3 Reasons to be Bullish about Rocket Internet

North America has Amazon.com (FRA:AMZ).  China has Alibaba (NYSE:BABA). For everyone else, there is Rocket Internet (ETR:RKET).

At least, that’s how the world will look like in a few decades if the Samwer brothers have their way. Rocket Internet is 52% owned by the three Samwer brothers and its mission is “to become the world’s largest internet platform outside the United States and China”.

The Berlin-based company is going public on 2 October on the Frankfurt Exchange. According to the company’s IPO prospectus, 24% of Rocket Internet — or, about 38 million shares — is part of the IPO, which would value the company at €6.2 billion — assuming the mid-point of the planned €35.5 to €42.5 share price is reached.

I believe Rocket Internet could be a very successful investment. In fact, compared to Zalando (ETR:ZAL), another e-commerce IPO on my watch list, I see much more potential in Rocket Internet. However, similar to Zalando, I am not planning to buy shares on IPO day.

The company today

Established in 2007 by the Samwer brothers, Rocket Internet focuses on starting up Internet companies, with the aim of growing them into market leaders.

Its geographical focus is the developing world and Europe — the company is present in over 100 countries across 5 continents, though it has avoided North America and China. The company’s focus is mainly on retail e-commerce and has created strong market players like Dafiti in Latin America and LaModa in the CIS region. However, it has also recently started to enter into other segments as well, such as real estate (with Wimdu), food delivery (Foodpanda) and financial services (Lendico).

Three reasons that make me bullish about Rocket’s prospects

1.  Focus on emerging markets dominance
While Amazon.com and Alibaba have built up — and are still largely focusing on — today’s major markets, Rocket is building dominant positions in tomorrow’s growth markets. According to Rocket’s IPO prospectus, in 2013, 76% of the world’s total population, 69% of global Internet users and 74% of global mobile users lived outside the US and China. Further, the company expects these countries to beat the U.S. and China in terms of population growth, Internet and mobile penetration growth and middle class growth (and, consequently, stronger consumer spending growth). This, coupled with a much less developed offline “brick and mortar” retail infrastructure and a generally younger, “digitally native” population that is more open to online commerce, creates huge e-commerce opportunities — and Rocket Internet is pushing full steam ahead to build dominant positions.

2.  Operational excellence
The company is often dismissed as a clone-factory that simply replicates ideas developed by others. It is true that Rocket Internet is not trying to be an innovation powerhouse — as CEO Oliver Samwer told The New York Times, “if there’s a clear business model that is proven to work, we will look at it”. Instead, the company focuses on building and scaling proven business models.

The true strength of the company, then, lies in its execution capabilities. Rocket has focused on turning building a new company into a highly standardized and easily repeatable process. In doing that, best practices are being shared, many processes and technologies are being centralized, and rigorous reporting and measurement systems are being implemented. As a result, the company said in a recent presentation to investors that it can launch a new business within 100 days. Rocket averages of three to six new ventures every year, and in the first four months of 2014, 48 new country websites were launched. Simply put: Growth is not held back by operational constraints.

3.  Experienced leadership, aligned with shareholders
Rocket Internet is led by CEO and co-founder Oliver Samwer who — together with his brothers Marc and Alexander — will continue to own almost 40 percent of the company even after the IPO. According to the Frankfurter Allgemeine, all major shareholders want to keep their shares and don’t plan to exit, which is typically a positive sign.

The three brothers have significant experience with Internet ventures: Over the last 15 years, they have founded several Internet sites based on established business models, many of which ended up being bought by the dominant global player in the industry. That list includes:

• Alando, which was purchased by eBay (ETR:EBA),
• Jamba (best known for the Crazy Frog ringtone), which was snapped up by Verisign (FRA:VRS) and
• CityDeal, which went to Groupon (ETR:G5N).

In addition, senior management is coming from top-notch companies like Amazon.com, Google (FRA:GGQ1), Boston Consulting Group and Goldman Sachs (NYSE:GS).

A word of caution

Based on the above, I believe investing in Rocket Internet has the potential to generate very high returns for long-term minded, “buy and hold” investors. There are, however, also significant risks involved that may negatively impact investing returns.

From an external standpoint, development of the emerging countries can be slower than expected and competition can become fiercer if Amazon.com or Alibaba decides to focus more on these regions. As a result, both profit and cash generation may be delayed, reduced or may not happen at all.

From an internal standpoint, the company may continue to finance its growth primarily through selling stakes in its more established companies, or regularly issuing new shares. Both can have a significant negative impact on future earnings per share, therefore I hope a healthy portion of growth financing can be done with debt (the company’s IPO prospectus currently shows zero external debt on Rocket’s balance sheet). Separately, Oliver Samwer leaving the company would also be a significant setback.

In my view though, the opportunities outweigh the risks; therefore, Rocket Internet is high on my watch list. However, I won’t be buying on IPO day, because I want to avoid the hype around the IPO. I believe there may be a better entry point for the stock at a future date. I would also like to see how the company is doing as a public entity before I make my investment decision.

Final thoughts

For investors planning to invest in Rocket Internet because of its potential, I recommend a few things to keep in mind:

• This is a growth investment with high potential, but also with substantial risks, so I’d only feel comfortable allocating a small portion of my portfolio to the company.
• It will require years (maybe even decades) for the Rocket Internet story to play out –- so early investors need to be prepared for the long haul.
• There will likely be a lot of volatility in the stock price, so keeping emotions in check is especially important.
• Finally, there is a lot of hype built into the IPO price. That may make waiting a good strategy — it could mean both the opportunity for a lower buy-in price if the hype wanes and more time to learn about the company.