China’s Economic Slowdown Is A Dark Cloud For Alibaba Group Holding Ltd (NYSE:BABA), But There Is A Silver Lining

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As China’s leading e-commerce operator, Alibaba Group Holding Ltd (NYSE:BABA)’s performance closely tracks China’s economic growth. When the domestic economy cools, Alibaba feels the heat. That explains why Alibaba’s gross merchandise value (GMV), a key performance metric for online retailers, increased slower in F3Q2016 compared to a similar quarter a year earlier.

Although Alibaba’s earnings in the quarter topped expectations, concerns remain about what might be lying ahead for the company. This Alibaba analysis article examines the company’s risks and opportunities as it struggles to navigate economic slowdown in the domestic market. But first, here is a quick recap of last quarter’s earnings.

F3Q2016 highlight

Alibaba Group Holding Ltd (NYSE:BABA)’s EPS reading of $0.73 in F3Q2016 (December quarter) surpassed the consensus estimate of $0.70. Revenue came in at $5.3 billion, growing 56% sequentially and 32% YoY.

What’s exciting about Alibaba?

  1. Huge domestic growth opportunity

Although China’s economy may be slowing with first quarter growth coming at a mere 6.7%, down from 6.8% in the previous quarter and the slowest in nearly 7 years, online shopping in the country is growing rapidly. Deeper penetration of smartphones and widespread availability of telecommunication services are some of the factors fueling China’s e-commerce industry. It is estimated that Chinese e-commerce market will grow at an annual rate of 25% over the coming years to reach $718 billion by 2017, up from $390 billion in 2014. That’s sweet music to the ears of Alibaba Group Holding Ltd (NYSE:BABA) given that it controls more than 80% of China’s e-commerce industry.

There is even huge growth opportunity for Alibaba in rural China. For example, the number of online shoppers in rural China shot up 41% in 2014 compared to just 17% on urban China. Alibaba has identified the opportunity and it is going for it. The company has drawn an ambitious expansion plan targeting Chinese rural villages. For example, within the next five years, Alibaba wants to set up 100,000 fulfillment centers in rural China. So far, the company has expanded into 12,000 rural Chinese villages.

In addition to offering the rural masses a convenient way to shop, the company also wants to provide Internet connectivity to the villages that are yet to be covered by Internet. Providing Internet connectivity to villages will feed Alibaba’s core e-commerce business as it will be able to convert the people coming online for the first time into shoppers.

  1. Creating customer trust

The proliferation of e-commerce in China has also come with its challenges: the rise of counterfeit products. To combat the problem and earn customer trust, which is important in a competitive industry, Alibaba’s retail marketplace Tmall is only accepting listings from verified stores whose products are known to be genuine.

Arresting the problem of counterfeit goods should not only help Alibaba to earn customer trust, but also fuel the growth of its GMV, which is a key performance metric for e-commerce operators. The boost to GMV will come from more shoppers choosing Alibaba’s marketplaces over the competition and thus attracting more vendors to list on the platform.

  1. Strategic acquisitions

Alibaba Group Holding Ltd (NYSE:BABA) has a strategy to diversify its revenue streams by investing in e-commerce adjacencies. Toward that end, the company is acquiring strategic assets with online video, digital payment and digital mapping being some of the sectors that the company has been quite active in the recent times.

Alibaba paid $1.22 billion to add online video provider YoukuTudou to its portfolio. The company made the acquisition at a time when China’s Internet video industry is project to grow rapidly in the coming few years. Alibaba also paid $1.5 billion to bring dogital mapping provider AutoNavi (AMAP) Holdings under its armpit.

The company is also active in digital payments market through its Alipay platform. Alipay supports a wide range of mobile-based transactions such as paying for purchases and more. Alibaba is enhancing its play in digital payment at a time when digital payment industry is expected to explode in the coming years as online shopping becomes more widespread.

  1. Strong financial position

Alibaba has a massive cash stockpile that it can still use to fuel its growth and diversification. The company finished F3Q2016 with cash and equivalents of about $16.8 billion, which increased from $14.8 billion in the previous quarter. Total debt at the end of the last quarter was $8.6 billion.

  1. International growth opportunity

Alibaba Group Holding Ltd (NYSE:BABA) has a stated mission to first consolidate its Chinese base and then go for international growth opportunities. Not only will expanding abroad unlock new growth opportunity for Alibaba, but also provide the company with the opportunity to mitigate the impact of competition in its domestic market.

What’s worrying about Alibaba?

  1. Macroeconomic pressures

Economic slowdown in China is a threat to Alibaba. When the economy is not doing well, consumer buying power is diluted, thus adversely impacting Alibaba’s GMV and profits. In F3Q2016, Alibaba’s GMV grew only 22% compared to 28% in the previous quarter. Although expanding abroad could help Alibaba offset the slowdown in the domestic market, it will take time before international can generate substantial revenue to fuel Alibaba’s growth. Additionally, given China’s position as the world’s second largest economy and the fastest growing one, its domestic economic woes are quickly spreading abroad, thus limiting Alibaba’s growth abroad.

  1. Mobile monetization

PC still generates higher monetization value for Alibaba Group Holding Ltd (NYSE:BABA) compared to mobile. The small display of mobile means that navigating pages and entering information becomes tedious. As such, conversion rates on mobile are lower compared to PC. Therefore, with Alibaba’s mobile shoppers growing rapidly and overtaking PC, the company will have to content with lower monetization rates from mobile until mobiles conversions improve.

  1. Stiff competition

Domestically, Alibaba is facing growing competition from homegrown rivals JD.Com Inc (ADR) (NASDAQ:JD), Tencent Holdings Ltd (OTCMKTS:TCTZF) and Baidu Inc (ADR) (NASDAQ:BIDU). Because Alibaba has the largest share of the Chinese e-commerce market, it is the main target of the competition as rivals are trying to steal its vendors and shoppers. These competitive pressures are forcing the company to increase its marketing budget to try to fight back, but that means added expense burden that in turn eats into earnings.

Internationally, Alibaba is keen to expand in the U.S., but it won’t be easy given the success of Amazon.com, Inc. (NASDAQ:AMZN) and eBay Inc (NASDAQ:EBAY) in their domestic markets. Besides direct competition from e-commerce giants Amazon and eBay, it will also be difficult for Alibaba to penetrate the U.S. with its other services such as digital/mobile payment. PayPal Holdings Inc (NASDAQ:PYPL) is widely popular in the U.S. as digital payments provider and Apple Inc. (NASDAQ:AAPL)’s Apple Pay is also rapidly penetrating the U.S. mobile payments.

  1. Acquisition risks

While Alibaba Group Holding Ltd (NYSE:BABA) is determined to diversify its revenue streams by acquiring strategic assets, those acquisitions carry some risks. The benefits from an acquisition depend on successful integration of the acquired asset. But sometimes things don’t go as expected so an acquisition can take longer than expected to integrate, thus delaying the intended benefits and introducing extra costs.

Takeaway

The slowdown in the Chinese economy is a serious threat as it also adversely impacts Alibaba Group Holding Ltd (NYSE:BABA)’s interests abroad. However, the company has what it takes to successfully navigate the dark cloud of global economic slowdown as it has already demonstrated through its ability to maintain hold of the largest share of market and woo customers with innovative products. Alibaba’s flexible financial position also allows it to take risks that can unlock massive growth opportunities.

Neha Gupta

Neha Gupta has been in the financial space for over six years now. Gupta earned her MBA degree from Symbiosis Centre of Distance Learning in 2009 and her passion for finance led her to pursue Chartered Financial Analyst (CFA) course. She has successfully completed Level II of her CFA. She is a veteran in article writing, which is depicted in her numerous pieces published on SeekingAlpha, Nextiphonenews, InsiderMonkey, MarketWatch, and Techinsider. Her crisp and eloquent writing finds its best place in Researchcows, where emphasis is given on developing rich content for various websites, products, business plans, trainings, and book writing.

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