Three technology titans reshaping retail

FRANKLIN TEMPLETON THINKSTM EQUITY MARKETS

FEBRUARY 2019

How three disruptors are digitizing retail markets across the globe STEPHEN DOVER, CFA PURAV A, JHAVERI, CFA, FRM DAN SEARLE, CFA MARY KILLIAN TEK KHOAN ONG, CFA KATHERINE S. OWEN, CFA In this issue

Three powerful retailing disrupters—Alibaba, Key viewpoints • Our Growth and Value teams have and MercadoLibre—are reshaping expectations about different takes on Amazon. The US shopping and shipping by digitizing retail markets Growth team feels confident in Amazon’s path toward rising across the globe. New conveniences such as ordering profit margins, while our Value groceries with a simple voice command are upending analysts think the market is underestimating Kroger’s ability to the old world order. Each firm uses technology to successfully push into online improve customer experiences—making it easier to groceries, despite Amazon. browse, buy and receive goods—and increase sales by • Our Emerging Markets analysts in Singapore point out that Alibaba’s analyzing big data to anticipate customer preferences. profits outshine Amazon and think Amazon’s Whole Foods may To compare how each firm tailors technology to fit mirror Alibaba’s approach to “new retail.” local customs, lifestyles and payment abilities, we asked • Our Global Growth team thinks senior equity analysts across our Growth, Value MercadoLibre can remain the domi- and Emerging Markets teams to get their views. nant e-commerce player in South America, partly by replicating Each team approaches equities with a different invest- Alibaba’s approach to payment ment lens, but all three ground their analysis in services and consumer loans. modeling future cash flows to estimate a company’s • Each firm is integrating all aspects of retailing—from inventory to value. In the following discussion, our analysts highlight distribution and payments—into a some key assumptions in their cash-flow models, seamless continuum, though using different models. demonstrating that multiple lenses can reveal different investment opportunities.

Reshaping retail on the Alibaba and MercadoLibre didn’t need party sellers, which list their global stage to because they didn’t own inventory. products directly alongside Amazon’s Both firms initially had more in common own warehouse inventory. To say that Amazon has shaken up with eBay, allowing merchants to US retailing is almost cliché at this sell goods on their online marketplaces. Contrasting these evolving retail point. Looking globally, we see equally approaches, we start our discussion by powerful retailing earthquakes Over time, these distinctions have diving deeper into the mechanics of emanating from Alibaba in China and blurred. Alibaba and MercadoLibre Amazon. This sets the stage for a some- MercadoLibre in South America. These have been investing in logistics infra- what narrower overview of Alibaba, firms, however, aren’t cookie-cutter structure to help ensure deliveries and finally MercadoLibre. With each versions of Amazon. Whereas Amazon reach customers on time. Meanwhile, company, we focus on just a handful spent years building state-of-the-art over half of Amazon’s online sales of divisions and innovations our analysts warehouses and logistics infrastructure, now come from higher margin third- believe are strategically important to

2 Equity Markets / Three technology titans reshaping retail generating future cash flows, or for a profitable disruptor. That change higher rate than Google ads.1 That causing disruptions. One common has been driven, in part, by becoming means Amazon can make more money thread across all three is a culture of a powerhouse in online advertising. per ad. We expect Amazon will innovation and bold experimentation. generate advertising revenues of US$10 We conclude with a brief discussion of At the core of Amazon’s advertising billion for 2018, placing it in the current operating margins and the services is a rich pool of data it keeps number three position behind Google balancing act of spending to build future on the shopping habits of its estimated and Facebook in terms of digital ad growth versus generating higher near- 410 million active users globally. revenues. Going forward, our US Growth term profits. Amazon knows what customers browse team believes Amazon’s ad revenues for and buy and what they are willing will remain a significant profit stream. to pay, giving them an information Amazon—an advertising advantage over platforms that don’t Bezos’ innovation ethos powerhouse facilitate transactions themselves. Amazon hasn’t had a straight line to Amazon is big, and its disruptive impacts And because Amazon visitors are success since going public in 1997. are far-reaching—just as its name primarily there to make a purchase, And that’s perfectly fine with Jeff implies. But it has only recently become Amazon ads convert to sales at 3.5x Bezos, (CEO) and

THREE RETAILING DISRUPTORS—AT A SINGLE GLANCE Amazon Alibaba MercadoLibre

Business summary Amazon is one of the highest- Alibaba is the world’s largest MercadoLibre operates online grossing online retailers globally. online and mobile commerce marketplaces in over a dozen Dominating North America, company measured by annual Latin American countries, with Amazon built its brand on compet- gross merchandise volume. >90% of revenues coming from itive pricing, unparalleled It operates China’s most-visited , and . logistics with same-day shipping, online marketplaces: Taobao By combining its online payment and customer service. By wowing (consumer-to-consumer) and division (MercadoPago) with customers with its media, Tmall (business-to-consumer). integrated shipping and customer digital devices and Alexa-enabled Leveraging a deep pool of loyalty promotions, MercadoLibre products, Amazon deploys consumer data, Alibaba’s remains the dominant online innovative customer acquisition ecosystem now includes “new marketplace in South America. and retention tools. retail” brick-and-mortar stores— a precursor to Amazon’s likely strategy with Whole Foods.

Founder Jeff Bezos Jack Ma Marcos Galperin

Active users in 2018 410 million globally 636 million in China 249 million across

Gross merchandise volume US$390 billion US$850 billion US$13 billion

Areas of dominance • North American online retail • China online marketplaces • Latin America online • Cloud computing (AWS) • China online payments (Alipay) marketplaces • Cloud computing in China • Online payments (MercadoPago)

Key differentiators • Shipping and logistics • Digital-centric ecosystem • Robust technological • Digital devices (Alexa) • Chinese consumer data infrastructure • Cloud services (AWS) • Expanding into brick-and- • Strong payment services mortar retail division • Local knowledge of trends

Risks International expansion efforts Expansion outside China has had Main risks are macro-economic face headwinds from local incum- limited success, except Lazada. uncertainties stemming from high bents and foreign regulations. Could drain resources from its inflation and political turmoil. core China ecosystem.

Sources: Active users—company financial statements 2018. Gross Merchandise Volume—Amazon FactSet consensus estimate 2018, Alibaba financial statement calendar 2018, MercadoLibre FactSet consensus estimate 2018. For illustrative purposes.

1. Source: Varma N. “Amazon Versus Google Search: Who is Winning the Battle and How?” Marketing Technology Insights July 2018.

Equity Markets / Three technology titans reshaping retail 3 founder of Amazon. In his view, being Until then AWS was more or less hidden prefer using ’s cloud services a game changer requires experimenta- inside an “other” category for North instead of Amazon, but our US Growth tion, a willingness to fail, and a American sales. team thinks AWS can remain competi- long-term orientation that means capital tive by reinvesting in more capacity and investments can take five to seven First launched as a service in 2004, new innovations. years to bear fruit.2 This approach has AWS gives companies like NASA, led to some surprising breakthroughs, and online rival MercadoLibre Amazon’s Achilles’ heel like Amazon’s Echo smart speakers, access to Amazon’s cloud storage Waiting for Amazon innovations to powered by Alexa, the cloud-based and database infrastructure. With global deliver more profits is one thing. But voice assistant. But it’s also produced market share estimated between patience for the company gaining disappointments that unnerved 34–52%, AWS generates over half of a profitable foothold in China was shareholders, like the Fire Phone, and Amazon’s total operating profits, running thin for our Global Growth team mounting losses from failed efforts to with a US$27 billion annual revenue run as far back as 2014. Today Amazon 3 compete in China. rate as of last year’s third quarter. remains far behind Alibaba and JD.com If some digital innovations take a few in Asia and faces similar challenges On the heels of several failed launches more years to bear profitable fruit, in South America from MercadoLibre. and little progress in China, Amazon AWS can pick up the slack. See Exhibit 2. announced in early 2015 that it would break out the results of Amazon Can AWS maintain its global market Amazon isn’t alone in its global aspira- Web Services (AWS) for the first share, as shown in Exhibit 1? Large tions. Alibaba has pushed aggressively time in its financial statements. US retailers such as Walmart and Gap into the Asia-Pacific region with multiple

AMAZON MAINTAINS LEAD IN CLOUD SERVICES Exhibit 1: Worldwide market share Q2 2018 Annual Growth Rate %

Alibaba 100%

Microsoft

Google

Gaining market share; but a long way to go.

Overall Market Growth Rate Amazon IBM Rackspace

Salesforce

In a league of its own Strong niche players Oracle

0% 0% 35% Worldwide Market Share

Source: Synergy Research Group. For illustrative purposes.

2. Source: “Jeff Bezos: I’ve made billions of dollars of failures at Amazon” The Guardian December 2014. 3. Source: Synergy Research Group July 2018.

4 Equity Markets / Three technology titans reshaping retail AMAZON ACHIEVES RECORD OPERATING PROFITS OF US$3.8 BILLION experimentation and his concept of an Exhibit 2: Quarterly operating income in US$ billions interdependent “ecosystem.” From its From Q1 2015 to December 31, 2018 start in Ma’s apartment, Alibaba US$ Billions embodied the energy of a scrappy $5 Silicon Valley start-up. Each new busi- ness Alibaba launches retains the $4 autonomy Ma’s original start-up did,

$3 while also producing synergies that Alibaba’s other can leverage. $2 Case in point is Alipay, Alibaba’s online Amazon Web Services drives half of Amazon’s operating pro t payments service launched one year $1 after Taobao.

$0 Alibaba knew early on that Taobao needed something more than a colorful $-1 website tailored to Chinese aesthetics to Amazon’s international operations continue to lose money help merchants make a sale. Most $-2 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 shoppers in China didn’t own credit 2015 2015 2015 2015 2016 2016 2016 2016 2017 2017 2017 2017 2018 2018 2018 2018 cards, and many were suspicious that Total Operating Income Amazon Web Services (AWS) North America International online products might arrive as some-

Source: Bloomberg. For illustrative purposes. thing less than advertised. Alibaba developed Alipay to resolve both issues. It creates an escrow service in which acquisitions, including Singapore-based Alibaba’s retailing ecosystem cash received for a sale isn’t released Lazada in 2016. In response, Amazon Two years after Amazon went public in until the product arrives in satisfactory has refocused its efforts on India, 1997, China’s Alibaba launched a condition. Alipay was quite lucrative whose e-commerce industry is still rela- business-to-business (B2B) website for as a standalone business, but it also tively small. So too has Walmart, small manufacturers looking to export gave Taobao a leg up over e-Bay, which paying US$16 billion for a majority overseas. Alibaba’s birth as an online didn’t offer an Alipay-like service. stake in Indian e-commerce company retailing giant, however, didn’t really Today, Alipay processes 80% of all Flipkart. We think Walmart’s chess happen until four years later in 2003, transactions across Alibaba’s ecosystem move was a smart one. When it comes the year eBay acquired China’s of online marketplaces and 60% to emerging markets, merely trans- Eachnet.com. Countering eBay’s move, of China’s total mobile transactions.6 planting a US-centric business strategy Alibaba quickly launched an online without local knowledge and expertise marketplace called Taobao, connecting Consumer data drives profits can produce lackluster results. Both fledgling merchants and small Taobao’s rapid growth and ability to firms, however, received a big blow entrepreneurs with Chinese shoppers. outmaneuver eBay were extraordinary by in late December. The Indian govern- In just two years Taobao’s share any yardstick, and it became hugely ment revised rules that essentially of China’s market of small businesses profitable. Like eBay, Taobao didn’t own prohibit foreign firms like Amazon and selling to consumers—confusingly or hold inventory in expensive ware- Walmart from selling goods through referred to as consumer-to-consumer houses. Taobao’s strong operating Indian companies in which they have a (C2C)—approached 60%, forcing e-Bay margins come from consumer data, and 4 stake. If this rule goes unchanged, to close down Eachnet.com in 2006.5 the advertising services it sells to it could significantly derail the opportu- merchants eager to stand out from nities both firms originally saw in India. Alibaba’s ability to rapidly pivot and the online crowd. Advertising revenues launch Taobao came largely from also helped support Alibaba’s founder Jack Ma’s belief in

4. Source: Singh M. “Amazon and Flipkart face uncertainty as India readies new rules for foreign ecommerce companies” Venture January 2018. 5. Source: Analysys International August 2007. 6. Sources: “China 3rd Party Mobile Payment Report.” iResearch 2017.

Equity Markets / Three technology titans reshaping retail 5 business-to-consumer (B2C) market- and collect more detailed consumer place called Tmall, launched in 2008. data. The ability to follow and analyze Ant Financial By tapping into Alibaba’s vast trove of vast quantities of product and consumer In 2011, Alibaba made the Chinese consumer data, western brands data helps Alibaba eliminate inefficien- controversial decision to like Apple and Nike can better target cies with smart logistics, digital transfer ownership of Alipay to China’s rapidly growing consumer class, inventory management, anticipating a new entity under Jack Ma’s while also paying commissions to Tmall. evolving consumer trends and personal- sole control. Now called ized shopper experiences. Fast forward to the present, and Ant Financial, and 33% Alibaba’s constellation of online market- We think Alibaba’s Hema stores offer owned by Alibaba, the places generated gross merchandise a likely blueprint for Amazon to trans- company expanded beyond volume of CNY4.8 trillion (US$768 form its Whole Foods grocery chain. mobile payments to issue billion) for its 2018 fiscal year ending Launched in 2015, Hema stores serve a loans to consumers and small last March. That represents 75% of dual purpose as distribution hubs businesses. Alipay users, China’s CNY5.7 trillion online shopping for local online deliveries, and offline for example, can get revolving industry, and more than Amazon and platforms where shoppers can experi- credit lines for spare cash, eBay combined.7 ence new brands, pick fresh produce, and earn interest on unused and enjoy in-store dining. Chefs are cash balances from the

Digitizing brick-and-mortar retail on hand to prepare meals with the world’s largest money market Alibaba set a new record in 2018, ingredients shoppers just purchased. fund, Yu’eBao. Today, Ant generating US$30.8 billion in sales on Hema customers use an app to shop in Financial has issued US$95 Singles Day—an online shopping extrav- stores, which logs their purchases billion in consumer loans, aganza that Alibaba created in 2009. and preferences, lists product ingredi- more than China’s second- That’s more than the two biggest US ents and places of origin, and lets 9 Ant Financial shopping holidays—Black Friday and largest bank. them buy with Alipay or facial recogni- is expected to go public, Cyber Monday—combined. To celebrate tion technology. Revenue per square Singles Day last year, Alibaba threw a though recent trade tensions foot at Hema is 5x other grocery stores between the gala with celebrity Mariah Carey and in China, according to Alibaba. Online and China have delayed the showcased its “new retail” expansion shoppers within two miles can have initial public offering (IPO). into brick-and-mortar stores. deliveries at their doorstep within 30 Long before Amazon bought Whole minutes. About 60% of Hema’s sales Foods, Alibaba was investing in retail currently come through online delivery, Our Global Growth team sees two key chains, including a -like market but Hema’s founder Hou Yi is aiming 8 ingredients to MercadoLibre’s early called Sun Art, department-store to push that to 80% or higher. success: 1) a heavy emphasis on operator Intime, electronics retailer advanced technological infrastructure Suning, and its own home grown MercadoLibre’s evolution and, 2) tailoring its websites and grocery chain named Hema Xiansheng. from eBay to Amazon payments services to fit South America. By integrating offline and online Ten years ago when investors called Understanding Latin America’s specific retail, Alibaba wants to deliver products MercadoLibre the eBay of South local context was key to avoiding to shoppers by whatever route they America, they were halfway correct. the missteps eBay and Amazon made prefer—ordered online and delivered CEO Marcos Galperin started the in China. home, pre-sorted for in-store pick company in eBay’s image with his up, or neatly displayed so consumers Stanford business school classmates in In its early days, MercadoLibre gave can touch and experience new brands 1999. They’ve since transformed merchants the option of listing products in person. the company from an internet auction at fixed or auction prices. It quickly site into Latin America’s leading online discovered the majority preferred fixed Behind the scenes, Alibaba’s new retail marketplace on par with Amazon. prices. MercadoLibre also changed the strategy aims to digitize the entire way merchants interacted with buyers. supply chain, both online and offline,

7. Source: iResearch March 2018. 8. Source: Jacobs H. Zheng A. “Alibaba’s futuristic supermarket in China.” Business Insider May 2018. 9. Source: Kwan A. “Ant Financial Consumer Lending Reaches $95 Billion.” Bloomberg News March 2018.

6 Equity Markets / Three technology titans reshaping retail Shoppers couldn’t interact directly with from MercadoLibre merchants. Interest- from growth and value perspectives, sellers the way eBay allowed, because free loans offer tremendous value as shown in Exhibit 3. What struck MercadoLibre rightly understood to shoppers, given high interest rates in us right away was the impact Amazon’s that would likely cut it out of the trans- Latin America. This ease of doing capital-intensive business model action entirely. Instead, it developed business also increases customer has long had on its profit margins. Q&A message boards, which buyers loyalty, reducing the chances of shop- Compared with Alibaba, Amazon looks found helpful. pers migrating to rival sites like Amazon. anemic. Also noticeable are Alibaba’s declining margins and recent negative Over time, to attract more merchants These new approaches to financial margins for MercadoLibre. Given these to its busiest online marketplaces in services are one of the reasons our diverging trajectories, we asked our Argentina, Brazil and Mexico, Global Growth team thinks MercadoLibre analysts to explain their views and MercadoLibre developed logistical offers an efficient way to gain exposure reasons for remaining confident about shipping solutions through its to online retailing in South America. future cash flows. MercadoEnvios division, helping ensure As more internet users migrate to online merchant deliveries arrived on time and mobile commerce in Latin America, Amazon’s profits gain momentum for a better shopping experience. we believe MercadoLibre has the Since going public, Amazon’s heavy It also generated powerful synergies opportunity to capture a majority of investments in technology, logistics through MercadoPago, a payment these shoppers. and new products have long dampened services division. Much like Alibaba’s its operating income. Bezos must Alipay, MercadoPago offers an escrow Pathways to sustainable constantly balance between deploying service for shoppers who need to fund cash flows capital to build future growth and their accounts with cash. Today, holding back to boost near-term profits. Across our equity teams, we evaluated MercadoPago facilitates roughly 90% of It’s for this reason our US Growth recent company operating margins the transactions across MercadoLibre’s analysts think traditional valuation side-by-side so we could compare and online platforms.10 metrics like price-to-earnings and enter- contrast each firm’s accomplishments prise value/EBITDA aren’t good New financial technology It’s MercadoLibre’s push into new finan- cial technologies that holds significant OPERATING MARGINS VARY WIDELY ACROSS THREE RETAILING TITANS promise in our Global Growth team’s Exhibit 3: Amazon’s capital intensive business model stands out from its peers eyes. Half of Latin America’s population From September 30, 2013 to December 31, 2018 remains without bank accounts (or Operating Margin % credit cards), and its economies are still 60% largely cash-based. One side effect 50% for cash-based entrepreneurs is that banks won’t issue working capital 40% without a history of verified bank trans- actions. MercadoLibre, on the other 30% hand, has the data to determine credit- worthiness by tapping into its online 20% sales history and customer reviews. Spurned by banks, more merchants are 10% turning to MercadoLibre for loans. 0% For shoppers, MercadoLibre just -10% launched a digital wallet that lets users Sep Jan May Sep Jan May Sep Jan May Sep Jan May Sep Jan May Sep Dec earn interest on unused cash, as well 2013 2014 2014 2014 2015 2015 2015 2016 2016 2016 2017 2017 2017 2018 2018 2018 2018 as interest-free loans to buy products Alibaba Amazon MercadoLibre Source: FactSet. For illustrative purposes.

10. Source: MercadoLibre November 2018.

Equity Markets / Three technology titans reshaping retail 7 The Amazon effect Amazon grabbed the spotlight in 2017 when it bought Safeway in 2015. But with US$12 billion in debt, Cerberus’ Whole Foods—nicknamed “whole paycheck” for its pricey plans to unload Albertsons through an IPO have stalled. organic produce and ethically sourced proteins. In one fell swoop, Amazon pivoted into the brick-and-mortar grocery It turns out that scale alone is not enough to succeed, as business that its Amazon Fresh delivery service was struggling Kroger’s push into online grocery proves. We believe to disrupt. The market noticed. In recent years, publicly investments in technology are necessary to amplify economies listed grocery chains, drugstores and healthcare insurance of scale and offer more digital conveniences consumers providers all saw their share prices plummet when the media are looking for these days. Kroger is taking these steps reported Amazon was approaching, as shown in Exhibit 4. through ambitious acquisitions and partnerships. Last May, Clearly, the market takes Amazon’s disruptive retailing power Kroger bought a minority stake in the UK online grocer quite seriously. Ocado, striking an exclusive deal to build 20 robotic ware- houses in the United States to service its online traffic. Of course, Amazon isn’t the only disrupter. Performing an Using robots to pick and pack grocery orders should enable autopsy on a decade of brick-and-mortar bankruptcies, Kroger to shave off labor costs and improve margins. we note many struggled with large debt burdens as privately Kroger’s customers won’t ever interact with its warehouse owned companies. Using leveraged buyouts to gobble up robots, but its online shoppers in Scottsdale, Arizona, are a floundering business certainly has merits in a steady state already receiving their orders from Kroger’s fleet of self-driving environment. But in today’s rapidly evolving world of digitized cars. Kroger is testing driverless deliveries to gauge customer retailing, servicing too much debt can be damaging if you experiences before expanding to more stores. aren’t also investing in new technology. Our Value team put Kroger under the microscope just after That’s been the case with US grocer Albertsons. A creature Amazon’s Whole Foods announcement, sensing a potential of leveraged buyouts, Albertsons’ private equity parent bargain. They think Amazon’s disruptive impact may create Cerberus rightly thought economies of scale were critical for better share prices for some viable companies—whereas survival in the age of Walmart. Since 2014, dozens of Amazon’s own growth story doesn’t make sense to them from smaller US regional grocery chains have filed for bankruptcy, a valuation perspective. In their eyes, Kroger is a survivor and including Southeastern Grocers’ Winn-Dixie and Bi-Lo potential thriver despite the Amazon threat, largely because chains. To avoid a similar fate, Albertsons became the second of its scale and strategic investments in new technology. largest traditional grocer behind Kroger after merging with

THE AMAZON EFFECT—SPANNING GROCERY, DRUGSTORE AND INSURANCE INDUSTRIES Exhibit 4: Share price declines following market-moving Amazon announcements Chart shows stock price history for some of the affected companies from date of announcement to 1 month post announcement date. Prices are normalized to 100 on date before announcement. US$ Date: 06/16/17 Date: 01/31/18 Date: 06/28/18 $105 Announcement: Amazon to buy Announcement: Amazon to join JP Morgan Announcement: Amazon to buy online Whole Foods Markets. and Berkshire Hathaway to reduce health pharmacy Pillpack. care costs in US. $100

$95

$90

$85

$80 15 19 21 23 27 29 3571113 29 31 26812 14 16 20 22 27 29 35911131719232327 Jun 2017 Jul Jan 2018 Feb Jun 2018 Jul Kroger Walmart Target MetLife United Express CVS Walgreens Health Scripts

Source: Bloomberg. Historical stock prices are shown one month following an Amazon announcement. Prices normalized to 100 on day of announcement. For illustrative purposes.

8 Equity Markets / Three technology titans reshaping retail yardsticks for Amazon.11 Simply put, So how does Alibaba steer margins Nevertheless, our Global Growth team these metrics aren’t a reliable snapshot back in an expanding direction? Our is confident these investments can pay of Amazon’s long-term profit potential, Emerging Markets team sees a couple off by improving the customer experi- in our analysts’ views. of avenues, starting with growing ence and by attracting more merchants. its cloud computing business in China. Case in point are Amazon’s growing Alibaba also aims to help more The retail revolution is accelerating profit margins over the past year. brick-and-mortar retailers digitize their The reality of today’s digitized market- Operating profits were a record US$3.8 own back office supply chains through place means that not only has shopping billion in last year’s fourth quarter— smart logistics, and by boosting changed dramatically in just a decade, the fifth consecutive quarter that front-end traffic by tapping into the rate of change continues to accel- Amazon topped $1 billion of net income Alibaba’s deep pool of consumer data erate. It’s now easier for shoppers to get since 2017’s fourth quarter. Our US and cloud analytics. We see Alibaba tailored items and access products Growth analysts think Amazon’s margin less as a collection of e-commerce more quickly and conveniently than ever expansion story is finally taking root, marketplaces and offline retail hubs, before. Technology pioneers like thanks to strong advertising revenues, and more as a data-centric ecosystem Amazon, Alibaba and MercadoLibre AWS profit margins and selling more that drives profits through digitization are largely responsible for setting new high-margin third-party merchandise. and technology, while generating better standards in the world’s biggest customer experiences. markets—continually improving Alibaba’s data-centric ecosystem customer experiences by anticipating Unlike Amazon’s recent positive profit Building warehouses to stay on top their preferences, lowering prices momentum, Alibaba’s operating MercadoLibre is investing in shipping and delivering items faster. Plowing vast profits have faced headwinds from logistics and consumer incentives amounts of capital into new innovations spending on businesses outside its core to shore up its commanding lead over (sometimes to the detriment of near- China retail marketplace, including competitors like Amazon. Taking a term profits), these companies are logistics infrastructure, local food page out of Amazon’s playbook, raising the bar for everyone by reshaping delivery services where it competes with MercadoLibre is building new ware- customer expectations. We believe a Tencent-backed rival, and Lazada houses to serve as cross-docking each company bears close watching to in Asia. Profits from its “new retail” locations. It receives products from understand where the retail landscape stores will likely take years to materi- merchants at one end and then is heading next. alize. Agile competitors with deep turns around and delivers orders more pockets mean Alibaba needs to spend efficiently to customers at the other to keep existing customers happy and end. Yet costs to build these fulfillment to lure new ones. centers, plus free shipping incentives, have taken a noticeable bite out of profit margins in the past year.

11. Price-to-earnings is a ratio for valuing a company that measures its current share price relative to its per-share earnings. Enterprise value is a measure of a company‘s total value, often used as a more comprehensive alternative to equity market capitalization. EBITDA, or earnings before interest, taxes, depreciation and amortization, is a measure of a company‘s overall financial performance and is used as an alternative to simple earnings or net income in some circumstances.

Equity Markets / Three technology titans reshaping retail 9 Franklin Templeton Thinks: Equity Markets highlights the global views our equity invest- ment teams have across developed and emerging economies, sectors and individual companies. Each quarterly issue spotlights fresh insights that our analysts and portfolio managers bring to active security research, examining risks and opportunities from both growth and value frameworks.

Primary contributors to this issue

Stephen H. Dover, Purav A, Jhaveri, Dan H. Searle, Mary Killian Tek Khoan Ong, Katherine S. Owen, CFA CFA CFA, FRM CFA Research Analyst CFA Portfolio Manager / Head of Equities Investment Strategy / Research Analyst Franklin Equity Group Director of Research Research Analyst Franklin Templeton Portfolio Manager Franklin Equity Group Franklin Templeton Investments Franklin Templeton Emerging Markets Templeton Global Investments Equity Equity Group

10 Equity Markets / Three technology titans reshaping retail WHAT ARE THE RISKS? All investments involve risks, including possible loss of principal. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Special risks are associated with foreign investing, including currency fluctuations, economic instability and political developments. Invest- ments in emerging markets involve heightened risks related to the same factors, in addition to those associated with these markets’ smaller size and lesser liquidity. Investments in fast-growing industries like the technology sector (which historically has been volatile) could result in increased price fluctuation, especially over the short term, due to the rapid pace of product change and development and changes in government regulation of companies emphasizing scientific or technological advancement or regulatory approval for new drugs and medical instruments.

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