Big Profits at Alibaba, but Filing Has Gaps

Posted on May 7, 2014 by

The Alibaba Group opened its books on Tuesday, revealing a company raking in extraordinary profits from its vast online marketplaces in China.

But despite a parade of impressive headline numbers, investors may find themselves struggling to see how real its earnings are.

The company’s financial statements were released as part of its United States initial public offering, which is expected to take place in the coming months. The big numbers Alibaba has put up will probably excite many on Wall Street. The company says, for instance, that goods worth $248 billion were sold on its marketplaces in 2013, an amount more than that of Amazon and eBay combined. And Alibaba’s revenue grew 57 percent in the first nine months of its 2013 fiscal year. That pace is faster than at Facebook, currently one of America’s most successful technology companies.

Perhaps more important, Alibaba’s profit margins — which measure how much money the company gets to keep after paying its costs — will generate envy across Silicon Valley. The strong figures are encouraging some stock analysts to value the company north of $200 billion, which would be higher than IBM’s current stock market capitalization.

To put their own price on Alibaba, investors will most likely try to compare it against other technology companies. That may be difficult. While Alibaba shares characteristics of some well-known tech names, it is, over all, quite unlike any of them.

Like Amazon, Alibaba dominates its home e-commerce market. But, unlike Amazon, it does not amass large amounts of inventory. Instead, like eBay, it merely matches buyers and sellers. In some ways, though, Alibaba resembles Google. Alibaba gets a very large share of its revenue from sellers who pay for more prominent placement on the marketplaces. That income stream is akin to Google’s ad revenue. But the company did not say exactly how much revenue came from that source.

Alibaba is growing faster than eBay, Facebook and Google. Its revenue surged 57 percent in the first nine months of its 2013 fiscal year.

Compared with those American companies, Alibaba has far less revenue. But what excites investors is how much profit it earns. Alibaba’s operating profits in those first nine months totaled $3.1 billion, which was equivalent to 48 percent of revenue — a margin that is far higher than at Google, eBay and Amazon. Its operating margins are also better than those at other public Chinese Internet firms, including Baidu, a search engine, and Tencent, which is pre-eminent in messaging and gaming.

“In the last year or so, they seem to have pulled ahead of Tencent and Baidu,” said Brendan Ahern of KraneShares, which manages an exchange-traded fund that focuses on Chinese Internet stocks.

Still, investors seeking to fully understand Alibaba may feel shortchanged by Tuesday’s filing.

For one, the company did not provide crucial numbers that would allow outsiders to better gauge the performance of the two online marketplaces that generate nearly all of its revenue.

Some investors crave such numbers because they want to see whether Alibaba’s stellar profits growth can continue. Recent history shows that even the most successful Internet companies can be tripped up by abrupt shifts in consumer tastes and changes in technology.

“People want to know what the breakdown is across the various units,” Mr. Ahern said. “Hopefully, as we get closer to the I.P.O., we might see some unbundling.”

Alibaba makes most of its money from two major websites that dominate e-commerce in China. Taobao is a hectic-looking online bazaar where consumers can buy almost anything, from fresh groceries to building supplies to pets to concert tickets. The other is Tmall, a more streamlined marketplace where well-known brands are sold.

But the filing did not break out revenue or earnings for each marketplace. If growth at one of the two sites starts to slow down, for instance, outsiders might not be able to spot that trend for some time. Instead, Alibaba has combined revenue for both websites under a line called “China commerce retail business.” That revenue stream was $5.4 billion in the first nine months its 2013 fiscal year, which was more than 60 percent higher than in the same period of 2012. The Chinese retail revenue accounted for 83 percent of the firm’s total revenue of $6.5 billion in the period. Alibaba did not break out costs or earnings for the segment.

The Chinese company has gone to some lengths to explain its mobile business. Investors want to see evidence that the company can still post strong profit growth as consumers increase their use of mobile devices for shopping. Alibaba said that in the last three months of 2013, 19.7 percent of “gross merchandise value,” or the value of goods sold on its sites, came from mobile users. That is a sizable increase from 7.4 percent at the end of 2012. Alibaba, however, did not break out details for revenue from mobile. Other large e-commerce firms also do not break out such figures, but Facebook does disclose how much of its advertising revenue comes from mobile.

The big question hanging over Alibaba’s I.P.O. is whether it can protect its profits. Sometimes, such high levels of profitability can signal that a company has advantages that may fade and expose it to competition.

Alibaba’s supporters, however, say that the firm is fiercely competitive — and has gone to great efforts to keep rivals at bay.

The company has also taken brash steps to defend its revenue that, for now at least, seem to be paying off. The company, for instance, does not allow Baidu, the search engine, to search its marketplaces. As a result, consumers go straight to Alibaba’s sites to perform their shopping searches. This deprives Baidu of a form of ad revenue that Google has long earned when consumers click through to sellers from its search engine. Instead, Alibaba gets the search revenue.

As savvy as the Baidu ban looks now, it may become a source of concern. As the number of listings on Alibaba grows, it will need to ensure it attracts a steady flow of traffic to its sites. To do that, it may need the help of outside sites, like Baidu. If that were to happen, it might become less profitable as it is forced to share revenue with other firms.

But Alibaba’s public offering document only makes one mention of Baidu.

Analysts who are bullish on Alibaba say it makes sense to value it in line with Baidu or Tencent. Those firms have stock market values around 30 times the earnings analysts expect for next year. Applying that multiple to Alibaba’s 2013 calendar-year earnings of $3.6 billion would value the company at $108 billion, well below the $200 billion some analysts think is possible. To get to the higher number, they use estimates of future earnings, which they expect to be much higher as Alibaba increases its presence in China, where e-commerce activity is below that of Western countries.

“Investors are longing for growth — and here’s a company that really has it,” Mr. Ahern said.

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