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ALIBABA IPO

VALUATION AND NEGOTIATION


FIN 433 WINTER 2014
PROFESSOR GREGG JARRELL
Introduction
This case is based on the hypothetical assumption that Alibaba, the Chinese internet
company, will do an Initial Public Offering (IPO) in the United States in February, 2014.
You should assume that Alibaba is planning an IPO of 2,500 million low-vote common
shares to be sold at an IPO price agreed upon by Alibaba Management (AM) and
Goldman Sachs (GS), the Investment Banker that AM has chosen to execute the IPO. As
a private company, you should assume that Alibaba has 2,500 million low-vote (one vote
per share) common shares and 1,250 million high-vote (10 votes per share) common
shares prior to the IPO. Further, you must assume that all 1,250 million high-vote shares
are owned by Alibaba Management, whereas the 2,500 million low-vote shares are all
owned by private equity investors and employees other than Alibaba top management.
You also must assume that the high-vote shares are worth twice as much per share as the
low-vote shares.
The 40 teams have been assigned the role of either AM (20 teams) or GS (20 teams).
During the Report Phase each team must write a comprehensive report valuing Alibaba
and setting your teams strategy for the Negotiation Phase. In the Negotiation Phase, AM
teams and GS teams will negotiate and attempt to reach an agreement on the selling price
for the 2,500 million newly-issued IPO shares.
Moreover, 10 of the 20 AM teams have received authorization from Alibabas board to
award AM 2,500 million options on newly-issued, low-vote common stock to be
exercised at the same time as the IPO. Therefore, the 10 AM yes teams (AMY) must
also reach an agreement with GS on the (single) exercise price for these options. These
2,500 million options shall be valued at their intrinsic value, and neither the IPO price nor
the option exercise price may exceed $40 per share. Note that the option exercise price
and the IPO price are independent and need not be identical. The 10 AM no teams
(AMN) have not received board authorization to award any options. The 20 GS teams
may negotiate and transact with either kind of AM team at their discretion.
Team Roles and Communication Rules
There are three team roles consisting of Goldman Sachs (GS) teams, AMY teams, and
AMN teams. Team roles are assigned at the end of this write-up. Teams may not discuss
this case with any other team during the Report Phase. During the Negotiation Phase,

AM teams may communicate without restriction with GS teams, but AM teams are not
allowed to communicate with other AM teams until after the Negotiation Phase is over.
GS teams may communicate without restriction with any and all AM teams during the
Negotiation Phase, but GS teams may not communicate with other GS teams during the
Negotiation Phase. Notwithstanding the rules discussed above for teams not yet in deals,
once an IPO agreement causes your team to be out of the game, then your team cannot
discuss the terms of your IPO deal with any other AM or GS team until the end of the
Negotiation Phase. Your team can only be involved in at most one IPO deal as of the end
of the Negotiation Phase.
Valuation of Alibaba
Your report (hard-copy, no emails) is due at 3:00 PM on Wednesday, February 5, 2014.
Your teams first task is to estimate Alibabas Enterprise Value and Equity Value as of
January 1, 2014, based on DCF and multiples analyses, as well as based on implied
values from recent observable market transactions. An attachment includes data your
team can rely on as the bases for your valuation work. Your goal in valuing Alibabas
assets is to present the most reasonable strategic valuation of Alibabas Enterprise and
Equity Values, including the per share values of the low-vote and high-vote shares of
common stock, before accounting for any IPO or management options. A strategic
valuation is designed to advance the interests of the team. Thus, AM teams should
produce valuations designed to advance their interests in getting a relatively high IPO
price, whereas the valuations by GS teams should be designed to advance their interests
in obtaining a relatively low IPO price that maximizes post-IPO run-up in Alibabas stock
price. You will be graded on the reasonableness of your strategic valuation analyses, the
organization and clarity of your explanations of your assumptions and results, and the
merit of your bases for your assumptions, as well as the reconciliation of the valuations
based on your different valuation approaches, including DCF analysis, trading multiples,
and transaction-based evidence of value.
Valuation Assumptions
You should assume that the Valuation Date for your DCF analysis of Alibaba is January
1, 2014. You should assume that Alibaba has 2,500 low-vote shares and 1,250 high-vote
shares before the IPO, and that high-vote shares are worth exactly twice the per-share
value of the low-vote shares. You should assume that Alibaba has zero Debt and zero
Cash as of 12/31/13. Management stressed it has no plans to use debt financing in the
future, and considers its optimal leverage ratio to be zero. You should assume that
Alibabas Sales for the year 2013 are $7,575 million, and Management projects that
Alibabas Sales will increase by 50% in 2014 to $11,362.50 million. Alibaba
Management also projects that Sales will increase by 50% again in 2015, and that the
annual growth rate of Sales will decline by 5 percentage points each year thereafter in the
Forecast Period until it is 15% for 2022, the last year in the Forecast period. Alibaba
Management has informed you that it expects its EBIT margin to be 30% of Sales for the
8-year Forecast Period from 2014 to 2022. Management also projects that CAPX will be
7% of Sales, and Depreciation will be 5% of Sales, so that Net New Investment (CAPX

minus Depreciation) will be 2% of Sales, for all 8 years in the Forecast Period.
Management also informs you that its Accounts Receivables were $1,250 million, its
Inventory was $758.75 million, and its Accounts Payables were $1,630 million, as of
12/31/2013. Alibaba projects that its tax rate will be 16% of EBIT in all future years.
You should adopt all of these Management assumptions and projections in your DCF
work. Also, please assume the risk-free rate is 4%, the equity risk-premium is 6%, and
the size premium is zero when estimating the cost of equity capital based on the CAPM.
In addition, you should add a country-specific equity risk premium ranging from 3% to
5% because Alibabas legal status as a Chinese company increases the risks of accounting
and expropriation issues that have plagued US-traded Chinese companies in recent years.
But, otherwise, your team must select and defend all of the other assumptions required
for your strategic DCF valuation. Your assumptions regarding these other variables
should be selected so as to advance your strategic interests, and you will be graded based
on the reasonableness and persuasiveness of your defense of these assumptions. I have
provided some Ibbotson data for the relevant SIC code that you may rely on. I have
provided several research reports that you may use as you see fit. You may also do your
own internet research to help you select and defend your DCF assumptions. In doing your
DCF work, you must determine a point estimate for Alibabas per-share equity value of
the low and high-vote shares. You also must present sensitivity analyses of your pershare DCF equity value in response to small changes (plus and minus) to your projected
EBIT Margin in Perpetuity, Perpetuity Growth Rate, Beta, and Country-Specific risk
premium (3%-5%).
You must also do a Trading Multiples valuation, and I provide data that you may rely on
for this work. You may also do outside research for your multiples work at your
discretion, for example, if you want to compute and use forward multiples as part of your
multiples valuation. Finally, your report should reconcile your DCF valuation with your
trading multiples valuations and transaction-based evidence of value.
The first section of your report should be a two-paragraph Executive Summary (ES) that
discloses in the first sentence your team name, team role, and team goal in this case.
Your ES should also present your DCF per-share Equity Value and key assumptions, your
conclusions of Alibabas Equity Value per-share based on your trading multiples, and the
results of your transaction-based analysis. Also summarize your key strategic
conclusions and plans for achieving a good negotiation outcome. Remember, this is a
report, not a PowerPoint presentation. I urge you to review the course outline for
valuable hints on how to write an excellent report, which is worth up to 100 team points
in this case.
MVBS Analyses and Game Theory
In addition to your valuation of Alibabas Enterprise and Equity Values, your report
should contain an organized, detailed, and comprehensive MVBS analysis of the effects
of changes in IPO price on the payoffs to GS and to AMN teams, and of the effects of
changes in the IPO price and option exercise price on the payoffs to GS and to AMY

teams. Payoffs to AMN, AMY, and GS teams are defined below. Your MVBS analyses
should always be based on a fixed pre-IPO Enterprise Value of $200 billion for Alibaba,
rather than your strategic valuation estimate. I select an EV of $200 billion, which I
consider a maximum possible valuation of Alibaba, so as to provide a common basis to
compute payoffs and to rank and grade all of the deals from the Negotiation Phase.
Finally, you should discuss your expectations of the outcomes of the Negotiation Phase
for each of the 3 kinds of teams and discuss your game-theory strategy for achieving a
good outcome for your team given this expected market environment.
Negotiation Phase
The Negotiation Phase starts at 4:30 PM on Wednesday, February 5, 2014, and ends at
6:00 PM on Sunday, February 9, 2014. When two teams reach an agreement, both teams
must separately email me promptly disclosing team names, team roles, IPO price, and
the exercise price for the 1,250 million options awarded if the deal involves an AMY
team. I will acknowledge receipt of your email by replying OK, signifying that I have
received your emailed deal. If your team fails to email me within 10 minutes of the time
the other party to your deal emails me, then I will deduct 3 points from your Negotiation
score for this case. Walk Away rights are allowed and terms are negotiable. If your
contract has WA provisions, both parties must disclose the terms in the email reporting
your deal. The court will NOT enforce any WA rights or terms not disclosed to me at the
time of the deal. If I later determine your deal is invalid, I will notify your team promptly
via email. During the Negotiation Phase, I will periodically email the entire class
indicating which teams have entered deals and are out-of-the-game since my last email
update, according to my records. My email updates will not disclose any information
other than team names.
Team Payoffs and Grading for Negotiation Phase
I will use a fixed pre-IPO Enterprise Value of $200 billion, which is based on the
maximum allowable IPO price and option exercise price of $40/share, as the basis to
calculate the outcomes of all of the IPO agreements and the payoffs for the teams at the
end of the case. Thus, all teams will be evaluated using the same $200 billion Enterprise
Value for Alibaba, regardless of their strategic valuations or actual deals. I call this fixed
standard the Grading Fair Value (GFV).
AMY teams will be graded against all other AMY teams, and AMN teams will be graded
against all other AMN teams. GS teams will be graded against all other GS teams,
regardless of whether they deal with AMY or AMN teams. AMY and AMN teams will be
graded based on the post-IPO value of their 1,250 million high-vote shares (which equals
two times the post-IPO market value per share of Alibabas traded low-vote stock), plus
for the AMY teams the intrinsic value of the 2,500 million low-vote options that have
been awarded to them as part of its IPO deal, both measures computed based on GFV and
the terms of their specific IPO deals. GS teams will be graded based on the total dollar
run-up in the post-IPO stock price, which is defined as the difference between the postIPO market price of Alibabas traded, low-vote stock and the agreed-upon IPO price,

given GFV and the terms of their specific IPO deals, times the 2,500 million low-vote
shares issued in the IPO. Contracts may not contain any side payments or like provisions
that would affect payoffs other than the IPO price and the exercise price (if options
issued).
The AMY team that has the lowest payoff will receive a grade 60, and the AMY team
with the highest payoff will receive a grade of 100, for the Negotiation Phase. The AMN
team that has the lowest payoff will receive a grade 60, and the AMN team with the
highest payoff will receive a grade of 100, for the Negotiation Phase. The GS team with
the highest payoff will receive a score of 100, and the GS team with the lowest payoff
will receive a grade of 60, for the Negotiation Phase. Any team that is not involved in a
valid IPO deal at the end of the case will automatically receive a grade of 40 for the
Negotiation Phase. Team roles are assigned below.
Assigned Team Roles
AMN Teams (10)
Team One
Wolves of Wall Street
Nemesis
Genesee
Synergy
Argonauts
North West
Meliora
Golden Banana
Kaist
AMY Teams (10)
Vincens
Topex
Lannisters
Skywalkers
Jarrell Lynch
Sassy Sparrow
Alpha 4.0
Lucky 7
PMBA
Pt
GS Teams (20)
Unicorn
Rocksolid

Rocky Mountain Oysters


Alpha LLC
Phoenix
Rain Man
Wait For It
Falcon
Storm Survivors
New Bee
Risksolvers
Prestige
Valuators
Alfa
Roc Star
Los Pollos Hermanos
Excelsior
Hardrock
RockNRolla
Snow Storm