Alibaba’s growing challenges

The spotlight on Chinese e-commerce giant, Alibaba, is focused on what’s widely expected to be a record-breaking IPO with huge growth potential.

Alibaba
Source:Bloomberg

There’s no doubt that it’s highly profitable, earning $3.7 billion in the latest fiscal year – more than Amazon and eBay combined. However, what investors may want to note is that growth has slowed down to its slowest pace in six-years.

In Q1, revenue rose 39% to about $1.9 billion, although down from the 62% we saw in the prior three-months. This is the first time growth has been under 40%, since results were publicly available. Margins have also been under pressure, dropping to 45.3% year-on-year. While the numbers are still robust for most companies, it suggests Alibaba’s increasing costs and investments could weigh down the bottom-line in the near term.
 
Ahead of its listing, Alibaba shared some of the risks stock holders could face. In its latest IPO filing documents potential problems were highlighted, which could be material to its earnings, particularly in China where the bulk of its operations are located.

Government structural control over internet pipes

Alibaba noted that ‘almost all access to the Internet is maintained through state-owned telecommunication operators’ and under ministry regulatory control. This means it does not have access to any alternative networks in the event of disruptions, failures or other problems with China’s Internet infrastructure.

The challenge of monetizing mobile traffic

As access via mobile to Alibaba’s services increases, it will need to be able to monetize the platform as effectively as it does over the desktop. In the interim, this could be a tough transition which even Facebook is grappling with.

‘To date we have chosen not to display as many marketing impressions on our mobile apps as compared to what’s on our personal computer-based websites’, Alibaba noted in its filing, referring to its priority in attracting users first.

Tighter regulations over Alipay

Alibaba currently relies heavily on Alipay to conduct payment processing and escrow services in its marketplaces. The risk is that Alipay’s business is highly regulated, so any further clampdown could disrupt the business or increase costs.

The company pointed out that regulators and third parties in China have been increasing their focus to online and mobile payment services, such as those provided by Alipay. Recent examples include large commercial banks in China reducing their existing limits on transfers to linked accounts.

‘We rely on the convenience and ease of use that Alipay provides to our users. If the quality, utility, convenience or attractiveness of Alipay’s services declines as a result of these limitations or for any other reason, the attractiveness of our marketplaces could be materially and adversely affected’, Alibaba noted. It added shifting to any other provider would also see it no longer getting the preferential terms from Alipay.

E-commerce tax compliance and enforcement

E-commerce in China still developing, therefore sellers on its platform may find themselves subject to new tax obligations as rules get clarified. The risk is that the more stringent compliance requirements could deter sellers from using Alibaba’s service.

Uncertainty with interpretation and enforcement of Chinese laws

‘China has not developed a fully integrated legal system, and recently enacted laws, rules and regulations may not sufficiently cover all aspects of economic activities in China or may be subject to significant degrees of interpretation by PRC regulatory agencies’, said Alibaba.

It noted that with the relatively newness of the rules, enforcement would be subject to a significant amount of discretion, which could be inconsistent and unpredictable.

‘In addition, the PRC legal system is based in part on government policies and internal rules, some of which are not published on a timely basis or at all, which may have a retroactive effect. As a result, we may not be aware of our violation of these policies and rules until after the occurrence of the violation’, warned the e-commerce giant.

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