Initiating Coverage Of Alibaba At Price Estimate Of $80 Per Share

The buzz around Alibaba’s (NYSE:BABA) U.S. IPO (initial public offering) is not surprising considering the company’s dominance in China’s growing e-commerce market and its profitable business model. The IPO has generated a lot of demand which prompted Alibaba and its bank group to recently raise its IPO price band to $66-$68 and ultimately price at $68 per share. Alibaba’s growth story is impressive. Alibaba has become the biggest e-commerce firm in the world in terms of gross merchandise volume (GMV). In calendar year 2013, merchandise worth RMB 1,542 billion, or just over $250 billion, was sold on Alibaba’s China marketplaces. That’s more than the combined figure for Amazon (NASDAQ:AMZN) and eBay (NASDAQ:EBAY). In China, Alibaba commands roughly 80% of the country’s growing e-commerce market. In the light of its U.S. IPO, we have launched coverage of Alibaba with price estimate of $80. Our price estimate is based on a diluted share count which includes potential dilution due to the exercise of outstanding options and restricted stock units (RSUs). Overall, we value Alibaba’s business at little over $200 billion.

Our price estimate for Alibaba stands at $80

See our complete analysis for Alibaba

What Does Alibaba Do?

Alibaba operates online marketplaces where merchants can directly market and sell their products to retail and business customers.

China Marketplaces: For Chinese consumers, Alibaba operates Taobao, Tmall, 1688.com and Juhuasuan. While Taobao is a general online marketplace with the largest number of active buyers and sellers, Tmall primarily offers global branded products. Similarly, 1688.com primarily caters to wholesale buyers and sellers in China, whereas Juhuasuan is leveraged by merchants for promotional offers and flash sales.

International Marketplaces: Alibaba facilitates cross border commerce for international consumers through Alibaba.com and AliExpress. Alibaba.com is a wholesale marketplace where global wholesalers and manufacturers sell merchandise to global consumers. In contrast, AliExpress facilitates the sale of merchandise from Chinese wholesalers and manufacturers to global consumers.

How Does Alibaba Earn Money?

Alibaba earns bulk of its revenues from three sources.

First, it offers online marketing services to merchants on its marketplaces. The sellers that utilize Alibaba’s online platform bid for specific keywords, which upon being typed in a browser, display product listings. Alibaba charges the sellers on a cost-per-click basis and offers this service on its own platform, as well as third-party affiliates. The company also charges sellers on a cost-per-thousand impressions basis in exchange for an attractive display position on its platform (one of its marketplaces) or with third-party affiliates.

Second, it earns revenues through transaction fees, primarily from Tmall and Juhuasuan. Sellers pay a certain transaction fee to Alibaba for goods that are sold through the Tmall and Juhuasuan marketplaces and settled via Alipay. This fee typically ranges between 0.3% to 5% of gross merchandise volume.

Third, Alibaba offers premium subscriptions and value-added services. While these premium subscriptions allow merchants to manage their online storefronts, value added services help them generate valuable customer insights.

China Marketplaces Is Where 90% Of Alibaba’s Value Lies

We estimate that close to 90% of Alibaba’s value comes from its China marketplaces. While the retail online marketing business in China accounts for roughly 55% of Alibaba’s value, remaining 35% can be attributed to transaction commissions and storefront fees earned from Tmall, Juhuashuan, 1688.com and Taobao.

Here are two main reasons why China marketplaces will continue to remain key drivers of Alibaba’s growth.

1) We Expect 520 Million Average Active Buyers For Alibaba’s China Marketplaces By 2020

We expect strong growth in Alibaba’s average active buyers in China. This increase will be driven by continued growth in Internet penetration, Alibaba’s expansion on mobile devices, the continued increase in product categories and its investment in creating a more efficient and modern logistics network. In addition, Alipay will continue to be central to Alibaba’s growth, as has been the case for the past few years.

At the end of 2013, China had around 618 million Internet users and about 302 million online shoppers. ^[1] Also, Alibaba had close to 231 million active buyers at the end of 2013. ^[1] This implies that while roughly 49% of Internet users are shopping online, Alibaba’s active buyers account for 76% of these online shoppers. Going forward, we believe three things will happen. First, the number of Internet users will increase significantly. Second, the proportion of Internet users shopping online will increase sharply. Third, Alibaba’s share of online shoppers will continue to increase in the near term, but decline subsequently as competition heats up in this lucrative market. Keeping these expectations in mind, we believe that by the end of 2020, Alibaba may have close to 527 million active buyers for its China marketplaces. This will imply average active buyer count of about 520 million for the same year.

Our forecast is based on the following assumptions: We estimate that by 2020, China’s population will reach close to 1.4 billion, growing annually by roughly 0.48%, as has been the trend in the last few years. Furthermore, the Internet penetration (number of Internet users as percentage of total population) will grow from 46% in 2013 to 66% in 2020, implying close to 927 million Internet users in China by 2020. Additionally, we expect online shoppers as percentage of Internet users to increase from 49% in 2013 to around than 77% in 2020, implying close 691 online shoppers by that time. Approximately 76.5% of Chinese online shoppers were active buyers at Alibaba’s marketplaces at the end of 2013. We expect this figure to  increase to around 84.5% before declining to around 74% by 2020 driven by increased competition. In other words, Alibaba will continue to retain the mammoth share of online shoppers, even if it is not able to increase it much. These assumption suggest that the company will have close to 520 million average active buyers in 2020.

2) Average Spend Per Active Buyer Will Grow Significantly For China Marketplaces

We expect average annual spend per active buyer for the China marketplaces to grow from RMB 7,808 (or $1,271) in 2013 to RMB 11,683 (or $1,984) by 2020. We assume a slight increase in the exchange rate (USD per RMB). The growth in average spend per active buyer will be driven by the continued shift of consumers to online shopping, growth in per capita consumption and an increase in product categories and delivery efficiency. China’s e-commerce market has witnessed unprecedented growth in the recent years, growing from RMB 263 billion in 2009 to RMB 1,841 billion in 2013. ^[1] At the same time, online shopping as a percentage of total consumption has jumped from 2.0% to 7.9%. ^[1] Much of this can be attributed to growth in the number of Internet users and connected devices, boosted as well by the added convenience of shopping online.

Our forecast for the average spend per buyer is based on the following assumptions: Per capita consumption in China has increased annually at a rate of between 10% to 14% in the last three years. ^[2] The figure stood at an estimated RMB 17,168 (or $2,796) in 2013, and we expect it to reach RMB 24,732 (or $4,200) by 2020, growing at a CAGR (compounded annual growth rate) of about 5.5% over the next six to seven years. We take this annual growth in per capita consumption as a base and apply a 1% premium to calculate future growth in the average annual spend per online shopper (spending on e-commerce). The figure stood at RMB 6,768 (or $1,102) in 2013 and we expect it to reach RMB 10,417 (or $1,769) by 2020. These  implied growth rates are taken as proxy for future growth rate in Alibaba’s average spend per active buyer. Our assumptions and forecasts suggest that by 2020, China’s e-commerce market will reach RMB 7,154 billion (or $1,215 billion) with online shopping as percentage of total consumption reaching 20.6%.

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1. Alibaba’s SEC Filings [↩] [↩] [↩] [↩]
2. Inferred from data provided in Alibaba’s SEC filings [↩]