Alibaba (BABA) surged Tuesday after it announced that it will be restructuring itself as a holding company and splitting into six separate entities.
These entities will split up Alibaba’s existing cloud, logistics, entertainment, and other ventures. Each of these newly formed entities will be able to individually raise funds and explore IPOs of their own.
Why are Investors Pumped?
Well, first, who doesn’t love a good IPO? Especially when it is, for better or worse, a company that has a large following. With just 37 IPOs so far this year, we are well off the 2021 record of 1,035 and set to have even fewer than last year's 181.
So six potential IPOs in the nearish future is actually a lot.
But other than getting investors’ minds running, it might signal that Chinese companies are finally finding a way to satisfy Beijing’s orders following years of harsh crackdowns on the tech sector.
'Unlock Shareholder Value and Foster Market Competitiveness'
This was seemingly the big quote from the announcement. On its own, it's just your typical business jargon. But when you consider the rich history we had the displeasure of experiencing these past few years, whew! Tears to the eyes of burned-but-hopeful investors.
Chinese companies faced record-breaking fines and overnight regulation changes that turned valuations on their heads. All done with zero regards for foreign investors.
Alibaba set an all-time high on October 19, 2020. At this time, the stock was flying high with every other tech stock, surging to its peak of $309.92 after falling to $181.30 on March 16, 2020, as markets assessed lockdowns.
Part of the irony behind the clampdown on tech stocks had to do with issues regarding the centralization of power and decision-making. This spinoff, which separates the clouds from entertainment from the supermarkets, making them all independent with their own CEOs, certainly meets those demands.
Assuming this is a move authorities looked over and blessed before the announcement, it should definitely lessen the volatility that American investors in Chinese companies have come to expect. Alibaba is far from the only company in China’s crosshairs, so if this proceeds kindly, then you can expect more of these announcements as Chinese companies aim to lessen regulatory risk.
Key Word: Lessen
While the bulls have certainly come out to play following this news, many bears remain.
CFRA analyst John Freeman downgraded Alibaba shares to Strong Sell following the announcement, arguing that it makes “no economic sense”. Freeman called it a 'CCP-sponsored pump-and-dump ruse' that only gets worse if it goes through, asking: "what cloud-based business ever created value by breaking itself up into any major pieces, let alone six pieces?"
While this might lessen the regulatory risk, it surely doesn’t end it.
Spinoffs and carveouts can unlock lost potential. But this is like a shotgun divorce that immediately leads to six separate shotgun weddings. When the carveouts are voluntary, they are for the best of both the original and emerging businesses and by extension, their investors.
IPOs, while oftentimes exciting, tend to be pretty bad investments. More than 60% of IPOs from 1975 to 2011 had negative absolute returns after five years. Further, two-thirds underperform the market within three years of their IPO.
When they go right, the outsized returns are fantastic. But unicorns are rare under the best of circumstances.
What's next is anyone's guess, but with a clear goal by the Chinese government to limit the size and influence of any one company, it's hard to know how much growth potential there actually is for the companies, independent or otherwise.