Coupang: The Company That Beat Amazon In South Korea Is A Lucrative Investment

Feb. 16, 2021 1:59 PM ETCoupang, Inc. (CPNG)14 Comments10 Likes
Noah Wilson profile picture
Noah Wilson
1.32K Followers

Summary

  • The digital shopping platform has grown tremendously over the last few years.
  • Coupang operates in the fourth largest economy in Asia and the 12th largest in the world.
  • Listing on the markets and raising tens of billions of dollars will add rocket fuel to Coupang’s expansion.

South Korea’s largest online retailer, Coupang (NYSE:NYSE:CPNG), filed for an IPO on the US stock market, revealing in its S-1 statement that it had narrowed losses and dramatically grown revenues over the course of 2020. Revenues grew by an incredible 91% year-over-year, to $11.97 billion in 2020, while net loss narrowed from $698.8 million to $474.9 million. The company took the South Korean markets by storm in 2010, when, having been founded by Harvard graduate and current CEO, Bom Kim, it announced that its 'Rocket Delivery' service would allow it to make deliveries within 24 hours. This allowed it to gain market share from traditional, family-owned retail conglomerates like Lotte and Shinsegae. The company is often pitted locally against Amazon and has been backed by SoftBank since 2015. SoftBank owns 37% of the company and has funded Coupang to the tune of $1 billion in 2015, and $2 billion (by way of SoftBank’s Vision Fund) in 2018. In its last funding round, Coupang was valued at $9 billion. Coupang put a placeholder amount of $1 billion for the sum it intends on raising, so at present, we do not know the terms of Coupang’s offering. These will be revealed at a later stage.

Coupang’s value proposition is that it seeks to constantly improve customer experience at lower prices, innovating around their end-to-end integrated network of technology and infrastructure, new offerings, and effective merchant solutions. In this way, the company believes it will deliver superior selection, convenience, and low prices to customers, while also helping merchants to improve and grow their businesses. This discussion will look at the investment value of what the company has achieved in the last few years.

Rapid Growth with Profitability in Sight

The digital shopping platform has grown tremendously over the last few years. On a quarterly basis, revenues grew by 400% from the first quarter of 2018 to the fourth quarter of 2020, a rise from $900 million to $3.8 billion. On an annual basis, that represents a revenue compound annual growth rate (CAGR) of 43.46%, with revenue growing from$4 billion in 2018 to $11.97 billion in 2020. To put that into perspective, only 0.7% of companies across the world delivered a 3-year CAGR of that magnitude, between 1950 and 2015.

The company’s ability to make money has escalated markedly, with gross profits jumping from an already enviable 0.47 (Robert Novy-Marx’s research indicates that gross profitability above 0.33 is a sign of an excellent company) to 0.7.

As we said in the introduction, net losses have narrowed from $1.097 billion for the year 2018, to $475 million in 2020.

The company generated free cash flows of $163.51 million and operating cash flows of $301.55 million in 2020. As an investor, I seek growing businesses churning out free cash flows with an attractive yield. If we use the $50 billion that the Wall Street Journal believes will be the valuation at IPO, as our proxy for enterprise value, we arrive at a free cash flow yield of 0.33%, which is highly unattractive. Some outlets have suggested that Coupang will seek $30 billion, which would give a free cash flow yield of 0.54%. This would represent a free cash flow yield lower than the average free cash flow yield of the largest 2,000 companies in the United States.

The company’s operating margins are unimpressive, standing at 4.41% in 2020. Operating margins are highly persistent across one to five year periods -this is especially true in retail- and are a crucial indicator of profitability. Shareholder value is created whenever returns exceed the opportunity cost of capital employed. With a negative operating margin, it is unlikely that Coupang will be able to grow shareholder value from its business activities in the near-term.

A Network Whose Value is Always Growing

Coupang operates in the fourth largest economy in Asia and the twelfth largest in the world, an economy with a gross domestic product (GDP) of $1.6 trillion and GDP per capita of $31,847. Koreans spent $470 billion on retail, grocery, consumer foodservice, and travel in 2019 and are expected to increase that spend to $534 billion in 2024. Total e-commerce spend was $128 billion in 2019, which is expected to grow to $206 billion by 2024, implying a CAGR of approximately 10%. This is a huge addressable market to attack and Coupang has the ingredients to win the race to dominance.

In this huge market, Coupang enjoys network effects around its platform. Network effects imply that the marginal or additional user increases the value of a service or good, and in this broad conception, all companies need network effects. The type of network effect a company has differs immensely, along with the extent to which it directly improves the core product.

Coupang’s network effect is subtle: part of this effect derives from how shopping on Coupang improves your experience through things like rankings, reviews, and data feedback loops. Equally important, however, are two less talked about effects: first, the more customers shop on Coupang, the more attractive Coupang becomes to suppliers thinking about joining the company’s platform, increasing price competitiveness and selection appeal for everyone. In other words, Coupang, especially as it transitions even more aggressively into being more of a commerce platform and less of a retailer, is a two-sided network. There is another factor at work: Coupang’s incredible service rests on billions of dollars in investments, which in itself is a prohibitive cost preventing real competition from emerging; and that fixed cost investment will eventually have to be borne by customers, so, the more customers Coupang can bring into its orbit, the less any one customer is responsible for those fixed costs (which customers experience indirectly through lower prices and better service).

Coupang’s network effects are partly internalized and partly externalized, and similarly, it has differentiated suppliers that are highly subordinate to Coupang’s customer relationship.

Listing on the markets and raising tens of billions of dollars will add rocket fuel to Coupang’s expansion and allow them to achieve economies of scale while also growing the value of its network.

It is important to keep this in mind when looking at Coupang’s lack of profits. It stands at pretty much where Amazon was when its revenues kept growing, taking a larger and larger share of US retail, but seemingly never making any money. Coupang is still a few years off from making a profit, but its net losses have been narrowing significantly over the years and that is a reflection of network effects at play.

It is useful to think of Coupang as a bundle of businesses, such as Rocket Delivery, Rocket WOW membership, Rocket Fresh, and Coupang Eats, and Coupang Pay, all with different margin potentials and levels of maturity. Some segments are relatively old, and well established, and growing at slower rates, and others are profitable. Some segments are at the build-stage of the business and losing money as they grow. Other segments are very profitable, while others sell at cost or at a loss to drive traffic and spur loyalty. Furthermore, revenues, a usually reliable metric, are less useful with a company like Coupang because it only recognizes revenues from services rendered to third party companies, not the total value of goods sold. So the total value of goods that pass through Coupang are not accurately reflected in the revenue number. All we see are shipping and processing fees related to third parties, not gross revenue. This means even gross margins are misleading. What we have is a sprawling business with massive third party accounts, sitting on top of Coupang’s fulfillment and commerce platform.

Conclusion

Coupang, like Amazon, is run to maximize cash, not net income. The number to watch is free cash flow and that is positive. As the saying goes, profit is opinion, but cash flow is fact. The company enjoys healthy free cash flows as well as operating cash flows. Operating cash flow is basically the cost of running the business before the costs of infrastructure, M&A and financing costs. It really shows the effect of selling at low prices. Coupang is able to spin out rapidly growing sums of operating cash flows. Coupang’s ability to grow free cash flows will allow it to maintain a war footing, growing aggressively and pouring even more rocket fuel to its growth, as its share of an ever-growing Korean retail market grows.

This article was written by

Noah Wilson profile picture
1.32K Followers
I'm an independent investor with experience trading forex, cryptocurrency and stocks. I'm particularly interested in tech and biotech stocks with a long term growth philosophy. Originally from the UK, I worked for Barclays bank in London for 10 years before moving to the East coast of England. I currently run several online businesses while writing about investment as a hobby. None of the views I express should be taken as investment advice and is purely my own musings on a stock's investment potential.
Follow

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.

To ensure this doesn’t happen in the future, please enable Javascript and cookies in your browser.
Is this happening to you frequently? Please report it on our feedback forum.
If you have an ad-blocker enabled you may be blocked from proceeding. Please disable your ad-blocker and refresh.