Despite the fact that many market participants are viewing the Chinese economy with raised eyebrows, there are still worthwhile investment opportunities. With 80% local market share and the potential to compete globally, ecommerce giant Alibaba is one such opportunity.
Alibaba has grown from being one of the earliest ecommerce companies in China to the biggest
The company was founded by Ma (Jack) Yun (Chairman), Chung Tsai (Executive Vice President) and 16 other founding members in 1999 and is headquartered in Hangzhou, China. It has since grown to be the biggest ecommerce company in China, with a leading position in the consumer to consumer (C2C), business to consumer (B2C) and business to business (B2B) markets. Alibaba operates the largest online and mobile commerce company in the world, providing secure platforms where consumers can transact with third party sellers.
In addition to servicing the retail and wholesale marketplaces, Alibaba has strengthened its ecommerce ecosystem (all the parties and tools involved in an ecommerce transaction) to include infrastructure support services. These include a payments platform (Alipay), a logistic information system (China Smart Logistics), an online marketing platform (Alimama) and their cloud service platform (AliCloud), to mention a few.
The lack of retail infrastructure in China is supporting the growth of the ecommerce industry
Even though many economic commentators have stated that the Chinese economy must shift to be more consumption-driven, few have documented the differences between the retail infrastructures in China versus the US. The retail outlets in the US started in the late 1800s and developed at a fast pace over the past century. In comparison, China opened their first chain store in the 1990s. As a result, China’s current available retail infrastructure space (0.6m2 per capita, as per the 2013 Euromonitor) pales in comparison to that of the US (2.6m2 per capita) as well as Japan and the UK (1.3m2 per capita).
This lack of a retail infrastructure in China has resulted in ecommerce leap-frogging the “offline” retailers and Chinese consumers adopting online shopping (as shown in Figure 1) faster than their Western counterparts.
There are a number of factors that also contribute to the growth in online shopping. Firstly, there is an increase in income levels and consumption. According to JPMorgan, these levels increased from 35% of GDP in 2010 to 38% in 2015 as China continues to grow. The pace of growth is, however, slowing – consumption is expected to be 40% of GDP in 2018. Secondly, there is a continuous increase in the number of internet users as well as an increase in smartphone adoption and penetration rates. Lastly, there is a fear of unnecessary exposure to pollution in many big Chinese cities, with the largest cities near manufacturing hubs being worst affected.
Alibaba is a key beneficiary of the growing ecommerce industry
With Alibaba operating an ecommerce ecosystem that facilitates online shopping for both retail and wholesale buyers in China, it will continue to be a key beneficiary of the structural tailwinds in Chinese ecommerce.
Alibaba’s Chinese retail marketplaces (which includes Tmall and Taobao) accounts for approximately 80% of the country’s ecommerce market share by gross merchandise value (GMV). In 2014, it contributed 9% to China’s total consumption spend. To emphasise the scale of the advantage, it is useful to consider that an 80% market share in 2015 equates to:
- 350 million active buyers,
- GMV of $371 billion (RMB2.4 trillion), or
- the delivery of over 6 billion parcels.
Even on a global scale, Alibaba has the potential to beat the biggest ecommerce players
All these factors place Alibaba in the enviable position of dwarfing many of its global peers, including Amazon and eBay. The one area where Alibaba lags its global peers, however, is on its take rate – the percentage earned per transaction. At 2.5%, Alibaba’s take rate is quite low compared to Amazon (13.0%) and eBay (11.6%).
As the ecommerce market matures in China, Alibaba expects that they will be able to gradually increase their take rates. Due to differences in business models, we are not forecasting that it will achieve a similar rate to Amazon. Nevertheless, this lower take rate enables Alibaba to produce financial metrics that their global peers are envious of (as shown in Figure 3).
Alibaba’s firm foothold in the local market is based on a strong competitive advantage
As can be seen in Figure 4, Alibaba’s Chinese competitors are battling to gain a foothold against this giant that already has a staggering market share of approximately 80%.
However, Alibaba’s advantage over its competitors runs deeper than only having the biggest market share, which is the result of being one of the first Chinese ecommerce companies. It is entrenched by its closed-loop ecosystem that leads to a sustainable competitive advantage from:
- users’ loyalty to its platforms and ecosystem,
- a structural cost advantage in the form of lower marketing and traffic acquisition costs due to the network effect (there are sufficient sellers, which attracts buyers, encouraging more sellers to join the platform),
- accumulated user consumption data across platforms that enables Alibaba to make the most relevant product recommendations to users, and
- strong synergies across various business units (including retailers and wholesalers, merchant and service providers, as well as Taobao and Tmall).
The following statistics demonstrate the scale of Alibaba’s competitive advantage:
- The Taobao platform features more than a billion products and is one of the 20 most visited websites globally.
- In 2014, the Alibaba’s websites accounted for over 60% of the parcels delivered in China and 80% of the nation’s online sales.
- In 2015, the company reported $14 billion in sales on China’s “Singles’ Day” on 11 November (a day dedicated to people who are single), making it the biggest online shopping day in the world.
- Alipay accounts for roughly half of all online payment transactions within China.
We believe that Alibaba offers a good investment opportunity
In summary, it is ideally positioned to benefit from the increase in online shopping in China brought about by the rapid development of the country’s internet infrastructure, the increasing adoption of smartphones and, ultimately, the convenience of online shopping. Alibaba’s closed-loop ecosystem and dominant position in payments continues to entrench its competitive advantage. In addition, the company is expanding its product offering into periphery product lines, cloud services and O2O (online-to-offline) services (services that are bought online and consumed offline, such as movie tickets and food delivery). Alibaba also has the ability to expand its margins as its mobile platforms become more mainstream with Chinese consumers, specifically rural consumers. Looking at the fundamentals, it is clear that Alibaba is a highly profitable business, a strong cash generator and, most importantly, it is trading at a significant discount to our estimate of fair value. The company’s price-to-earnings (PE) ratio is trading one standard deviation below the average PE of the companies that comprise the MSCI Emerging Markets Index (as shown in Figure 5).
Alibaba provides a good investment opportunity and therefore forms part of the top 10 holdings in the SIM Global Emerging Markets Fund.
By Richard Shepherd