With the US market becoming an attractive destination for Chinese tech IPOs, it is worth revisiting the relative valuations of Chinese tech companies versus their US counterparts.
I have chosen to compare three US tech companies with their closest China counterparts. The primary two valuations metrics I will focus on are Enterprise Value (EV) / Revenue and EV / Net Income [note]Many blog posts focus on valuing the market capitalization of a company however this assumes the company is financed primarily through equity, market capitalization based valuations can become very misleading for companies with significant amounts of debt financing or that have large cash balances.
Enterprise value gives a much more complete picture of a companies’ valuation as it accounts for both debt and cash balances.
Thus the Price / Earnings ratio can be a very misleading and we will substitute Enterprise Value (EV) for the price (market cap) and so use EV/Earnings or EV/Revenue instead[/note]
In mature businesses (such as Microsoft or Intel) EV / Net Income is the primary multiple used in valuations. However young tech companies which have yet to achieve profitability or companies (such as Amazon) that are run at break-even will not have significant Net Income and as such Revenue can be used as the denominator.
Amazon vs Alibaba
Amazon’s closest Chinese counterpart is Alibaba.It should however be noted that there are a few major differences with the businesses:
- Alibaba operates several varieties of marketplace but does not take stock/inventory itself whereas Amazon operates a mixed model of both a marketplace and selling its own inventory
- Both have a large cloud businesses, although AWS is a much more mature business than Alibaba Cloud at of 10x the revenue and is generating $2.5B of operating income whereas Alibaba Cloud is still loss making.
- Alibaba has an online finance business – Ant Financial [note]Alibaba’s has no direct ownership of Ant Financial. Instead, Ant’s primary shareholder is Jack Ma and Alibaba has a complex arrangement whereby it is entitled to a third of any IPO proceeds and half of Ant’s profits[/note] , whereas Amazon has no corresponding finance business.
- Amazon has a vertically integrated supply-chain owning much of its logistics network such as warehouses, whereas Alibaba is operates asset-light model outsourcing much of its logistics [note]Note that this model is lightly to change somewhat at is consolidates control over its strategic investments [/note]
Nevertheless, they are both are the dominant eCommerce players in their respective markets.
In terms of profitability Amazon has consistently operated at breakeven whereas Alibaba’s net margin is close to 30% [note]As noted above this is partly due to Alibaba outsourcing its unprofitable logistics operations[/note]. As such the relevant valuation metric is EV/Revenue which is 3.1 for Amazon and a whopping 17 for Alibaba.
Alibaba core metrics are stronger – it enjoys higher gross margins (63% vs Amazon’s 36% [note]This is primarily due to marketplace’s having higher margins that direct sellers of the products[/note]) and is growing at close to 60% versus Amazon’s growth of 30%. Neither of which can fully justify the massive difference between the two valuations. The average eCommerce company is valued at under 3x revenue, and the closest valuation in my dataset of 150 tech companies is that of Atlassian which trades at 16x revenues. Atlassian is considered a best of breed Saas which are always valued at a premium to eCommerce companies due to their revenue quality (Atlassian enjoys gross margins of over 80%).
It is heard to find any tech company with a valuation comparable to that of Alibaba, and this is in spite of its opaque ownership and accounting.
Baidu vs Google
Whilst Google’s EV of $625 billion dwarfs Baidu’s $70 billion valuation they operate similar businesses, albeit of different scale, as both derive the majority of their revenue from search based advertising.
Google’s business looks by far the more healthy – both have similar net margins at approximately 25%, Google has a marginally higher gross margin (60% versus Baidu’s 50%). However, crucially Google is able to grow it’s revenues at 25% despite its higher base whereas Baidu’s growth has flat-lined and is currently a meager 6% per year.
Baidu’s prospects also look limited extremely limited – it has virtually no international presence and is not expected to be able to grow beyond China. Within China it’s share of digital advertising has been shrinking and currently stands at 17% and was overtaken in 2015 by Alibaba (which also blocks its Taoboa and Tmall listings from appearing in Baidu’s earch results). Google by contrast is maintaining its >50% market share of US search.
Despite these very divergent businesses, the valuations look very similar – Google is valued at EV/Revenue of 6 (vs 6.3 for Baidu) and EV/Net Income of 30 (versus 27 for Baidu) and thus Baidu’s valuation looks extremely expensive when compared to Google.
Expedia versus Ctrip
Both Expedia and Ctrip are both OTAs (Online Travel Agents) which provide distribution for hotels and airlines. Ctrip is the largest OTA, with Expedia the largest US player.
In terms of profitability for Ctrip and Expedia both have gross margins of approximately 80%, however, Ctrip is the more efficient able to capture nearly 10% net margin compared to Expedia’s 4%. Growth for Ctrip is stronger at 46% versus Expedia’s 20%.
Ctrip thus deserves to be valued at a premium to Expedia, however it trades at nearly double the EV/Net Income ratio (70 for Ctrip vs 40 for Expedia) and 3 times the EV/Revenue ratio.
In all three instances the China company is valued at a substantial premium to its US counterpart. The valuation premium combined by the clamp-down on backdoor listings in China as well as the large IPO backlog and an time to approval of close to 18 months will likely result in a surge of China based IPOs in the US from 2018.