The developing world is a fertile ground for innovative companies with durable advantages, and China, as a part of that world, has produced leading global companies especially in the area of internet services. There are several factors that have helped to create big opportunities for these companies – nearly ubiquitous broadband and wireless infrastructure; a continental scale economy and weak historical development of offline infrastructure in retail, content and media.
E-commerce is a good illustration – both nationally and globally. Retail space in China is 0.6 square meters/capita, far lower than the 2.6 square meters/capita in the U.S. Much of this space – particularly in rural areas – is characterized by massive brand fragmentation. Competitive apparel, durable and staple firms have struggled to support offline penetration in more rural geographies, due to an absence of modern distribution and logistics. As such, an opportunity has been created for e-commerce giants to enter the market with a solution for these structural challenges. In 2014, China’s e-commerce market reached $426 billion, or 10% of total national retail sales. This contrasts with the United States, which despite being the world’s largest consumer marketplace, posted $305 billion in e-commerce merchandise value, or approximately 7% of total national sales. Thus, China’s gross merchandise value (GMV) is nearly 30% larger in value than the U.S., and is growing twice as fast. In 2014, China’s e-commerce GMV grew 32% compared to the U.S. which grew only 16%. Similar leapfrogging is evident in internet media and content (online video, mobile gaming), verticals (travel, classifieds) and internet services (ride hailing, online-to-offline).1
Growth matters, but market structures underpin profitability and returns. A unique characteristic of China’s largest new economy leaders is that they have nearly unrivaled dominance domestically, which allows them to generate superior economics. This is clearly the case among the ‘BAT’ firms – Baidu (search), Alibaba (e-commerce) and Tencent (social networks). But it is also increasingly prevalent amongst a number of important verticals. CTRIP, for example, spent 2015 consolidating its two most significant challengers – Qunar and Elong – effectively monopolizing much of the online travel market, as the combined group now has in excess of 80% of the travel GMV in China. The concentration of the travel sector should permit CTRIP to see a significant expansion in ‘take rates’, operating margins and returns through time.2
Widespread anxiety about macro challenges in China – much of it misplaced, in our view – have led to unusually attractive valuations for some of the world’s largest and most innovative internet firms. Alibaba is an excellent illustration. Operator of the world’s largest marketplace ($500 billion 2015E GMV), Alibaba has an 80% market share of China’s enormous ecommerce GMV. We believe Alibaba is attractively priced both in absolute terms and relative to its nearest U.S. analog, Amazon. Alibaba’s market capitalization ($150 billion) is just 67% of the market capitalization of Amazon ($225 billion) and despite its size, Alibaba has more than 2.5 times the GMV than Amazon ($500 billion vs $175 billion). Alibaba is also significantly more profitable ($6.5 billion v $0.6 billion 2015E) and these profits are largely premised on the marketplaces. Alibaba also has potentially massive opportunities as the largest internet finance (Ant Financial) player and cloud computing (Aliyun) platforms in China through their subsidiaries.
We invest in extraordinary companies with long-term growth, sustainable competitive advantage and significant real options. Rarely do such innovative firms with unrivaled dominance have inexpensive valuations. In periods of controversy – like now – opportunities present themselves.
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1 Citibank, 9/3/2015.↩
2 As of 12/31/15 Developing Markets Fund invests 3.71% in Alibaba Group Holding Ltd,Sponsored ADR; 3.14% in Baidu, Inc.; 2.56% in Ctrip.com Intl Ltdl, ADR; and 4.06% in Tencent Holdings Ltd.↩
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