There are any number of reasons to find Alibaba alluring: a global footprint, scads of cash and ownership that has its eyes focused firmly on future growth.
That doesn’t mean, though, that the glittery initial public offering, which prices Thursday evening, is all gold. Indeed, there are at least three potential drawbacks investors should consider before banging at the door Friday to get a piece of what very likely will be the largest IPO ever.
1. It plays in China, but will it play in the U.S., too?
But there’s still that nagging worry over whether it will connect with U.S. consumers, who in the past have been less than willing to buy into Chinese retailers of any sort.
“We think it’s going to be challenging for them to gain a lot of traction, at least directly, with Western and particularly U.S. consumers,” Scott Kessler, equity analyst at S&P Capital IQ, said in an interview.
Indeed, there is a long and unpleasant history for Chinese companies in the West, whether it’s with consumers or investors. Publicly traded Chinese stocks gained just 7.9 percent from 1993 to 2013, a time when U.S. stocks returned 555 percent, according to calculations recently reported by The Associated Press.
“Just because the Western world is largely untapped for (Alibaba), suddenly there seems to be this massive potential,” Kessler added. “While that may be the case in some respects, we think it’s been very difficult for Chinese companies to make major inroads with Western and specifically U.S. consumers.”
2. And then there’s that whole China thing
Because of a long history of financial curiosities, Chinese companies carry their own special cloak of mystery. For Alibaba, it’s a little different, but still enough to give pause.
No one is challenging the company’s riveting sales or profit figures, but there is some concern about the way Alibaba is headquartered in China but incorporated in the Cayman Islands. It’s certainly not the first company to do that—China prevents foreign ownership of company assets—but there are still some unique challenges.
For one, investors won’t own common shares, they’ll actually be buying American depositary receipts. FinancialWeb does a nice job of explaining the potential issues here:
One of the disadvantages of investing in an ADR is a lack of information. There is not as much information available about many foreign companies as there tends to be about domestic companies. This can increase your risk as an investor.
Another disadvantage of investing in an ADR is that you have to worry about political conditions in the country where the company is located. This can add another layer of risk for you to be concerned with.
“Political conditions” in China obviously can be tenuous, but hopes are that Alibaba can overcome any China-related stigma.
“This may signify a born-again trust in Chinese companies, at least in the big bulge-bracket scale,” said Gregory Sichenzia, an IPO and securities lawyer with Sichenzia Ross Friedman Ference in New York. “What we’re hoping to see is that Alibaba does restore some confidence in investing in Chinese companies.”
3. Of course, there’s been just a little bit of … HYPE!!!!
Yes, if you haven’t seen the headlines, Wall Street’s a little excited over this one, and we know these things don’t always end well. They don’t always begin so well, either.
In fact, Alibaba itself is highly conscious of the 2012 Facebook debacle, arguably the host-hyped IPO ever. The social network’s market debut was a disaster: Nasdaq failed to get trading off on time, underwriter Morgan Stanley priced the shares at the top of the expected range then had to scramble just to get the stock to break even on the opening day, and investors dumped Facebook shares for months after.
“The price seems to be creeping up every day,” Sichenzia said. “It’s getting expensive even as we speak, before it trades, which scares me a little bit. There is a lot of hype here. There is going to be a little bit of a bubble.”
Alibaba took the unconventional step of listing a big tech company on the New York Stock Exchange instead of the Nasdaq. For that reason, and the Cayman Islands issue, Alibaba will not be included in most major indexes and thus most big exchange-traded funds, potentially limiting its liquidity.
Securities lawyer Andrew Stoltmann warned investors to consider all the potential pitfalls.
“Investors should steer clear of the Alibaba IPO despite the breathtaking pitches of near-certain riches by their financial advisers and stockbrokers,” he said. “Thousands of investors have been burned and scammed by believing the hype when it comes to Chinese companies. Alibaba might be the next one to lure unsuspecting investors into large losses.”