Article / 06 May 2015 at 5:03 GMT

Earnings preview: Alibaba under pressure to perform

China Watcher / Shanghai
China
  • Alibaba reports fiscal fourth-quarter earnings on Thursday May 7
  • Late Chinese New Year will likely have had a detrimental effect
  • There have been no major counterfeit issues in the fourth quarter

By Neil Flynn

Online retail giant Alibaba reports its fiscal fourth-quarter earnings on Thursday May 7 before the opening of the US markets, with investors expecting a return to normality after the huge Single’s Day and 12.12 events in the fiscal third quarter. But whilst the firm won’t have any major counterfeit product issues to deal with, the late timing of the Chinese New Year may have caused a notable decline in revenue growth. Ahead of the earnings release, these are the four key points that investors should focus on:

The 'late Chinese New Year' effect

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  The later the date of Chinese New Year, the longer the period of slow business. Photo: iStock

As I discussed in my preview of Baidu’s fiscal first-quarter earnings, the late timing of the Chinese New Year festival will likely have had a detrimental effect on Alibaba’s fiscal fourth quarter revenues. The time between Christmas and Chinese New Year is very quiet for business in China because, as western clients are coming back to work after their holidays, Chinese firms are preparing for the week-long festival. However, to avoid the queues and traffic of the world’s largest human migration, people start returning to their home towns up to two weeks before the festival begins, and return up to two weeks after it ends. Therefore, the later the date of the Chinese New Year festival, the longer the period of slow business in China. Chinese New Year typically falls at the end of January or start of February, but this year it was on February 19. 

This is relevant to Alibaba because the firm relies on third-party merchants and couriers to deliver products to customers, and as they return to their home towns for the festival, business is very slow, and revenues fall. As an example, I tried to order a product from Alibaba a week before Chinese New Year, but the earliest that it could arrive was in the middle of March. An additional consideration is that as people leave the major cities to return to their home towns, where the quality of internet connection and Wi-Fi is much lower, customers will likely have found it difficult to shop online, particularly on mobile.

Investors should be expecting lower year-on-year revenue growth as result of the late timing of the festival, but should consider that this isn't a company-specific problem. I fully expect to see the same from JD.com and other rivals when they report their own earnings.

Alibaba's Revenues
Source: Alibaba Group Investor Relations 

The double edged sword of growing the mobile business

After the release of the fiscal third-quarter earnings, investors were concerned that the increase in mobile’s contribution to total revenues would see revenue growth slow. This is because the monetisation rate of mobile is less than that of PC. The third quarter saw a huge increase in mobile GMV (gross merchandise volume) due to the Single’s Day and 12.12 shopping events, and investors should be expecting to see slower growth from the fiscal fourth quarter. Nevertheless, with mobile contributing 41.5% to GMV in the third quarter, it is likely to have increased to around 46% in the fourth quarter, and to 60% by the end of the next fiscal year.

Alibaba's Mobile GMV
Source: Alibaba Group Investor Relations

As mobile contribution to GMV grows, investors shouldn’t be concerned about the monetisation rate. I have previously argued that lower revenue growth is a short-term symptom of longer-term growth. Mobile is becoming the core business strategy of all of China’s tech firms, and building mobile market share is essential. The issue is that firms plan to increase mobile monetisation after this period of mobile land grabbing subsides, but for the time being, the increase in mobile’s contribution to revenues will see blended monetisation rate growth slow. From Alibaba’s perspective, it has to build its mobile user base, because its online shopping business faces genuine competition from JD.com, which is leveraged upon Tencent’s huge mobile ecosystem.

In the fiscal fourth quarter, investors should expect to see that the mobile monetisation rate has grown, but as mobile contributes almost half of the firm’s GMV in the quarter, the blended monetisation rate should decline.

Alibaba's Monetisation Rate
Monetisation rate is calculated as revenue divided by GMV. Source: Alibaba Group Investor Relations  

Commentary on anti-counterfeit procedures

Before the release of Alibaba’s fiscal third-quarter earnings, a government white paper on counterfeit products was released, in which Alibaba’s C2C shopping platform Taobao was unfairly criticised. Alibaba released a statement about the report and its anti-counterfeit measures during its conference call, which overshadowed what would have been an otherwise decent earnings release.

During the fiscal fourth quarter, there hasn’t been any major counterfeit issues, which should allow investors to focus on the financial results. However, one minor issue is that the American Apparel and Footwear Association asked the Office of the US Trade Representative and the SEC to add Taobao to the Notorious Market list, which identifies Internet marketplaces that deal in counterfeit goods. The problem for Alibaba, and the industry as a whole, is that it is virtually impossible to completely eradicate the risk of counterfeit goods online, because it relies on third-party merchants. I have discussed numerous times how cosmetics retailer Jumei has all but removed this risk by effectively banning third-party merchants at the expense of GMV, but this isn’t an option for Alibaba. The firm’s B2C Tmall platform is reserved for high-quality third-party merchants and brands, so Taobao can’t imitate this business model. The only measure that Alibaba can take is to increase the testing procedures, and to be stricter on any infringements. Investors should expect that management will discuss the quality of their anti-counterfeit measures during the conference call, focusing on how many accounts the firm has banned, and how the firm has increased the number of products that it tests.

The smart home and smart car ecosystems

2014 saw China’s tech firms developing their mobile ecosystems by adding a whole range of different services and verticals in order to create a closed loop, which is the concept that a user would never have to use a rival’s services, because everything that the user could ever need can be found within a firm’s mobile ecosystem. Therefore, Alibaba’s mobile ecosystem consists of the core shopping platforms and Alipay mobile payment service, as well as video, music, social media and gaming, among other services. In 2015, we will see Alibaba transfer this mobile ecosystem into homes and cars, in order to develop the smart home and smart car ecosystems. 

The smart home will be focused on the television, where users can browse Alibaba’s media content and shop. As I discussed last week, the firm is also focusing on smart appliances, such as air conditioners, which can be integrated into the smart home via wireless routers. Investors should expect to see Alibaba partner with appliance manufacturers in order to develop products that can be easily integrated into a smart home.

Alibaba announced that it has partnered with Shanghai-based vehicle manufacturer SAIC to invest $160m into internet connected cars. The first product will be released in 2016, and will be equipped with Alibaba’s services ecosystem.

The smart home and car ecosystems are important for Alibaba because they allow for data collection on user behaviour on a much greater scale than smartphones and PC. This data can be monetised through tailored advertising, and can help the firm to identify media trends. As these are core strategies for the firm in 2015, management will likely focus on these businesses during the conference call.

View from the markets

The May Week 2 $79.50 straddle closed last night at a mid-price of $5.71 on the screen, which implies that the market is predicting a move of 7.2% between now and the expiration of the straddle on Friday. Since its record-breaking IPO in September last year, the firm has only released two earnings reports, which makes comparing this implied move with the earnings history somewhat difficult. Nevertheless, the firm won’t have to deal with major counterfeit issues, and the effect of the late Chinese New Year on revenues has already been seen in the earnings of major rival Baidu, so investors should already be expecting similar from Alibaba. In addition, Alibaba’s share price fell to its lowest level last night, so I wouldn’t expect to see a 7.2% fall unless the earnings release is notably disappointing.

Short interest in the shares has been rising since its IPO, and would currently require 3.34 days to cover. A disappointing earnings release would put further pressure on Alibaba’s share price, and I would expect to see the short interest rise.

Alibaba's Short Interest
Source: Nasdaq  Create your own charts with SaxoTrader; click here to learn more.


– Edited by Susan McDonald
Neil Flynn is a portfolio manager at Alcuin Asset Management. Follow Neil or post your comment below to engage with Saxo Bank's social trading platform.


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