Baba = drool. If you are a native Spanish speaker, then you would have already known that. But for those who aren't, there's your quick Spanish lesson before we talk finance and economics.
Investors drool over IPOs. Actually, let me rephrase that, SPECULATORS drool over IPOs. Speculators want to invest in the next Apple (AAPL, Financial), or Amazon (AMZN, Financial) on the ground floor and make millions or billions of dollars by holding the stock for 20 years. First of all these speculators are subject to hindsight bias. Looking back from our current perspective, we could connect the dots in history to show that these investments would have been foolproof. However, there was no way to predict that these companies would grow as much as they did, and these "investments" would have been risky speculations at that time. IPOs do one thing very well, and that is to make the pre-IPO investors rich.
IPOs are a way for companies to raise capital. But they are also a way for founders and other investors to cash in on their initial investments by unloading their shares to the unsuspecting public. They are also an investment bank's bread and butter, so they will do everything in their power to ensure that the IPO is successful and that there is a lot of interest around them. Ben Graham has warned to never invest in an IPO for these very reasons, but it seems that investors can get swept up in the mania and become speculators when a hot IPO is set, only to regret it later on. I guess IPOs are the hangovers of investments and will only leave you with a headache.
Now, let's look at Alibaba (BABA, Financial) just to hammer these points home. This company has garnered so much media attention, which has only resulted in a ridiculous price for this company. I'm not saying the company is terrible. I've used their service in the past and have no qualms about BABA. But the way investors drool over the company and present the information about the company to the public is misleading in the best case scenario. The information is so misleading that I've had people, who don't have a lot of experience investing, ask me if they should invest in BABA. The short answer: NOOOO!!! A longer answer: you'll have a better chance to make money by drooling, or spitting, into a cup and trying to sell it for $90 (current BABA price per share). But if that isn't a satisfactory answer, let's take a deeper look:
First, we need to clarify how BABA makes money. It does not create any products. It does NOT carry inventory like Amazon. It is an ecommerce platform providing a service for sellers to sell products. BABA did NOT generate or sell $240 billion worth of products. The platform SUPPORTED $240 billion sales transactions that the sellers on the platform generated. BABA actually generated $6.9 billion in revenue and had net income of $2.9 billion. Revenue is generated from three major platforms, Tmall, Taoboa Marketplace and Alibaba. This income comes from advertising fees charged to sellers, as well as monthly storefront fees. Alibaba also offers cloud-based computing services.
Next, let's look at market cap and pricing. Initially, the company was going to be priced at what was said to be the top of its range at $68. Investor's drool levels became so high that BABA opened at over $90 a share!! That's over a 32% increase from the prospective price. No one was really able to get the stock at $68, and if you're a regular "investor" like me, you would have never been able to get the stock for $68. But it was a big payday for the founder Jack Ma and anyone else who invested when the company was still privately held. Now we really need to ask ourselves, is a company that only generated a net income of $2.9 billion worth $221 billion? Is a company with no dividends and priced around 30 times its book value worth spending $90 per share? It's time to stop drooling.
