Coming off a banner year in which shares almost doubled, Alibaba (NYSE:BABA) stock sold off hard after its latest earnings report. The leading Chinese e-commerce platform posted strong 56% revenue growth, but enthusiasm was tempered by lower operating margins, which shrank from 39% to 31%.
There are a lot of moving pieces to Alibaba's sprawling empire, but basically, the company is investing hard in customer acquisition, as it believes the lifetime value of new customers -- as well as their data -- will yield a big payoff in the years ahead. Here are all the ways Alibaba is reinvesting in future growth.
1. Watermelons and apples
Last September, Alibaba took majority control of Cainiao, a logistics company Alibaba co-founded as a joint venture four years ago. That acquisition meant Alibaba now consolidates Cainiao with its financial results, the deal contributed 4% growth, but lowered margins, as logistics is a lower-margin business than Alibaba's core marketplaces. Cainiao will nevertheless enable Alibaba to pursue its "New Retail" strategy, the seamless integration of both online and offline shopping in China.
While Alibaba has a leading market share in Chinese e-commerce, the Chinese economy is still only 20% e-commerce versus 80% offline. Tencent (OTC:TCEHY) had acquired a stake of just over 20% in e-commerce rival and logistics specialist JD.com (NASDAQ:JD) in 2014, beginning a huge rivalry for the Chinese consumer. Thus, the acquisition of Cainiao -- in which Alibaba already owned a sizable minority stake -- is a natural extension of this long battle.
Management claims investors shouldn't worry, however, as the integration will ultimately produce more shareholder value. Said CFO Maggie Wei Wu:
... remember first of all lower margins does not necessarily equal to a lower profit, because we are making the pie much bigger. So, 60% of apple compared to 40% of watermelon, right, which one do you want. And ... lower margin not necessarily equals to lower cash flow. For example, inventory can be a positive contribution to cash flow, due to negative working capital nature of the retail and the risk of the inventory can be reduced with consumer insight and data technology.
2. Ant Financial
The second big item was the company's acquisition of a 33% stake in Ant Financial, the parent company of Alipay. Ant enables digital payments and has other business lines in wealth management, lending, insurance, and credit scoring. Ant was initially part of Alibaba but was spun off in 2011 in preparation for new regulations from the People's Bank of China -- which wound up never materializing. As Alibaba's main payment platform, Ant was recently given a $60 billion valuation in a private funding round in 2016, making it the largest private company in the world.
Alibaba is reacquiring the 33% stake in Ant in exchange for certain intellectual property rights, for which Ant had been paying Alibaba. Those payments will stop in exchange for equity ownership, which some believe could presage an initial public offering for Ant in the near future.
Ant's quarterly performance mirrored that of the overall company, with strong top-line growth but lower margins. Executive Vice Chairman Joseph Tsai said Ant was profitable in its three main businesses -- payments, lending, and wealth management -- but that Ant had embarked on a "very ambitious user-acquisition strategy," which doubled active users year over year. Tsai also claimed third-party data showed Ant had taken market share in the quarter. Financial services and wealth management can be very "sticky" products, so I think the aggressive marketing should pay off for Ant in the long run.
3. Original content
Finally, Alibaba is looking to become the leading streaming service in China, via video platform Youku Tudou, which Alibaba acquired in 2016. Youku was once considered the YouTube of China, but is now a Netflix (NASDAQ:NFLX) style of subscription service, posting impressive subscription growth over 100% in the quarter. Speaking of Netflix, Youku licensed its original series, Day and Night, to Netflix last quarter, marking the first Chinese original program to be globally distributed through the streaming giant.
But also like Netflix in its earlier years, Youku loses money and lots of it. The subsidiary is part of the company's "Digital Media and Entertainment" category, which posted adjusted EBITA margins of negative 41%. Still, that's an improvement from last year's negative 60% margins, as the company looks to scale the business to increased profitability, as Netflix has.
The big picture
Alibaba's quarter showed strong growth but lower profits, in line with other e-commerce platforms around the world. Investments in logistics, financial services, and streaming video may have lowered margins, but as companies such as Amazon and Netflix have shown, investors will reward a less profitable company if users and revenue exhibit strong, sustained growth. I expect that to happen here as well.