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BABA: F-1 Unwind

INTRODUCTION

Below is a review of BABA’s registration statement (F-1), which is over 500 pages, so we’re only highlighting the major points to keep this as brief as possible.  We’re emphasizing the risks to the story (since no other firm appears to be discussing them), but that doesn’t mean we’re negative on the company; we still have more work to do before we make a call here.  Feel free to reach out with any questions, or to discuss in more detail. 

 

NOTE OUTLINE

  1. KEY TAKEAWAYS
  2. BUSINESSES
  3. BUSINESS MODEL
  4. MAJOR REVENUE DRIVERS
  5. MAJOR RISKS

 

KEY TAKEAWAYS

  1. BABA Derives Majority of Revenues from Advertising: Despite the emphasis of Gross Merchandise Value (GMV) transacted through its platforms, the majority of revenues (~60% in F2014) comes from advertising, and roughly 77% of that is tied to its P4P ads, which is directly linked to the amount of traffic BABA generates of its sites.  That means revenue growth is largely tied to user growth. 
  2. Dependent on the China Growth Story: BABA’s organic prospects appear highly dependent on the China growth story (particularly growing consumption patterns) given its astronomical share of the e-commerce market in China, coupled with its stated Market Opportunities/ Growth Strategies.  BABA makes multiple references to the opportunity in China given that it dwarfs many major economies in terms of consumption, internet penetration, and online shopping behavior.   That may be true, but the question is what is the real runway.  We’ll be working with our Macro team on the long-term picture in China, but their near-term macro view is calling for slowing growth.
  3. At the Mercy of the Chinese Government: The most glaring yet undercovered risk is that none of its PRC subsidiaries or variable interest entities have been classified as an advertising company, which comes with a series of restrictive regulations that could hamper the business, along with a 3% tax on those revenues that could be enforced retroactively.  This doesn’t mean that PRC is going to drop the hammer, but it does mean that BABA has to play ball; whatever that means.
  4. Contractual Obligations Limit Strategic Options: BABA has almost USD $10 billion in contractual obligations over the next 5 years, with ~$4 billion due in the NTM, $2 billion of which for “Investment Commitments” for equity interests in other companies that are yet to close.  BABA itself will only be receiving $10.1 billion of the $25.0 billion IPO proceeds.  Based on its CY 2Q14 balance sheet and IPO proceeds, we estimate that BABA a has net cash position of$ 10.5 billion; not much M&A ammo considering it generated roughly $8.5 billion in sales in FY2014.
  5. Potential Near-Term Share Dilution Considerable: There are 368M ADSs floated post the IPO.  Another 128M shares are not subject to lock-up and freely convertible into ADSs.  After 181 days from the date of the prospectus (9/15/14), the lock-up will expire for another 427M shares.  Even if only a small portion of these share trade convert to ADS, the dilution could be considerable. 

 

BUSINESSES

  1. Taobao: C2C/B2C shopping platform similar to EBay.  This is China’s largest online shopping destination,  and is the source of the majority of BABA’s  unique visitors and GMV (Gross Merchandise Value) transactions.  Taoboa offers products and services in over 100 different categories.
  2. Tmall: B2C shopping platform similar to Amazon.  Tmall is China’s largest B2C platform in terms of GMV, representing roughly 1/3 of BABA’s GMV in China.  Platform also allows international companies to target Chinese consumers.
  3. Juhuasuan: B2C group-buying platform similar to a Groupon.  Juhuasuan is the most popular group-buying platform in China, and BABA believes it is the world’s largest in terms of GMV.  Juhuasuan sellers must also be Taobao or Tmall to offer promotions.
  4. 1688.com: a leading B2B online wholesale marketplace in China.  The majority of buyers on 1688.com are also retailers on Taobao & Tmall. 
  5. AliExpress: Global B2C platform that allows international companies to buy directly from Chinese wholesalers and manufacturers.  Offers three different sites in the local languages of Russia, Brazil, and the U.S.
  6. Aliababa.com:  China’s largest B2B online wholesale marketplace in China in terms of revenuesPlatform focuses on global tradeSellers are mostly Chinese wholesales/manufactures, but also include companies in India, Pakistan, Thailand, and the U.S.  Leading buyers are small and medium-sized business located in the U.S., India, and Brazil. 
  7. Alipay: transaction service similar to PayPal.  BABA does not own Alipay due to certain PRC restrictions, but the company is majority owned by Jack Ma, BABA’s CEO.

 

BUSINESS MODEL

  1. Online Marketing (~60% of FY2014 Revenues): Over 95% of BABA’s online marketing revenues are sourced from its Chinese retail marketplaces (Taobao, Tmall, & Juhuasuan).   The overwhelming majority of that comes from its Pay-for-Performance (P4P) ads where BABA gets paid when consumers click on a seller’s/advertiser’s ads.  Ad Prices (Cost-Per-Click, or CPC) are determined through an online auctioning process, where advertisers bid on the price and positioning of ad spots available.  BABA also delivers general display ads.  All its ads are delivered across its major platforms, and also on 3rd-party sites, which generate roughly 5% of total revenue for BABA.  
  2. Commissions (~25% of FY2014 Revenues) BABA receives commission on the GMV transacted on both its Tmall and Juhuasuan platform, specifically on transactions settled through its Alipay payment services.  The commission rate ranges between 0.3% and 5% depending on the product category (higher margin product categories = higher commission rates).  BABA also generates commissions through its international retail platforms (AliExpress), but it contributes only ~5% of total commissions.
  3. Member Fees & Value-Added Services (~10% of FY2014 Revenues): Primary avenue for monetizing its wholesale marketplaces.  BABA charges membership fees in the form of China TrustPass (1688.com) and Gold Supplier (Alibaba.com); both of which allow businesses to host storefronts (vendor’s own webpages on BABA sites) as well as “Value-Added Services”, which are basically data analytic tools, and storefront enhancements. 
  4. Cloud-Computing & Internet Infrastructure: (~1 of FY2014 Revenue): Exactly as it sounds, BABA offers cloud-based computing/storage and web hosting tools for businesses.
  5. Others (~3% of FY2014 Revenues): Mainly interest income off its micro loan business that offers loans with terms under a year to SMEs (Small and Medium-Sized Enterprises).  BABA no longer owns this business, but is partially liable for existing loan book.  Also included in here are storefront fees in the form of a software subscription to Wangpu, which is for decorating storefronts on BABA sites.

 

MAJOR REVENUE DRIVERS

  1. The China Growth Story: BABA has a dominant presence in the Chinese Internet e-Commerce market.  According to iResearch data as July, Taobao and Tmall represent over 75% of all Chinese Internet shopping traffic in China (total visits, page views, & time on site).  Given BABA’s massive scale and limited room for incremental penetration, much of its revenue growth from here will be tied to the growth of the Chinese consumer; particularly internet users and internet shopping population.
  2. Traffic Patterns Drive Its Ad Business:  ~60% of BABA’s revenues are generated from Advertising, and roughly 77% of that is driven by its P4P ads.  That means any slowdown in either user traffic and/or ad engagement of that user traffic will directly impact ad revenues.  For example, in CY 2Q14, the number of buyers on BABA’s Chinese Retail sites increased 51%, yet ad clicks increased only 39%; meaning ad engagement declined.  Traffic has also been migrating to mobile, which currently has lower advertiser demand and CPC rates.  In CY 2Q14, CPC rates declined -7% y/y, largely due to a largest shift in its mobile GMV %.
  3. Tmall Migration a Major Tailwind: The majority of the GMV transacted in its China Marketplaces occurs on Taobao, where BABA doesn’t generate commission revenue outside of traffic directed there from its group-buying platform Juhuasuan.  Tmall GMV has been growing as a proportion of total Retail GMV, in turn, Commission revenue was the fastest growing portion of its China Retail revenues.  Tmall GMV currently represents 1/3 of its total China Retail GMV, so there is runway here, question is how much, and how much influence BABA has here.
  4. Monetizing Alipay Wholesale?: BABA is not currently monetizing Alipay transactions settled on its Wholesale platforms, which generated roughly 70% of its total payment volume on Alipay in CY 2Q14.  We’re not sure why BABA hasn’t done so to date.  The fact that its two wholesales businesses are it longest running businesses suggests there could be a structural headwind to doing so (potentially lower margin profiles of wholesale businesses, competitive dynamics).  Still, a nominal fee on those transactions, if possible, could make a big impact; something to watch out for.

 

MAJOR RISKS

  1. Mobile Monetization: As mentioned above, advertisers are not willing to pay comparable CPC ad rates for mobile ads relative to desktop ads.  The mix-shift effect will pressure CPC rates unless advertiser demand catches up with the migration of GMV toward mobile.
  2. Incremental User Growth May Have Limited Yield: Per-capita retail consumption is considerably higher in Tier 1 & 2 cities (35 major cities in China) relative to the rest of China; $5.4K vs. 1.9K, respectively.  BABA penetration of the total population in Tier 1 & 2 cities in the LTM was slightly over 40%, but likely much higher for working-age individuals.  User growth from here may come with a declining per-capita GMV on its sites.
  3. Market Share to Cede: While BABA has dominant market share in the China e-commerce market, it has been ceding traffic share to competitors over the few years to competitors according to iResearch data.  Given that BABA still draws over 75% of e-commerce traffic in China, we suspect it has more share to lose than gain from here.
  4. At the Mercy of the Chinese Government: None of BABA’s PRC subsidiaries or variable interest entities have been classified as an advertising company, which comes with a series of restrictive regulations that could materially hamper the business, along with a 3% tax on those revenues that could be enforced retroactively. 
  5. ADR Holders Have Essentially No Control: the ADR terms allow the Alibaba Partnership to maintain majority control over its board of directors, and BABA also has voting agreements with both Softbank and Yahoo to vote their shares along with Alibaba partnership.  The shares underlying the ADS from the IPO represent only ~15% of BABA’s outstanding shares.
  6. Potential Near-Term Share Dilution Considerable: There are 368M ADSs floated post the IPO.  Another 128M shares are not subject to lock-up and freely convertible into ADSs.  After 181 days from the date of the prospectus (9/15/14), the lock-up will expire for another 427M shares.  Even if only a small portion of these share trade convert to ADS, the dilution could be considerable.  

 

Let us know if you have any questions, or would like to discuss in more detail

 

Hesham Shaaban, CFA

@HedgeyeInternet

 


Moving America's Future Forward

This note was originally published at 8am on September 15, 2014 for Hedgeye subscribers.

“Sometimes you got to go back to actually move forward.”

-Matthew McConaughey in the new Lincoln MKC commercial

 

 

I thought Lincoln nailed it with this one-minute McConaughey spot (click here Lincoln’s newest commercial). Both our personal and collective histories have always provided great sources of leadership and inspiration in this country. “You just have to know where to look.”

 

Moving America's Future Forward - 4g7

 

As our firm moves forward, we’ll continue to be the change we’d like to see in America. We’ve created an outreach program called HedgeyeCares and tomorrow we’ll be hosting our inaugural golf tournament to support the area’s youth through the Bridgeport Caribe Youth Leaders, a 501(c)(3) organization. (Here’s a short video we put together with testimonials from current recipients: https://www.youtube.com/watch?v=t5NgER166I0).

 

We’re also extremely thankful to The Lincoln Motor Company for its title sponsorship.  Lincoln is a great American luxury brand that recognizes the importance of giving back to communities across the country.  With its test drive program  “Driven to Give”, it has raised more than $3.27 million dollars for schools and charities across the United States since it was created in 2011. That’s a great win!

 

Thanks again to all of our event sponsors and participants. Change doesn’t happen unless we make it happen, together.

 

Back to the Global Macro Grind

 

Change happened in macro markets last week. They went backwards! And it wasn’t just stocks that pulled back. They smoked pretty much everything from commodities to bonds to any stock that looked like a bond. That leaves us with a lot to think about ahead of the Fed this week.

 

Will the US Federal Reserve get more hawkish or dovish at its Wednesday meeting? With the US Dollar having had its biggest point to point ramp since 1997, and the 10yr bond yield ramping +15bps week-over-week to 2.61%, expectations for hawkishness are high.

 

Since I think this USD ramp has been largely driven by horrendous economic data in both Europe and Japan (weaker Euros and Yens), I think you fade the recent strength in US interest rates and buy what was down the most last week:

 

  1. Long end of the bond market (TLT and EDV) with no support for the 10 and 30 yr yields to 2.34% and 3.11%, respectively
  2. Gold (GLD) was down -2.8% last week (to +2.1% YTD), and has immediate-term upside to $1275
  3. Utilities (XLU) were down -3.1% last week (to +11.3% YTD), and has immediate-term upside to $44
  4. REITS (VNQ) were down -5.4% last week (to +13.2% YTD), and has immediate-term upside to $77
  5. Emerging Markets (VWO) got sacked last week (MSCI LATAM -6.7% on the wk) and have immediate-term upside to $46

 

That’s why you see me investing what was our largest Cash position of the year in the Hedgeye Asset Allocation Model, taking up our US Equity exposure from 0% to 6% (split the net long position between Utilities and REITS, and stay short the Russell, Housing, and Regional Banks).

 

The alternative to buying slow-growth #YieldChasing is, of course, chasing the #MoBros. You know, something like Argentina (ARGT) which was up another +6.1% last week to +105% YTD – even though you really can’t get your money in/out of the country.

 

With the Russell 2000 down for the 2nd straight week to -0.3% for 2014 YTD, that’s why I still like staying net short (for long onlys its called underweight) one of the most obvious bubbles in America right now – small cap stocks that trade at 50x trailing earnings, with no liquidity.

 

In other #bubble news, at 30x revenues and $220B in market cap, you’ll have plenty of liquidity in AliBubble (BABA) this week!

 

While I am sure BABA is a fantastic story… as I see it, the problem with Jack Ma’s company is that... I can’t see it. While the Old Wall is fist pumping this sucker to oblivion this week, that’s the bear case – #opacity. And that’s all I have to say about that.

 

The other big #bubble callout from last week was #deflation.

 

Unfortunately, your cost of living didn’t deflate much (CRB Food Index was up another +1.3% on the week to 18.3% YTD, Cattle prices were up another +0.7% to +33.4% YTD, etc.), but that was one of the most broad based selloffs across asset classes of the year.

 

Most of this #deflation was driven by the biggest currency move (in weekly rate of change terms) we’ve seen in 17 years. When stuff moves that fast, what you get is this thing called volatility.

 

In rate of change terms, the +10.1% week-over-week move in front month US Equity volatility (VIX) was peanuts compared to the % move in volatility in foreign currency and fixed income. That’s what happens when the Fed suppresses volatility to all time lows. The bubble peaks.

 

If we’re right and we’re set up for one of the most asymmetric moves in volatility ever (see our Q3 Macro Theme deck titled #VolatilityAsymmetry), Americans may be looking back at late 2007 a lot faster than they think.

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 2.34-2.62%

SPX 1977-1998

RUT 1151-1169

VIX 11.84-14.04

EUR/USD 1.28-1.30

Gold 1229-1275

 

Best of luck out there today,

KM

 

Keith McCullough
CEO

 

Moving America's Future Forward - Chart of the Day


China, USD and the Russell 2000

Client Talking Points

CHINA

Hang Seng slammed for a -1.9% loss on the protest news being the Top Trending Story in macro this morning, but somehow the Chinese marked up the Shanghai Comp on the close +0.4% to a new year-to-date high of +15.1%!

USD

Big deflation signal continues as Draghi devalues (we only like US #GrowthAccelerating on USD up, when Rates are up – and they are falling); we don’t think the Japanese, European or American central plans ultimately work where it matters (i.e. in real economic growth terms).

RUSSELL 2000

Russell 2000 slammed for a -2.4% loss last week, making that its 4th consecutive weekly loss and taking its draw-down from its all-time #bubble high -7.4%. Liquidity traps out there are real. Respect them.

Asset Allocation

CASH 56% US EQUITIES 2%
INTL EQUITIES 8% COMMODITIES 4%
FIXED INCOME 28% INTL CURRENCIES 2%

Top Long Ideas

Company Ticker Sector Duration
EDV

The Vanguard Extended Duration Treasury (EDV) is an extended duration ETF (20-30yr). Now that we have our first set of late-cycle economic indicators slowing in rate of change terms (ADP numbers and the NFP number), it's time to really think through the upcoming moves of this bond market. We are doubling down on our biggest macro call of 2014 - that U.S. growth would slow and bond yields fall in kind.

TLT

Fixed income continues to be our favorite asset class, so it should come as no surprise to see us rotate into the Shares 20+ Year Treasury Bond Fund (TLT) on the long side. In conjunction with our #Q3Slowing macro theme, we think the slope of domestic economic growth is poised to roll over here in the third quarter. In the context of what may be flat-to-decelerating reported inflation, we think the performance divergence between Treasuries, stocks and commodities may actually be set to widen over the next two to three months. This view remains counter to consensus expectations, which is additive to our already-high conviction level in this position.  Fade consensus on bonds – especially as growth slows. As it’s done for multiple generations, the 10Y Treasury Yield continues to track the slope of domestic economic growth like a glove.

RH

Restoration Hardware remains our Retail Team’s highest-conviction long idea. We think that most parts of the thesis are at least acknowledged by the market (category growth, real estate expansion), but people are absolutely missing how all the pieces are coming together to drive such outsized earnings growth over an extremely long duration. The punchline of our real estate analysis is that a) RH stores could get far bigger than even the RH bulls seem to think, b) Aside from reconfiguring 66 existing markets, there’s another 19 markets we identified where the spending rate on home furnishings by people making over $100k in income suggests that RH should expand to these markets with Design Galleries, and c) the availability and economics on large properties for all these markets are far better than people think. The consensus is looking for long-term earnings growth of 28% -- we’re looking for 45%.  

Three for the Road

TWEET OF THE DAY

Senate democrats pushing CFTC to investigate LME metal warehousing. LME-Midwest premium is 3x higher than  historical avg

@Hedgeye_Comdty

QUOTE OF THE DAY

I have been up against tough competition all my life. I wouldn’t know how to get along without it.

-Walt Disney

STAT OF THE DAY

The Russian stock market slammed below its AUG closing lows, -1.1% this morning to -17.8% year-to-date.


investing ideas

Risk Managed Long Term Investing for Pros

Hedgeye CEO Keith McCullough handpicks the “best of the best” long and short ideas delivered to him by our team of over 30 research analysts across myriad sectors.

CHART OF THE DAY: Legislating Deflation? (10YR Yield vs US Dollar Index)

 

CHART OF THE DAY: Legislating Deflation? (10YR Yield vs US Dollar Index) - 09.29.15 USD vs. 10 Yr


Legislating Deflation?

“There are far too many great men in the world; there are too many legislators.”

-Bastiat

 

Today in 1789, the 1st United States Congress adjourned. There were no political parties in Congress back then. Members of US Congress were grouped (informally) according to their voting records. There was at least some peer review and accountability in that.

 

As far as who was a “great” man back then, I personally can’t tell you for sure. My only certainty is that the more I try to understand #history through the lenses of different perspectives (books), the less I know.

 

I can tell you with 100% certainty that, of all the great men and women I know, not one is a legislator. The thing about great leaders is that they embrace their own imperfections and rarely feel certain about anything. Find me that in today’s political media and I will happily reconsider. Sadly, the deflation of my expectations continues to accelerate on that front.

 

Legislating Deflation? - founding fathers

 

Back to the Global Macro Grind

 

Deflation and depression aren’t cool feelings. I guess that’s why the Bush/Obama politicians who perpetuated the most recent decade of US economic growth surprising on the downside call the recession a #Great one.

 

There’s always spin from political incumbents who aren’t telling you the truth about economics.  The Federal Reserve is going to be spinning its wheels with a conflicted “World Economic Think Tank” from Germany called the Kiel Institute this week.

 

Their topic: “The Labor Market After The Great Recession.” Their problem: that both the US and Germany may very well be entering their next recessions. Yep. So let’s make sure US legislators get told what to do by left-leaning German states in preparation for that…

 

Deflated yet?

 

Back to real world leading economic indicators in Global Equity markets, here’s what happened last week:

 

  1. The illiquid small-cap #bubble component of the US stock market continued to deflate
  2. The Russell 2000 was down another -2.4% on the week and is now down for 4 consecutive weeks
  3. The more liquid (and “cheaper”) Dow and SP500 were down -1.0% and -1.4%, respectively
  4. US Industrial Stocks (XLI) led losers, falling -2.1% on the week and have lagged for the last 3 months
  5. REITS (MSCI Index) corrected another -1.9% as deflation in real estate prices continues in #Quad4
  6. Emerging Markets deflated another -2.7% and -4.2% on the wk for the MSCI EM and LATAM indexes, respectively

 

In what we call FICC (Fixed Income, Currencies, and Commodities), here’s what Mr. Macro Market said last week:

 

  1. Draghi’s (un-elected) Devalued Euro move continues with the EUR/USD down another -1.1% on the week
  2. US Dollar Index added to its most deflationary move since 1997, closing up the same that the Euro was down
  3. Canadian Dollars dropped -1.7% in kind, and the Japanese Yen fell another -0.2% on the week to $109.29 vs USD
  4. Commodities (CRB) Index held the 280 line (where it started 2014), closing +0.3% on the week
  5. Gold and Copper were +0.1% and -3.7% on the week, respectively (YTD: Gold +1% vs Copper -10%)
  6. UST 10yr Bond Yield dropped another -5 bps to 2.53%, down -17% YTD (or down 50bps)

 

That last thing (10yr yield falling) is one thing that the perma-US-growth-bulls have had a very hard time explaining (especially overlayed with the Russell). Since US #history tells you that falling bond yields are never a sign of accelerating growth, that’s for good reason.

 

Much like the politically partisan, perma-growth-bulls are very good at seeking data that confirms their bullish biases. Instead of talking about early cycle-stocks like Housing (ITB), Regional Banks (KRE), and Consumer Discretionary (XLY) being down for 2014 YTD, they’re now all experts on #Strong Dollar and “falling oil prices” (even though WTI crude was +2% last week to flat on the YTD).

 

I like #StrongDollar, but only as a leading indicator of US economic #GrowthAccelerating when long-term interest rates are RISING at the same time. Let me write that one more time in these terms: Dollar Up, Rates Up = Hedgeye Bullish On Growth!

 

That, of course, was why we loved US growth stocks in 2013 and had an equal amount of joy shorting the US bond market. This year, being the only decisively bi-partisan bull/bear risk managers you pay, we have had precisely the opposite position.

 

I’ll go through the why on Dollar Up, Rates Down (it’s called #Quad4 deflation) on our Q4 Global Macro Themes call this Thursday afternoon at 1PM EST. Institutional Investors, please ping for access.

 

I’d like to extend an invite to any Member of The 113th US Congress who would like to learn something about where economic risks are going (rather than where they’ve been). I don’t hang with them, so I’d appreciate it if you passed it along to your local central planner.

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 2.48-2.58%

SPX 1

RUT 1100-1136

VIX 13.53-16.13

EUR/USD 1.26-1.29

Gold 1

 

Best of luck out there this week,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Legislating Deflation? - 09.29.15 USD vs. 10 Yr


September 29, 2014

September 29, 2014 - Slide1

 

BULLISH TRENDS

September 29, 2014 - Slide2

September 29, 2014 - Slide3

September 29, 2014 - Slide4

September 29, 2014 - Slide5

 

 

BEARISH TRENDS


September 29, 2014 - Slide6

September 29, 2014 - Slide7

September 29, 2014 - Slide8

September 29, 2014 - Slide9

September 29, 2014 - Slide10

September 29, 2014 - Slide11


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