Want a Piece of the Alibaba IPO? Buy Yahoo

The long-awaited initial public offering of Chinese web company Alibaba.com raised $1.5 billion from institutional investors, who paid $1.74 apiece for the 858.9 million shares offered for sale in the second-largest Internet IPO since Google (GOOG). The stock will begin trading Tuesday — on the Hong Kong Stock Exchange. That's little consolation to U.S. investors who want a piece of the action, but thanks to a trans-Pacific connection between Hangzhou-based Alibaba and Sunnyvale's very own Yahoo (YHOO), there's still a way to ride the iron rooster.

Yahoo snaffled up a 39% stake in Alibaba in 2005 for a relatively cheap $1 billion, joining the legion of investors and China watchers who've fallen under the sway of Jack Ma, a former English teacher turned Internet mogul. It also got 7% of the IPO in a $100 million purchase, raising its estimated stake to 40%. Alibaba is now valued at $6 billion, making Yahoo's cut worth $2.4 billion. That's not a bad return over two years.

Yahoo's ties to Alibaba are no secret, and the stock has climbed ahead of the IPO. Adding to the run-up in the shares was Yahoo's better-than-expected third-quarter profit, reported Oct. 16. The stock is up 13% in the two weeks since the numbers were released.

But investors with a long-term view of the opportunities the Internet offers in China should look past the frenzy created by Alibaba's IPO, which was marked by heavy share subscriptions and more than a little wuli rexin — irrational exuberance. Many tech watchers and securities Sinologists believe that Yahoo's investment in Alibaba could offer a considerable payoff, even if the bubble in Chinese Internet stocks deflates.

ComScore World Metrics, which measures Internet traffic, calls Alibaba the 15th-busiest web site in the Asia-Pacific region, and within China, which has the largest online population in the 10 countries in the zone, it's closing the gap with other popular Chinese Internet properties, though the country's exact statistics remain hard to quantify. The research firm says China's Internet users, which ComScore puts at 91.5 million and the government-affiliated China Network Information Center calculates at 162 million, are still putting more time in at Tencent, a messaging service; search engine operator Baidu (BIDU); portal site Sina.com (SINA); gaming site NetEase (NTES); and Sohu (SOHU), another portal.

Alibaba is a leader in e-commerce. Ma, the company's chairman and chief executive officer, has assiduously assembled a network of businesses including an English-language business to business site, auction site Taobao.com, online payment site AliPay, portal site Yahoo China and newly added Alisoft, a web service support site for small businesses.

Rob Sanderson, an analyst at American Technology Research, is one of the more bullish observers of the Alibaba-Yahoo relationship. In a research note published last week, he wrote that Alibaba could add $13 to $15 a share to Yahoo over the next three to four years, particularly if Taobao and Alipay realize their growth potential. They've already proved to be stiff competition for eBay (EBAY) and PayPal in China, claiming a 65% market share for auctions, and 50% greater payment volume than PayPal, representing "a tremendous value creation opportunity," Sanderson wrote on Oct. 26.

Yahoo shares won't necessarily move in lockstep with Alibaba's trading debut, though analysts predict the U.S. company will see a short-term bump. Estimates vary wildly, from between $1 to $4 a share, but that's vulnerable to post-IPO disappointment if Alibaba's price declines. Longer-term investors on Yahoo's China play will need to watch Alibaba's management closely, says David Pasquale, an analyst at the Ruth Group, a New York investor relations firm specializing in health care and technology.

"The IPO itself is a seminal event for the market there," Pasquale says. "It's one of the longest rumored and worst-kept secrets on Wall Street for years. Jack Ma has done an excellent job at marketing the company in advance of the offering itself. The affiliation with Yahoo was extremely shrewd on his part and only added to the allure of the deal."

But after the expected trading hubbub subsides, a listed Alibaba will need to deliver consistent results, Pasquale says. In documents filed with Hong Kong regulators for the IPO, Alibaba forecast a profit of $83.5 million this year, up from $29.5 million in 2006 — figures that lag far behind the enormous expectations for the stock.

"On an ongoing basis it's an extremely competitive space, and marketing and PR are very different skill sets from operating a company," Pasquale says. "The other issue is that Jack Ma has gotten away with very limited disclosure and gotten to characterize developments and results as he saw fit. As a public company he's going to be held to a different standard."

There's no doubt that Alibaba's debut in Hong Kong is serving as a positive short-term catalyst for Yahoo. Looking further out, the Chinese company bears watching to gauge its ongoing effects on its 40% stakeholder. By buying Yahoo shares now, U.S. investors should benefit from the immediate IPO buzz and be positioned to make the most of Alibaba's fundamental performance.