- Alibaba is the leading e-commerce company in China that is much more profitable than Amazon and eBay.
- Contrary to the popular belief that Alibaba is China's Amazon, its business model is very different.
- The company will be the 'Next Big Thing' after Facebook's and Twitter's IPOs due to its enormous size and profitability.
- The company will likely be a bargain if it is traded at $120 billion or lower.
In my research to look for the next Apple (NASDAQ:AAPL), Google (NASDAQ:GOOG) or Amazon (NASDAQ:AMZN), I realized that there are many great companies that are not yet well-known in North America, but are widely known in other countries such as China or Russia. Some of these companies are so competitive that they can easily crush their American-counterparts in their domestic markets. A great example is Baidu (NASDAQ:BIDU) of China, that owned over 63% of the search market in December 2013, while Google China owned around 1.6% (source: Techinasia). Another great example is Alibaba--a company that is expected to go public in 2014--that dwarfs Amazon in China's enormous e-commerce market. In this article, I want to provide you with a background of Alibaba and explain why I think it will be 'the Next Big Thing' after Facebook's (NASDAQ:FB) and Twitter's (NYSE:TWTR) Initial Public Offerings (IPOs).
Alibaba (the group) is a family of internet-based businesses founded in 1998 by 18 people led by Jack Ma, who is a former English teacher. Contrary to popular belief, its business model is different from and much more profitable than Amazon. The company is not an online retailer and does not sell its own products like Amazon does. Instead, it operates a number of websites or marketplace platforms (Consumer-to-Consumer or C2C, Business-to-Consumer or B2C, and Business-to-Business or B2B) and earns most of its revenues from advertising and commissions.
Source: Yahoo's fourth quarter 2013 earnings release
Since the company does not own products or have inventory costs, its net profit margin is much higher than Amazon's. For example, the company had $1.78 billion in revenue and $801 million in net income for the Q3 2013 (see image above). This equates to an exceptionally high net profit margin of 45% compared with Amazon's 0.93% in the latest quarter. (Note that Alibaba's Q3 2013 is the latest data from Yahoo's Q4 2013 earnings report.)
Alibaba's Websites and Competitive Moats
Alibaba is the leading e-commerce company in China with the largest market shares in C2C, B2C and B2B. It owns a portfolio of e-commerce websites (see image above). I have listed the major ones below with short descriptions:
- Taobao.com is the most popular C2C marketplace in China. Most people in China use it to buy products online for the lowest prices.
- TMall.com is the leading B2C marketplace in China that connects businesses and customers. It focuses on higher quality and brand name products. It is also the most popular website in China for customers to buy products directly from large businesses [e.g. Nike (NYSE:NKE), Gap (NYSE:GPS)].
- Alibaba.com and 1688.com are both the leading B2B marketplace platforms for small businesses. Alibaba.com connects small businesses worldwide to facilitate cross-border trades while 1688.com connects domestic small businesses in China.
- Alipay is the most widely used third-party online payment solution in China that is similar to Paypal.
Alibaba has very strong competitive moats. For example, the company is the dominant leader in every aspect of e-commerce (C2C, B2C and B2B) in China. This is different from Amazon, which is the global market leader in B2C, and eBay (NASDAQ:EBAY), which is the global market leader in C2C. More importantly, many sellers and businesses in China rely on Taobao and TMall to sell their products online because they can often get more sales from both platforms than their own websites. Most online customers also use the two platforms because they have the largest selection of products, and because Alibaba has authentication services that can verify the seller as well as the buyer (source: The Economist). Many customers in China are reluctant to buy goods online except through well-known sites such as Taobao and TMall.
As mentioned earlier, Alibaba's business model is very different from Amazon's. According to an article on The Wall Street Journal, it earns the majority of its revenue from advertising paid by sellers and businesses that want to make their products more prominent on Alibaba websites. In addition, the company also makes commission fees on each transaction on some of the platforms. Its net profit margin is exceptionally high--45% in Q3 2013--because it does not buy products from merchants and sell products directly to consumers like Amazon. [Note that we will know Alibaba's business model much better once it files a pre-IPO prospectus].
'The Next Big Thing' after Facebook and Twitter's IPOs.
As you may already know, Alibaba's proposal to be listed on the Hong Kong Stock Exchange (SEHK) last September was rejected. The reason was that the exchange does not permit a partnership structure that gives the company's partners the right to nominate the majority of directors on its board. While Alibaba has not decided where to list its shares, it is considering to be listed on the NYSE or Nasdaq. Both exchanges have confirmed that Alibaba is allowed to give its partners control over board nominations, according to The Wall Street Journal. If this is the case, Alibaba will become the 'Next Big Thing' after Facebook and Twitter IPOs. According to a Bloomberg article, analysts valued Alibaba at $120 billion or up to $190 billion. This is much larger than Facebook's valuation of $104 billion in 2012.
Beyond the valuation estimate, Alibaba has already surpassed both Amazon and eBay combined, in terms of the total volume of merchandise handled (source: The Wall Street Journal). Moreover, its revenue growth rate is much higher than Amazon and eBay. A major reason is that the e-commerce industry in China is still in its early growth stage and that most people use Alibaba's marketplace platforms. Despite the seemingly high analyst valuation estimates, Alibaba still has a lot of growth opportunities in e-commerce as well as in cloud computing (Aliyun.com, a business owned by Alibaba). Since the company has not released any public financial statements (except through Yahoo's (NASDAQ:YHOO) earning reports), I can only speculate that its market cap can easily go above $200 billion within one to two years, assuming that Alibaba will have a high P/E ratio at the time of IPO.
Here is a summary of Alibaba's revenue and net income between Q4 2012 to Q3 2013 (Q4 2013 is not available at the time of writing):
(click to enlarge)
Source: Yahoo's earnings reports
Here is a comparison of Amazon, eBay, Facebook and Alibaba's profitability and market caps as of Feb. 14, 2014:
If we compare Alibaba's revenue and net income with Amazon, eBay and Facebook, you will notice that it is the most profitable company among all of them. And if the company is traded at $120 billion or lower in market cap at the time of IPO, the company will likely be a bargain compared to Amazon and Facebook.
While some analysts are concerned that Alibaba's revenue growth has slowed, I believe that investors should be content as long as the company's growth rate is aligned with the overall e-commerce growth rate in China.
Another risk is the company's management. Jack Ma-the company's lead co-founder-delisted Alibaba's B2B business-Alibaba.com-on the Hong Kong Stock Exchange in 2012 for several reasons: mismanagement of the B2B business, slumping share prices for five straight years (between 2007 and 2012) that caused dissatisfied investors, low employee morale due to slumping share prices, a scandal within the company and a change of strategy for the company (the full story can be read at The Economist). This time will likely be different for Alibaba since the company's e-commerce businesses are already well-established and since the management is planning to list most of its businesses (Taobao, Tmall, Alibaba, etc.) instead of only its B2B business.
The Bottom Line
Alibaba may well be the 'Next Big Thing' after the Facebook and Twitter IPOs. The company is exceptionally profitable and has already surpassed Amazon and eBay in the total volume of merchandise handled. If the company decides to be listed on the NYSE and is traded at $120 billion or lower in market cap, then I believe it will be a bargain even though it is above Facebook's 2012 valuation of $104 billion.
Source: Yahoo earnings reports, Alibaba Group sites, Morningstar, The Economists, The Wall Street Journal, Bloomberg and Techinasia. Victor Liang is a co-founder of Intelligent Stocks Newsletter.
Additional disclosure: I have no positions in Alibaba since the company is not public traded yet.