Article / 30 January 2015 at 5:26 GMT

Forget the revenue miss, Alibaba had a huge quarter

China Watcher / Shanghai
China
  • Alibaba's share price slide looks like an overraction, given its impressive earnings
  • Vice chairman Joe Tsai’s comments on the fake goods issue may have made it bigger than it actually is, and probably contributed to the share price fall
  • Tackling the fakes issue was important because customer trust is vital in e-commerce, but it will probably be forgotten by the next earnings release

By Neil Flynn

Alibaba released its calendar fourth quarter earnings report on Thursday morning, with investors disappointed at the revenue miss. The share price closed at $89.81, down 8.78% from Wednesday’s close, which I feel is an overreaction, especially given that the vast majority of the earnings release was very impressive. With strong user metrics, particularly in mobile, I expect that the firm will enjoy another stellar year in 2015.

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Alibaba has 334 million annual active buyers, but there is still huge scope for growth in rural areas, where about half of China's population of 1.4 billion resides. Photo: iStock
 
The headline results

Analysts were expecting to see EPS of $0.75 and revenues of $4.45 billion, and whilst Alibaba beat EPS consensus by posting $0.81, revenues of $4.22bn left investors disappointed and sparked a major sell-off. In addition, net income declined on an annual basis from 8.36bn yuan to 5.98bn yuan ($964m) because of share based compensation expenses related to the IPO and an early repayment fee of $8bn bank borrowings .

The fourth quarter is always the strongest for Alibaba because of the two shopping extravaganza events that it has created – Singles' Day and 12.12. Gross merchandising volume (GMV) conducted on Taobao (the C2C platform) and Tmall (the site for large, established brands) was 787bn yuan during the quarter, which is sequential growth of 41.64% and annual growth of 48.86%. The firm continued its streak of beating the previous year’s Singles' Day record by recording 57bn yuan of sales in just 24 hours, which was 58% higher than in 2013.

Platform GMV Growth

















Source: Alibaba  

Looking into Taobao and Tmall annual growth trends, Taobao recorded an annual GMV growth rate of 42.89% in the fourth quarter, up from 38.23% in the third quarter. However, Tmall’s annual GMV growth rate slowed in the fourth quarter to 60.11% from 77.78%. This is part of a much wider trend that has seen Tmall’s annual growth decline towards a steady state level, in the same way that the more mature and larger Taobao platform has done.

Throughout 2014, management did mention that they had been promoting the Taobao app more than Tmall, and because users of the Taobao app can access Tmall listings, Tmall in turn sees a decline an organic traffic growth. Purchases through the Taobao app of Tmall listed goods were recorded as Taobao GMV, so whilst it would seem as though Tmall GMV growth had a notable decline, it’s deceptive.

Platform Growth


















Source: Alibaba  

Alibaba continued to see strong growth in annual active buyers, which stands at 334 million as of the end of December. Perhaps equally impressively, its sequential growth rate has remained relatively stable at between 8% and 10% over the past three years.

To put this into context, this is more than the whole population of the US, and more than half of China’s Internet population of 648m. But given that China has a population of 1.4bn, and online retailers have yet to infiltrate rural areas and provinces, there is still huge scope for growth.


Active Customer Growth

















Source: Alibaba  

I was slightly disappointed that there was no commentary on expansion outside of China, and the only discussion of expansion into rural China was a seemingly prepared statement by CEO Jonathan Lu. However, he did discuss that the living room will be an important part of the 2015 strategy, and centre on smart TVs. Alibaba has had a set-top TV box for a few years, and its latest incarnation, which was released on Singles' Day, allows users to enjoy on-demand media, as well as shop through the TV on the firm’s retail platforms. Alibaba has been working hard to promote this, and I expect to see further developments in this area throughout the year.

In addition, COO Daniel Zhang discussed the pharmaceutical retail business, although he didn't reval anything that investors didn’t already know. The firm currently runs an OTC medicine retail platform, and they are currently working with the government to see whether this can be expanded to prescription medication sales. I personally believe that this is a formality, given the money that Alibaba has invested into online pharmaceutical firms that have attained a license to sell prescription medication online.

Mobile showing very strong growth

The key aspect of the earnings report was the stellar performance of mobile, which enjoyed strong growth on the back of Singles' Day and 12.12. Despite disappointment over the revenue miss, mobile revenue from the China commerce retail business (Taobao and Tmall) increased 72.63% sequentially and 448.25% annually to 6.42bn yuan. This strong growth during the quarter has seen mobile contribution to GMV jump from 35.82% to 41.53% over the quarter, whilst mobile contribution to revenues only increased from 29.13% to 30.18%.

Mobile monthly active users (MAU) grew 48m to 265m, the biggest increase in the firm’s history, and represented sequential growth of 22.12%, and annual growth of 94.85%. To put this into context, Alibaba’s mobile monthly active users would be the fifth largest population in the world.

Mobile Growth










Source: Alibaba  

The firm saw strong performance in its monetisation rate (take rate) across mobile, PC and blended, and after a disappointing calendar third quarter, all three monetisation rates increased in the fourth quarter. Mobile has a slower monetisation rate than PC because mobile is a much more recent retail platform than PC, and in order to boost the adoption rate, monetisation was delayed.


Monetisation Rate



















Source: Alibaba  

As the chart above shows, the monetisation rate for mobile is lower than for PC, so the concern for investors is that as mobile continues to contribute more to GMV and revenues, this would see the overall (blended) monetisation rate decline from its current level, meaning that the firm would generate less revenue from GMV transactions.

Whilst this is true, it’s too simple to think in this way. China’s migration to mobile has seen a notable difference in user habits, whether that is in terms of search, gaming, or purchases. Therefore firms are having to adapt their services in order to meet these user habits, and it is no different for Alibaba. The firm is seeing that mobile tends to be used for more impulse type purchases, or smaller ticket items, whereas PC is used for more expensive items. This is logical because if a user is wanting to buy a new TV, they would usually rather sit in front of a PC and take the time to research the purchase before spending a large amount of money. This is also why PC will always continue to contribute a reasonable amount to GMV and revenues, despite mobile’s rapid growth.

Whilst this may seem that Alibaba is chasing market share at the expense of revenues, mobile offers a much more valuable source of information to Alibaba than PC. The concept of the mobile ecosystem is integral for all of China’s tech firms because the more that a user stays with the confines of Alibaba’s services, whether that by shopping, online video, search, or browsing, Alibaba can learn more about the user’s habits, and can tailor both advertisements and suggested purchases to the user. PC doesn’t offer this level of user data to Alibaba, and this is why mobile monetisation will outgrow PC monetisation over the coming years.

Credit through Ant Financial

A very interesting business for Alibaba in 2015 is consumer and SME credit, which would be undertaken by Alibaba’s finance arm Ant Financial. Because Alibaba can garner a strong understanding of a user’s spending habits and history, Ant Financial’s Sesame Credit would be able to generate a credit score based on this behaviour by individuals and small businesses.

This business has huge potential, because the level of data that Alibaba can collect through its retail platforms and Alipay is unrivalled in China. There are more than 300 million real name registered users and 37m small businesses on Alibaba’s platforms. In addition to these, Sesame Credit would also obtain user data from partners, public agencies, financial institutions and other types of merchants. 

All of the financial services business will be done through Ant Financial, so Alibaba would benefit through a profit share arrangement. Because credit risk would be undertaken through loans and credit, it would be on Ant Financial’s balance sheet, so Alibaba avoids the risk whilst taking a share of the profits.

Clarification of the SAIC report

One of the most telling parts of the conference call was executive vice chairman Joe Tsai addressing the recent news that Alibaba and Taobao had been criticised by China’s State Administration of Industry and Commerce (SAIC) in a report on the presence of fake goods in online retail. In addition to this, the firm was criticised in a SAIC white paper about a meeting with regulators in July last year. Taking the time to publicly criticise a government report and file a formal complaint to said department is a rare occurrence in China, and its something that Alibaba wouldn’t do unless it genuinely felt wronged.

I fully agree with Joe Tsai in this regard, because the SAIC report was flawed. In total, 92 products were tested from six online retailers, with at least 51 of these products coming from Taobao alone. The results of the test showed that less than 40% of the Taobao products were authentic, whilst B2C platforms JD.com and Tmall scored 90% and 85.7% respectively. Even at first glance, this score is clearly wrong, because if less than 40% of Taobao’s products were authentic, then users would not keep returning to Taobao to make their purchases.

The online retail industry in China is occasionally hit with reports of fake goods on certain platforms, and one such report in July last year kick started a string of events that led to Jumei losing two thirds of its equity valuation, although that was mostly through management’s overreaction to the report. So whilst B2C platforms can’t completely eliminate the risk, C2C platforms are more susceptible, because they rely more on smaller vendors, which makes it more difficult to perform product testing. Taobao has been so successful because it allows small vendors to sell their products and to make a living, so it will probably never be able to completely mitigate the risk of having fake products on the platform. However, Taobao and the industry as a whole will continue to make it more difficult for third party merchants to sell fake goods. Therefore whilst it will likely always be possible to do so, there will be very little to gain from selling fake goods.

Joe Tsai’s comments probably made the issue bigger in the eyes of international investors than it actually is, and probably contributed to the big fall in the share price on Thursday. The discussions amongst analysts that this will be a major feud between Alibaba and the Chinese government are wrong, and I expect that the issue will be all but forgotten by the next earnings release. But it was necessary for the comments to be made, because the fundamental reason that Alibaba has grown into the world’s biggest e-commerce company is because of the trust it has gained from its customers, and when this trust is put in doubt, then the firm has to fight its corner.

– Edited by Robert Ryan

Neil Flynn is head equity analyst at Chinese Investors. Follow Neil or post your comment below to engage with Saxo Bank's social trading platform.

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