Heavy O2O Spending Could Depress Alibaba Stock

  • Alibaba has recently announced that it will invest $1.25B in Ele.me, an O2O business, in what is to become its largest O2O investment.
  • Alibaba is becoming aggressive with O2O, a business that has been responsible for decimating Baidu's bottom line.
  • What does this mean for Alibaba stock's future performance?

Shares of leading Chinese eCommerce giant Alibaba (NYSE:BABA) have remained depressed in 2015--down 20% YTD-- as the company’s top line growth slowed down while the Chinese market debacle continued decimating Chinese stocks both at home and in the U.S. Investors have been disgruntled by Alibaba’s top line growth which has now dropped to low-30% range from mid-40% a few years ago. During the last quarter, Alibaba posted revenue growth of 32% Y/Y to $3.42B while net income was up 36% to $1.43B.
BABA stock chart

Source: Alibaba Stock Price Data by amigobulls.com

It was Alibaba’s Gross Merchandise Volume, however, that caught the attention of the investing world. Alibaba’s GMV increased 28% to $17.26B, considerably slower than top line growth. GMV is an important growth metric for ecommerce companies such as Alibaba, and a slowdown in GMV is frequently taken as an indication that the popularity of an ecommerce platform is eroding.

It therefore hardly comes as a surprise that Alibaba is taking concerted steps to accelerate its GMV growth through online-to-offline, or O2O, ventures. O2O is shorthand for the business of marrying traditional brick-and-mortar experiences with modern ecommerce. Through O2O, Chinese companies such as Alibaba and Baidu (NASDAQ:BIDU) find ways to lure brick-and-mortar customers to spend money on online stores. O2O employs the Internet and mobile to make buying stuff in online stores efficient, convenient, and even fun.

Now the O2O business is growing very rapidly in China, and companies such as Alibaba and Baidu have jumped at the opportunity. Alibaba has several O2O ventures including AliPay, its mobile payment platform, as well as partnerships with giant stores such as Suning and taxi app Didi Kuaidi. Alibaba usually does not divulge much about its O2O business. But Baidu usually lets investors in on sales numbers of its O2O ventures. During the last quarter, Baidu’s O20 businesses recorded a GMV of $9.5B, a robust 119% growth. Baidu’s O2O ventures include Qunar, Baidu Takeout Delivery, and Baidu Nuomi. So this is a really fast-growth area.

Alibaba has been gradually expanding its O2O footprint. Earlier this year, the Alibaba announced that it was jointly investing $483M with Ant Financial for a 50% stake in Koubei.com, an O2O venture meant to enhance local dining and shopping experiences. But Alibaba’s growing intent in O2O became even more apparent when it announced about a few days ago that it had agreed to invest $1.25B for a 27.7% stake in online food delivery service Ele.me, which roughly translates to ‘‘Hungry ,Now?’’ in Mandarin.

Now the big problem with O2O ventures is that companies are not making any money yet from this new business model. Although Alibaba does not talk much about its O2O ventures, comments by Baidu during its last earnings call shed some useful light into what’s going on behind the scenes:

They're all growing very, very fast and together with our peers and competitors, we are educating the Chinese consumers the better way to order services. So eventually, we will be able to take a cut, a sizeable cut from that, but whether that's three-year or five-year, it's really hard to tell at this point.

In plain terms, Baidu was saying that it was making no money from O2O despite handling a large amount of business on its platform, and did not expect to do so over the next 3-5 years. It appears as if the company is more interested in building a loyal O2O userbase first before starting to take commissions from the service. Although we do not yet have much information about how Alibaba’s O2O business works, there is a strong possibility that it’s pretty similar to Baidu’s, which implies that BABA might not be making any money from it.

Baidu is well ahead of Alibaba as far as O2O investments go. Unfortunately the company’s heavy O2O investments have been badly depressing Baidu’s margins and have led to poor stock performance over the last two years. The Ele.me venture will become Alibaba’s largest O2O investment to-date. Whereas it might provide a nice boost to Alibaba’s GMV, it’s likely to have just the opposite effect on the company’s bottom line and Alibaba stock price.


Alibaba seems to increasingly be moving in the direction of O2O. The problem is that this is mostly a future investment with little if any payoff expected over the short-term. Heavy O2O investments have led to a sharp drop in Baidu’s bottom line growth. The same could happen to Alibaba as it starts becoming aggressive with this new business model. If this happens, you can expect Alibaba stock to stay depressed over the near-term and medium-term.

Brian Wu Brian Wu   on Amigobulls :
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