By Jason Zweig | 6:38 pm ET Sept. 15, 2014
It won’t be easy for individual investors to get a piece of Alibaba Group Holding as the Chinese Internet retailer sells up to $24 billion in shares this week in the most anticipated initial public offering of 2014.
Anyone jumping in expecting a quick killing is apt to be disappointed. If you have money you can afford to lose and you get shares in the IPO at a price under $70, you should probably hang on—but don’t even think about buying in the first place if you scare easily.
Investors have a natural tendency to think of each company going public as a special case. But you will get a clearer sense of what to expect for Alibaba’s IPO if you think of it not as a unique case but rather as part of a class, meaning a broader set of similar companies.
By changing your perspective from what Nobel Prize-winning economist Daniel Kahneman calls “the inside view” to “the outside view,” you increase your odds of understanding the opportunities and the risks facing Alibaba and its investors.
Alibaba’s size is encouraging. Companies that are already large when they go public tend to perform better after the IPO.
“If there was one single item that I would want to know about an IPO to predict its long-run performance,” says Jay Ritter, a finance professor at the University of Florida who has analyzed data on public offerings on U.S. exchanges between 1980 and 2012, ”it would be the sales of the company.“
On average, he says, ”the bigger they are, the better is [their] long-run stock performance.”
The 84 foreign companies in Mr. Ritter’s database that went public with more than $1 billion in sales went on to outperform the U.S. stock market as a whole by 7.4 percentage points annually over the three years afterward. The nearly 500 big U.S. companies he tracks outperformed the market by an average of 5.9 points annually over the ensuing three years.
Alibaba’s sales for the year ended March 2014 totaled $8.5 billion, according to its offering document.
You could also consider Alibaba as a member of the class of Chinese companies going public in the U.S. Here the picture is less rosy: Chinese listings on U.S. exchanges have underperformed the overall U.S. stock market by an average of around nine percentage points annually in the three years after their IPOs, he says.
James Anderson, head of global equities at Baillie Gifford in Edinburgh, Scotland, which manages $183 billion, says Alibaba belongs to the class of “West Coast innovators.” These companies, many with roots in Stanford University and Silicon Valley, have brash and “profoundly disruptive” CEOs who shatter traditional business models, fund most of their growth with internal torrents of cash and ignore short-term earnings.
Typically, says Mr. Anderson, these firms have “an indirect approach to making money,” placing the interests of customers first, followed by those of employees, with the interests of outside investors almost an afterthought.
Mr. Anderson believes that Alibaba’s governance structure, designed to keep power in the hands of Executive Chairman Jack Ma and his close associates, is meant to ensure that “the company has longer-term interests than most of its shareholders do.” That doesn’t just mean day traders, but also mutual-fund managers who can barely hold on to the typical stock for a year at a time.
Among Mr. Anderson’s favorite “West Coast” companies are Amazon.com, Facebook, Google, LinkedIn Corp. and Tesla Motors. His firm has owned Alibaba since 2012, when it purchased approximately 0.1% of the stock in a private offering at around $18.50 a share.
Because these firms are focusing on growth not just for years to come but for decades, their stocks tend to fluctuate far more than the rest of the market.
Amazon’s stock is off 19% this year amid worries about sluggish sales for its Fire phone. Facebook lost over half its market value in its first four months as a public company—and then more than tripled in the past two years. In October 2013 alone, Tesla’s stock fell 17%; since then, it is up nearly 60%.
If you buy Alibaba’s stock, you should brace yourself for a similarly long and turbulent ride.
He declined to discuss Alibaba at a recent meeting, saying the firm is “not in a field I’m trying to be expert in.” But in a classic speech in 1996, Mr. Munger urged investors to “think in reverse,” because “many problems can’t be solved forward.”
Mr. Munger imagined a hypothetical investor facetiously named Glotz, who offered to put up $2 million to fund a new business that would be worth $2 trillion in 150 years. That 1-million-fold growth is equivalent to roughly a 10% return annually over a century and a half.
“You have 15 minutes to make your pitch,” said Mr. Munger. “What do you say to Glotz?”
Mr. Munger then made his: The business should have a strong trademark, plus “universal appeal” from harnessing “powerful elemental forces” that compel consumers to buy almost addictively. He fleshed each step out in detail until he had described Coca-Cola Co.
Alibaba already refers to its partners and consumers as an “ecosystem,” but for the company to meet today’s great expectations, it will need to show it belongs in the class of firms that can build an indomitable moat world-wide.
If you would find yourself standing speechless before Mr. Glotz, then you should stand aside from the Alibaba IPO.
Source: The Wall Street Journal