1. Build arguments for and against that Alibaba should issue bonds in China.

For:
Fixed exchange rate of PBOC with USD fostered growth while simultaneously reducing
uncertainty. It received a rating of A+ from S&P and Fitch ratings and A1 rating from
Moody’s investor services, making it investment grade. Since people didn’t get an
opportunity to invest in Alibaba (being listed in NYSE), Chinese population should be
looking forward for future investment opportunities.

Against:
Higher bond valuations because low interest rates in US, broader investor base due to a
diverse pool of investors, more recognition of the Alibaba brand within the US investor
community, more corporate governance due to strict US regulations and inflow of foreign
currency can help Alibaba in its future expansion plans in the global market.
It would take an immense effort from PBOC to resist any upward pressure as a result of
devaluation of Chinese Yuan. With a major flow of revenue of Alibaba coming from
China, a reduction in the possibility of a further Yuan devaluation shall be beneficial to
the company on repayment if issue is made in USD.
Also, the lack of a legitimate approval by the Chinese government along with regulatory
concerns (Variable Interest Entities Structure of Alibaba) puts forth another case that
should discourage bond issue by Alibaba.

2. Explain that financing with bonds is preferred over syndicated loans for Alibaba. 

Following are the differences between financing with bonds and Alibaba’s previous
forms of debt financing with syndicated loans:
 Rated versus unrated- The bond issue of Alibaba is going to be determined on the basis
of the earlier forms of syndicate debt raising during the period when the company was
unrated. The is because it was only recently that Alibaba received its initial debt ratings.
S&P, Fitch and Moody’s have provided investment grade rating to Alibaba in the current
debt financing round.
 Channels (Direct/Indirect)- Even though syndication involved direct dealings with
banks with no intermediaries/channels involved in between, bond issue would involve a
whole range of middlemen such a Investment Banks and associated entities.
 Information Cost- Risk cutting was possible in syndicate loans due to the higher
availability of information with lenders as a result of the involvement of a consortium of
lenders. Hence, both rate and yield on loans were low. Due to the unavailability of
information in the case of bond issue, the nature of investors as well the acquisition spree
was more prominent. Hence, both interest rate and yield could be higher.
 Risk Premium- A factor of country risk premium might be charged on these bonds
which would otherwise be absent in the syndicated loans as the issue is being made in a
 country from which substantial revenues are not being generated and due to the high
degree of international risk.

3. Timing of bond issue.

It does appear to be a good time for the issue of bonds due to the following reasons: -
 Lower interest rates with anticipated increase- An expectation of a rise in the
prevailing interest rates due to the changing position of the US Federal Reserve makes
this a good time to raise loans to leverage the benefits of a low interest rate.
 Financial Indicators- High interest coverage of ratio gives a lot depicts strong
repayment capabilities. Further, high return on equity and return on assets ratios depict
financial soundness of the company which would help in raising debts at appropriate
rates.
 Rating Agencies- Alibaba was given investment grade ratings by U.S. rating agencies-
“A-plus” from Standard and Poor’s and Fitch Ratings and an equivalent “A1” rating from
Moody’s Investor Services.
According to the IMF concerns about the growing speculation in the debt market and Fed
official’s plans of reducing quantitative easing from Jan 2014 has caused the market to
expect an increase in the interest rates soon. The current scenario is ideal for issuing
bonds as the company can offer attractive coupons as compared to the market interest
rates. However, in the long run the bonds may trade at a discount because of increasing
interest rates.

4. How would you price Alibaba’s bonds?

Yield= Rf + Risk Premium
Rf= US treasury 5 – years yield: 1.66%
Risk premium= 0.966% (taken from exhibit 12)
Since Oracle’s 5-year bond has the similar credit rating, its spread over the Treasury
bonds is taken a reference point.
Bond Yield= 1.66% + 0.966%= 2.626%

Another method that can be looked into is the discounted cash flow methodology wherein
the yield on US 10-Year T-Note may be used as a parameter to arrive at the discount rate
for the bonds and the spread shall be calculated based on the risk premium of the
company. Further risk premium would be involved due to the VIE structure due to the
issue being made by a Chinese company in the US. The aforesaid risk premium shall be
further adjusted keeping in mind the latest bond issues by tech companies in the US such
as Google, eBay, Oracle, and the like. The ratings of these companies as provided shall
be considered while adjusting the premium on these bonds. Matrix pricing technique can
be used to price the bond based on other bond’s quoted prices which are similar in terms
of credit rating, maturity etc.