Alibaba IPO Marks China Moving Beyond Smokestacks of Mao

Alibaba Group Holding Ltd. is preparing to file for an initial public offering in the next few days that reflects an evolution of China’s economy: The high-tech vision of executives like Alibaba’s Jack Ma is edging out Mao Zedong’s dream of a nation covered in smokestacks.

The world’s second-largest economy has reached a tipping point in its drive to become a global technology giant to rival the U.S. or South Korea. Last year, for the first time, electronics surpassed steel as the largest industry by revenue, with the rise of companies like Huawei Technologies Co. and Xiaomi Corp. Alibaba is the latest sign of change, building an e-commerce business that connects buyers and sellers of everything from fruit to forklifts.

A blend of government policy and consumer demand is nudging China away from state-led heavy industries such as steel and cement toward a demand-led, market-driven model of electronics and services. Technology’s advance may help deliver the higher wages, jobs and productivity gains the nation needs to maintain economic growth and raise living standards.

“This is significant because it shows they are adjusting industrial structure,” said Karlis Smits, senior economist at the World Bank in Beijing.

Photographer: Andrew Harrer/Bloomberg

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Photographer: Andrew Harrer/Bloomberg

Sales from electronics totaled 7.7 trillion yuan ($1.2 trillion) in 2013, compared with 7.6 trillion yuan from steel smelting, according to China’s National Bureau of Statistics. In 2012, sales of electronics totaled 6.9 trillion yuan, trailing the 7 trillion yuan for steel.

China’s Champions

South Korea’s economy reached a comparable tipping point between 2001 and 2003 when manufacturing of electrical and electronic equipment surpassed petrochemicals and metals. Last year, electronics alone was 16 percent greater than metals, textiles and petrochemicals combined, led by Samsung Electronics Co. (005930), the world’s largest mobile-phone maker.

China has its own technology powerhouses. Lenovo Group Ltd. (992) surpassed Hewlett-Packard Co. to become the world’s top personal-computer maker in 2012, while Huawei has climbed to No. 2 in the telecom-equipment industry. China Mobile Ltd. (941) has become the top wireless operator, with 781 million subscribers. Smartphone maker Xiaomi is challenging Apple Inc. and Samsung.

Alibaba: China's E-Commerce Giant

Almost two decades after Ma started Alibaba, it has become the nexus for online commerce in the world’s second-largest economy, connecting 7 million retailers to customers across China. Analysts estimate the IPO will value Alibaba at $136 billion to $245 billion. At the top of the range, the company would rank behind only Google Inc. (GOOG) among the most valuable Internet companies, eclipsing Amazon.com Inc. (AMZN) and Facebook Inc.

The rise of electronics is occurring in tandem with the expansion of a consumer class that works in services, owns the best digital devices China can make, and enjoys life more than their parents.

Soy Sauce

Two recent stock offerings illustrate the changes under way. The largest domestic initial public offering so far this year has been for Shaanxi Coal Industry Co., a classic old-China company. The second-biggest was for soy-sauce maker Foshan Haitian Flavouring & Food Co. (603288), a beneficiary of the new consumerism.

Foshan heralds the fading of “extreme dependence on investment and debt to drive growth,” according to Gavekal Dragonomics, a Hong Kong-based consulting firm.

Foshan boosted revenue last year 19 percent to 8.3 billion yuan, while Shaanxi Coal’s sales declined 2.3 percent to 42.4 billion yuan.

Foshan is a city of 7 million near Hong Kong that’s famous for rebelling against imperial authority and as the birthplace of Bruce Lee’s style of kung fu. To build up Foshan, farmers left their fields in the 1980s to provide the cheap labor for 36 market towns inside Foshan municipality.

Each market town developed its own manufacturing specialty, and Foshan as a whole sold everything from steel to furniture in the first wave of economic-policy shifts, most of it for export.

Foshan’s Service

Today the city is richer on a per-capita basis than Shanghai or Beijing. Yet higher wages have pushed out low-cost manufacturing, and exports account for only 18 percent of local gross domestic product.

Foshan is changing again, this time to become a hub for service workers. One example: HSBC Holdings Plc has located its biggest back office worldwide in Foshan. Simon Constantinides, regional head of global trade and receivables finance at HSBC, said the attraction wasn’t cheap labor.

“You do it for the skilled workforce and infrastructure,” he said. “They have all the components.”

State-Owned

Alibaba has built its business by expanding its reach in cities and rural areas. More than 22 percent of the 7 million stores on Alibaba’s two main commerce platforms, Taobao Marketplace and Tmall.com, originated from Internet Protocol addresses in villages and towns, the company said last year.

China’s goal is to double per-capita income by 2020 and join the ranks of high income countries by 2030. In absolute terms, China already has the world’s largest middle class, defined by the World Bank as consuming between $10 and $100 a day. Yet only 11 percent of China falls in that category, lagging well behind Brazil and South Korea when they were at similar stages of economic development, Smits said.

One reason is China’s steel industry, which has loomed large ever since 1957, when Mao began the Great Leap Forward in a disastrous attempt to industrialize. Today, China is the biggest steel producer in the world and has an estimated 300 million metric tons of overcapacity, according to Bloomberg Industries.

“Steel is the poster child” of China’s old ways, said Louis Kuijs, chief Greater China economist at Royal Bank of Scotland Group Plc in Hong Kong. “There’s a lot of government involvement. Overcapacity caused downward pressure on prices.”

Overcapacity Legacy

The excess capacity, a symptom of the old way of investing in inefficient industries, leads to depressed wages and profits in a sector that creates fewer jobs per dollar of output.

The cost of that growth has been a legacy of overcapacity and pollution, with levels in Beijing this month reaching more than 10 times the levels considered safe by the World Health Organization. Productivity gains from moving farmers to the cities and infrastructure spending have been largely tapped out.

The new economy that’s emerging in China will have consumers, not bureaucrats, picking winners and losers. As consumer power rises, policy makers will have to accelerate the liberalization of the banking system so the banks can compete to manage the assets of the middle class and lend to the most promising companies.

“Twenty years ago, China’s leaders knew that they needed cement and steel, so they could easily build plants,” the World Bank’s Smits said. “Going forward it is internal demand changing as people want consumer products. It’s harder to address this need with the existing economic model.”

Consumer Demand

Premier Li Keqiang has announced plans to beef up China’s nationwide information-technology system by investing in new wireless networks and connecting broadband to every village. Spending on infrastructure will benefit Huawei and give Alibaba access to more potential customers.

China already has 618 million Internet users, according to the China Internet Network Information Center. Alibaba is catering to China’s growing consumer class, connecting customers with sellers throughout China and the rest of the world.

“The influence is really huge,” said Chen Xiao-Ping, a professor of management at the University of Washington who focuses on China business. “Alibaba plays a very important role, not only the service it provides but also the value that they convey to people.”

To contact the reporter on this story: Shai Oster in Hong Kong at soster@bloomberg.net

To contact the editors responsible for this story: Peter Elstrom at pelstrom@bloomberg.net Peter Elstrom, Scott Lanman

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