Is Alibaba Your Best Way to Invest in China's Rapidly Growing E-Commerce Industry?

Alibaba's IPO is well anticipated, but investors might actually find more upside in shares of two already public companies.

Jul 9, 2014 at 1:00PM

The Alibaba IPO is upon us, and shares of Chinese e-commerce peers Vipshop Holdings (NYSE:VIPS) and JD.com (NASDAQ:JD) are soaring to new highs in anticipation of the event. While Alibaba might in fact be the largest and most anticipated IPO in history, could Vipshop or JD.com present a better opportunity?

A wide disconnect among the top three
In the first quarter, China's e-commerce gross merchandise volume rose 27.6% to exceed $73 billion. China's e-commerce industry now accounts for 7.4% of the region's total retail sales, with a forward-looking growth rate of around 30% annually. Hence, analysts believe it will soon become a much larger piece of the overall retail pie.

Alibaba's Tmall site alone commands a 50.6% market share while JD.com has a 23.3% share. In a distant third place comes Vipshop and its 3% share, which shows a great disconnect in market share among each of these three leaders.

Three different strategies
Even though they are all in the same industry, each of these companies have remarkably different operating strategies. While all of them sell products via e-commerce, Alibaba doesn't actually collect much revenue from the sale of goods, but rather from advertising that drives consumers to specific brands or products. Therefore, it has low costs and high profits.

JD.com does sell its own goods and is also responsible for 70% of its transportation. The company has a large infrastructure that includes nearly 90 warehouses, over 1,620 delivery stations, and 210 pick-up stations. As a result, JD.com might have revenue growth in excess of 65% annually, but is still unprofitable.

Lastly, Vipshop operates a flash-selling site where goods are bought and sold in bulk at specific times from 350 partnered brands. The company's revenue has soared more than 125% while its active customer count rose by 5.6 million to 7.4 million in its last quarter. Notably, flash-selling allows it to keep costs in check by keeping inventories down, which is why it reported an operating margin of nearly 3.7% for the last 12 months.

Showing cracks in its armor
While JD.com and Vipshop are already public companies, Alibaba's IPO, expected in August, has been speculated to value the company at anywhere between $150 billion and $200 billion. Seeing as how the company finished its fiscal year with $4.44 billion of net income and annual revenue of nearly $8.5 billion, Alibaba would trade at 45 times earnings if it debuts with a $200 billion market capitalization.

However, Alibaba is now starting to show cracks in its armor, as its revenue grew just 39% during its fiscal fourth quarter, , which significantly lagged its top-line growth for the year in excess of 50%. Alibaba does own half of a market that's growing at 30% annually, which means that its 50% growth is unsustainable. Ahead of its IPO, 45 times earnings for a company with growth that will naturally become more difficult is a steep price to pay.

Foolish thoughts
With JD.com and Vipshop both growing aggressively while holding smaller market shares, both companies should have more upside potential than Alibaba. Yet the problem with JD.com is that despite $12.5 billion in annual revenue it still can't produce consistent profits, which likely worries many investors and might make its $40 billion market capitalization generous.

This leaves Vipshop, a company with a 5.4 times sales multiple that may look pricey. However, with surprisingly high margins, its 41 times forward earnings multiple may look attractive given its rapid revenue and margin growth. This is a company that controls just 3% of its target market with 7.4 million customers in one of the largest markets in the globe. Therefore, Vipshop could have significant upside potential, and at least for now the company is showing no signs of slowing down.

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Brian Nichols has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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