Sunday, 11 May 2014

Alibaba a seller of clicks not products

Alibaba is China's largest online commerce company with overall sales of US$248 billion (gross merchandise volume) it sells more than Ebay and Amazon combined. In a sign of the times Alibaba is basically a China only company with international contributing only 12% of sales yet it is the world's largest online commerce company. 

Operates like Ebay but makes money like Google
Alibaba has been described as a mix of Amazon, Ebay and even Google. It has two main sites Taobao a consumer to consumer site with 8 million sellers and Tmall which sells goods direct from 100,000 brands. The Tmall business model is similar to Amazon with sales commissions ranging between 0.5% to 5% of GMV. Taobao operates like eBay but it monetises similar to Google with sellers using advertising to stand out from competitors. This is great from an investor point of view as unlike Amazon Alibaba does not have to hold or bear inventory reducing the capital required for the business. China's highly competitive online market is also great for Alibaba as more competition means more advertising as sellers try to differentiate themselves. Alibaba is a seller of clicks not products, because of this Alibaba's business has growth attributes of all the best technology companies but with better margins (see below).

* Adjusted net income/revenue from F1 SEC filing

Alibaba is dominant with 83% ecommerce market share of China's $296 billion market so going forward Alibaba will be reliant on overall market growth rather than market share. Luckily only half of China's 1.35 billion population is online and again only half that number are internet shoppers suggesting that there is future growth. This optimism is backed up by the lack of offline retail in China which is not yet built out compared to other developed countries (see below). It is not such great news for the US which has a retail footprint much larger than peers.

                                                                               *Source Alibab F1 SEC filing

Mobile traffic will exceed desktop
Mobile is a big focus for US companies in China its even more important as users in China leapfrog desktop computers for smartphones. For example China's biggest search engine Baidu expects mobile search to surpass PC as the biggest source of search traffic later this year. In the three months ended December 31, 2013, mobile accounted for 19.7% of  gross merchandise sales, up from 7.4% in the prior year, revenue has not been disclosed.

The smartphone has been good news for most technology companies as it now means users have access to the internet on the go. The companies that have struggled with this shift have been companies that rely on advertising. Smaller screens have made it harder to advertise an issue companies like Facebook know all about. Alibaba is facing similar issues in the F1 they disclose that they will not display as many ads on their mobile apps compared to the PC, a transition investors should pay attention to.

Show me the money (Alipay)
78.6% of Alibaba sales were settled through Alipay which is similar to Paypal. Alipay has helped Chinese buyers overcome trust issues over the internet with the ability for customers to escrow payments until they have received their goods. Alipay helped pioneer the market as credit usage was and still is low.

For all the talk about Alipay investors should note that Alipay has not been included in the IPO due to regulatory issues. This is material given the value investors have placed on similar business like Paypal (which is owned by Ebay) as investors value the subsidiary Paypal more than the auction site. This is critical as Alipay enables 78.6% of transactions on the site. The business was controversially separated in 2011 due to restrictions on foreign ownership now Jack Ma (the founder) and management are Alipays major investors. To decrease any conflicts of interest Jack has committed to limit his economic interest in Alipay to a percentage that is not more than Alibaba.

One great trade
The major shareholders are Yahoo and Softbank. In 2005 Yahoo purchased 40% of the company for $1 billion in cash and folded Yahoo China into Alibaba. Yahoo sold 20% of Alibaba shares back to the company in 2012 that valued Alibaba at $35 billion or US$13.5 per share for $7 billion and is obliged to sell 40% of its remaining stake (overall 24% holding) in the IPO. The increase in Alibaba's valuation has driven the performance of Yahoo and Softbank's shares in the past year. 

But how will Alibaba do?
We don't know how the IPO will price but we do know that there is a lot of hype surrounding Alibaba. We actually believe that the initial IPO price could be reasonable as Alibaba will likely not sell many shares the majority of the share selldown will come from Yahoo. We believe Alibaba's motivation for a successful IPO will likely exceed Yahoo's motivation for more money because of this there will likely be expectations for a good first day rise. In our opinion given the likely first day pop investors who don't get allocated shares might just be better of waiting to see if like Facebook Alibaba can successfully transition to a mobile first world.


Disclosure: Decisive owns a position in Yahoo (YHOO) stock

The material in this article is for informational purposes only and in no way constitutes a solicitation of business or investment advice. The material has been prepared without regard to any client's or other person's investment objectives. Before making an investment decision you should consider the assistance of a financial adviser and whether any investment or service is appropriate in light of your particular investment needs.