What's the Best Way to Play 2014's Hottest IPO?

With technology IPOs, 2011 was the year of LinkedIn; 2012 was the year of Facebook ; and 2013 was the year of Twitter . Looking ahead, 2014 is all about Alibaba, and if current valuations of online tech juggernauts are any indication, its IPO might be an opportunity for the ages.

Alibaba: A highly anticipated IPO
The performance of prior Internet-based company IPOs could make Alibaba a huge success on its IPO later this year.

Alibaba is China's fastest-growing and largest e-commerce company but unlike Amazon.com does not earn the bulk of its revenue via products sold but rather advertising, making it similar to social-media giants.

Yet, trying to predict Alibaba's upcoming IPO, including its market capitalization, has become very difficult. For one, if we look at total transactions on the company's two main e-commerce platforms, sales in 2014 are expected reach to $350 billion. In other words, Alibaba is nearly four times larger than Amazon.com as an e-commerce company; Amazon has a market capitalization of $180 billion.

Yet, as previously mentioned, Alibaba does not earn the bulk of its sales via transactions. As a result, its margins are significantly higher than those of Amazon. Also, Alibaba is growing much faster than Amazon's 20% annual rate.

With that said, Alibaba is expected to earn $8.6 billion in revenue and net income of $3.5 billion in 2014, both of which represents growth greater than 50%. In comparison, Facebook, a $133 billion company, is expected to produce sales of $10.4 billion and net income of $2.7 billion. Also, $10.4 billion in revenue would represent growth of 36%, far less than Alibaba.

How do you value Alibaba?
With all things considered, investors are left with a problem when trying to determine whether or not to invest in Alibaba.

Alibaba is clearly larger than Amazon as an e-commerce company but in terms of fundamentals is producing earnings that are very similar to Facebook.

However, investors must note that Alibaba is growing significantly faster that Facebook, and in this market, growth is often awarded with a hefty premium.

Just look at Twitter: Analysts expect sales growth of 76% in 2014, which is relatively close to Alibaba, and Twitter trades at 33.2 times 2014 estimated sales. In comparison, Facebook trades at 12.8 times 2014 estimated sales.

Therefore, investors must assume that it's the growth differential that separates Twitter from Facebook on a valuation-multiple basis, or the idea that Twitter has more upside growth opportunities. Thus, with Alibaba growing faster, would a $150 billion valuation really be all that excessive?

Seriously, Alibaba would then trade at 17.4 times this year's sales, and given its high profitability -- versus a negative operating margin of 25% for Twitter -- it's not unrealistic to foresee a $200 billion valuation. Because although Alibaba would trade at 23 times this year's sales, $200 billion would translate to 57 times this year's earnings, and with social-media valuations, that's not too bad!

How to play Alibaba
Alibaba is without question a tough stock to figure out, but due to the level of buyers for social-media companies, one has to believe that its IPO will be a huge success.

Therefore, investors have three ways to play it:

First, investors can invest in Alibaba itself once it goes public, setting a limit for the price you're willing to pay per fundamentals. As previously stated, $200 billion is reasonable. Although, $37.5 billion for Twitter is not reasonable. Hence, it is possible that Alibaba reaches a level that is far beyond what we believe to be possible.

Second, there are a number of exchange-traded funds that are sure to include Alibaba as a heavyweight. Particularly, there is a small ETF that tracks Chinese Internet companies (KWEB), which was also a 2014 pick of CNBC's Josh Brown. In the first two days of 2014 it has gains 0.3% versus a 1% loss in the Nasdaq, thus suggesting that others might have the same idea, as Alibaba will likely carry the heaviest weight in this ETF.

Lastly, there is Yahoo!, which owns approximately 24% of Alibaba. If Alibaba has a market cap of $150 billion or $200 billion, then Yahoo!'s stake would be worth $36 billion to $48 billion.

Currently, Yahoo! has a market capitalization of $41 billion, meaning its Alibaba investment is worth about the same as its entire company, thus negating Yahoo's fundamentals. Once divested, Alibaba will give Yahoo! mountains of cash for research and development, expansion, and of course, acquisitions. Therefore, Yahoo! has been a popular way to play Alibaba and could be the best choice.

The bottom line: There are many ways to play Alibaba, a near-term IPO that is sure to create quite a stir on Wall Street.

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The article What's the Best Way to Play 2014's Hottest IPO? originally appeared on Fool.com.

Brian Nichols owns Yahoo. The Motley Fool recommends Amazon.com, Facebook, Twitter, and Yahoo!. The Motley Fool owns shares of Amazon.com and Facebook. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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