ALIBABA’s IPO this month could raise as much as $21.1bn for a company that dominates China’s e-commerce sector. It would make it the largest technology or internet-related float in history. But although the company has set its price range surprisingly low, founder Jack Ma will need to reassure shareholders for the company to trade at a par with its peers.

Why so cheap? Alibaba has achieved something astonishing. It has taken the fragmented retail market of the largest and perhaps most heterogeneous country in the world and united it on the internet. In the past year, buyers and sellers used Alibaba platforms to complete 14.5bn transactions worth $300bn. From this, the company earned $9bn in revenue and $5bn in adjusted net profit. And Alibaba is still growing fast. Transaction volume and revenue are both rising at 50 per cent; profit is rising faster still.

It is a shock, then, that the company set the initial price range for its public offering - expected before the end of the month - so low. At $60-$66, Alibaba’s market capitalisation will be between $148bn and $163bn. Some analysts peg the company’s value at well over $200bn. The price range amounts to 30 to 33 times Alibaba’s net profit over the past 12 months. This may not appear cheap in absolute terms. Relative to its frenetic growth, however, it makes Alibaba one of the cheapest mega-cap stocks in the world. If earnings grow at 50pc in the fiscal year ending March 2015, half the rate of the previous year, the forward-looking price/earnings multiple is an alluring 24.

Alibaba is selling only an eighth of its equity — offering 123m American Depositary Shares. A low price limits the chance of a post-IPO slump and buys goodwill. In a red-hot equity market, though, there must be more to the story than this.

Room for growth :China’s e-commerce market is, in places, strikingly advanced. In 2013, 6pc of US retail sales were transacted online, according to the Census Bureau. In the first half of this year, Alibaba’s retail business alone accounted for 8pc of China’s total retail sales, according to data from Alibaba and China’s National Bureau of Statistics. Even allowing for imprecision in both sets of figures this is amazing. Yes, in the US, Walmart accounts for almost 10pc of retail sales, cars and restaurants excluded. But Walmart sells groceries and petrol and its stores are on every corner. Alibaba is just 15 years old and does not own a distribution network.

Further, Alibaba’s 280m customers are habitual digital shoppers. In the past year they made an average of one transaction a week, spending an average of $1000 annually.

But the market is bifurcated. China still has half a billion citizens without internet access. And only half of China’s internet users shop online compared with nearly two-thirds in the US, according to the research group IDC. Add the conventional view that the Chinese economy is shifting from its export-driven model towards consumption, which is currently just 36pc of GDP. There is, then, a mature e-commerce market in developed China and an untouched one in rural China. Alibaba’s growth depends on that split dissolving.

Barriers to entry: Alibaba’s profitability is as strong as its growth. Its net margin is nearly 50pc; free cash flow exceeds net income; return on invested capital is over 20pc. This compares favourably with more mature, slower-growing internet companies from eBay to Google. Most impressive, the business is not investment-intensive. Its capital expenditures were 8pc of revenues over the past year; at eBay, growing at a fraction of Alibaba’s speed, the ratio was similar. Returns this high must attract competition, and unless the barriers to entry are very firm, will not last.

Alibaba’s profitability has much to do with its pure marketplace model. It connects buyers and sellers, leaving to others the costly business of moving goods about. Helping merchants market their wares in China accounts for half of Alibaba’s top line; sellers’ commissions account for a quarter; most of the rest comes from the wholesale business and international commerce. None of this brings significant cost of sales.

In the US things are different. The undisputed e-commerce champion is Amazon, which owns most of the inventory it sells and has poured money into sourcing and distribution. Low-margin and capital-intensive, it has blown past eBay, the leading US representative of the marketplace model. In 2000, the two had the same market values. Today Amazon is twice as large. It is hard to beat the company that has more products on hand, at lower prices, and gets them to customers faster. Will no one play Amazon to Alibaba’s eBay?

It is not that Alibaba does not exert control over distribution. Its China Smart Logistics subsidiary, a joint venture with logistics and real estate companies, operates the IT system that coordinated the movement of 6.1bn packages in the past year. But incredibly, given the size of CSL’s task, Alibaba has invested only $270m in it. Alibaba plans to invest more - it may have to be very big indeed.

Getting mobile: The wall around Alibaba’s business is the network effect. The company has the most sellers and buyers, giving current users an excellent reason to stay and new users reason to come. As this volume advantage is translated to profits, Alibaba can invest more, too. So how might a competitor get a toehold?

Mobile commerce is one possibility. Alibaba concedes it has been slow to earn money from sales on mobile devices, and to make good profits from these sales. Alibaba’s revenues come primarily from marketing, which on mobile is a tricky game. In the second quarter, the company only earned $1.50 for every $100 of goods paid for on its mobile sites, compared with its average of $2.50 for fixed-point transactions.

Alibaba’s share and profitability are growing fast. But there are players in the market with much larger mobile user bases than Alibaba’s 188m.:In March, messaging and gaming company Tencent took a 15pc stake in the number two e-commerce company in China, JD.com. Tencent has half a billion mobile users, and the two together already hold nearly one quarter of the total retail e-commerce market, according to iResearch. JD.com uses an Amazon-like merchant model instead of a marketplace one, owning warehouses and a delivery network.

Last month unlisted entertainment and property conglomerate Dalian Wanda, Tencent and China’s largest search engine Baidu announced an e-commerce joint venture. It will target offline to online sales, where traditional shops push products to nearby shoppers’ mobile phones.

Alibaba has not stood still. It has bought a one-third stake in Sina’s microblogging subsidiary Weibo, which has 150m active users, and UCWeb, a mobile browser with two-thirds of the Chinese market. But the competitors will keep coming.

You don’t own it :Much has been written about Alibaba’s doubly poor ownership structure. Owners of the ADSs will have a stake in a Cayman-registered company that - via intermediaries - owns onshore Chinese companies. These operate much of Alibaba’s business. Because Chinese law restricts ownership of certain telecoms assets to its own nationals, however, the licences that make Alibaba’s business possible - and some of the group’s profits - are held in so-called ‘variable interest entities’ owned by founder Jack Ma and his colleague Simon Xie. The two have contractual relationships with the companies that shareholders own. Owning the ADSs is a bet that these contracts will not leak value.

Whatever they own, equity holders have no control. The 27-member management committee has the right to nominate a majority of the board and the right to simply appoint directors, should the committee’s nominees fall into the minority.

Silicon Valley companies such as Google also reduce shareholders to serfs but the problem goes deeper at Alibaba. The company has limited stakes in two of its key subsidiaries. It owns only 48pc of China Smart Logistics. Alibaba argues that this structure will mean that CSL can use debt and equity financing from third parties to build out Alibaba’s distribution capacity. Fair enough; but if logistical capacity is a competitive advantage, full control would be preferable.

Then there is Small and Micro Financial Services, the entity that houses Alibaba’s payments platform, Alipay. A popular, secure payments platform captures much of the value of marketplace companies. This was made clear by eBay. Activists wanted to break the company up, and contended that its PayPal payments platform was more valuable than its marketplace. Providing credit to sellers is also an increasingly important part of Alibaba’s model.

At the end of June, it had $2.4bn in small business loans outstanding, more than double the year before. But because the Chinese authorities have not given clear guidance about foreign ownership of payments companies, ownership of Alipay was transferred from Alibaba to SMFS (in effect controlled by Mr Ma) in 2011, and replaced with a profit-sharing agreement. The lending business followed Alipay into SMFS this year. Where there is value there is no substitute for ownership. And shareholders will not have ownership in the payment and lending subsidiaries.

It’s Jack’s call:Alibaba’s business, isolated from its structure, deserves a rich valuation. Whether it carries a discount instead depends on how Mr Ma and his team run the company over the next few years. Mr Ma says his priorities are ‘customers first, employees second, and shareholders third’. What will this mean in practice?

Published in Dawn, Economic & Business, Sep 15th, 2014