Alibaba (NYSE:BABA) generates most of its revenue from China, but the tech giant's dependence on overseas markets is rising. One of its key growth markets is Southeast Asia, home to over 600 million consumers.

A joint report from Alphabet's Google and Temasek claims that the region's e-commerce market will grow from $5.5 billion in 2015 to $87.8 billion by 2025, fueled by higher incomes and internet penetration rates.

A young woman makes a purchase on her smartphone.

Image source: Getty Images.

That's why it wasn't surprising when Alibaba took control of Lazada, the region's largest e-commerce player, in 2016. That investment didn't move the needle for Alibaba at first, but its importance is growing. Baird analyst Craig Sebastian expects Lazada to generate $13 billion in GMV (gross merchandise volume), or the value of all goods sold on its platforms, this year, and add 5% to 10% to Alibaba's enterprise value. 

Pivoting away from China

$13 billion is a drop in the bucket compared to Alibaba's GMV of 4.82 trillion RMB ($768 billion) in 2018. However, Alibaba's GMV growth at its core Tmall marketplace decelerated throughout the first three quarters of 2019, mostly due to the slowdown in the Chinese economy, which was exacerbated by trade tensions with the US.

Metric

Q1 2019

Q2 2019

Q3 2019

Tmall GMV

34%

30%

29%

Year-over-year growth. Source: Alibaba quarterly reports.

To offset that slowdown, Alibaba expanded into overseas markets like Russia, Mexico, India, and Southeast Asia. As a result, its international e-commerce retail revenue rose 23% annually last quarter and accounted for 5% of its top line. Its international wholesale revenue grew 31% and accounted for 2% of its sales.

How big is Lazada?

Alibaba doesn't disclose its exact sales for each international platform, so it's unclear how much of that revenue comes from Lazada. Lazada disclosed that it generated $154 million in revenue in 2014, and Owler estimates that it currently generates about $200 million in annual revenue -- which would equal less than 1% of Alibaba's 2018 revenue. That's a tiny percentage, but it could climb quickly if e-commerce adoption rates rise as quickly as market estimates suggest.

Yet Lazada is still unprofitable. It disclosed an adjusted operating loss of $153 million in 2014, and Alibaba reported a combined loss of 8.22 billion RMB ($1.23 billion) from Lazada, its local consumer services, its new retail and direct import unit, and its Cainiao logistics division last quarter.

Tiny parcels in a miniature shopping cart on a laptop keyboard.

Image source: Getty Images.

Alibaba didn't disclose how much of that loss came from Lazada, but it's clearly still running the platform at a loss to compete against its primary rival, Sea's (NYSE:SE) Shopee marketplace. Sea is also running Shopee at a loss, which gives Lazada very little room to grow its margins.

Alibaba's main strategy for narrowing Lazada's losses is to reduce its direct sales (which require higher logistics and fulfillment expenses) and increase its reliance on third-party marketplace retailers. That move caused Lazada's total revenue growth to decelerate last quarter -- but Alibaba stated that Lazada's third-party marketplace generated "robust" GMV growth, and that the shift better positions the platform for "sustainable and scalable long-term growth."

A top investment priority

Alibaba isn't worried about making Lazada profitable anytime soon. During last quarter's conference call, CFO Maggie Wu stated that Alibaba would continue reinvesting its cash into "four strategic areas" in order of priority: local consumer service, Lazada, retail and Tmall direct imports, and Cainiao.

Wu acknowledged that Alibaba was still taking losses on all four businesses, but that it was already starting to see "efficiency gains and greater synergies" from those businesses that should deliver better returns over the long term.

Wu also suggested that the strength of Alibaba's core Chinese marketplaces (Tmall and Taobao) would offset those losses. Even after factoring in those losses, Alibaba's core commerce EBITDA still grew 20% to 46.1 billion RMB ($6.7 billion).

Short-term pain, long-term gains

Investors shouldn't expect Lazada to move the needle for Alibaba anytime soon. Its GMV will remain a sliver of Alibaba's total GMV, and its losses will weigh down its earnings. But over the long term, Alibaba's investments in Lazada could pay off as the Southeast Asian e-commerce market matures.