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How cheap is Alibaba?

When Alibaba reported its full year FY18 results in early May, one number that surprised us the most was the revenue guidance for FY19. Heading into the result, Wall Street analysts were expecting FY19 revenue of around RMB 350 billion, or year-on-year growth of around 40%. Instead, Alibaba delivered a stunner – 60% revenue growth guidance, or RMB 400 billion for FY19 – a full RMB 50 billion higher than consensus estimates.

While this guidance includes the benefit of previously announced acquisitions that are yet to close or lap (primarily Cainiao and Ele.me), organic revenue growth is still expected to be north of 50% year-on-year. For a company to generate this kind of organic growth off an already large base, it needs numerous revenue drivers and an enormous moat. For the past two years, Alibaba’s 50%-plus revenue growth was driven by increases in ad inventory and improvements in the personalisation algorithms that deliver ads to the platform’s 600 million-plus users. Going forward, the company is spreading its tentacles into ever-more sectors of the Chinese (and global) economy. Indeed, Morgan Stanley estimates that Alibaba’s current and planned investments could double its already unfathomably-large total addressable market (“TAM”) of US$5 trillion to over US$10 trillion, growing to as high as US$19 trillion by 2027[1].

But what’s better than doubling the size of the pie? It’s doubling the size of the pie andincreasing one’s share of it. One important detail that often gets lost in the big headline numbers is Alibaba’s share of the overall economics of its platforms (the “take rate”). To provide some brief context for the following discussion, Alibaba has two platforms – Tmall and Taobao. Tmall is Alibaba’s third-party (“3P”) B2C platform for Chinese and global brands and generates revenue from both advertising and commissions charged to merchants. Taobao is Alibaba’s 3P C2C marketplace platform and generates revenue only from advertising.

Now consider the chart below. This chart shows Amazon and Alibaba’s revenue from their 3P marketplace platforms divided by total gross merchandise value transacted on those platforms – effectively the companies’ take rates. What is immediately obvious is the disparity of the columns. Morgan Stanley estimates that 3P merchants pay away up to 25% of their sales dollars to Amazon through a combination of commissions, logistics/fulfillment and advertising. In other words, for a $100 sale, the merchant pays Amazon an average commission of $12, Fulfillment by Amazon fees of $9 (if using this service) and advertising fees of $4 (if using this service), before even getting to the merchant’s cost of goods sold.

Chart 1: 3P marketplace take rates

Source: Morgan Stanley

For Alibaba, Morgan Stanley estimates that 3P merchants only pay away 3.5% of their sales dollars to Alibaba. Noting that 3P commissions are only relevant to Tmall merchants, we estimate that Alibaba’s take rate on Tmall is 4.6% (2.2% commissions and 2.4% advertising), while its take rate on Taobao is only the 2.4% advertising fee (logistics is negligible). Considering that Alibaba is both the largest commerce platform and advertising platform in China, Tmall and Taobao are undeniably cheap channels for merchants. The same merchant selling $100 of goods on Alibaba only pays $2-$5 of fees.

When you combine the above with the fact that retail occupancy ratios in China of 15%-20%[2]are not too dissimilar to the US (for non-anchor tenants), it suggests there is substantially more room for Alibaba to increase its take rate. In Amazon’s case, a 12% commission for a merchant who would otherwise be paying 15% of sales in rent doesn’t leave much room for Amazon to raise its fees before the proposition becomes uneconomical for the merchant. For Alibaba, Tmall merchants are getting an online storefront with arguably greater overall customer exposure for less than 1/3rdof what they’d pay for physical retail space, and many small Taobao merchants are getting an infinitely good deal as they likely couldn’t afford to operate a physical store.

For now, Alibaba has not needed to pull the pricing lever to generate stellar growth, but management maintain that they have numerous options available to continue to drive robust top line growth. If Alibaba can even gradually double its overall take rate from 3.5% to 7%, current market implied expectations may prove too conservative. Because the only thing better than a bigger pie is a bigger share of the bigger pie.

Montaka owns shares in Alibaba (NYSE: BABA)

[1]Morgan Stanley, Amazon vs Alibaba: The Next Decade of Disruption, May 29, 2018

[2]DBS, China Retail Property Sector: Don’t underestimate rental upside, July 31, 2017

DH5_2155Daniel Wu is a Research Analyst with Montaka Global Investments. To learn more about Montaka, please call +612 7202 0100.

Our Montaka Active Extension strategy strives for maximised return over the long-term. Owning the Montaka long portfolio typically scaled up to approximately 130 percent - and the Montaka short portfolio typically scaled down to approximately 30 percent – this strategy results in a net market exposure of approximately 100 percent most of the time.

Our Montaka variable net strategy strives for significant downside protection – but with minimal upside reduction. Focused on owning the world’s great and growing businesses when they are undervalued, while managing a portfolio of short positions in businesses that are deteriorating, misperceived, and overvalued, this strategy is our flagship long-short

Our Montgomery Global strategy strives to act as a core, high conviction, global portfolio holding. Consistent with the long portfolios in our Montaka strategies, this offering is focused on owning the world’s high quality, undervalued businesses – and cash when appropriate – to outperform its benchmark. Branded as “Montgomery Global” in Australia to reflect a key.

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Our Montaka Active Extension strategy strives for maximised return over the long-term. Owning the Montaka long portfolio typically scaled up to approximately 130 percent - and the Montaka short portfolio typically scaled down to approximately 30 percent – this strategy results in a net market exposure of approximately 100 percent most of the time.

Our Montaka variable net strategy strives for significant downside protection – but with minimal upside reduction. Focused on owning the world’s great and growing businesses when they are undervalued, while managing a portfolio of short positions in businesses that are deteriorating, misperceived, and overvalued, this strategy is our flagship long-short

Our Montgomery Global strategy strives to act as a core, high conviction, global portfolio holding. Consistent with the long portfolios in our Montaka strategies, this offering is focused on owning the world’s high quality, undervalued businesses – and cash when appropriate – to outperform its benchmark. Branded as “Montgomery Global” in Australia to reflect a key.