The Phenomenal Rise of Alibaba

According to Forbes, Alibaba Group is set to list before 2015. The rise of the US$40bn company is nothing short of meteoric, given it took just 10 years for the firm to become the number one e-commerce brand in China. BMI believes the technology juggernaut is well-positioned to capture the growing e-commerce market in China given favourable industry trends and superior business model.

Favourable Macro Conditions

BMI believes the macroeconomic forces in China are very supportive of a booming e-commerce market. Firstly, the demographic structure of China itself comprises mainly of the 20-24 years age segment. This group of consumers are characterized by their high level of literacy, are internet savvy and are also the consumer segment that will see the greatest appreciation in purchasing power over the next three to five years as they transit from school to the workforce. More importantly, these groups of consumers are less resistant to the concept of online shopping, which hitherto has prevented the e-commerce industry from reaching its full growth potential.

Bulk Of China Population In the 20-29 Years Age Group
2012 Chinese Population ('000)

The Phenomenal Rise of Alibaba

According to Forbes, Alibaba Group is set to list before 2015. The rise of the US$40bn company is nothing short of meteoric, given it took just 10 years for the firm to become the number one e-commerce brand in China. BMI believes the technology juggernaut is well-positioned to capture the growing e-commerce market in China given favourable industry trends and superior business model.

Favourable Macro Conditions

BMI believes the macroeconomic forces in China are very supportive of a booming e-commerce market. Firstly, the demographic structure of China itself comprises mainly of the 20-24 years age segment. This group of consumers are characterized by their high level of literacy, are internet savvy and are also the consumer segment that will see the greatest appreciation in purchasing power over the next three to five years as they transit from school to the workforce. More importantly, these groups of consumers are less resistant to the concept of online shopping, which hitherto has prevented the e-commerce industry from reaching its full growth potential.

Secondly, China has the biggest Internet user base in the world with more than 560mn people connected to the web. This is more than double the 266mn Internet users in the US, which has birthed some of the world's e-commerce juggernauts such as Amazon and eBay. More remarkably, China has achieved the biggest internet subscription base with just a penetration of 41.0% in 2012, which means there could only be greater growth potential ahead given that the developed nations (represented by Japan, South Korea, USA, France, Germany, UK) recorded an average penetration rate of 82.3% in 2012.

Bulk Of China Population In the 20-29 Years Age Group
2012 Chinese Population ('000)
Rising Internet Penetration Rate
2010-2017f

Supportive Industry Trends

Within the e -commerce industry, market data also support our bullish outlook for the medium term. According to iResearch, China 's leading internet market research firm, gross merchandise value (GMV) of the Chinese online shopping market is set to increase by a compounded annual rate of 16.8% over the next three years. The bulk of this growth is predicted to come from the consumer-to-consumer (C2C) market pl ace, replacing the traditional business-to-c onsumer (B2C) model which has propelled growth for the past three years. That said, BMI warns of short-term downside risk as Chinese GDP growth is expected to slow down over the coming years. This could increase consumers ' propensity to save and , therefore, negatively impact discretionary spending. Over the medium term, our outlook on online spending is more positive as the Chinese government looks to rebalance growth towards domestic consumption.

GMV To Grow By CAGR of 16.8% Over Next Three Years
2006-2015
C2C To Drive Ecommerce Growth Over Next Three Years
2009-2015

Alibaba Has Sustainable Competitive Advantage

Alibaba was founded in 1999 by Jack Ma with the support of friends. Ma, a former teacher who had experience building websites for Chinese companies, created Alibaba to assist small and medium-sized companies (SMEs) to sell their products on the internet. By 2002, Alibaba started to turn profitable. The Hangzhou-based company operates in all segments of the online marketplaces: Alibaba.com, an international business-to-business (B2B) exchange that assisted Chinese SMEs to find overseas trading partners; Taobao, a B2C and C2C exchange for Chinese retailers and consumers; Alipay, an online-payment service platform; and, Alimama, a marketplace for online advertising inventory.

Alibaba's B2B platform was the first launched by the company in 1999. During the time of inception, the vast majority of the 40mn SMEs in China had limited access to online channels to market their products. The greatest challenge was to get SMEs to trust their online trading partners, and vice versa. To engender this trust, Alibaba provided detailed product information, a virtual tour of the company and TrustPass verification programme for its premium subscribers. Under the TrustPass programme, Alibaba asked independent parties to verify the corporate registration and banking information of its members. TrustPass members were also allowed to post and view feedback about other TrustPass companies. With an assurance system in place, Alibaba's B2B business surged. By 2007, the company had 700,000 storefronts on its international marketplace and 2.26mn storefronts on its China marketplace. Premium subscribers using the international marketplace paid an annual subscription fee of RMB50,000, while each standard TrustPass package cost RMB2,800. Additional sources of income included promotional placements, banner advertising and keyword searches. Alibaba listed its B2B business at the end of 2007. The company was trading at a phenomenal P/E ratio of 320 post IPO.

In the B2C and C2C marketplace, Alibaba Group's main competitor was eBay. The US ecommerce giant entered the Chinese market in 2002 via an US$30mn equity investment in EachNet. At that time, EachNet commanded an 85% market share with revenues of RMB12mn. In order to differentiate itself from eBay, Alibaba sought to imbue Taobao with a strong local culture, reflecting a deep understanding of Chinese consumers and an attitude of informality. For instance, Taobao designed its website to be cluttered to cater to the Chinese consumers' preference for busy web designs with strong colours. This is in contrast with Westerners' tastes for sparse and simple sites akin to Google's layout. To eliminate settle risk among trading parties, the escrow service Alipay was introduced in 2004, for free, to Taobao users. The introduction of Alipay inspires trust in Alibaba online transaction platform, the single most important factor in getting new subscribers to purchase their goods online. Unlike its US competitor, Taobao does not charge listing or transaction fees. This helped the firm to grow its market share significantly. So much so that, by 2006, eBay was forced to shut down its Chinese site.

Today, the group enjoys huge market share advantage over its competitors in both the B2B and B2C sectors. In the e-commerce market, having scale advantage is critical as a large enough subscriber base is essential to match buyers and sellers. Owners of small e-commerce firms typically find themselves out of the market after three years after sustaining heavy losses. As Alibaba has one of the lowest commission fees in the market, new entrants need to start on a large enough scale in order to compete at the same cost level as the incumbent firm. The difficulty of scaling up in a short period of time creates a huge barrier of entry to the e-commerce space.

Taobao Mall Enjoys Strong Market Share
B2C Market Share by Revenue (1Q13)

Alibaba has come a long way since its 18-ma n team in 1998. Today, Alibaba's two online marketplaces, Taobao and Tmall, together handle more total dollar transactions than any ecommerce platform in the world. However, more than 90% of those transactions come from PCs. As Chinese consumers increasingly rely on their mobile devices for online activities, Alibaba needs to reinvent the way it w oos consumers to defend its leading position in China's rapidly growing e -commerce market. The recent 18% equity inves tment by Alibaba into SINA 's micr oblogging service Weibo is a testament to the company 's effort to connect and build relationships with Weibo users. Besides reinventing its product offerings, Alibaba is also keen to expand its footprint overseas. In September 2013, the company officially made a move to go global by launching its Taobao marketplace in Singapore to reach out to the broader Southeast Asia market. BMI believes the future of the company looks promising, as it prepares itself for an IPO that could be worth at least US$40bn.

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