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Alibaba Goes Public

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Alibaba Goes Public I. Executive Summary
Alibaba competes in the e-commerce industry with a focus in China. The main service offering in the e-commerce industry is to provide an online marketplace that links buyers and sellers across a wide breadth of product lines. The ability to connect buyers and sellers on an accessible platform allows market constituents to engage in trade opportunities to which they previously would not have access. II. Key Factors
Alibaba Group had the pioneer advantage and gained a significant share of the Chinese e-commerce industry. Its core value proposition of connecting “small and medium-sized Chinese manufacturers” has been dramatically revised as a result of the business’ rapid growth to suffice customer needs. Categorizing their business units according to the profile of the vendor, the Alibaba Group has established market exclusivity in an effort to segment their vast consumer market. Segmenting their market allowed the firm to expand their consumer base, while strategically positioning themselves competitively and avoiding the risk of cannibalization across their services. To support the large extent of commerce, the business units are supported by peripheral services, Alipay and Yu’e Bao, which structure Alibaba’s main service offering. Alibaba Group strengthened the value of their existing service offerings by providing an escrow service, Alipay, to reduce the risk of online purchasing. This supporting service is a response to the market demand for a safer platform for transactions. In order to account for the large volume of money being exchanged on their various market platforms, Alibaba Group created a bank for customers to store their money. Again, the firm considered the needs of users and provided an appropriate response. Alibaba Group has seen success as a result of the strategic value proposition demonstrated by each business unit. III. Value Proposition
The value behind the Taobao service offering lies in matching small and medium-sized buyers and vendors in a competitive marketplace. Taobao generates revenue via merchants who pay for advertising and other services to market their store-front, appearing on search results. This revenue model is a two-faceted system dependent on a continuous stream of website traffic and merchant purchasing. The ability to gain and retain users in an effort to encourage vendor spending on advertising, in addition to capturing users from competitors, is a challenge. To maintain competition between similarly sized vendors in addition to legitimizing a marketplace for high-branded goods, Alibaba created TMall. Like Taobao, the revenue stream relies on user traffic. The firm took advantage of their established brand loyalty to encourage prestige brands to join the marketplace as a new outlet to reach customers. The potential for counterfeit goods to be sold as legitimate branded products poses a challenge. The merchants in TMall will not want to keep spending money on membership and advertising fees when there is a high threat for substitutes. The company’s primary means for success are exhibited in two main areas. One area of excellence is the ability that Alibaba Group has to respond to market conditions and customer needs. Each of the new business units and the supporting services is evidence of co-creation, adding value to Alibaba Group service offerings. Second, through the success of developing their product breadth and maintaining reliability, Alibaba Group has secured a high level of brand loyalty and awareness. Having such a significant level of brand equity encourages website traffic and contributes to revenue, bolstering financial health. IV. Financial Analysis
Prior to the IPO, Alibaba maintains stable financial health. Through significant revenue growth, high gross margins, and a low-cost structure, profit margin retains a large portion of total revenue. Although the firm has seen considerable revenue growth from 2012 to 2014, the company’s identity as an e-commerce entity allows for operational expenses to be paid on maintenance and development for the online marketplaces. The absence of an inventory balance and other assets related to the logistics of selling inventory allows for a smaller offset against total revenues. It is clear that Alibaba Group is financially very healthy due to the high levels of cash flow. Their strong cash balance gives them financial flexibility and stability with planned and unforeseen activities that require spending. Alibaba Group funds a large portion of their assets with debt. This can be a potential weakness if the company has a lower cash balance in future operations. At the current moment, this is not a factor due to the large amount of financial flexibility they retail. Although these metrics may reflect upon Alibaba Group’s financial structure, the numbers provided in the case are skewed due to the 2012 privatization, the 2013 discrepancies in accounting (related to the decrease in retained earnings), and the 2014 IPO. The Return on Equity demonstrates that Alibaba Group returns a large percentage of their earnings to their stockholders. This firm is extremely attractive as it can offer favorable returns in the future. It is clear that Alibaba does not have any significant financial weaknesses considering their high profit margins and revenue growth. However, their IPO poses a potential weakness. If an overvalued IPO leads to a declining stock price, this could lower investor confidence and trigger stock sell-off, which would further devalue the company’s share price (Exhibit 1). V. The Decision to Go Public
Alibaba Group chose to list on the NYSE, rather than on the HKEx due to the restrictions of Alibaba Group’s governance structure. The firm did not list on HKEx because their request was rejected due to the call for two classes of stock. Issuing a priority type stock would give investors with priority shares more voting rights per dollar of equity than investors holding the normal class of stock. The HKEx rarely allows for preferred or differentiating stock to be issued. The firm proposed the dual-class structure to maintain its governance structure. Since the board is voted on by Alibaba partners (a governance they require), Alibaba Group wanted to make sure that the ordinary investor did not have influence over the company’s governance. They rejected the decision to enlist on the Shanghai Stock Exchange due to various restrictions that limited direct foreign investment. The firm’s priority was to grow and source the most capital, limiting their investor potential to the Chinese market would prevent this goal. This decision to enlist on the NYSE sufficed the stock requirements. Alibaba Group’s request to maintain board governance by the firm’s partners was accepted. Enlisting on the NYSE preserves their governance and voting structure in addition to establishing the firm as a more global company.
Upon the initial public offering, investors had a large appetite for Alibaba Group stock. Exhibit 1 displays the various metrics, which show financial performance. A notable figure is the profit margin, where Alibaba Group retains on average 25-30% of their total revenue in net income. With revenues continuing to grow, the earnings potential remains extremely attractive for investors as the firm will see an increase in stock price and might potentially pay dividends due to Alibaba Group’s high profitability and large cash balance. Alibaba sets itself from other e-commerce companies due to the high volume of transactions in comparison to their lead competitor - an indicator of a high demand for the company’s services. VI. Recommendations
Alibaba Group has received criticism for their corporate structure and “lack of shareholder rights and independent board representation” (9). Jack Ma and the Alibaba Partners need to reorganize the board members of Alibaba Group to prevent further scrutiny. Due to the governance structure of the company, the board is already controlled by the partners. In order to instill confidence in investors the board members must not display further discrepancies, whether perceived or real. For example, the appointment of Daniel Yong Zhang as a director and Chief Operating Officer of Alibaba Group (18). Zhang’s previous position as senior manager at PricewaterhouseCooper’s Audit Division in Shanghai questions the independence of PWC as Alibaba Group’s independent auditor. Another example of these discrepancies is Jerry Yang’s position as an Independent Director. A co-founder of Yahoo! Inc., Yang was with the firm in an executive capacity until January 2012. As Yahoo! had an ownership stake of 22.4% in Alibaba Group at the time of the IPO, and would continue afterward with an 11.2% stake in the company, it is doubtful that a former top executive at Yahoo! could perform his fiduciary duties to shareholders with any independence. Jack Ma’s control of Alipay through Small and Micro Financial Services Company (SMFS), which he “fully controlled and substantially owned,” is another example of a conflict of interest (5). As the case mentions, the Alibaba Partnership, with only a 13.1% equity stake and simple majority control of the board of directors, has an incentive to divert value from Alibaba Group to entities that have a greater equity stake. Jack Ma’s SMFS is an example of this investor concern. Ma, as Alibaba Group chairman, would be able to create contracts for the use of Alipay which would favor SMFS at the expense of Alibaba Group.
A further concern with Alipay involves the Alibaba Group’s reliance on Alipay for day to day business operations. For instance, in 2013 “Alipay handled 70% of China’s electronic payments” (3). Alibaba Group’s core business is almost entirely dependent on Alipay as a way of transferring funds. The fact that Alipay is not controlled by Alibaba Group is a potential threat to the firm as a going concern. Regardless of the Chinese legal restrictions, which necessitated the divestiture of Alipay, this is a major concern for any investor. Moving forward, Jack Ma and the directors should take any course of action, which would mitigate investor concern on this issue. We recommend finding a way to bring Alipay back under Alibaba Group control, which does not conflict with Chinese central bank restrictions on payment services firms owned by foreign entities. If this is not feasible, Alibaba Group must establish long-term contracts with SMFS Company to ensure the continuation of Alipay’s escrow services and mitigate the group’s risk exposure to its dependence on an external entity.
Another recommendation for Jack Ma and the directors of Alibaba Group is a concentrated focus on improving internal controls which handle issues of fraud and copyright infringement. As the firm has previously experienced in 2012, there is a liability risk related to “fraud stemming from fake electronic Alibaba.com storefronts” which had evaded internal controls (5). This fraud culminated in the loss of 1.7 million which Alibaba paid to the victims of the fraud. In addition, Alibaba experienced the investor backlash to this issue when the share price of Alibaba.com declined in the wake of these revelations (5). Alibaba group must consistently make the internal controls related to consumer fraud a top priority in order to avoid similar scenarios of fraudulent activity in the future and protect consumers as well as share value in the company. As a publicly traded company on the NYSE, Alibaba Group will also face stricter copyright infringement laws than previously encountered in China. Jack Ma and the directors must also focus internal controls on the regulation of goods sold through their online platforms to ensure compliance with these copyright laws and avoid litigation. Although the company does not actively sell bootlegged merchandise, recent cases suggest the United States Justice Department could hold the group liable as active participants as the proprietors of the marketplace on which these illegal items are sold. FedEx is currently involved in litigation with the DOJ over its alleged role in the illegal sale of prescription drugs which could cost the firm a reported $820M (Gullo). Even though FedEx’s involvement as a common carrier of goods for the general public, the DOJ has continued to hold them liable as co-conspirators. This exposes Alibaba Group to the same liability as their e-commerce websites could facilitate the sale of bootlegged goods regardless of whether the company is actively involved in copyright infringement.
A final recommendation to Jack Ma and the directors of Alibaba group is to focus on expanding their e-commerce market share in the global marketplace. Exhibit 1 shows a downward trend of International commerce revenue as a part of the total revenue from 19% in 2012 to only 9% in 2014. While China commerce revenue increases from 78% to 86% during the same time frame, Alibaba group must look outside of the Chinese market for continued growth. This can be done through expansion into emerging markets as well as the U.S. and European marketplace. E-commerce could prove useful to rural areas of India and South America in the same way it has proven useful to remote villages in the Chinese market. While the barrier to entry is substantially higher in the more mature European and U.S. markets, ad campaigns in these markets could draw away consumer traffic from competitors.
You do a good job of analyzing the facts and data, rather than just retelling the story of the case. Also, your appropriate integration of concepts from all disciplines of business (financial, management, accounting and marketing) strengthens your paper. Although the recommendations flow from the reasoning, you need to draw the paper to a close in a more focused manner at the end. Overall, your writing style is quite strong, but watch some of the details as explained in the comments (such as the use of commas and passive voice).
Grade: 94 minus 4 points for grammar = 90

Exhibit 1 Income Statement Metrics | | | | | 2012 | 2013 | 2014 | Gross Margin | 67% | 72% | 74% | Profit Margin | 23% | 24% | 45% | China Commerce Revenue (% of tot. revenue) | 78% | 85% | 86% | International Commerce Revenue (% of tot. revenue) | 19% | 12% | 9% | Total Revenue Growth | | 72% | 52% | China Commerce Revenue growth (% of tot. revenue) | | 87% | 55% |

Balance Sheet Metrics | | | | 2012 | 2013 | 2014 | Debt to Asset | 0.27 | 0.83 | 0.63 | DuPont Identity | | | | Profit Margin | 23% | 24% | 45% | Total Asset Turnover | 0.42 | 0.54 | 0.47 | Equity Multiplier | 1.37 | 124.34 | 3.67 | Return on Equity | 0.14 | 16.38 | 0.77 |

Bibliography
Gullo, Karen. "FedEx Pleads Not Guilty to Illegal Drug Shipping Charges." Bloomberg.com.
Bloomberg, 29 July 2014. Web. 25 Jan. 2016.

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