Invesco Perpetual's Asian equities team is usually sceptical about participating in initial public offerings (IPOs), but William Lam, manager of Invesco Perpetual Pacific Fund (GB0033028449), has been persuaded by Chinese internet retailer Alibaba (US: BABA), which listed on the New York Stock Exchange in September.
"We are usually very sceptical about participating in IPOs because often a very knowledgeable owner is selling the shares, and they exercise their influence to maximise the selling price.
"But we don't think Alibaba is a typical IPO. Yes, its founder and chairman Jack Ma is selling some of his shares, but not a significant portion of his stake. The largest seller is a minority shareholder, Yahoo!, which has no control over the company and little control over the IPO process. And the whole reason for the IPO was so that minority shareholders such as Yahoo could monetise their stake in a reasonably fair way.
"We believe the company's management are more interested in creating a positive association with the brand than in establishing a high price for the IPO. In our meetings with the company it was clear that management was not encouraging investors to hold excessively high expectations for future growth. For example, they said margins could fall.
"We also have faith in Alibaba's figures for its current earnings. It makes money by selling advertising space to its vendors in a keyword system similar to Google and Chinese internet company Baidu. While Google and Baidu tend to place paid search results at the top of the page, Alibaba still places them at the side and at the bottom. Its management say: "We know we could increase revenue by putting the paid results at the top, but we don't do that because it is arguably not in the best interests of our users."
"We were further encouraged by our work on valuation. When we compared the free cash flow yield of Baidu and Alibaba at its IPO price of $68, we found that Alibaba's yield was higher than Baidu's. Yet we feel that Alibaba's competitive position and its growth rate are at least as good as Baidu's, and Alibaba met our criteria of buying stocks where we believe they are available at a discount to fair value."
