Alibaba Group Holding Limited:
- The company accounts for 80% of all online retail sales in China.
- As of 2015 the company has 350 million active users, larger than the entire population of the United States.
- Alibaba recorded $9.3 billion worth of orders in just one day in November 2014, during the holiday known as “Singles Day.”
When I first started doing the e-commerce stint using Fulfillment by Amazon (FBA), I inevitably used the portal Alibaba (to source for goods from manufacturers).
I have been planning to start a US stock portfolio for the longest time. However, with the US markets at all time high, I have been shelving it.
For the US Portfolio, I was looking for growth stocks, and hopefully, companies with high profitability and low capital expenditure. Inevitability, the FAANG stocks would come to mind – Facebook (FB), Amazon (AMZN), Apple (AAPL), Netflix (NFLX), and Alphabet (GOOG).
However, to me, I would probably also classify Alibaba up there as well (just that it originated from China, not the US). Before thinking about investing in Alibaba Group Holding Limited, it is first important to understand the business model of Alibaba Group Holding Limited. I reckon in thinking about the model, it would be easier if I compare Alibaba with Amazon (since I used both platforms when doing Amazon FBA).
Prior to thinking about investing in Alibaba Group Holding Limited, one must first think about the business model of Alibaba Group Holding Limited. I reckon in thinking about the model, it would be easier if I compare Alibaba with Amazon (since I used both platforms when doing Amazon FBA).
Alibaba vs Amazon
Firstly, the business model of Alibaba is different from the e-commerce leader in the United States, Amazon.com. Three major web portals make up the core of Alibaba’s businessː Alibaba, Taobao, and Tmall. And all three of these e-commerce websites serve to connect various types of buyers and sellers, wherein Alibaba acts as a middleman.
- All the Western companies you’d have to combine to get something like Alibaba (read here)
Unlike Amazon, Alibaba Group holds no inventory and owns no warehouses. Rather, Alibaba has created software platforms that facilitate the exchange of goods and services. While Alibaba’s revenues are only a fraction of Amazon’s, it has higher operating margins and profit margins.
Personally, I find that there are pros and cons to this. Yes, with no inventory and warehouses, the profitability is higher (capital expenditure is low). However, it is also because of Amazon Fulfillment Centres which make Amazon such a formidable competitor to all e-commerce site.
Put it in another way, the revenue of Alibaba (USD 23.41B) is only a fraction of Amazon’s revenue (USD 150.12B). However, the Gross profit of Alibaba (USD 99.65B) is way higher than that of Amazon (USD 47.72B). So as I mentioned earlier if I am looking for a high profitability and low capital expenditure stock, Alibaba would fit right in (not Amazon).
However, it is also because of Amazon Fulfillment Centres which is why Amazon is such a formidable competitor to all other e-commerce platforms (it is like Tesla with their own set of charging stations, which charge much faster). Seldom you see an e-commerce site (that is business-to-consumer or consumer-to-consumer focused) which has both a successful online platform and an extensive net work of high tech fulfillment centers ensuring goods are delivered promptly to customers.
From what I have read, Alibaba’s core business resembles that of eBay. Alibaba acts as a middleman between buyers and sellers online and facilitates the sale of goods between the two parties through its extensive network of websites. The largest site, Taobao, operates as a fee-free marketplace where neither sellers nor buyers are charged a fee for completing transactions.
Ok, I have not used Taobao. However, if Taobao is like ebay, then it is in comparison relatively less sophisticated than Amazon’s platform which is backed by its extensive network of fulfillment centers. Amazon’s platform is also backed by their partner retailers who often sell less common items or those with a higher purchase price, allowing Amazon to avoid holding slow-moving inventory that could dilute profit.
Between Amazon and Alibaba, the starkest contrast can be seen in the philosophy each company has.
Jeff Bezos’ long standing goal is to build the world’s most customer centric company. And it’s hard to argue with his progress. Despite their size, Amazon’s customer service – in terms of pricing, delivery and customer support – is impressive.
Amazon is obsessed with the customer and getting them the best possible price – at almost any cost. They’re notorious for alienating suppliers, content partners and publishers in their pursuit of this goal.
Jack Ma and Alibaba have a different focus. The following quote is taken from their recent IPO prospectus:
“Our proposition is simple: we want to help small businesses grow by solving their problems through Internet technology. We fight for the little guy. Since our founding in 1999, we have helped millions of small businesses to achieve a brighter future.”
Alibaba’s goal to help small businesses stands in stark contrast to Amazon, who is often (fairly or otherwise) criticized for making it harder for small businesses to compete and stay relevant online.
The feeling from the ground when Amazon and Alibaba reached Singapore
To be clear, I am trying to view this from the existing retailers’ perspective rather than the customers’ perspective.
As mentioned earlier when it comes to the business model of Alibaba, what’s important to note is that Alibaba’s platforms merely facilitate the transactions. They manage the marketplace and charge a small commission, but don’t hold – or sell – any merchandise themselves.
Amazon, by comparison, plays in both markets. On Amazon.com, you’ll find thousands of products you can buy directly from 3rd party businesses. But Amazon is also in the business of stocking items and selling products directly to consumers. In many instances, they’re competing directly with the same merchants who are using their platform to sell.
Somehow, from a retailer’s point of view (whether you have a brick or mortar store or an e-commerce site), personally, I sense a difference in perception when it comes to Alibaba and Amazon’s expansion into Singapore.
The way Alibaba does expansion overseas is primarily via buying stakes in foreign companies. In fact, indirectly Alibaba has been in Singapore prior to Amazon through Lazada, Redmart and Singapore Post.
- In March 2016, Lazada claimed it recorded a total of $1.36 billion in annualized across its six markets in Asia, making it the largest e-commerce player.
- In April 2016, Alibaba Group announced that it intended to acquire a controlling interest in Lazada by paying $500 million for new shares and buying $500M worth of shares from existing investors.
- In June 2017, Alibaba Group announced it will pump in another $1 billion in Lazada to raise its stake to 83 per cent from the 51 per cent it had acquired last year.
- Alibaba-backed Lazada acquired Singapore online grocer RedMart in Nov 2016.
Interestingly, Bloomberg reported in September 2016 that Redmart had run into financing problems and was seeking a buyer. It held unsuccessful talks with a number of potential suitors, including supermarket chain FairPrice, Singapore sovereign wealth fund GIC and online retail titan Amazon.
- In 2014, Alibaba invested $312.5 million for a 10.35 per cent stake in SingPost at $1.42 a share, making it the postal and e-commerce group’s second largest shareholder after Singtel.
- In October 2016, Alibaba raised its stake to 14.4 per cent from 10.2 per cent with a further investment of S$187.1 million.
- In October 2016, Alibaba also subscribed for a 34 per cent stake in Quantium Solutions International, SingPost’s e-commerce logistics unit, for $86.2 million.
Basically, the operations of Lazada, Redmart and Singapore Post have not changed drastically after the investment. And the fact is, residents of Singapore are already familiar with these companies/platforms. So the presence of Alibaba has not been felt acutely.
However, besides financial support, Alibaba’s investment has helped these companies in many ways. For instance, Alibaba has boosted Lazada’s range of merchants and improved its logistics.
Alibaba has a soft approach in not competing head on when it comes to expansion. Instead of starting from scratch in a new eco-system, they similar adopt the best companies and strengthen their operations.
Between Alibaba and Amazon, Jack Ma seems to position Alibaba as the ‘good guy’, and like to ride the wind of other’s success (you know, kind of like the biker riding directly behind the lead biker in competitive biking, thereby avoiding the headwinds).
Amazon, on the other hand, exports their system.
One Platform: The Amazon platform is very consistent worldwide and it’s discrete services based architecture means that each piece of it can be rolled out incrementally. This means that programs such as Amazon Prime can be launched in one geography, tested and learnt and then rolled out elsewhere for relatively little development cost. While local geographies can adjust, it is more tinkering (e.g. the Super Saver threshold in the UK is £0) than wholesale change.
In many ways, Amazon’s services are superior when compared to many other online retailers (as can be seen in the popularity of their Amazon Prime launch here).
“Singaporeans make a just fraction of total purchases online now, but the country’s shoppers rushed to download the app, which offers free delivery on orders of S$40 ($29.50) or more. For now, Amazon is waiving the membership requirement.”
Amazon competes externally, and sometimes even against their own retail partners.
In fact, when I was researching on FBA, it is not uncommon to read about experiences whereby Amazon launched a new product in direct competition with some of the FBA sellers. Look, in FBA, as a seller, you basically don’t even need to see your goods. You can literally ship your products directly from the manufacturer to the fulfillment centers and Amazon take care of the rest.
Operation wise, as a retailer, it is that easy. Which is why I am able to do so, while still having a full-time job. However, by so doing, there is a catch… Amazon basically knows how well your product is doing and where you source your supplies from.
Many of the small time retailers using Amazon are aware that they are working on borrowed time, and sooner or later they may face competition not just among themselves but also from the very platform from which they sell their products.
Maybe, a simplistic way of defining (at least on a superficial level), is that I relate Alibaba more to Berkshire Hathaway while I see Amazon more like the typical America Inc eg. Starbucks, MacDonald…
The key difference can be boiled down to one word, ‘Control’.
Alibaba, does not seem to like to interfere too much with the day to day operations of the companies they invest in (well at least on the surface). In their words, they are ‘facilitating’…or some might say, ‘create’, and help the ‘little guys’.
However, some might even say that their investments lack focus (but well, the investments do help to expand their online presence/empire).
On the other hand, Amazon competes directly with anyone (it is either you integrate with their system or compete.. no 2 way about it). And Amazon is known to compete aggressively at all costs (even if it is at a loss to them in the short term, so as to gain market share). Or some might say, ‘eliminate’ the inefficiency.
For instance, Amazon Prime (which costs member USD 99 per year) is not profitable. Read the article below.
- How Amazon Loses on Prime and Still Wins (read here)
Which is why when Amazon Prime is launched in Singapore, there is an ominous feeling that many brick and mortar retailers and even online retailers would face extinction.
They are basically going up against a giant with extremely deep pockets who does not mind losing money for a very long time, just to gain market shares. And bringing the best services.
And just how big is Amazon? Just for comparison:
- Amazon’s revenue: USD 150.12 billion
- Singapore GDP in 2016: USD 297 billion
It is more than half of Singapore’s GDP.
You know, Warren Buffett often mention how he classifies a company as a ‘good’ company. It is the kind of company he would not compete against (eg. Coca Cola, etc), even if he is given a billion dollar to do so since he knows for sure that he would lose….. Well, Amazon seems to fit the bill really well.
Aswath Damodaran in his talk at Google talked briefly about Amazon (Watch here, fast forward to 1:04:30). Amazon’s concept is to him, an “if you build it, they will come” concept.
Aswath mentioned that Amazon spends about $400 to service each Amazon Prime customer (who pays only $99). However, like what Aswath Damodaran, once mentioned, he won’t be surprised if one day, Amazon add a third 9 after the first two 9 in the subscription fee for Amazon Prime.
- Singapore slings? Taking on Alibaba, Amazon launches Prime Now in the city state (read here)
And like many of the big American corporations, as a customer, you basically know what kind of service you are getting. You go to a MacDonald/Starbucks anywhere in the world, and you can be sure to find similar services and products.
Financials of Alibaba
A quick study on the financial statistics of Alibaba Group Holding Limited.
When looking at growth stocks, I try not to look too deeply into their valuations (else I will be sorely disappointed). Let’s look at its profitability and see if it justify the price.
- The Profit Margin and Operating Margin is definitely high.
- However, the Return on asset and Return on Equity is at best mediocre.
- The balance sheet is strong. The resultant cash (after deducting debt is now USD 8.74B. Total debt/equity level is not exactly low but acceptable.
- The current ratio is good at 1.95. Note: Acceptable current ratios vary from industry to industry and are generally between 1.5 and 3 for healthy businesses.
- Alibaba does not offer any dividend.
In terms of the historical trend of the ROA, ROE and ROIC. From the below table, one can see that there is a peak in 2014 (the year Alibaba was listed – 19 September 2014). ROIC has been rather consistent hoovering at around 11 to 13 after 2014.
Trailing PEG and Intrinsic value
Let’s do a quick study on the trailing PEG and intrinsic value of Alibaba Group Holding Limited.
1) Trailing PEG
P/E: 60.54 (Data from POEMS)
Dividend Yield (%): N.A.
EPS compound growth rate (5 yrs): 58.88%
The trailing PEG will be 60.54/(58.88+0) = 1.03. Which is not good (> 1), however, it is very close to ok.
2) Intrinsic Value
First, let’s look at the estimated 5 years earning growth. We are going to use a time-frame of 5 years from now for this purpose. Given EPS and a PE ratio, the stock price can easily be calculated for any company. Using the below formula.
F = P(1+R)N where:
- F = the future EPS
- P = the starting (present) EPS (USD 2.52)
- R = compound growth rate (Using the 5 yrs CAGR which is 58.88%. However let’s take a 20% discount, and use 47.1% as I am not really sure if growth can be maintained.
- N = number of years in the future (5)
Estimated future EPS: USD 17.40
I will be estimating the future PE of Alibaba Group Holding Limited to be 40.4 (See below data from Morningstar) – average of the PEs from 2014 to 2016.
Future Stock Price
P = future stock price
EPS = future EPS
PE = future PE
Hence future stock price of Alibaba is 17.40 x 40.4 = 702.96
P = present (intrinsic) value
F = future stock price (702.96)
R = MARR (15% or 0.15)
N = Number of years (5)
Hence, the intrinsic value of Alibaba is USD 349.
Given that the share price of Alibaba Group Holding Limited (BABA) on 28 July 2017 is USD 157.56, there appears to be a margin of safety.