By Dr. Manish Sinha
On 19 September 2014, a fifteen year-old company founded by former English teacher Jack Ma in Hangzhou, China embarked upon the largest initial public offering (IPO) in U.S. corporate history. In doing so, it smashed the 6-year record held by American financial services giant Visa by over 40 percent. The conglomerate, Alibaba Group Holding Ltd., raised as much money from the investment community as AT&T Wireless Group and General Motors combined, giving its founder a 9 percent stake valued at approximately $20 billion. Due to restriction on direct foreign ownership of Chinese companies, Alibaba raised $25 billion (inclusive of add-ons) by selling American Depository Receipts through a Cayman Islands vehicle, giving the Western public exposure to an e-company that dominates one of the most crucial foreign markets. Upon its IPO the company ranked amongst the most expensive companies globally; the following morning the company’s market value approached $230 billion. Such a stratospheric valuation catapulted the company to similar rank in terms of market capitalization as Procter & Gamble and JP Morgan Chase and, among technology behemoths, fourth behind Apple, Google and Microsoft. The newest member of the technology elite chose to list in the US in contrast to Hong Kong, as the latter’s stock exchange refused to accept the proposed company and voting structure. So what really is Alibaba and how significant a threat does it pose to its globally revered competitors Amazon, eBay and PayPal?
Alibaba is the most popular online shopping destination in the world's fastest growing e-commerce market. It has evolved, through an amalgamation of organic growth and external acquisition, into an interconnected and diverse group of businesses. It encompasses an online business-to-business portal, a shopping search engine, a retail and payment service and cloud computing services. Essentially, a synthesis of eBay, PayPal and Amazon Web Services with undisputed market size to match: transactions in 2013 totaled $248 billion, more than eBay and Amazon combined. The opportunities for investors are immense: China’s e-commerce market has grown from $74 billion in 2010 to $295 billion in 2013 and is projected to cross $713 billion in 2017. At the time of its stock offering the overall Group’s website activity accounted for over 60 percent of all parcels delivered in China by March 2013 and over 80 percent of the country’s online sales. An investment in the company therefore represents a wager on two fronts: an increase in its dominance of the Chinese market and, crucially, a successful expansion into foreign markets.
Alibaba Group is a multi-faceted organization constituting distinct pillars. Firstly, Taobao Marketplace, which is China’s most popular online shopping site and analogous to Amazon. Secondly, TMall, which represents the country’s largest brands and retail platform that sells directly from brands. Thirdly, Alipay, which resembles PayPal and which processed $623 billion of digital payments in the fiscal year 2014. Fourthly, Aliyun, which offers the Group’s cloud services and infrastructure facilities and which contributed $102 million in profit. The success of the Group’s online market place has been resounding, in part, due to the historic weakness of in-person retail shopping in China in comparison to Western markets. According to the Census Bureau, US e-commerce sales in the first quarter of 2014 accounted for 6.2 percent of total sales whereas in China that figure was almost 8 percent according to iResearch.
Investment in Alibaba’s IPO comes with a key unquantifiable risk: historically unforeseen changes to legal rules governing the Chinese market place. Furthermore, despite a continuation of China’s economic expansion, its rate of growth has decelerated by 4.5 percent over the past four years and it is hitherto unclear whether this trend will continue, stabilize or reverse. Whereas private consumption comprises approximately 75 percent of gross domestic product for the United States, this figure is little more than one-third for China and may constitute an indubitable opportunity for domestic growth. However, how conceivable is an appreciable increase in private consumption where, at the last measure, the World Bank estimated that 27 percent of residents live on less than $2 per day? Alibaba recently reported a shift to mobile traffic with mobile-related sales increasing from 7.5 percent of gross merchandising volume to 19.7 percent over the past year. Failure to monetize this traffic represents a significant risk to future profitability; particularly given that China’s 600 million-plus internet users are migrating to smartphones whilst Alibaba simultaneously attempts to expand onto mobile platforms. Its toughest rival is Tencent Holdings Ltd., which runs the WeChat mobile app with 355 million users and one-fifth market share of China’s mobile app distribution. The tangled web of domestic competitors comprises at least forty distinct companies that are investing billions of dollars into businesses that can help compete with, and erode, Alibaba’s advantage.
Alibaba has diversified its revenue source by venturing into an unrelenting acquisition drive of key foreign companies, purchasing majority and minority stakes in 29 companies for $16 billion. Furthermore, it permits users to invest in a money-market fund via Alipay and, with $87 billion under management, runs the fourth-largest money-market fund globally. In 2005, it invested $4 billion into US Internet search giant Yahoo! Once restricted from foreign ownership, in 2013 the Federal Communications Commission permitted foreign investments in US companies to exceed 25 percent on a case-by-case basis. Alibaba also led a $215 million funding round for messaging app Tango and invested $120 million in video game start-up Kabam, in process gaining a seat on its board. Its partnership with Brazil’s state-owned postal services company Correios enables small businesses to utilize Alipay when selling their products in China and also invested $250 million in Singapore Post. At the time of writing, it is in talks to invest in Delhi-based online retailer Snapdeal in an attempt to enter the voracious Indian market enabling it to compete directly with Flipkart, the country’s largest e-commerce company, and Amazon. Alibaba’s investment targets enjoy direct, reciprocal access to the Chinese market that is crucial for their future aspirations as several are focused on mobile and e-commerce.
Such explosive growth has Alibaba witnessed and so successful has its business been that entire towns have mushroomed across China that thrive solely upon executing business based upon Alibaba platforms. The number of so-called “Taobao villages” – previously rural townships expeditiously transformed into commercial hubs – has grown by 50 percent since 2012 and as of September 2014 exceeded one million. Indeed, seventy percent of areas where the rate of growth of online shopping is the highest are rural, less well-developed regions of China. An archetype of this paradigm transformation is Donggaozhuang where amongst 400 households lie 20 stores with annual trading volume in excess of one million yuan and where online master classes are held for aspiring entrants to China’s e-commerce boom. Similarly, East Wind village in the eastern province of Jiangsu mostly exported wheat, rice and soybean. Today, the former farming village has metamorphosed into a key player in the domestic furniture industry. Currently, more than 600 stores sell furniture to customers as far away as New Zealand. Between Taobao, TMall and the group-buying site Juhuasuan, there were 255 million active buyers and 8 million active sellers. Across all Alibaba sites, on average 34 million transactions were processed each day.
An examination of the group’s financial statements from the second quarter of 2014 elucidates similarities and disparities with its US counterparts. For instance, its gross merchandising volume of 80 billion in the second quarter of 2014 was four-fold higher than that of eBay, partly owing to the sheer variety of its market places. However, the revenue earned trailed that of most of its peers at approximately half of eBay’s and ten-to-fifteen percent of both Amazon and Google. Its low cost base, however, enabled it to make a net profit almost twice that of eBay and two-thirds of Google, whilst Amazon continues to make a loss. One metric in which it unquestionably shone was net profit margin, or the amount of profit it generates for every unit of revenue. For Alibaba, this reached a high of eighty percent whereas, comparatively, both eBay and Google languished at twenty percent.
Ultimately, it is challenging to predict how Alibaba’s business model will adapt to direct competition from established foreign multinationals, which may limit genuine growth opportunities in uncharted territories. Whilst its investment trail in an array of companies should assist in generating independent sources of revenue, the likes of Amazon, eBay and PayPal will not relinquish their stronghold quietly and will no doubt provide extremely stiff competition to the industry’s new entrant. Alibaba will find it demanding establishing itself in new frontiers and its partnerships with locally established, albeit globally smaller, firms would play a crucial role in facilitating and expediting this. Only time will tell whether Alibaba succeeds in living up to the hype surrounding its record-breaking IPO but one thing is clear – it will be a journey encapsulated by governmental and commercial uncertainty and epitomized by potentially much tougher impediments than it has encountered during its meteoric ascent thus far.