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Alibaba is a phenom — just not in America

Rick Newman
Senior Columnist
People walk at the headquarters of Alibaba in Hangzhou, Zhejiang province, April 23, 2014. REUTERS/Chance Chan/Files

American investors will clamor for a piece of the action this week when Chinese e-commerce giant Alibaba (BABA) holds its highly anticipated initial public offering. Yet even though the firm will be listed on the New York Stock Exchange, Alibaba is unknown to most Americans, and a huge splash in financial markets won’t necessarily raise the company’s profile on Main Street.

[Yahoo Finance's parent company, Yahoo, has a 22.6% ownership stake in Alibaba and stands to profit from the IPO.]

Alibaba, which could end up being the biggest IPO of all time, is often compared with Amazon (AMZN) and considered by some to be a major threat to the huge American e-tailer. But while Alibaba has ambitions in the United States — and a lot of cash to invest, following the IPO — its main focus seems to be dominating the market in China and other developing nations, which are far from mature. “There’s so much more they can do in China,” says Jeff Walters, a partner with the Boston Consulting Group who focuses on the Chinese consumer market. “I don’t doubt they have ambitions in the United States, but it’s hard to see a master plan beyond just getting a feel for the market.”

A white-hot IPO

Alibaba is a white-hot IPO for three basic reasons. First, it has a remarkable 80% share of the e-commerce market in the world’s most populous country. Second, since China’s consumer economy isn’t nearly as developed as in Europe or the United States, Alibaba is in a prime position to cash in on fervent growth. And finally, Alibaba has built a start-to-finish e-commerce infrastructure (company executives say “ecosystem” a lot) that gives it a stake in nearly every aspect of its customers’ online purchases. That sort of “vertical integration” can be such a competitive advantage that, in some western countries, it might trigger antitrust concerns.

Alibaba is similar to Amazon in the sense that it offers a huge range of products to Chinese shoppers. Its Taobao online marketplace sells cheap, everyday items; Tmall offers more-branded, upscale products; and Juhuasuan is a “group buying” website that offers big discounts for buyers who band together to make bulk purchases. With nearly 9 million sellers, the three sites combined offer almost every product Chinese consumers might want.

Beyond that, there’s Alipay, an online payment service similar to eBay’s Paypal, which in a way is Alibaba’s secret sauce. Chinese consumers are wary of getting ripped off and were very reluctant to send money over the Internet during the Web’s early days. Alipay proved reliable at safeguarding shoppers’ money until they had received their merchandise. That helped Alibaba’s shopping sites earn trust and catch on sooner than others, which is now a huge advantage. Even Amazon doesn’t yet have such a payment system.

Alibaba crafted a vast distribution system by relying on more than a dozen shipping partners able to reach over 600 cities, some deep in China’s remote interior. Amazon didn’t need to do that, since the postal service, FedEx (FDX) and UPS (UPS) already had such networks in place. Alibaba earns fees from sellers, like eBay (EBAY) and Amazon do, but earns the majority of its revenue from advertising by merchants eager to get more attention on Alibaba's busy (some say cluttered) sites. That's more akin to Google (GOOG) or AOL (AOL) than retailers. Alibaba also offers cloud computing services and detailed analytics drawn from all its customers — as does Amazon.

Really bigger than Amazon?

News reports frequently describe Alibaba as bigger than Amazon, but that’s misleading. It does handle more transactions, with its various sites selling $300 billion worth of merchandise per year, compared with only about $120 billion for Amazon. But in terms of actual revenue, Amazon is far bigger (for now), with about $91 billion in annual revenue; Alibaba will hit perhaps $10 billion this year. Alibaba is a profit machine, however, with $3.8 billion in net income during the last 12-month period, for a stunning profit margin of 45%. Amazon’s net income for its last fiscal year was just $274 million, or a scant margin of 0.4%.

Alibaba will probably spend some of the proceeds from its IPO beefing up its share of the mobile market in China, where it has a strong presence by U.S. standards but is behind market leader Tencent, which is sort of like a Chinese Facebook (FB). Beyond that, Alibaba founder Jack Ma has said the company plans to expand in the United States and other countries, and it has already invested in a handful of American startups such as Tango, a messaging app, and Kabam, a gaming company. The company hasn't spelled out its U.S. strategy, but it appears to be seeking a foothold in Silicon Valley, to tap into the region's cutting-edge technology and the deep-pocketed investors who fund it. The ability to transfer the latest technical and financial know-how between the United States and Asia could help Alibaba grow even faster.

Alibaba has also started a U.S. shopping site, 11main, which is sort of like a subdued Etsy. But the U.S. e-commerce market is mature and ruthlessly competitive compared with China, with retail giants such as Walmart (WMT), Target (TGT) and Costco (COST) battling Amazon and others for online market share. It’s not at all clear Alibaba could offer anything that’s not already available to American consumers. “I don’t think American consumers will encounter the Alibaba brand directly,” says Andrew Frank of the Gartner Group. “They may encounter it indirectly, through ad networks or services that deliver content to American consumers.”

Alibaba may try to offer products direct from its millions of Chinese sellers to American shoppers. That's basically what Walmart had been doing for years, though Alibaba could offer many more merchants and perhaps undercut Walmart's markup, since it doesn't need to finance a huge network of superstores.

The most aggressive play for Alibaba might be buying an established U.S. e-tailer. Amazon is probably beyond reach, but eBay might be a possible target at some point. Alibaba may have to grow even bigger before it can digest that sort of meal, however. The real question may be whether Chinese consumers will spend enough to give Alibaba the heft it needs to compete in the United States.

Rick Newman’s latest book is Rebounders: How Winners Pivot From Setback To Success. Follow him on Twitter: @rickjnewman.

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