Alibaba has been doing well in the market since I last published on them. The stock has hit my ‘price target’, and their first results went well. If I were really covering the stock, I would raise my estimates and probably take my price target to $150. I think there is still some headline risk around slowing growth in China and whatever ails the broader market, but for a variety of reasons I think China’s economy is moving in directions that will actually help Alibaba over the next few years. I will get into those in a future post (or you can just cut to the chase and go read Michael Pettis’ excellent coverage of China’s economy).
Today I want to return to a subject I touched on in my last post, and the root of my interest in Alibaba – it’s payments business, Alipay. (A side note: Alipay recently rebranded itself as Ant Financial, but I will refer to it in this post as Alipay.) Alipay is one of those well-known but poorly understood businesses that I think of as hidden gems in stocks. I own Amazon stock because I am a big believer in its cloud computing business AWS, hugely profitable with immense long-term staying power, but almost invisible in the company’s financial filings.
Like Alibaba, Alipay holds several businesses. It is best known as a payment platform. You can use Alipay to buy all kinds of things in China, from online goods to cab rides. If you talk to people in China today, it is shocking how quickly Alipay has gotten so widespread. This alone makes Alipay attractive.
However, beyond this payment service, there is a lot more.
First, Alipay is an escrow mechanism for online merchants selling through the core Alibaba web sites. My premise is that BABA is an attractive stock because it has built up all these merchant accounts, and their ability to grow and better monetize those relationships are the core of Alibaba’s success. Alipay is a huge part of that loyalty.
For those who have not donebusiness in China, it is often a surprise to find how difficult it can be to collect on a bill. Suppliers often have to suffer through payment terms of 180 days, 270 days, a year. This is not some weird cultural quirk, it is a function of a still-developing financial system. The problem compounds, one company cannot collect from its customers, and thus cannot pay its suppliers. And I know many companies that survive solely on the working capital float they generate through some special access to preferential payment terms from one or two customers.
By contrast, if a merchant sells something on through Alibaba, the use of Alipay means they get paid within days of shipping a product. If you are used to waiting nine months to get paid by a customer, getting paid in a week through Alibaba is hugely attractive.
Then a few years ago, some smart people at Alibaba realized they could take this further. They were already providing the equivalent of a small business banking account to their merchants, why not take it a step further and just provide a whole suite of banking services. This led them to launch a mutual fund and peer-to-peer lending services. There are intriguing businesses, especially in light of the recent Lending Club IPO, but they are consuner services, and for this post I want to focus on the the merchant services.
In 2010, Alipay launched their Micro Loan business. As the name implies, this service makes small loans to merchants, 7 days to 360 days in term. Essentially working capital loans, a service that small businesses in the US take for granted from their local bank, but which in China are hard for a small company to tap.
When I first read about this in the company’s IPO filings my eyes lit up. This is a small piece of revenue for Alibaba, the interest on these loans was about 5% of revenue in FY13, but it is by far the fastest growing item in their income statement. (And yes, you can actually track this business from the company’s filings, a big bonus.) As mentioned above, banking in China is still far from mature. The financial system is heavily tilted in favor of large, state-owned enterprises. For small and medium-sized enterprises (SMEs), there is a huge shortage of good banking products.
Recall that SMEs are the heart of Alibaba’s merchant accounts, and you should start to see the appeal. Alibaba is not just the online marketplace for a large chunk of the Chinese economy, they are rapidly emerging as that segment’s banker as well. Combine Amazon and eBay of today with Citibank and JP Morgan of turn of the 20th century, and Alibaba’s importance starts to emerge.
That all being said, I need to point out a few very important wrinkles with this.
Top of the list is the fact that Alipay is not actually part of Alibaba, at least not anymore. For domestic regulatory reasons, Alibaba divested Alipay into a separate company in preparation for the BABA IPO. A very large chunk of the S-1 details the two company’s new relationship, it is complex. The two companies share some executives and have all sorts of contractual ties to each other. Some executives in one company are entitled to incentives from the other, or both. And investors do capture some of the Alipay revenue stream. More importantly, Alipay is linked very tightly to the core Alibaba platform, ensuring that those merchants still get access to the service. Nonetheless, investors in BABA do not get straightforward access to Alipay. Recall that BABA is itself a Cayman’s Island-registered variable interest entity which sits on the far side of a legal dotted line from Alibaba the company. And that company, in turn, sits on the far side of another legal dotted line from Alipay. It will always be hard for outside investors to grasp the full relationship between Alibaba and Alipay.
Nonetheless, I think the two companies offer a very attractive bundle that will wield tremendous influence over the development of the Internet in China and globally.