Rocket Internet vs. Alibaba: Showdown of the e-Commerce IPOs of 2014

All price data is as of 24.10.2014, unless otherwise noted.

If I had a time machine, the first thing I would do is go back to 1997 and buy Amazon.com (NASDAQ: AMZN)(STG:AMZ) shares. (Okay, maybe it wouldn’t be the first thing. But it’s on the list.)

Let’s admit it: We all dream of investing in a company like Amazon before they become household names and generate great returns for their shareholders. The e-commerce giant has had an amazing run since its initial public offering (IPO) with its share price increasing almost 200-fold compared to the initial offering price — and also became the first “100-bagger” investment recommendation of The Motley Fool.

In the absence of a flying DeLorean, though, we can’t buy into the Amazon of 1997 — so we need to find our own big winners. Luckily, there are not one, but two e-commerce companies that went public in the last few weeks. Which of them is more likely to follow Amazon’s footsteps and become an investment success story? Let’s have a showdown!

In the red corner: Rocket Internet (ETR: RKET). Founded in 2007 by the Samwer brothers, the German Internet start-up incubator is less well known than its opponent, but just as ambitious. The company’s stated mission is “to become the world’s largest Internet platform outside the United States and China”. You can read more of my thoughts on Rocket Internet here.

In the blue corner: Alibaba (NYSE: BABA). Already the world’s largest online and mobile commerce company, the Chinese giant, whose mission is “to make it easy to do business anywhere”, is poised for further growth — at least according to all the investors who turned the flotation into the largest ever global IPO.

Round 1: Profitability

Rocket: €13 million loss on €47 million sales in the first half of 2014
Alibaba: $3.7 billion net income on $8.5 billion sales in year ended 31 March 2014

Rocket actually made €174 million net income in 2013. This however didn’t come from operating profits but mainly from the sale of the company’s stake in Zalando (ETR: ZAL), Europe’s biggest online fashion retailer. The operating entities in which Rocket has a stake — even though they showed strong growth — still generated significant losses.

Alibaba, on the other hand, is generating strong profits from its day-to-day operations. This is partly driven by its business model: Alibaba is operated as a marketplace platform for third parties and generates revenues from marketing services, commissions and membership fees, as opposed to being involved in direct sales activities and holding inventories. This allowed for a quick scaling of profits as gross merchandise volume increased to almost $300 billion by 2013.

Winner of the round: Alibaba (0:1)

Round 2: Cash Generation

Rocket: €(56) million cash outflow from operations in the first half of 2014
Alibaba: $5.2 billion Free Cash Flow in 2013

Rocket doesn’t generate enough cash from its operations to finance the growth of its existing businesses plus invest in new ideas. As the operating businesses has grown, it’s kept going back to outside investors for multiple financing rounds. As a result, its share in the businesses — together with its share in future profits and cash flow — has been diluted. Rocket decided to go public in order to stop this trend and be able to increase its stake in the more established “proven winners” and keep a bigger stake in its new businesses.

The big questions are: Will the businesses start generating positive cash flow before the money raised through the IPO runs out? And if not, what source of financing will Rocket turn to next?

Alibaba doesn’t have this problem. The company is generating more than enough cash for its ongoing operations. The prospectus didn’t specify what the IPO proceeds would be used for, only that it plans to keep the money outside of China. “General corporate purposes” would normally be a red flag for me, but in this case, I assume Alibaba is planning to use the money for strategic acquisitions. It will be interesting to see exactly what it will end up doing.

Winner of the round: Alibaba (0:2)

Round 3: Market Capitalization

Rocket: $7.2 billion (€5.7 billion)
Alibaba: $236 billion (€186 billion)

Alibaba’s market valuation is 33 times that of Rocket Internet. Normally, the bigger a company is, the more difficult it becomes to drive further growth. Let’s illustrate this with a theoretical example that shows the size of the two companies based on different levels of market capitalization growth:

* 2013 GDP values; source: World Bank

So if both companies became 50 times larger than they are today, Rocket would be about the size of Google — meanwhile, Alibaba would be 27 percent bigger than the entire GDP of China.

Looking at it from a different angle: To double sales, Alibaba needs to find another €6.7 billion in additional sales. Rocket, on the other hand, needs a mere €87 million to double its sales.

While I can’t predict whether either of the two companies would ever achieve any of the above mentioned growth levels, I think most of us would agree that Rocket’s growth scenarios look less unrealistic.

Winner of the round: Rocket Internet (1:2)

Round 4: Valuation

Trailing twelve months as of June 30 2014

This round is a tricky one, as proper comparison of the valuation metrics is very difficult. Here is why: On the sales multiple, Rocket seems to fare worse than Alibaba. However, most of Rocket’s businesses are accounted for under the equity method — without the revenues showing up in Rocket’s sales numbers. If we took the total sales of its portfolio of “proven winners” and weighted it with Rocket’s share in these businesses, it would result in a sales multiple of 26.6, which is more similar to Alibaba’s number.

(Amazon looks much better with this metric, but this is because Amazon engages in direct sales to customers. This results in higher sales numbers, but also lower margin rates.)

On the P/E ratio, Rocket and Alibaba look similar — and both much better than the notoriously low-profit Amazon. (Note that Rocket — even though it is unprofitable in the first half of 2014 — generated profits on a trailing twelve month basis, so a P/E ratio can be calculated.) At the same time, while Rocket’s earnings are mostly from the Zalando sale and from changes in the equity value of the operating companies, Alibaba’s earnings are mostly coming from day-to-day operations and are therefore probably more stable and repeatable.

This round is a tie – there is no clear winner (1:2)

Round 5: Market potential

Rocket: all the world, outside of the US and China
Alibaba: China and its global commerce partners

Rocket aims to become the leading Internet platform outside the US and China — which are dominated by Amazon.com and Alibaba respectively. Alibaba, on the other hand, wants to further expand its reach in China and to develop cross-border commerce opportunities between China and the rest of the world.

Both companies mention similar underlying drivers as catalysts for future growth in their respective regions: strong Internet (and specifically mobile) penetration growth, purchasing power increase through the rise of middle classes and underdeveloped offline retail infrastructure.

However, based on the basic figures, the size of the potential market for Rocket is bigger: In 2013, the world outside of the US and China accounted for 65% of global GDP (China: 12%), 76% of global population (China: 19%) and 69% of global Internet users (China: 22%). Also, Internet penetration rate is only 35% in Rocket’s regions, well below China’s 46%, giving more room for growth.

Winner of the round: Rocket Internet (2:2)

Round 6: Corporate Governance Risks

Rocket: listing in the Entry Standard as opposed to General or Prime Standard
Alibaba: risky corporate structure through Cayman Island entity

Some people are suspicious about Rocket Internet’s listing in the Entry Standard of the Frankfurt Stock Exchange due to the lower disclosure requirements. I am less worried about this. There are still reporting requirements here: Annual and interim reports and audited financials need to be released and any material developments need to be published.

Rocket Internet has provided a thorough prospectus for the IPO and expects to move to the General Standard within a few years. Entry Standard is a way to have the company’s shares traded efficiently with only few formal requirements, not a ploy to rob investors from the visibility they want. Also, frankly — if your investing horizon is measured in decades, do you really need quarterly reports?

Alibaba worries me more: Shareholders actually do not own Alibaba’s Chinese assets, they own shares in a Cayman Islands entity that has contractual rights to the profits of Alibaba China. This so-called variable interest entity structure is risky, as it may be illegal under Chinese law. In addition, Alibaba’s corporate structure gives founder and CEO Jack Ma and his partners firm control over the company board, leaving ordinary shareholders with little leverage over the company. You can read more about risks with investing in Chinese companies here.

To summarize: all other things being equal, I would rather invest in a German company — even if it is listed only in the Entry Standard — than in a Cayman Island entity that doesn’t own the company that generates the actual profits, may be illegal, where any litigation would need to go through Chinese courts and where ordinary shareholders have no influence at all on the board of directors.

Winner of the round: Rocket Internet (3:2)

Overall winner: Rocket Internet (3:2)

Closing Thoughts

Comparing the two big e-commerce IPOs of 2014 was tough — both companies have good arguments both for and against them and there is no clear-cut winner.

Alibaba clearly has a more solid financial situation, generating both profits and cash in abundance. However, the sheer size of its market cap makes growth more difficult, and there are some serious corporate governance risks associated with the company.

Rocket Internet, on the other hand, still has to prove that it can turn into a profitable enterprise. Ultimately, though, Rocket has a more compelling growth opportunity ahead in the emerging world, provided that it doesn’t go bankrupt in the process. Based on this I believe Rocket carries a bigger risk — but it also has a better chance to become the next Amazon.com investing success story.