The E-Commerce Titan of Asia-Pacific
Alibaba Group (NYSE:BABA), along with Tencent (HKEX:700) and Baidu (NASDAQ:BIDU), forms the famous ‘BAT’ trio, representing three of China’s biggest and most exciting Internet companies. Due to its remarkable dominance (58.2% of market share) in the e-commerce industry, Alibaba is essentially synonymous to online shopping in China.
Alibaba operates two of China’s most-visited online B2C and C2C marketplaces, Tmall (天猫) and Taobao (淘宝) with a total gross merchandise value (GMV) of RMB 4.8 trillion in FY18. The majority of its FY18 revenue (83%) is derived from its core commerce segment, primarily through advertising fees and commissions. The company also has significant operations in cloud computing, digital media and entertainment, as well as other initiatives like online payment and consumer services (Chart 1).
Chart 1: Alibaba Derives Majority Of FY18 Revenue From Core Commerce Segment
1. Dominant Online Ecosystem That Value-Adds Through Positive Network Effect
Having achieved such critical mass in China, its e-commerce platforms exhibit positive network effect, facilitating transactions effortlessly between both shoppers and merchants. Serving as conducive marketplaces for businesses, Alibaba’s large and active shopper base effectively means merchants have to list their products on Taobao/Tmall, in order to reach these shoppers.
As merchants compete for a more visible presence online, a wider catalogue of brands and products becomes available on Taobao/Tmall. For shoppers, such diversity of merchandise provides a more dynamic shopping experience, thus enticing them to visit more often and stay longer. This is evident in the strong growth in active shoppers on its platforms, which cumulatively held a total of 576 million active unique shoppers in June this year – a 24% increase from a year ago (Chart 2).
Chart 2: More Active Online Buyers Are Purchasing On Alibaba’s E-Commerce Platforms
This effectively implies that more than 70% of the 800 million-strong Chinese Internet users shop on Taobao/Tmall. While there are concerns over waning user growth, it is worth noting that Alibaba has shifted its focus towards generating more revenue per buyer, via greater ad revenue and commission, as users spend increasingly more time on the platforms.
Even with the recent emergence of several smaller e-commerce retailers like Pinduoduo (NASDAQ:PDD) and Gome Retail (HKEX:493), Alibaba has successfully held up against the increasingly intense competition. In the first half of 2018, Alibaba continued to account for more than half of all retail e-commerce sales, demonstrating its firm foothold on China’s online retail scene (Chart 3).
Chart 3: Alibaba Tops E-Commerce Market Share Despite Facing Fresh Competition In China
2. Growing E-Commerce Scene In China
With online sales accounting for less than a fifth of total retail, China’s online retail market still has further headroom for growth. It is projected to grow at double-digit CAGR of 16%, reaching an enormous size of RMB 11.7 trillion by 2021.
This upward trajectory can be attributed to three key trends:
Firstly, the paradigm shift towards e-commerce is still well underway. Online sales in China contributed to 17% of total retail sales in 2017 and is projected to accelerate toward 25% by 2020 (Chart 4). Not only are consumers purchasing more merchandise online, they are purchasing across a wider range of categories, such as fresh groceries and fast moving consumer goods (FMCG). These categories have low e-commerce penetration rates and hence, have ample room for growth.
Chart 4: E-Commerce Taking a Larger Share of Total Chinese Retail Sales
Secondly, China has been shifting toward a consumption-driven growth model in recent years, thanks to an ever-rising disposable income per capita. Consumption is expected to grow by an average 6% annually to nearly double in size across 2016-2027, from RMB 29 trillion in 2016 to RMB 56 trillion by 2027, stimulated by the middle class that will comprise an estimated 65% of households by 2027.
Lastly, consumers in rural regions are emerging to outspend those in high-tier cities online. While urban dwellers have been the major driving force behind e-commerce, the rural populace in lower-tier cities are starting to grow wealthier and more eager to spend.
E-commerce has been an instant hit with the rural populace, as it gave them access to brands and products that were previously unavailable, especially with fairly limited shopping options in rural areas. Empowered with better Internet connectivity and rapidly rising disposable income, the rural population presents tremendous potential for e-commerce growth (Chart 5).
Chart 5: Low-Tier Cities Set to Spend More On E-Commerce Than High-Tier Cities
3. New Retail – Beyond E-Commerce For Physical Goods
Having secured its dominance in China’s e-commerce, Alibaba is fast progressing into two new segments: online consumer services and O2O (online-to-offline) retail. Coined as ‘New Retail’, Alibaba aims to integrate online, offline, physical goods, services and logistics across a single value chain – forming a complete retail ecosystem. With China’s consumer service market almost equal in size as retail market, Alibaba has essentially doubled its total addressable market, paving the way for Alibaba to sustain its extraordinary growth rate in the years ahead (Chart 6).
Chart 6: Consumer Services Market Is Almost As Big As The Retail Market In China
As living standards continue to improve, Chinese consumers are spending more on services – especially online services via their smartphones – such as transportation, beauty treatments and food delivery. The online consumer service industry is projected to reach RMB 7.9 trillion by 2023, penetrating beyond 24% of the entire services market (Chart 7).
Using food delivery as the entry point into China’s local services sector, Alibaba aims to establish a multi-dimensional local instant-delivery network to complement its e-commerce ecosystem. Spearheading efforts through Ele.me (饿了么), China’s 2nd most popular online food-ordering service, Alibaba aims to deliver meals on-demand to some 350 million Chinese customers, 70% of them ordering online at least once a week.
Ele.me also synergises with Cainiao Logistics (菜鸟), whose delivery capabilities translate to quick and efficient fulfilment of customers’ demands, be it food takeout or merchandise purchase.
Chart 7: Online Consumer Services Is Underpenetrated and Growing Rapidly
Besides online services, Alibaba is also pursuing an online-to-offline (O2O) concept, connecting e-commerce seamlessly with physical retail stores. Adopting an omni-channel approach is essential because consumers of today shop across channels: they might visit stores to look at products and then eventually buy them online, or they might research on products online and then buy them in stores.
Hema Supermarket (盒马鲜生) is one such ‘New Retail’ initiatives. A hypermarket chain selling high-quality fresh food ranging from fruits to seafood, users are encouraged to purchase groceries in-store using the Hema app (linked to users’ Taobao/Alipay account). Once shoppers become convinced of Hema’s quality, they are easily converted into using its online groceries delivery service regularly.
We think that ‘New Retail’ represents an exciting new chapter for Alibaba – its smooth and immersive shopping experience will be critical in ensuring its market leadership and sustainable long-term growth.
4. Digital Payment, The Critical Last Piece of Retail Ecosystem Puzzle
Given the synergies between online payment and e-commerce, Alipay (Alibaba’s eWallet service) is of strategic importance to Alibaba’s retail ecosystem. It empowers Alibaba to provide additional services for its users, differentiating itself from competitors. For example, Alipay users are automatically provided with free escrow services when shopping on Taobao/Tmall, allaying any fears of fraudulent transactions. As a result, Alipay dominates China’s online payment market, having held more than 50% of total market share consistently for the last three years (Chart 8).
Chart 8: Alipay Accounted For More Than Half Of All Online Payment Transactions In China
Through the ease and safety provided by Alipay, users are encouraged to cycle comfortably across the numerous services within Alibaba’s retail ecosystem. Alibaba can then expose its user base to ‘cross-selling’ opportunities, with financial services such as wealth management, consumer credit and insurance. As users grow increasingly reliant on more services in the ecosystem, they become more deeply entrenched, ensuring a high rate of user retention.
At the same time, Alibaba is capable of collecting and analysing data sufficient to construct detailed profiles of individuals’ tastes and preferences, making its targeted marketing more effective. This not only generates greater advertising (customer management) revenue in the process, but also drives higher customer traffic through Alibaba’s retail ecosystem.
5. Emerging Markets Opportunities Into South-East Asia
Beyond its primary China market, Alibaba has also set its sights on the Southeast Asia (SEA) region as a future growth engine. Through Lazada, the leading e-commerce platform in six different SEA markets (such as Indonesia and Singapore), Alibaba aims to reach out to over 600 million potential customers via its online marketplace.
According to Google-Temasek, SEA is grossly underpenetrated in terms of e-commerce, with online transaction still accounting for less than 5% of retail sales across the region. The e-commerce market is projected to grow at CAGR of 30% to reach USD 88.1 billion by 2025 (Chart 9). As such, Lazada is well-positioned to tap on the massive potential of SEA region, especially as the middle class populace is expected to expand by over 150 million over the coming years.
Chart 9: South-East Asian E-Commerce Market Is A Massive Growth Engine For Alibaba
With the explosive double-digit growth in SEA e-commerce, the region has attracted much interest from retailers, especially Amazon (NASDAQ:AMZN) and Sea Ltd's Shopee (NYSE:SE). In the face of such intense competition, Alibaba has been investing heavily (total approx. USD 4 billion) into Lazada’s regional expansion, especially on its logistics and delivery capabilities. It has previously acquired a 15% stake in SingPost (SGX:S08) back in 2014.
Extending its ‘New Retail’ strategy into SEA, Lazada (Alibaba) is also developing online services presence in the region (alongside e-commerce business), having acquired Redmart (Singapore-based online grocer) two years back. We are positive Alibaba can easily emulate its successful e-commerce/local service model through Lazada, to emerge strongly as a dominant player in SEA, given its years of experience and expertise in online retailing.
Investment Risks
Fair Valuation
Using a sum-of-the-parts valuation approach, we value Alibaba at a total valuation of USD 610 billion and fair value per share of USD 220 (Table 1). This represents a potential upside of 40%, based on the closing price of USD 157.46 on 11-Sep-18.
The current end-2019 forward PE ratio of Alibaba is at 24.0X is slightly lower compared with the peer average. We think Alibaba deserve a premium over peers instead, considering its dominance in China e-commerce. We estimate a robust 3-year revenue CAGR at 40% between FY2017-20, which is higher than majority of its peers (Table 2).
Our other key assumptions include:
Table 1: Sum-Of-The-Parts Valuation For Alibaba
Table 2: Alibaba Is Projected to Grow Faster Than Its China E-Commerce Peers
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