prev

Retail Callouts (9/29): DG, BBBY, M, SPLS, WMT, UA, AMZN

Takeaway: DG, M, SPLS: added Short on Ideas List. BBBY added Long. WMT Sat meeting now Optional.

HEDGEYE RETAIL IDEA LIST

 

Retail Callouts (9/29): DG, BBBY, M, SPLS, WMT, UA, AMZN - chart1 9 29

 

This week's changes

Several changes this morning...three shorts, one long.

  1. We moved Dollar General form the Short Bench to the Top Short list. This one is simple. It's not a good business. It's expensive in its own right. But it's captured $3bn in EV since it announced it is stepping into the bidding process for Family Dollar.  If it 'wins' Family Dollar, it loses -- as it will have a bigger but lower quality portfolio and will have to divest the best stores in the portfolio. If it loses the bid, then the $3bn in equity value goes away.
  2. We added BBBY to the Long Bench. The company has missed for the better part of two years, and last week's print was a potential turning point. At its core, this is a quality management team with an outstanding track record. We rarely like to add a long after a positive print. But after disappointing for so long, it's unrealistic to assume that the first positive surprise will be the last.
  3. We moved Macy's two notches higher on our Short Bench. Same story, just getting closer to where we're willing to get louder from a timing perspective.
  4. We added Staples to the Short Bench. We've shorted this one several times in the past. Re-vetting it now.

EVENTS TO WATCH

 

Tuesday (9/30)

  • WAG - Earnings Call: 8:30am

 

COMPANY HIGHLIGHTS

 

WMT - Walmart’s new CEO has made its iconic Saturday morning meeting optional

(http://qz.com/272018/walmarts-new-ceo-has-made-its-iconic-saturday-morning-meeting-optional/)

 

  • "Walmart’s Saturday morning meetings have been a long-term fixture for the company. Once a month at 7:30 on a Saturday morning, the US retail giant’s top executives gather in an auditorium at its Bentonville headquarters. The required meetings have been described (paywall) as 'part evangelical revival, part Oscars, part Broadway show.' People bring their kids, and there’s a company cheer and awards for associates, as well as a more serious rundown of sales figures."
  • "But according to a recent speech by Walmart’s SVP of change management, Celia Swanson, one of new CEO Doug McMillon’s first actions as CEO was to make those Saturday meetings optional—for the first time in the company’s history."

 

Takeaway: It's been a while since Walton wrote, "If you don't want to work weekends you shouldn't be in retail." And the Saturday morning meeting has morphed from a deep dive on numbers into a dog and pony show complete with celebrity acts. The meetings moved from weekly to monthly in 2008 and now are optional for all. It may just be a sign of the times - heck even Baseball, hotdogs, apple pie, and Chevrolet have become passé. But, according to the report McMillon has taking the onus upon himself to reinvigorate an institution that has more or less become irrelevant.

 

UA - Kevin Plank Invests in Knot Standard

(http://www.wwd.com/fashion-news/fashion-scoops/kevin-plank-invests-in-knot-standard-7948761)

 

  • "Kevin Plank...has made an investment in online bespoke men’s wear firm Knot Standard through his personal investment arm, Sagamore Ventures."
  • "Founded in 2010 by Matthew Mueller, Knot Standard offers handmade suits using 3D imaging to obtain exacting measurements. The etailer is also unusual in that there are physical showrooms in various cities New York City; Dubai; Washington, D.C.; Dallas; Houston and Los Angeles. The new funding round will enable the four-year old firm to expand its showroom locations, as well as online offerings over the next six to 12 months."

 

Retail Callouts (9/29): DG, BBBY, M, SPLS, WMT, UA, AMZN - chart2 9 29

 

Takeaway: Since the early days of Plank investing in racehorses, Plank's investment portfolio has grown to include real business that actually make money. The bespoke suit business is one that has actually proven to be fairly lucrative. In most instances, there's at least one in-person measuring session, after which customers can go online and buy suits at will. This model works reasonably well for menswear, where sizing is fairly standard. Sizing standards are unfortunately not the same with women.

  

M - Macy’s, Inc. to Hire 86,000 Seasonal Associates in 2014

(http://phx.corporate-ir.net/phoenix.zhtml?c=84477&p=irol-newsArticle&ID=1971706&highlight=)

 

  • "Macy’s, Inc. today said it plans to hire seasonal associates for approximately 86,000 positions at its Macy’s and Bloomingdale’s stores, call centers, distribution centers and online fulfillment centers nationwide for the 2014 holiday season. The company’s 2014 season hiring plan compares to approximately 83,000 in 2013 (an increase of about 3.6 percent)."
  • "In 2014, approximately 10,000 of the 86,000 total seasonal positions will be based in the direct-to-consumer fulfillment megacenters in Martinsburg, WV; Goodyear, AZ, Portland, TN, and Cheshire, CT, and well as in product-specific fulfillment centers in Sacramento, CA, Stone Mountain, GA, Secaucus, NJ, and Joppa, MD."
  • "About 1,125 associates will be hired to interact with customers via telephone, email and online chat at customer service centers in Mason, Ohio; Clearwater, FL; Tempe, AZ; and St. Louis, MO."
  • "Approximately 3,000 positions will be assigned to work in the fulfillment areas of Macy’s and Bloomingdale’s stores that are equipped to fill and ship orders directly to customers, as well as to support the Buy Online Pickup in Store service available in every location.
  • More than 850 persons will be hired across the country to support the 88th annual Macy’s Thanksgiving Day Parade®, Santalands and other iconic holiday events."

 

Takeaway: M is steady when it comes to Holiday hiring plans. Consistently taking it's seasonal work force up about 3%-4% annually. Of course, these numbers say nothing about hours worked per employee, etc. But, put into context the M number implies about 102 new employees per store, compared to Kohl's at 60 and WMT US at 15. About 15% will be used to bulk up the e-commerce side of the business…that seems low to us. Plus an additional 1% brought in to keep blown up Snoopy dogs from flying away at the Thanksgiving day parade. These releases are all about public relations after all - intended to flaunt the good each retailer is doing for the US economy and job reports rather than a leading indicator for Holiday performance.

 

OTHER NEWS

 

Prada - PROCEDURE BY ITALIAN AUTHORITY

(http://www.pradagroup.com/system/pdf_ens/168/original/e-Announcement%202014.09.28.pdf)

 

  • "PRADA S.p.A. announces that Ms. Miuccia Prada Bianchi and Mr. Patrizio Bertelli, who are the Chief Executive Officers, as well as Executive Directors and substantial shareholders of the Company, have just been informed by the Italian Judicial Authority of the existence of an ongoing examination according to Article  of Legislative Decree n. 74/2000 regarding the accuracy of certain past tax filings by them as individuals in respect of foreign owned companies."

 

AMZN - Amazon’s Grocery Delivery Business Coming to New York City

(http://recode.net/2014/09/26/amazons-grocery-delivery-business-coming-to-new-york-city/)

 

  • "Amazon is preparing to start its Fresh grocery delivery business in New York City as early as next month, according to two people who have been briefed on the plans, as the online retailer takes more aggressive steps toward making its same-day delivery service national."
  • "The company has been building up its food inventory in a warehouse in Avenel, N.J., with the goal of launching its grocery delivery business in New York City as early as October, one of these people said. The warehouse is located about 20 to 25 miles from Manhattan, in a part of New Jersey near Staten Island, New York."

 

Hong Kong Protests Rattle Retailers

(http://www.wwd.com/business-news/government-trade/hong-kong-protests-rattle-retailers-7955354?module=Business-latest)

 

  • "Central Hong Kong descended into chaos on Sunday as pro-democracy protesters converged on barricades as hundreds of police cordoned off streets and walkways and tensions flared amid the arrest of several lawmakers. Police used tear gas to disperse demonstrators."
  • "The protests happen to coincide with this week's National Day holidays — a key shopping season. Mainland Chinese travelers are likely to avoid the city due to planned protests in the city, so the downtrend in retail sales in the former British colony is set to extend beyond its six-month slide."

 

Aldi vows to fight on in supermarket price war as UK profits leap 65%

(http://www.theguardian.com/business/2014/sep/29/aldi-vows-to-fight-on-in-supermarket-price-war-as-uk-profits-leap-65)

 

  • "Aldi has vowed to maintain the supermarket price war that has drawn legions of cost-conscious shoppers to its aisles as it announced a 65% increase in its UK profits."
  • "The German discounter said it would respond to price cuts from competitors with further discounts and claimed that attempts by rivals to match its budget approach had only served to boost sales."

 

PBY - Pep Boys President & CEO Mike Odell Resigns - Director John Sweetwood Named Interim CEO

(http://www.pepboys.com/about_pep_boys/media_center/press_releases/2014/mike_odell_ceo_resignation)

 

  • "The Pep Boys – Manny, Moe & Jack, the nation's leading automotive aftermarket retail and service chain, announced the resignation of President & CEO and Director Mike Odell. Director John Sweetwood was named interim CEO, effective immediately."
  • "Mr. Sweetwood has served on Pep Boys’ Board of Directors since 2002 and is currently the President of Woods Investment, LLC, a private real estate investment firm.

European Banking Monitor: Swaps Widen Across the Board

Below are key European banking risk monitors, which are included as part of Josh Steiner and the Financial team's "Monday Morning Risk Monitor".  If you'd like to receive the work of the Financials team or request a trial please email 

 

--- 

 

European Financial CDS - Swaps widened sharply across the European bank complex last week. Spanish and German banks were among the most changed. Sberbank of Russia rose 40 bps to 380 bps and is now up 71 bps m/m. 

 

European Banking Monitor: Swaps Widen Across the Board - chart1 Financials CDS

 

Sovereign CDS – Sovereign swaps widened across the board last week. Italian sovereign swaps widened by 21.6% (+19 bps to 107). Japanese swaps rose 6 bps to 39 bps (+19%).

 

European Banking Monitor: Swaps Widen Across the Board - chart2 sovereign CDS

 

European Banking Monitor: Swaps Widen Across the Board - chart 3 sovereign CDS

 

European Banking Monitor: Swaps Widen Across the Board - chart 4 sovereign CDS

 

Euribor-OIS Spread – The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States.  Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal.  By contrast, the Euribor rate is the rate offered for unsecured interbank lending.  Thus, the spread between the two isolates counterparty risk. The Euribor-OIS spread was unchanged last week at 13 bps.

 

European Banking Monitor: Swaps Widen Across the Board - chart5 euribor ois spread

 

Matthew Hedrick 

Associate

 

Ben Ryan

Analyst

 

 


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.

THE HEDGEYE MACRO PLAYBOOK

Takeaway: The Hedgeye Macro Playbook is a daily 1-page summary of our core ETF recommendations, investment themes and noteworthy quantitative signals.

CLICK HERE to view the document. In today’s edition, we highlight:

 

  1.  The breakdown across various pocket of the Fixed Income & Yield Chasing primary asset class
  2. Our preference for large-cap Consumer Staples (XLP) in lieu of Utilities (XLU) on the long side going forward

 

Best of luck out there,

 

 

Darius Dale

Associate: Macro Team


MONDAY MORNING RISK MONITOR: RISK IS RISING

Takeaway: High yield rates are blowing out, while domestic and EU bank swaps are doing the same.

Current Best Ideas:

 

MONDAY MORNING RISK MONITOR: RISK IS RISING - 19 

 

Key Callouts:

* High Yield (YTM) Monitor – High Yield rates rose 36.3 bps last week, ending the week at 6.23% versus 5.86% the prior week. 

 

* European Financial CDS - Swaps widened sharply across the European bank complex last week. Spanish and German banks were among the most changed. Sberbank of Russia rose 40 bps to 380 bps and is now up 71 bps m/m.  

 

* U.S. Financial CDS -  Swaps widened for 27 out of 27 domestic financial institutions. The large cap global US Banks were wider by an average of 10 bps on the week, while the specialty finance names widened an average of 25 bps.

 

 

Financial Risk Monitor Summary

 • Short-term(WoW): Negative / 2 of 12 improved / 7 out of 12 worsened / 3 of 12 unchanged

 • Intermediate-term(WoW): Negative / 4 of 12 improved / 4 out of 12 worsened / 4 of 12 unchanged

 • Long-term(WoW): Negative / 2 of 12 improved / 3 out of 12 worsened / 7 of 12 unchanged

 

MONDAY MORNING RISK MONITOR: RISK IS RISING - 15

 

1. U.S. Financial CDS -  Swaps widened for 27 out of 27 domestic financial institutions. The large cap global US Banks were wider by an average of 10 bps on the week, while the specialty finance names widened an average of 25 bps.

 

Widened the least WoW: AON, CB, UNM

Widened the most WoW: AXP, ALL, AIG

Widened the least/ tightened the most WoW: MMC, ACE, AON

Widened the most MoM: AGO, RDN, MBI

 

MONDAY MORNING RISK MONITOR: RISK IS RISING - 1

 

2. European Financial CDS - Swaps widened sharply across the European bank complex last week. Spanish and German banks were among the most changed. Sberbank of Russia rose 40 bps to 380 bps and is now up 71 bps m/m. 

 

MONDAY MORNING RISK MONITOR: RISK IS RISING - 2 5

 

3. Asian Financial CDS - Chinese bank swaps widened sharply on the week, alongside a notable rise in Indian bank swaps. Japan's banks were little changed, aside from Daiwa, where they rose 15 bps. 

 

MONDAY MORNING RISK MONITOR: RISK IS RISING - 17

 

4. Sovereign CDS – Sovereign swaps widened across the board last week. Italian sovereign swaps widened by 21.6% (+19 bps to 107). Japanese swaps rose 6 bps to 39 bps (+19%).

 

MONDAY MORNING RISK MONITOR: RISK IS RISING - 18

 

MONDAY MORNING RISK MONITOR: RISK IS RISING - 3

 

MONDAY MORNING RISK MONITOR: RISK IS RISING - 4

 

5. High Yield (YTM) Monitor – High Yield rates rose 36.3 bps last week, ending the week at 6.23% versus 5.86% the prior week.

 

MONDAY MORNING RISK MONITOR: RISK IS RISING - 5

 

6. Leveraged Loan Index Monitor – The Leveraged Loan Index rose 9.0 points last week, ending at 1868.

 

MONDAY MORNING RISK MONITOR: RISK IS RISING - 6

 

7. TED Spread Monitor – The TED spread rose 0.1 basis points last week, ending the week at 22.1 bps this week versus last week’s print of 22.01 bps.

 

MONDAY MORNING RISK MONITOR: RISK IS RISING - 7

 

8. CRB Commodity Price Index – The CRB index fell -1.3%, ending the week at 280 versus 284 the prior week. As compared with the prior month, commodity prices have decreased -3.8%. We generally regard changes in commodity prices on the margin as having meaningful consumption implications.

 

MONDAY MORNING RISK MONITOR: RISK IS RISING - 8

 

9. Euribor-OIS Spread – The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States.  Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal.  By contrast, the Euribor rate is the rate offered for unsecured interbank lending.  Thus, the spread between the two isolates counterparty risk. The Euribor-OIS spread was unchanged last week at 13 bps.

 

MONDAY MORNING RISK MONITOR: RISK IS RISING - 9

 

10. Chinese Interbank Rate (Shifon Index) –  The Shifon Index fell 16 basis points last week, ending the week at 2.677% versus last week’s print of 2.84%. The Shifon Index measures banks’ overnight lending rates to one another, a gauge of systemic stress in the Chinese banking system.

 

MONDAY MORNING RISK MONITOR: RISK IS RISING - 10

 

11. Chinese Steel – Steel prices in China fell 3.0% last week, or 89 yuan/ton, to 2910 yuan/ton. We use Chinese steel rebar prices to gauge Chinese construction activity, and, by extension, the health of the Chinese economy.

 

MONDAY MORNING RISK MONITOR: RISK IS RISING - 12

 

12. 2-10 Spread – Last week the 2-10 spread tightened to 195 bps, -6 bps tighter than a week ago. We track the 2-10 spread as an indicator of bank margin pressure.

 

MONDAY MORNING RISK MONITOR: RISK IS RISING - 13

 

13. XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows 1.0% upside to TRADE resistance and 0.3% downside to TRADE support.

 

MONDAY MORNING RISK MONITOR: RISK IS RISING - 14

 

Joshua Steiner, CFA

 

Jonathan Casteleyn, CFA, CMT

 


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

 


Attention Students...

Get The Macro Show and the Early Look now for only $29.95/month – a savings of 57% – with the Hedgeye Student Discount! In addition to those daily macro insights, you'll receive exclusive content tailor-made to augment what you learn in the classroom. Must be a current college or university student to qualify.

next