Look to the Mice, Not the Elephants

03/21/2014 10:30 am EST

Focus: GLOBAL

Jim Jubak

Founder and Editor, JubakPicks.com

The coming IPO from China's leading retail site by sales volume, has set off a buying spree, and MoneyShow's Jim Jubak thinks it might be better to play off of the little guys that stand to benefit, rather than the big guys.

The coming IPO (initial public offering) for China's Alibaba, the biggest online retail site by sales volume in the world, has set off a gold rush among Chinese Internet companies.

And it's easy to understand why. Alibaba's offering—likely in New York rather than Hong Kong—could well come in as the biggest IPO ever, easily surpassing the $16.1 billion Facebook (FB) raised in 2012 and the $19.65 billion raised in Visa's (V) 2008 offering.

That has led to announcements of upcoming offerings from other Chinese Internet companies. For example, Sina (SINA) has said its Weibo social media network subsidiary, has filed to list in New York. The initial $700 million figure for the IPO would value Weibo at $7 billion to $8 billion.

But let the recent fourth quarter earnings report from Alibaba's biggest Chinese competitor, Tencent Holdings ((TCEHY) in New York and (HK:700) in Hong Kong), serve as a caveat emptor moment—and food for thought about another way to look at this “opportunity.” The company reported fourth quarter net income of 3.91 billion yuan ($631 million), well short of the 4.1 billion yuan figure expected by the 17 analysts who follow the stock.

The big reason for the shortfall? Revenue climbed 40% year over year for the quarter, but selling and marketing expenses climbed 39% from the third quarter.

Alibaba and Tencent are locked in an all-out war for market share in everything from e-commerce to over-the-Internet savings accounts. That's expensive for these two elephants, but it's most threatening to the mice in the sector. Their best course, it seems right now, is to hope that one of the two giants will decide to acquire all or part of their business.

The acquisition pace in China's Internet sector is stunning. Chinese Internet companies have made 48 acquisitions or investments in other Internet companies with a total value of $19.7 billion since 2012, according to Bloomberg.

Think you know where some of the money raised by these IPOs might be headed? And does that suggest that maybe the best buys aren't the big companies raising the IPO cash but the smaller fish they might be intended to swallow?

Some of those fish? Recent deals suggest where to look.

For example, in March, Tencent Holdings bought 15% of Chinese e-commerce Web site JD.com to bulk up its e-commerce business against Alibaba. In February, Tencent bought 20% of Dianping, which operates a Yelp-like Web site in China. Both of these deals suggest that investors might look to target companies that can fill in gaps in strategy for Tencent and Alibaba.

Among stocks that are available to US investors through a listing in New York, the list includes Ctrip.com International (CTRP), China's biggest online travel retailer; Qihoo 360 (QIHU), a leading mobile security company; 58.com (WUBA), the Craigslist-like operator of a classified site, and SouFun Holdings (SFUN), the owner of China's biggest real-estate site.

These are all highly speculative trades, of course. If you want to take the risk down a bit, look for companies with solid growth so that you aren't left holding an empty sack if an acquisition doesn't happen.

Full disclosure: I don't own shares of any of the companies mentioned in this post in my personal portfolio. When in 2010 I started the mutual fund I manage, Jubak Global Equity Fund, I liquidated all my individual stock holdings and put the money into the fund. The fund may or may not now own positions in any stock mentioned in this post. The fund did own shares of Tencent Holdings as of the end of December. For a full list of the stocks in the fund see the fund's portfolio here.

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