Alibaba Faces A Greater Threat Than The Trade War

About: Alibaba Group Holding Limited (BABA), Includes: PDD, TCEHY
by: Bluesea Research

Alibaba is facing a new rival, Pinduoduo, which has reported rapid growth in the past few quarters.

The average monthly average users of Pinduoduo has risen to 289 million, which is 74% YoY growth.

Pinduoduo’s last 12-month gross merchandise value has also risen to RMB557 billion or $83 billion, YoY growth of 181%.

Alibaba’s MAUs stand at 721 million and GMV was $853 billion in FY19.

Alibaba would need to fend off this challenge by improving its investment in pricing and improving logistics in lower tier cities.

Alibaba (BABA) faces greater competition from a new startup which is grabbing a big chunk of the e-commerce market in China. Most of the analysts believed that the Chinese e-commerce market was a two-horse race between Alibaba and JD (JD). However, Pinduoduo's (PDD) growth in the past few quarters shows that there is still a possibility of new entrants in this market.

In the latest earnings report, Pinduoduo has reported last 12-month, LTM, gross merchandise value, GMV, of RMB557 billion or $83 billion. This is equal to 181% YoY growth. The average monthly users have also risen to 289 million, showing 74% YoY growth. Alibaba would need to launch new initiatives to counter the rapid growth of PDD.

The current bearish sentiment towards Alibaba stock is due to the trade war. However, if PDD continues on this growth trajectory, Alibaba would face a bigger threat from this rival compared to external factors.

Tough competition

PDD has been able to expand its user base by using the social buying features within its platform. Customers who order in bulk by adding their friends for a particular order get greater discounts. This feature helps in the marketing of its products and builds a stronger customer following. We can see the results in the latest quarterly report of PDD. The average monthly users have increased to 289 million which is 74% YoY growth. This number is even more impressive when we compare it to Alibaba’s MAUs.

Alibaba has reported 721 million MAUs on its e-commerce platform. Hence, PDD has 40% MAUs compared to Alibaba. This is quite an achievement considering the fact that PDD started operations in 2015.

Source: PDD filing

The last 12-month GMV has increased to RMB557 billion or $83 billion. This is close to 10% of Alibaba’s GMV. While Alibaba’s showed 19% YoY growth in GMV in the fiscal year 2019, PDD has reported YoY growth of 181%. If PDD continues at this growth trajectory, it will soon be taking significant market share away from Alibaba.

Source: PDD filing

Another important metric to watch out for is the annual spending per active buyer. This metric has increased by 87% YoY to RMB1,257 or approximately $200. Higher spending per buyer shows the ability of PDD to retain customers and convert them into repeat buyers.

Can Alibaba defend its turf?

PDD is heavily dependent on Tencent’s (OTCPK:TCEHY) WeChat platform. Tencent was also a big investor in PDD during the early stages of its growth. Tencent is the main rival of Alibaba and it can continue to increase its partnership with PDD. Alibaba’s platform lacks the social media advantage which WeChat has. This makes it difficult for Alibaba to launch certain group buying options which are relatively easier for PDD.

PDD has shown faster growth in lower tiered cities of China where customers are more price conscious than Shanghai, Beijing and other big cities. Alibaba has also launched a number of initiatives to improve its sales in the lower tiered cities. Alibaba is also investing heavily in the digital media segment. This helps Alibaba attract customers to its e-commerce platform.

PDD is still losing money at a rapid pace. Hence, Alibaba can engage in a greater price war to attract more customers.

It is unlikely that PDD would be able to afford these losses over the long term. Alibaba also has a much higher free cash flow. These resources can help Alibaba in building a stronger moat around its core-commerce segment and prevent customers from moving to PDD’s platform.

Impact on margins

If Alibaba tries to engage in heavy discounts to defend itself against the growth of PDD, it will end up hurting the margins.

Fig: Alibaba’s EBITA in various segments.

Alibaba’s core commerce generates all the profits for the company. These profits help Alibaba in building its cloud operations, delivery services, digital media, and other segments. Slower growth in core commerce or a significant decline in margins will hurt the sentiments around Alibaba stock.

Alibaba stock is still a strong buy due to its valuation level and future growth options. The forward P/E ratio of the company is at 23 while its growth rate is at a respectable 40%+ range. The forward revenue growth guidance by the management is also quite good. But the next few quarters will depend on how well the company can defend itself against a rapidly growing PDD.

Investor Takeaway

Alibaba is facing a strong challenge from Pinduoduo. PDD has been able to increase its MAUs by 74% from the year-ago period. PDD’s MAUs of 289 million is now 40% of Alibaba’s 721 million. Increase in purchases per buyer has also helped in the growth of PDD’s GMV. Alibaba can use its massive resources to engage in a pricing war with PDD. The losses for PDD are equal to 36% of the revenues. This limits the ability of PDD to sustain a long-term discounting strategy.

Investors should note the future trend of growth in PDD and the impact it has on Alibaba’s growth. PDD is one of the biggest challenges for Alibaba in the last few quarters. The result of the competition between PDD and Alibaba will have a big impact on the sentiment around Alibaba stock.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.