Chinese companies love U.S. markets. And U.S. investors love Chinese companies. It’s a match that has proven extremely equitable for everyone since the turn of the millennium, with Chinese technology and internet companies being the most courted debutantes by Wall Street.
Thanks to a burgeoning middle class of nearly half a billion – more than the entire U.S. population – China’s online retail market is expected to surpass America’s this year for the first time, with sales volumes in excess of $180 billion.
“Investors are very hungry for a piece of the consumer e-commerce space in China,” Francis Gaskins of IPO research company IPODesktop.com revealed to Reuters.
When the Chinese IPO craze peaked from 2009-11, 67 Chinese companies had raised $8.26 billion on American exchanges.
But now, one single Chinese e-commerce giant stands poised to steamroll over all of them… Beijing-based JD.com, China’s answer to Amazon (NASDAQ: AMZN).
As China’s second largest e-commerce company behind Alibaba, JD.com recently filed its intent to raise $1.5 billion in a U.S. initial public offering, the date and share price remaining undisclosed.
Posting over $8 billion in revenues for the first three quarters of 2013 and hitting $16.5 billion in sales for the year, the $1.5 billion IPO seems likely to leave a lot of money on the table for early investors to swoop in for a meaty feast.
Should you? Some are sceptical, citing recent accounting fraud by Chinese auditing firms. And then there’s the feared slowdown in China’s growth, which some anticipate could fall below 7 percent in 2014 for the first time this millennium.
Might the Chinese IPO train have finally derailed?
Money on the Table
Even if the Chinese economy were to slow again this year, there seems to be plenty of room in JD.com’s IPO for early investors to turn a tidy profit from the get-go. Let’s run some simple comparisons among several e-retailers to get an idea of where JD stands.
With 35.8 million active customer accounts, JD.com processed some 211.7 million orders during the first nine months of 2013, with revenues surpassing $8 billion for the period, or some $228 per account.
The closest American counterpart would be Amazon.com, which is estimated to have more than 215 million active customer accounts generating some $74.45 billion in revenue last year, or some $346 per account.
But here’s the amazing part… with U.S. average hourly wages of $10.30 x the average workweek of 34.4 hours x 52 = an average annual income of $18,424 in America, compared to China’s average annual income of 46,769 yuan, or $7,716 – figures from TradingEconomics.com show.
This means JD.com is much more effective at sucking money out of its customers’ wallets than Amazon is, with JD achieving an efficiency of $228 / $7,716 = 2.95 percent, while Amazon manages just $346 / $18,424 = 1.88 percent.
Let’s now compare JD’s price-per-sales to that of Amazon, eBay (NASDAQ: EBAY), Facebook (NASDAQ: FB) and Twitter (NYSE: TWTR).
• Twitter: Market cap $36.12 billion / annual sales $543 million = share price / sales 66.52
• Facebook: Market cap $154.24 billion / annual sales $8.03 billion = price / sales 19.24
• Ebay: Market cap $68.52 billion / annual sales $16.2 billion = price / sales 4.23
• Amazon: Market cap $159.71 billion / annual sales $74.98 billion = price / sales 2.13
The hype surrounding Facebook and Twitter has pushed their stock prices way too high over their sales compared to Ebay and Amazon. And Facebook and Twitter aren’t even retailers.
But there’s a problem in trying to compare JD.com to this group, as the company has not revealed how many shares it will issue nor at what price. All we know is that it intends to raise $1.5 billion, and that it posted annual sales of $16.5 billion in 2013.
So let’s make an assumption that the company will issue only 50 percent of its stock to the public, keeping the remaining 50 percent for itself, quite a conservative estimate. This would give the company a market cap of 2 x $1.5 billion = $3 billion on its initial opening. How does it compare now?
• JD: Market cap $3 billion / annual sales $16.5 billion = price / sales 0.18
Now that leaves an awful lot of money on the table for investors. Even if the company were to sell just 25 percent of its shares to raise the $1.5 billion it seeks, its price / sales would still come in at 0.36, about 17 percent that of Amazon’s. This means that JD’s stock could rise 588 percent just to catch up to Amazon’s price / sales.
It’s Been Done Before
Think it’s quite the stretch to expect JD.com’s debut to be so powerful? It’s happened before with another Chinese internet giant – search engine Baidu.com (NASDAQ: BIDU). Remember this report from MarketWatch back in August 2005?
“Shares of the Chinese Web-search-engine operator Baidu.com vaulted 354 percent Friday in the IPO market’s biggest splash in at least five years… Baidu.com opened at $66, more than double its $27 price… ending its historic opening day at $122.54.”
That’s right. Baidu surged 354 percent above its initial offering price during its first day of trading.
“With about 32.3 million shares outstanding, a company with $8 million in revenue in its most recent quarter is carrying a market cap of more than $4 billion,” the report outlined.
That represented a ratio of price / revenue of 125, meaning that price / sales was even higher. And you thought Twitter’s 66 was a stretch.
Other recent Chinese IPO’s have fared remarkably well themselves, including:
• Sungy Mobile (NASDAQ: GOMO) – market cap $665 million and price / sales ratio 13.64. Shares rose 44 percent above its IPO price on the first day of trading on November 22nd, rising 83 percent in the 2.5 months since then.
• Online gambling giant 500.com (NYSE: WBAI) – market cap $1.23 billion and price / sales ratio 38.88. Shares rose 70 percent above its IPO price on its first day November 22nd, climbing 196 percent since then.
Sentiment Warming Up
The recent resurgence of interest in Chinese IPO’s has come at an important time, as accounting scandals nearly brought them to a halt.
After peaking at some 39 offerings in 2010, Chinese IPO’s in the U.S. fell to 15 in 2011, and to just two in 2012, as a slew of Chinese stocks were delisted from U.S. exchanges when their companies were charged with accounting fraud by the U.S. Securities and Exchange Commission in 2012.
The Chinese branches of four major auditing firms – Deloitte Touche Tohmatsu CPA Ltd, PricewaterhouseCoopers Zhong Tian CPAs Ltd, Ernst & Young Hua Ming LLP and KPMG Huazhen – were charged for not handing over IPO audits prepared in China owing to the Chinese government having classified them as “state secrets”.
But sentiment toward Chinese IPO’s have improved since May of last year when the U.S. Public Company Accounting Oversight Board struck a deal with Chinese regulators to allow the U.S. S.E.C. to see audit records and other documents of Chinese companies filing for U.S. IPO’s.
Chinese IPO’s have subsequently risen to 8 in 2013, with plenty more planned for this year, including JD.com’s
$1.5 billion offering and the eventual Alibaba issuance expected to raise as much as Facebook’s $16 billion.
The only question remaining is… does China’s economic outlook justify investing in Chinese IPO’s?
Will Chinese e-Commerce Stall?
Granted, China’s economy has slowed considerably from GDP levels well above 12 percent at the start of the millennium to some 7 percent now, and still slowing.
But 7 percent growth, or even 6 percent if it gets there, still equates to robust expansion by any measure. And most of that expansion is taking place in China’s urban middle class – the very foundation of internet e-commerce.
Research firm McKinsey and Company in its “Mapping China’s Middle Class” report of June 2013 noted that “the explosive growth of China’s emerging middle class has brought sweeping economic change and social transformation—and it’s not over yet.”
“By 2022, our research suggests, more than 75 percent of China’s urban consumers will earn 60,000 to 229,000 renminbi ($9,000 to $34,000) a year.” Remember the above calculation showing how well JD.com has been able to exploit Chinese purchasing power?
“Just 4 percent of urban Chinese households were within [that salary range] in 2000—but 68 percent were in 2012,” the report compares. “In the decade ahead, the middle class’s continued expansion will be powered by … initiatives that push wages up, financial reforms that stimulate employment and income growth, and the rising role of private enterprise which should encourage productivity and help more income accrue to households.”
“And the Internet’s consumer impact will continue to expand. Already, 68 percent of the middle class has access to it,” the report revealed.
So take a 1 or 2 percent drop in Chinese GDP in stride. It will be a mere blip on the screen in a year or two. The future of China’s middle class and its e-commerce companies is paved with gold. JD.com should be snapped up with gusto.
And Alibaba. When that one debuts, I for one would be prepared to sell my car for as much of that stock as I can get my hands on.
Joseph Cafariello
