Invest in China’s Internet Sector

Alibaba is expected to list its shares on the New York Stock Exchange (NYSE) under the ticker “BABA.” Based on its current schedule, the stock should begin trading on Sept. 19, and you should be able to invest in the Alibaba stock on that day, as well.

Underwriters flogging Alibaba stock fear another Facebook fiasco, where a highly touted stock tumbles after its debut on the market. Some investors are already grumbling that both the management structure and business strategy of Alibaba aren’t quite up to snuff.

As skeptical as I am about most Chinese investments, it’s hard to see how an investment in Alibaba can go wrong over the long term. After all, overnight, it is set to become the biggest Internet company in the world’s biggest Internet market. And unlike most Internet companies, it is not only growing fast, but also making money. And those fearing another “Facebook flop” should understand that even Facebook is trading at twice its IPO price two years after the bottom fell out of its IPO.

That said, I am never a fan of putting your eggs in one basket — Chinese or otherwise.

That’s why I recently recommended a Chinese Internet ETF to subscribers of my investment service The Alpha Investor Letter.

I pointed out last month in The Alpha Investor Letter that the ETF’s sponsors confirmed that they will be adding Alibaba after the stock’s 11th trading day and the fund will be one of the first ETFs to add the company to its portfolio.

In case you missed it, I encourage you to read my e-letter column from last week about whether a September swoon is in the cards. I also invite you to comment in the space provided below.