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Alibaba: The Battle Enters Decisive Point
May 27, 2018 6:09 pm|Comments (0)

Alibaba’s (BABA) Ant Financial plans to raise fresh funds at a valuation of $ 150 billion, but it faces a number of headwinds. Alibaba recently suffered a setback when Walmart (WMT) dropped Alipay from all its stores in Western China. This step could be followed by a nationwide rollout in which all the Walmart stores in China accept only Tencent’s Tenpay. Walmart has 443 stores in China which include 406 Supercenters, 18 Hypermarkets, and 19 Sam’s Clubs.

Both Walmart and Tencent have a big stake in JD.com (JD), which is Alibaba’s biggest competitor in China. As the Chinese retail ecosystem is being fought over by Alibaba and Tencent, both big and small retailers have had to choose between either of the two goliaths. Tencent has some major advantages in this market which it is using to increase its market share.

According to a recent disclosure, Ant Financial Services group’s wealth management business has Rmb 2.2 trillion or $ 385 billion of assets under management. It has 600 million users. This makes it the biggest customer wealth management platform in the world. There are other financial products which can be introduced by Alibaba to maximize the potential of its payments ecosystem. If Alibaba is able to retain its market share in this very important segment, we should see huge upside potential for the entire platform and the stock.

Tencent makes up for its late entry

Tencent was quite late in entering the payments market. Alibaba’s Alipay has been used since 2004. By early 2014, Alipay had a 70% market share in China’s online payment market. But this has changed significantly in the past few years. Recent estimates by Beijing-based consultancy iResearch show that Alipay has 53% market share where Tenpay is close on its heels with 40% share.

Source: WSJ

The stakes for both Alibaba and Tencent are quite high. China is seeing a rapid increase in transaction volume through mobile payment as customers move away from bank cards and other payment options.

Source: WSJ

This means that over the next three years, we will not only see a doubling of total transaction volume but also a much higher share of mobile payments within the overall pie. Both the companies have realized the importance of this segment and are going full throttle in their expansion initiatives. Alibaba is at a minor disadvantage in this battle because all its competitors are moving under Tencent’s banner. Hence, even though Alibaba has a greater market share and a good growth runway due to its rapidly growing retail operations, it still needs to compete against a growing list of retailers that have started using Tenpay.

Tencent also has other advantages besides the fact that it is the only company which can challenge Alibaba. As the urban market gets saturated by payment options, both Alibaba and Tencent have started moving into rural areas. In these areas, Tencent already has a big customer base due to its WeChat application. Most of the potential customers for Tenpay would have already used WeChat and hence using the payment platform is a mere extension of the core app. On the other hand, the use of Alibaba’s e-commerce platform is not as widespread in rural parts as it is in urban areas.

Launch of new financial products

The payments market is just the beginning for Alibaba and Tencent. As they get greater customer data, they will be able to gauge the creditworthiness of a customer and provide tailor-made financial products using data mining. This can extend from loans and insurance to more exotic products. All these segments have much higher margins and significant growth potential within China. It must be noted that most of the customers in China skipped the entire credit card growth phase and have now settled with Alipay and Tenpay.

Source: FT

Alibaba formed Yu’e Bao in 2013 to manage the leftover cash from spending on its e-commerce platform. By 2017, this money market fund had amassed $ 165.6 billion under management. This number is now closer to $ 385 billion according to recent disclosure by the company. The rapid growth of this fund shows the future potential of Alibaba’s financial division and the innovative financial products it can bring to the market. The future growth in these products will closely follow the market share of Alibaba and Tencent within the payments ecosystem. Hence, it has become extremely important for Alibaba to defend its turf and build a strong moat.

The payments battle is not limited to China but extends in almost every part of the world. For example, Alibaba has a huge stake in Paytm which is the biggest payments player in India. This company has seen rapid growth in the last 30 months. It is highly possible that Alibaba is able to gain a decent footprint in the payments ecosystem of developed markets over the next few years. In order to avoid regulatory pushbacks, Alibaba is more likely to invest in unicorns and promising startups in developed countries instead of growing its own platform. A similar approach in India has allowed Alibaba gain a strong foothold through investments in Paytm and online grocer Big Basket.

What to expect in the next few quarters?

Alibaba’s “New Retail” initiative was a response to the expansion of Tencent/JD within offline retail. Alibaba has already made some big-ticket investments in brick and mortar stores. These include $ 2.9 billion investment in Sun Art, $ 2.6 billion in InTime and $ 4.6 billion in electronics retailer Suning. In February, Alibaba made RMB 5.45 billion or $ 867 million investment in Easyhome Furnishing for 15 percent stake. This pace of investments should continue for the next few quarters. Some of these are defensive purchases which are made to prevent future acquisition by Tencent.

We should also see a negative impact on the margins as more incentives are given to customers to lure them. When Tencent announced its recent earnings it mentioned that the company would “aggressively” invest in video and payment, which may hurt margins. This warning was enough to send the stock sliding down by 4.6% even though the net profit beat estimates.

A similar trend is possible within Alibaba which can lead to lower margins, even if the revenue growth is high. Alibaba also needs to make bigger investments in digital segment because it does not have a core social app like Tencent which can retain customers within its ecosystem.

Investor Takeaway

Alibaba has a decent lead over Tencent in the payments market. Also, Alibaba’s market share in payments is closely following the market share of the company within e-commerce. The penetration level of financial products in China is still quite low compared to U.S. and Western Europe. Alibaba can use its ecosystem to attract customers to new financial products and also use its market leadership to build a better moat against rivals.

Although we could see some margin contraction in the next few quarters, the long-term growth story for Alibaba is intact. Alibaba is a good buy-and-hold option for investors with long-term horizon.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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