A Pair of Underdogs in China’s Bustling E-Commerce Industry

Leo is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

When most investors think about China’s e-commerce market, they will probably think of Internet giant Alibaba Group (NASDAQOTH: ALBCF.PK), and for good reason - the Hong Kong-based company headed by Jack Ma is larger than Amazon and eBay combined. Alibaba’s Taobao controls 95% of the consumer-to-consumer (C2C) market, while Tmall controls 44% of the business-to-consumer (B2C) market. The dominance of these two sites has made it very tough for domestic and foreign companies to break into either industry. To date, Amazon holds less than a 1% share of the B2C market in China.

However, investors who are looking for an alternative to investing in Alibaba, which can be purchased on the pink sheets or on the Hong Kong stock exchange, can also consider two frequently overlooked names in Chinese e-commerce - Vipshop Holdings (NYSE: VIPS) and E-Commerce China Dangdang (NYSE: DANG).

Vipshop Holdings

Vipshop Holdings is a Guangzhou-based B2C discount retailer of various global brands, both foreign and domestic. Vipshop is also one of the few vertically integrated Chinese B2C e-tailers to actually report a quarterly profit. Last quarter, the company reported earnings of $0.11 per ADR share, or $5.8 million, up from a loss of $0.33 per share, or $8.6 million last year. Revenue rose 207.6% year-on-year to $310.7 million. Gross margin rose from 21.2% to 23.4%.

<img alt="" src="http://media.ycharts.com/charts/e8398e9458f1680b3fe1316ee2b50b47.png" />

Vipshop’s active customers rose from 1 million to 2.8 million. Even though that is a tiny sliver of the market compared to Tmall, which has 100 million registered users, it is still impressive growth for a company that is often ignored by its larger competitors. In May, Vipshop ranked ninth in total visits compared to its Chinese B2C competitors, but if its first quarter earnings were a clear indication of its current growth trajectory, that ranking could improve dramatically over the next few quarters. To stay competitive, Vipshop has been expanding partnership with foreign brands to attract more affluent customers, to increase sales volumes as well as the average revenue per transaction.

Investors haven’t been oblivious to Vipshop’s growth potential. The stock has risen nearly 570% over the past twelve months, but it could be getting ahead of itself, since it now trades at 430 times trailing earnings. Yet its forward P/E of 22.8 and 5-year PEG ratio of 0.63 suggests that its price could be justified if it continues meeting earnings expectations.

However, investors should be aware that short sellers recently claimed that conflicting web traffic data from Alexa suggests that Vipshop could be inflating its page visits and revenue growth, charges the company denies on grounds that many Chinese users do not have Alexa plugins installed in their browsers.

E-Commerce China Dangdang

E-Commerce China Dangdang, more commonly known as Dangdang, is often considered to be the “Amazon of China”. Just like Amazon, Dangdang started out as an online bookstore, but it expanded its products to include digital devices, home appliances, household merchandise, music, clothing and cosmetics. Like Vipshop, Dangdang has a small but rapidly growing user base, adding 2.4 million active customers to reach 7.4 million at the end of the quarter.

Unlike Vipshop, however, Dangdang is still unprofitable, and reported a loss of $11.7 million quarter, a moderate improvement from the loss of $16.2 million a year earlier. Revenue, however, climbed 23% year-on-year to $214.7 million. Gross margin also rose from 14.2% to 17.2%.

<img alt="" src="http://media.ycharts.com/charts/645b0e5f3572dd3d1c2bf8ed83f289f8.png" />

Books and media sales rose 24% year-on-year to $139.1 million, comprising 65% of the company’s top line. The company is notably selling an e-reader similar to Amazon’s Kindle for 699 RMB ($114), in an effort to increase e-book sales.

Dangdang’s revenue from sales of other merchandise rose 12% to $66.3 million, accounting for 31% of the company’s top line. Investors have noticed Dangdang’s improving numbers, and its shares have risen 55% over the past twelve months. However, until the company can actually produce a profit, much of this growth is speculative without concrete fundamentals.

An increasingly crowded market

Although Vipshop and Dangdang’s growth has been encouraging, investors should remember that the two companies are tiny players in a massive market, as seen in the following chart.

<img alt="" height="395px;" src="https://lh4.googleusercontent.com/heZmlMyhK2nyqE2Egk0FJ7jO3iV4vp_v1CuKkT9YbfP8GRNoCNuK5kx1icjdcDLpRW7-241v0FmrdTj44LHrRoYDs5Sy0DnOwLKzlj33suL6DSDVjK5_M0Rn" width="550px;" />

Yet in the end, there will be an inevitable market consolidation in which Tmall or 360Buy could buy out (or wipe out) the rest of the competition.

However, there is one company notably missing out on the party - Internet giant Baidu (NASDAQ: BIDU), commonly referred to as the “Google of China”. In theory, Baidu’s 81.6% share of the search market should have granted it a valuable competitive edge in the e-commerce market.

However, Baidu fell flat on its face last year when it closed its e-commerce site, Lekutian, after only two years on the market. Lekutian was a joint venture with Japanese e-commerce leader Rakuten, and fell apart after the Chinese and Japanese management teams failed to agree on the future direction of the company. Drawing users away from Tmall and 360buy also proved too difficult a task, especially when both companies had already established considerable brand loyalty among shoppers. Lekutian was Baidu’s second e-commerce initiative, after its first attempt, Baidu Youa, failed in a similar manner.

I believe that at some point in the future, Baidu could start buying up some of the smaller e-commerce sites, such as Vipshop and Dangdang, to finally claim a piece of the rapidly growing B2C market. Baidu has a cash hoard of $5.4 billion, which is more than enough to acquire both Vipshop and Dangdang, which respectively have market values of $2.04 billion and $1.05 billion. Acquiring these businesses could finally help Baidu reverse its slowing year-on-year top and bottom line growth over the past several quarters.

The Foolish Bottom Line

In closing, Vipshop and Dangdang are still speculative, risky investments. However, I believe that their improving user numbers, rising top and bottom line growth, and resilience in a market dominated by two major players prove that they could keep growing over the next few years. In addition, their small size means that there could be a lot more upside for both stocks, especially if major Chinese Internet companies like Baidu, Tencent or Sohu get more interested in expanding across the e-commerce industry.

Leo Sun has no position in any stocks mentioned. The Motley Fool recommends Baidu. The Motley Fool owns shares of Baidu. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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