AVCJ Awards: Exit of the Year - IPO: Alibaba Group

Asked if there are any pre-existing models that suggest how Alibaba Group might fare in its international expansion, Ken Hao, managing partner at Silver Lake, notes that conventional rules don't seem to apply to the Chinese e-commerce giant.

An investor in Alibaba since 2011, Silver Lake has been a "helpful ally" as the company has retained its leading position in fast-growing China market. The technology-focused private equity firm has brokered relationships between Alibaba and some of its other portfolio companies, and clearly can be an important partner as Alibaba looks to build up its business in the US and other markets. But Hao demurs from offering a view on how this might turn out.

"I cannot predict what Alibaba might do in the US, but I don't think it will be conventional," he says. "Alibaba's success in going cross-border will become more evident over the next 12 months. This is a global technology company that happens to be based in China and it was founded to be a global technology company. If Alibaba's model continues to be as scalable as it has been in the past I think they are going to prove themselves to be more global than other e-commerce companies have been in the past."

Silver Lake is understood to have invested about $500 million in Alibaba. The PE firm took $278.8 million off the table as part of a $25 billion IPO - the largest ever seen - in September. Its remaining 2.2% holding was worth $3.7 billion based on the IPO price of $68 per share. However, Alibaba's stock opened at $92.70 and has since gained an additional 25%, putting the Silver Lake interest at more than $6 billion.

Overcoming uncertainty

It has been a hugely successful investment, but the PE firm disregarded its conventional rules in order to back this unconventional company. Silver Lake describes its investment approach as disciplined, valuation sensitive and control-oriented. Alibaba set two records: the highest valuation Silver Lake had ever paid for a deal in absolute terms and multiple terms; and the lowest percentage ownership.

Furthermore, Alibaba was not well understood - it had a Hong Kong-listed B2B subsidiary while the now more valuable B2C and C2C-related assets remained in private ownership - and the company had just spun out its Alipay payments business, briefly causing tensions with major shareholders Yahoo and SoftBank. And then the transaction presented to Silver Lake in 2011 was an entirely secondary offering: it was a liquidity event for employee shareholders and a number of early investors.

At one point this uncertainty looked set to limit the PE firm's investment in Alibaba to $100-200 million, but it ended up committing more than that as part of a consortium that paid $2 billion for a 5.7% stake and brought in two LPs as well.

Silver Lake re-upped the following year, contributing to the $3.9 billion equity portion of a $7.6 billion buyback through which Alibaba picked up approximately half of Yahoo's 40% interest in the company. This followed a privatization of the Hong Kong-listed unit.

"Our first investment wasn't done in contemplation of a big Yahoo buyback but that was the strong preference for Alibaba at the time," Hao says. "The privatization and the buyback were constructive and accretive transactions, but the big bet was that Alibaba could defy the law of large numbers with its growth rate and market position, and continue to build on its success. That is clearly what has been borne out."

This has been driven by continued growth in internet usage, broadband and mobile internet penetration, and online shopping. China had 618 million internet users at the end of 2013, more than double the 2008 figure, while online spending has risen 100-fold to $305 billion over the same period. Crucially, only about half of those internet users currently buying goods online. By 2016 Chinese online shoppers are expected to be spending $769 billion.

Future glories

On the domestic front, new e-commerce verticals are springing up as an alternative to Alibaba's broad-based marketplace, but Hao notes that the industry is large enough to accommodate multiple players.

"It will be a while before we get to the point where for every winner there needs to be a loser and it's a zero-sum game," he explains. "That said, I don't believe that marginal companies can easily exist because Alibaba has such a powerful ecosystem that if someone is not adding true value to the e-commerce proposition then they don't need to exist. China is a uniquely valuable but hyper-competitive e-commerce market and there can be more than one company, but I do see Alibaba at the center of it all."

As such, Silver Lake is in no hurry to exit Alibaba because wants to take advantage of the company's long-term potential. But it has no immediate plans for another foray into Chinese e-commerce. The private equity firm is likely to stick with its primary strategy of investing in core technology - companies that sell technology as opposed to what Alibaba does, which is use core technology to shape an e-commerce experience.

In this sense, Silver Lake is therefore looking for the Chinese equivalent of Apple or Cisco Systems, but it will be a gradual process.

"Over time in China there is going to be an ecosystem of advanced core technology companies," says Hao. "There are only a small number of players now, but it is a space we are watching. We need the right relationships with the right people at the right time."

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