Alibaba: 7 Bear Cases Their Bankers May Not Mention To You

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As Alibaba Group’s initial public offering approaches, investors and analysts are considering both bullish and bearish theses. The IPO is one of the most highly anticipated ones this year, so there’s likely to be a lot of movement when the Chinese online retailer does hold its offering. At this point though there are still a lot of unknown details, like the price of the shares at the IPO.

Bernstein analysts are warning investors to be cautious if considering in snapping up shares of Alibaba at the offering.

Issues with Alibaba’s GMV numbers

In a report dated July 28, 2014, and titled “Alibaba: 7 Bear Cases Their Bankers May Not Mention To You”, analyst Carlos Kirjner offered several bearish considerations about Alibaba. For example, He said noted that there could be a “potentially significant difference” between the company’s reported gross merchandise volume in China, which is almost $270 billion, and the net or settled volume. He said this could imply that the Chinese ecommerce company has a limited ability to drive revenue growth by increasing its monetization rate. He thinks that this is actually likely, in fact.

It’s also possible that Alibaba might have the opposite problem with its gross merchandise volumes. He estimates that the company has about a 13% e-commerce penetration in China, using the company’s reported GMV and dividing it by Chinese core retail sales. In the U.S., however, e-commerce is growing in the mid-teens, and he estimates a rate of 7.5%. Because of this, he suggests that gross merchandise volume will decelerate more quickly than expected.

Alibaba’s sales of counterfeit items causes risks

And then there’s the issue of the quality of Alibaba’s gross merchandise problem. He notes that sales of counterfeit items on the Chinese e-commerce platform, mostly on Taobao, create risks. The U.S. added Taobao to its list of “notorious markets” because officials found that infringement of intellectual property rights to be happening on a “commercial scale.” Taobao made up approximately 70% of Alibaba’s retail gross merchandise volume in China in the 2014 fiscal year.

Although U.S. officials removed Taobao from the list two years ago, Kirjner thinks this issue continues.

Risks to Alibaba’s margins

Kirjner also believes Alibaba will see a smaller-than-expected opportunity from revenue growth due to ads because gross merchandise volume is shifting over to mobile devices. He notes that the Chinese online retailer’s documents suggest that its monetization rates for Taobao and TMall are significantly lower on mobile devices than they are through the Web and will remain so for some time.

He also notes that Alibaba is going to be investing in infrastructure for fulfillment and deliveries so that it can stay competitive. The result is going to be negative impacts to its cash flows and / or margins. Of course, Inc. (NASDAQ:AMZN) is a case in point of this sort of thing, although it took a long time for investors to tire of all the spending.

However, he thinks these risks are exaggerated. For example, he said experience in developed markets show that companies don’t necessarily need a fully integrated logistics operation. He notes that the case might be different in China, but it’s not always the case. In addition, he said their conversations with current sellers on Alibaba haven’t revealed any big logistics problems, so the company might need to invest there.

He does see a risk to margins if Alibaba invests in new and emerging businesses, which he expects through acquisitions and / or organically. He said these investments will have a negative impact on the company’s cash balances, operating income, free cash flow and margins.

What’s a shareholder to do?

And finally, he notes that Alibaba Executive Chairman Jack Ma and his partners have total voting control over the company, which means shareholders will have a nearly impossible task if they want to influence management. He also notes, as others have, that the company’s variable interest equity corporate structure posts “fundamental risks and merit a substantial discount.

However, he reminds investors that this high level of control isn’t new, as Facebook Inc (NASDAQ:FB), Google Inc (NASDAQ:GOOG) and others are in the same situation. But it does require shareholders to really trust Ma and the rest of Alibaba’s management.

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