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Summary

  • Vipshop Holdings; how overpriced can a stock become?
  • Sorry, but 433% return for 1 year and 137% YTD is enough.
  • This is not Alibaba and definitely not the eBay/Amazon of China. Sorry, sell it.

Vipshop Holdings (NYSE:VIPS) has had an extraordinary increase in shareholder value. After beginning the year at $82.62, it closed at $198.61 on July 18 for a 140% YTD return and representing a market cap of 11.22B according the Yahoo Finance and Capital IQ. Its revenue (TTM) numbers totaled $2.09B and its earnings meanwhile were reported at $87.09M EBITDA or $1.25 per share and a book value per share of $4.83. Its total cash is $1.20B (mrq) with debt representing $787.74M (mrq) and total stockholders' equity of -$1.550B. Based upon these figures we have simply a not too palatable total Debt/Equity (mrq) of 255.40 (or 2.55). In addition, its PE ratio is 158.51. Can anyone say implosion?

Let's discuss its numbers and model further. As many know, according to Yahoo Finance: "Vipshop is an online discount retailer for various brands in the People's Republic of China. It offers a range of branded products, including apparel for women, men, and children; fashion goods; cosmetics; home goods and other lifestyle products; footwear; sportswear and sporting goods; luxury goods; and gifts and miscellaneous products. The company provides its branded products through its vipshop.com and vip.com websites, as well as its cellular phone application." All of the website is in Chinese and is not easy to navigate in other languages but can be understood, albeit slightly, with Google translate.

The high shareholder value and valuation argument is that "flash selling" is the new wave in China and will take off. According to an article in June by the Fool.com: "Flash-selling answers the margin problem. Unlike traditional e-commerce companies that sell many products and have to maintain massive loads of inventory, a flash-selling company sells certain products in bulk at specific times. The company acquires these goods at a discount, sells them at a low price, and then ships them out in bulk. It sees higher margins as a result." Didn't I hear this same story two or more years ago by Groupon (NASDAQ:GRPN) and their other competitors before they died a slow death? At that point we were hearing that group buying was the answer and that Amazon (NASDAQ:AMZN) and eBay (NASDAQ:EBAY) would have trouble maintaining market share. Amazon's expensive warehouses and inventory management, systems, infrastructure and labor are not the answer the pundits are now stating.

Allowing everyone to buy mobile and on their laptop anytime and anywhere, especially in China, is the new solution to fighting the malls. I commend the company on its opening of seven store outlets in the Guangzhou area and one near its Jianyang warehouse to sell certain clearance inventories and I look forward to seeing them firsthand (the Peter Lynch method?). I enjoy a bargain and am always searching for one. The problem I have here is the rate of growth, a possible further slowdown in China, and yes, inevitable nimble and vicious competition. It happens constantly in China. I call it a race to 0 margins. Everyone fights for a smaller and smaller market share until only a few survive and achieve scale. I saw it firsthand in the US and a worst-case scenario in Hong Kong with the competition for discount brokerage commissions. The failures are simply immense. In addition the valuation is simply too high here. At the present price, the company, according to Thomson Reuters, is trading at a forward P/E of Dec. 31, 2015 earnings of 41.57. We are assuming earnings of $4.75 per share or based upon my approximate calculation and using post conversion shares (I will tell you about them shortly) as well, I come out with net income of $289M. Even with the February 2014 acquisition of a 75% equity interest in Lefeng.com Limited, I don't see that visibility to the share price. Right now, the profit margin is 3.50% with the operating margins running 3.50%. eBay's operating margin is an attractive 20.83%, while Amazon is only 0.91%, thanks to the infrastructure, amongst everything else. Amazon thankfully has net income of $300M and earnings growth of 31.70% and has a diversified revenue model that is quickly evolving, i.e.. Kindle Prime. The problem is that Vipshop is now growing in a low interest rate environment and in a space which has simply grown too fast, (again, think Groupon). Groupon's profit margin is now -4.73% and their all-important (in my mind) operating margin is 1.44%. Unfortunately, Vipshop will end up with this margin within a few years' time due to competition in China and the general business conditions in this sector.

One additional comment aside. I had a guest from Beijing visit over the past week. She was visiting Hong Kong with her son on the way to Hong Kong Disneyland and to Europe. I asked her if she knew of Vipshop and had bought anything from them. In her broken English, she stated she had seen and knew of a few people who may have bought from the site but she thought that she could not trust the products on the site as being genuine. Whether this is correct or not, it would appear to be a PR issue for the company going forward. It would appear that other investors are not concerned with this or simply haven't traveled in Mainland China.

Now, let's take a quick look at the technicals. On July 17, TheStreet.com called Vipshop a "momo momentum stock." According to their definition of this term: "'Momo Momentum' stocks are valuable stocks to watch for a variety of reasons including historical back testing and price action. Market technicians refer to such stocks as being in a mark-up phase before a possible distribution period and price decline." The article continued, "the holding period on momo momentum stocks must always be a primary consideration, and this part of the puzzle is ultimately at the discretion of each individual's risk tolerance and portfolio risk management skills." In another words how much torture can you take in an equity before you decide to sell? Our opinion is to "jettison the pod" and get out. I remember one young investor here in Hong Kong asked me about a company called Nu Skin Enterprises Inc. (NYSE:NUS). It was trading around $140.00 in January of this year. I told him to get out. I stated "I don't have a crystal ball but from everything I see and everyone I speak to it is significantly overvalued. Is it going out of business? No, but I have no way of knowing the day when it will turn." He said he was quite happy with his return and would wait to see signs of a turn in the stock. I laughed and stated, "okay, you will see." He woke up one morning and was quite disappointed to see the stock down over $30.00 due to various reasons, i.e. multi-level marketing in China, medicinal claims, etc. My point is not to wait for a stock to a have a more realistic value but take advantage of your profits or take advantage of the impending pull back which will inevitably occur.

Returning to Vipshop, the company decided to issue US$550M of Convertible Senior Notes due 2019 in March of this year. According to the terms of the offering: "the Notes will be convertible into the ADSs at any time prior to the close of business on the second business day immediately preceding March 15, 2019. The Notes will initially be convertible at a conversion rate of 4.9693 ADSs per US$1,000 principal amount of Notes, which is equivalent to an initial conversion price of approximately US$201.24 per ADS." The notes are paying only 1.50% and issued when the shares traded at $143.75. Yes, I am only partially concerned with this interest exposure. I am more concerned with what will occur when the share price closes at $202 or $205. When this occurs I expect the majority of the institutional convert holders to liquidate at an attractive profit to their funds and holdings. Unfortunately, the dilution effect of an additional 2,581,150 shares cannot be fully simulated or modeled. Granted, not all convert holders will convert. There may be a conversion premium remaining, albeit limited. Think of a conversion premium as an option price. You can take the profit or wait to see if there will be more premium as the shares increase further and it goes deeper in the money (conversion level). But, I know of few funds that will stick with the 1.50% coupon when they have the option to convert at a premium to market and move on to the next company, especially when the markets are at highs and their fund holders are seeking competitive returns. As such, I see a tremendous downturn ahead should shares close in the next week above $202. The Sword of Damocles is ready to strike the shareholders. Or will it be Jack Bauer in the final episode of "24:Live Another Day" doing his own justice with a sword to Cheng Zhi? I am not waiting around to find out. Sorry, sell!

Source: Vipshop Holdings: Overpriced Or A Value Chinese E-Commerce Company?