The Groupon of China

PricewaterhouseCoopers released its 2011 outlook for the consumer in Asia this past Monday, which concluded, among other things, that "Online retailing may be on the brink of staggering growth in China." The evidence supporting this thesis was that Internet sales in China are up 60% year over year despite the fact that the sector remains relatively immature and underdeveloped.

Perhaps most impressive is that China's leading online retailer, Taobao.com, now gets more traffic and sells more merchandise than Amazon.com (Nasdaq: AMZN  ) here in the United States despite the fact that just one-third of China's population is online today. In other words, China is a huge market that can only grow bigger.

Maybe you already knew that
While PwC's entire report is worth reading, it's clear given the recent action in Chinese dot-coms that it doesn't cover a lot of new ground for investors. The leading Chinese Internet companies, including search engine giant Baidu.com (Nasdaq: BIDU  ) , popular instant messenger operator Tencent Holdings, and b2b commerce enabler Alibaba.com, already have very aggressive growth expectations priced into their stocks. All three trade for more than 10 times sales and 25 times EBITDA.

While those valuations strike conservative ol' me as expensive, I concede that the outlook for the Chinese consumer -- and the online Chinese consumer in particular -- is promising. As I've written before, the Chinese consumer is one of the best ways to play China today.

It's important, however, to be careful when it comes to purchasing Chinese stocks. Not only are there governance, currency, and other risks associated with investing abroad, but it's clear today that -- a la the tech bubble -- a significant portion of hot China stocks today simply won't end up living up to their hype.

The Groupon of China
Yet Chinese Internet plays are popular today, and I'll wager that you clicked on this article in the hopes of being told about the Groupon of China -- a company you hope is early in its lifecycle that will go on to become China's next great consumer Internet business and earn you mind-blowing profits in the process. While I do promise to reveal the Groupon of China, it's important to note at this point that your and my idea of Groupon are likely quite different. Rather than see an emerging online superbrand in Groupon, I see a company with our country's 79th most popular website, trailing the likes of Pandora, Constant Contact, and BBC Online, no durable competitive advantages, and significant emerging competition.

With that as background, I present to you the Groupon of China: E-Commerce China Dangdang (NYSE: DANG  ) . Both companies' websites rank in the 70s in terms of popularity in their country and get approximately 60 million monthly page views, according to FindWebStats. They also have roughly the same revenue -- $300 million -- provided you believe recent analyst estimates that Groupon is on track to have $600 million in sales this year and ding Groupon for grossing up its sales and booking the value of the coupons it sells as revenue and not just the 50% it keeps as commission, as an industry contact tells me it does.

Wait a second ...
Assuming you know Chinese stocks, you can't believe newly listed Dangdang is the Groupon of China. In fact, you may think I'm selling Dangdang short even if you believe in a bright future for Groupon. That's because Dangdang, an online retailer of books in China, has naturally been hyped by the media and its promoters as the Amazon.com of China.

Although Amazon and Dangdang both got their start selling books, that's where the similarities end. Amazon today operates the world's 15th-most-popular website and the fifth-most-popular website in the United States. Further, it's sold more than $30 billion worth of product and earned more than $1 billion over the past year while expanding into consumer electronics and cloud computing. Dangdang, on the other hand, had just $300 million in sales and was barely profitable over the same time period.

But wait, Dangdang today, you might argue, is a lot like Amazon was 10 years ago. It's not the Amazon.com of China, but the next Amazon.com of China.

This, too, is wrong. Amazon, in its early days, was a disruptive innovator pioneering sales online. Its first-mover advantage and resulting network effects are the reasons the company remains successful today. Dangdang is neither of these things in China. As I alluded to above, its flagship website was only the 77th most popular in China last year, according to data from Alexa, trailing direct online retailing competitors Taobao.com and Paipai.com. Further, neither of these competitors will be easy to beat. They are run by well-capitalized companies, Alibaba Group and Tencent, respectively, and are already vastly more popular than Dangdang.

The global view
This is what makes Dangdang's premium valuation, at more than three times sales and 300 times EBITDA, so preposterous. The company is, in short, an also-ran, but many U.S. investors are flocking to own the stock because it's among the few Chinese online retail options available to them -- Tencent is listed in Hong Kong and Taobao.com parent Alibaba Group remains closely held.

This is what makes Dangdang such a dangerous stock to buy or own today. Like Groupon, it's a mediocre business with no sustainable competitive advantage operating in a competitive space against much bigger players -- and trading at a premium valuation to boot. Of course, maybe it's not such a bad thing to own the Groupon of China. Google, in its infinite capital allocation wisdom, may swoop in and try to acquire it for $6 billion.

Get Tim Hanson's top global stock picks by joining Motley Fool Global Gains. Tim's "Global View" column appears every Thursday on Fool.com.

Tim Hanson is co-advisor of Motley Fool Global Gains. He does not own shares of any company mentioned. He does not own shares of any company mentioned. Google and Baidu are Motley Fool Rule Breakers recommendations. Google is also an Inside Value pick. Amazon.com is a Stock Advisor selection. The Motley Fool owns shares of Google. You may not care about any of that, but telling you is part of our comprehensive disclosure policy.


Read/Post Comments (10) | Recommend This Article (9)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 16, 2010, at 2:09 PM, cbinewman wrote:

    Agree. Taobao is WHERE the 90% of people I know shop in online there. It will be spin-off from alibaba most likely, but it may remain being listed in HK. On the other hand, having Dangdang is not the end of day.

  • Report this Comment On December 16, 2010, at 5:10 PM, will19699 wrote:

    Everyone bashes Dang, why? It has low float of 35 million shares, it makes a profit and now the market cap is less than 900 million 3x sales. What about growth almost 300% YOY? The IPO will definitely give them needed cash to expand and do more marketing. Just because it is not the number one shopping place doesn't make it bad buy.

    If you want to Bash- Yoku is WAY overpriced, they lose money and they have float of over 100 million shares with like a billion shares authorized. This business model is much scarier than DANG who makes money and is actually growing. Yes, Youku gets a lot of traffic but they are not making any money. And there a few other Youtubes of China too. They have copyright issues now too and their management is not even based in China.

    I think you will eat your words on Dang someday.

  • Report this Comment On December 16, 2010, at 6:07 PM, cbinewman wrote:

    Youku is actually in the media business, be aware of its social tradition. Dang is a true e-retailer pioneer in China and have generated cash flow for many years already, although the e-biz phenomenon is not on its side right now.

  • Report this Comment On December 16, 2010, at 8:26 PM, TMFMmbop wrote:

    Totally agree oon YOKU and mocked it last week. Still think DANG is weak for reasons given above... It's not even 1, 2, or 3 in its space!

    Tim

  • Report this Comment On December 17, 2010, at 2:50 AM, ecleechina wrote:

    No one should bash a good stock if there is solid business underlying the valuation. However, there are some flaws with the Dang biz model, which a long term investor should think about...

    1. Dang's only competitive advantage is its book business, b/c of its early mover and long term relationship with the major publishing houses. However, with Amazon China competing neck to neck, and publishers going direct to Taobao, Dang is slowly losing this advantage. If you look at the revenue breakdown, DANG's YOY growth has mostly come from its book business, not to mention that book is the ONLY category that is slightly profitable. But with the growth of ebooks, and the decline reading population, how long can DANG's book category sustain and drive the company's high growth?

    2. DANG has no comeptitive edge whatsoever in its other general merchandise categories, compared to Amazon US. There is a strong industry verticle B2C retailer in virtually every profitable/nonprofitable category:

    - 360buy for electronics/3C

    - Vancl for cheap gap-like clothing

    - Redbaby for maternity/baby, food, cosmetics

    - #1.com for food & stuff

    - Sasa for cosmetics

    - And how can we forget the big behemoth of TAOBAO sucking in 9 out of every 10 consumers who wants everything under the sky

    3. This brings us to the last point, to maintain its growth, DANG must find categories beyond books. Otherwise, it will get streamlined as Taobao races to acquire every single online buyer in China, which sounds unlikely, but not entirely impossible. Personally, my own online shopping behaviour has switched from DANG and Redbaby to solely Taobao within the space of 1 year. With Taobao's direct-from-manufacturer prices, e-retailers who want to find profitable categories are struggling to keep up with the prices. Hence, none of DANG's general merchandise categories make a single dime in profits.

    As the group of up-and-coming young consumers enter the shopping universe, the traditional "book" retailers like DANG will only get left behind with its group of 40+ age group loyal diehards who buy books at $1.50 plus free shipping.

    In end, e-commerce is a tough business in China. It has the demands of traditional retail (supply chain, merchandising, etc), plus all the headaches of online business (shipping/logistics, online operations, competitive cut-throat pricing, competitive CRM programs), the list goes on and on.

    My bet is on Taobao. But I congratulate those who made profits on the 1st week of DANG's IPO. It's definitely not a long term buy/hold in my books, the environment is too tough in China to see who'll be left standing in 3-5 years. Be patient, the good one s are coming...anyone interested in Taobao?

  • Report this Comment On December 17, 2010, at 3:27 PM, jondastkpickr wrote:

    Only thing I care about is when they report next qtr earnings. If they show that revunues grew @ a 20-25% clip the stock will move up aggressively giving the prospects for further growth. If revunue growth is less....timmmmbbbbeeerrr. I believe the naysayers will get a rude awakening with DANG.

  • Report this Comment On December 17, 2010, at 3:29 PM, jondastkpickr wrote:

    oppps.... REVENUE....MY BAD

  • Report this Comment On December 17, 2010, at 3:45 PM, jondastkpickr wrote:

    Now on the other hand BONA is a dog with flees. I jumped on the China IPO bandwagon and got trampled. They have a decent source of revenue but I wasnt thinking when I made purchase considering that most of the media in China is controlled by the government so there is no room for growth and government will deter any kind of expansion with an entity they dont control. I had to average down and now Im just hoping I can get out and break even and eat the cost basis. I hope that I am wrong but the stock price is proving me right so far...what do I do :-(

  • Report this Comment On December 21, 2010, at 3:21 PM, TheSecretHistory wrote:

    About a week ago China's CPI reached a 28-month high:

    http://www.chinadaily.com.cn/cndy/2010-12/12/content_1168797...

    The Chinese government just raised diesel and gasoline prices:

    http://www.chinadaily.com.cn/china/2010-12/21/content_117360...

  • Report this Comment On March 02, 2011, at 5:36 AM, jeff432 wrote:

    Have you guys heard of the new Groupon like site?

    It's the same thing as Groupon except when someone signs up through your referral link, if they or anyone they sign up ever buys a coupon from this site (which you get in a daily e-mail), you earn 5% commission of the coupon purchase price! You earn 5% commission up to 5 levels deep!

    Also, if you sign up a business and they ever offer a coupon, you get 2% of all of their coupon sales!

    About 1000 members are joining everyday now.

    It is 100% free to join.

    There are no coupons yet since the company is in pre-launch.

    It is launching around March 2011 though!

    Check it out:

    http://newgroupon.thecustomeradvantage.com

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