Source: Alibaba 10Q presentation
BABA has been described as the Ebay of China except BABA has 80% of Chinese ecommerce marketshare. Its actually twice as dominant as a combined Ebay and Amazon around 35-40% of the US ecommerce market. The average user buys from BABA 52 times a year, whereas the average Amazon user buys 16 times a year. This dominance has meant that brands like Tesla and Costco have setup stores on BABA's Tmall to sell direct to consumers. Costco will sell their usual products including baby goods and beauty items, mailing from the US to the customers door in China. If you're shopping in China you start on one of BABA's sites. Like most internet sites BABA benefits from the network effort. More buyers attracts more sellers which attract more buyers its a virtuous circle see below.
Source: Alibaba IPO roadshow
BABA actually monetizes more like Google with advertising. In fact it is the second largest search advertising engine in China. BABA's retail revenues are driven by Taobao and Tmall. Taobao is a consumer to consumer stie similar to Ebay while Tmall is similar to Amazon where big brands open stores. Alibaba does not hold inventory but sells clicks. Its a great business model in a competitive market like China where sellers bid to position themselves higher on the site. According to Merrill Lynch estimates Tmall's take rate is around 6%. Tmall charges commissions and advertising whereas Taobao's rate is lower around 2% because there are no commissions for selling on the site.
Growth and monetisation potential
BABA has 307 million customers while this is a big number its less than a quarter of China's population. 34% of urban Chinese use e-commerce but only 9% of rural Chinese use e-commerce. They plan to help these farmers sell their goods to the city while also buying products in the city from BABA. The longer a customer has been with BABA the more comfortable they are on spending. It really is a weekly habit. Average spending levels for a year old customer is RMB1,000, 5 years is RMB15,000 and 10 years is RMB30,000.BABA is not looking to maximise their monetization rate of sales but if you compare their rates versus the global averages there is plenty of upside. Ebay and Mercadolibre (Latin American e-commerce) site typically monetise around 9% of their sales. If BABA wanted to maximise its rates it could nearly triple its revenue, with no change in expenses this would drop to the bottom line. A dominant Chinese e-commerce site also has a good chance to go global because China is the manufacturer to the world its 42 million small to medium enterprises are more than the US, India and Japan combined.
Corporate Governance risk
The risk is corporate governance. Like most tech companies BABA will be controlled by a select few. We feel the Variable Interest Entity (VIE) structure is the main risk. Foreigners are not allowed to have majority control of certain businesses in China. Many Chinese companies create a domestic vehicle that contains the restricted business and licenses which are owned by a local Chinese. Through legal agreements the economic interest is transferred to a foreign listed company. Alibaba has tried to minimize this risk by holding their licenses in the VIE while conducting as little business as possible in the VIE. 11.9% of BABA's revenue is conducted in its VIE.
Optionality on growth
BABA also has some great emerging businesses. They own the largest cloud computing business in China which can leverage BABAs IT infrastructure to lease to other businesses at competitive prices. It also has a stake in logistics and delivers around 50% of packages in China. The amount of data they have on customers is also compelling. Knowledge of a users buying pattern means they can personalise pages for different buyers improving conversion rates. They also receive 37.5% of profits from Alipay (online escrow payment) which has 300 million users twice the number of Paypal.
BABA has unprecedented growth and monetisation potential. It takes quite a business to make Amazon and Ebay look mediocre. In its first result BABA has done just that.
Jason
Disclosure: Decisive has a long position in Alibaba (BABA) stock.
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