INTERNET – Spending Binge Bites Alibaba Profit
Bottom line: Shares of Alibaba could be due for a pull-back as investors become aware of its aggressive spending and shrinking profits, which could benefit the more conservative Tencent and Baidu.
Everyone is buzzing about the maiden earnings report from newly listed e-commerce giant Alibaba (NYSE: BABA), which shows strong revenue growth and rapidly shrinking profits. So rather than repeat everyone else by simply reviewing the numbers, I’ll take this occasion to compare the Alibaba figures with those from leading rivals Tencent (HKEx: 700) and Baidu (Nasdaq: BIDU), often called the Internet “big 3” of China and increasingly referred to collectively by the name BAT.
The big picture is that Alibaba and Baidu are both spending aggressively on acquisitions, product development and moving their core products to mobile platforms, resulting in significant profit erosion. Tencent has taken a more focused and conservative stance to spending, which in my view looks healthier and should enable it to prosper in the future while maintaining profit growth in the present.
All that said, let’s shine our spotlight on the newly released earnings report from Alibaba, which made global headlines last month when it raised $25 billion in a New York IPO — the world’s biggest of all time. Shares in the offering priced above their original range, and since then Alibaba stock has repeatedly defied gravity and climbed to new highs. The shares rose another 4 percent after the new quarterly results came out, and now trade 56 percent above their IPO price of $68 per American Depositary Share (ADS).
The actual earnings look rather so-so to me, but that doesn’t seem to matter to anyone else. Investors were excited by the company’s top-line growth, as revenue rose a healthy 54 percent to $2.7 billion in the third quarter. (company announcement; Chinese article) The company’s costs soared by a much larger 86 percent to $912 million, as it spent heavily to promote its core e-commerce services and also on acquisitions and general promotion to raise its profile in the run-up to its IPO. As a result of that spending binge, Alibaba’s profit tumbled 39 percent for the quarter to just under $500 million.
Next let’s look at Baidu, which announced similar trends in its third-quarter results last week. Like Alibaba, Baidu’s revenue also rose a healthy 52 percent to $2.2 billion as it consolidated its place as China’s most profitable search engine. (previous post) Baidu’s costs also rose much faster than its revenues, climbing 73 percent for the quarter. As a result, its profit grew by 27 percent for the quarter, or about half the rate of its revenue growth.
Finally there’s Tencent, which will release its third quarter results a week from now. (earnings calendar) In its second-quarter report, the company reported top line growth that was a bit slower than the other 2 giants, with revenue rising just 37 percent to $3.2 billion. But it was able to control its costs, which rose by just 15 percent, with a result that its profit rose 58 percent. That makes it the only BAT company whose profit is currently growing faster than revenue.
None of these trends is really anything new, and the numbers just reflect different strategies by each company toward new investment, promotion, and cost control. I do find it a bit strange that investors have given Alibaba such a high valuation, since it earns less revenue than Tencent and is far less profitable. Alibaba currently has a market value of $261 billion, or 77 percent more than the $147 billion value for Tencent.
That huge discrepancy is a direct result of Alibaba’s huge spending on promotion. But the promotion factor is mostly hype, and it really does seem almost inevitable that Alibaba’s shares will have to come down when people start looking at fundamentals. When that happens, we could see its stock drop sharply in the first half of next year. That exodus could benefit the more cost-conscious Tencent and even Baidu, as people shift their money to those stocks.
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