Deutsche Bank Research Asia Industry Date China 27 May 2019 China E-commerce Technology Initiation of Coverage Software & Services A tale of two camps - and we favor the one with strong growth prospects Han Joon Kim We have a growth bias in the China e-commerce landscape and hence favor Alibaba Research Analyst and Pinduoduo (PDD). We also like VIPS as a GARP stock. We reiterate Buy on Aliba- +852-2203 6157 ba, initiate coverage of PDD as a Buy, VIPShop (VIPS) as a Buy, and JD.com (JD) as a Hold. We adjusted Alibaba's valuation in synchronizing all our e-commerce Maria Ma Research Associate stocks, which lifts its target price to US$220 from US$197. In this report, we look +852-2203 6242 at the key themes reverberating across the China e-commerce landscape, which we have put together after our interviews with companies, industry experts and merchants. We look at the evolution of the FMCG segment and the demographic Key Changes and geographic penetration in China, along with a comparison of the key metrics Company Target Price Rating and market positioning of leading companies. BABA.N 197.00 to 220.00 - JD.OQ - to 29.40 - to Hold PDD.OQ - to 26.20 - to Buy We favor the growth-oriented camp VIPS.N - to 9.30 - to Buy At the risk of oversimplifying a dynamic and complex market, we see two camps Source: Deutsche Bank emerging in the Chinese e-commerce landscape. One camp comprises companies with a meaningful TAM (total addressable market) outlook but a weaker near-term profit momentum as they invest in operations. We include Alibaba and PDD in this Companies featured growth-oriented camp. The other camp consists of companies with slower top-line Alibaba (BABA.N), USD156.00 Buy growth but which are transitioning towards a focus on sustainable profit rather than 2019A 2020E 2021E P/E (x) 29.7 22.7 16.5 revenue growth. JD and VIPS are in this camp. Both camps are equally viable as EV/EBITDA (x) 21.7 16.6 11.6 investable stocks but we favor the growth-oriented camp for two reasons. 1) We are EV/FCF (x) 35.1 29.1 21.4 not paying for a significantly higher valuation of these stocks' underlying core oper- JD.com (JD.OQ), USD26.70 Hold ations. For example, Alibaba is trading at 17x EV/EBITDA vs. JD at 22x in CY19E and 2018A 2019E 2020E P/E (x) 69.7 35.7 25.0 PDD is trading at 7x EV/FCF vs. VIPS at 10x in CY20E. 2) The latter camp has shifted EV/EBITDA (x) 42.9 21.9 14.9 to a profit-focused strategy in the past few quarters and we are not yet sure whether EV/FCF (x) - 42.5 12.7 this strategy will be sustained and executed on a multi-year basis. After all, China Pinduoduo (PDD.OQ), USD20.53 Buy has a dynamic e-commerce scene that is prone to new competitive and regulatory 2018A 2019E 2020E risks. P/E (x) -30.3 -35.1 40.7 EV/EBITDA (x) -40.9 -20.7 35.4 EV/FCF (x) 18.3 21.5 7.2 KPI comparison across e-commerce platforms, including a merchant ROI analysis Vipshop (VIPS.N), USD7.50 Buy Given the notoriously different disclosure metrics and definitions across the com- 2018A 2019E 2020E P/E (x) 12.9 11.2 8.3 panies and data sources, we spent a meaningful amount of time curating the data EV/EBITDA (x) 7.2 6.1 4.3 shown herein . We compare and contrast key KPIs such as the GMV, fulfilled order EV/FCF (x) 13.5 18.2 10.0 volume and average ticket size, fulfillment cost and user acquisition efficiency of Source: Deutsche Bank leading e-commerce players. We took time to interview merchants and analyze Deutsche Bank AG/Hong Kong Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report Distributed on: 26/05/2019 21:00:14 GMT as only a single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI (P) 066/04/2019. THE CONTENT MAY NOT BE DISTRIBUTED IN THE PEOPLE'S REPUBLIC OF CHINA ("THE PRC") (EXCEPT IN COMPLIANCE WITH THE APPLICABLE LAWS AND REGULATIONS OF PRC), EXCLUDING SPECIAL ADMINISTRATIVE REGIONS OF HONG KONG AND MACAU. 7T2se3r0Ot6kwoPa 27 May 2019 Software & Services China E-commerce data on brands and customers, which resulted in our merchant ROI calculations of different e-commerce platforms. The results present a clearer picture of market positioning and the key pain points, which we advise investors to look out for. For one, we believe PDD will need to justify its merchant ROI over the coming quarters. Valuations and key risks Our analysis of the historical valuations of the e-commerce stocks indicates that investors have valued growth significantly over value in this space; there is a wide range of valuations, depending on the perceived growth prospects. We use EV/ EBITDA and EV/FCF to focus on a cash-based earnings outlook. The key industry risks are increasing user acquisition cost due to competition, regulatory interven- tion, and an aggressive pace of investment. Page 2 Deutsche Bank AG/Hong Kong 27 May 2019 Software & Services China E-commerce Table Of Contents Industry overview...............................................................5 Focus on New Retail for growth........................................................................5 Geographic expansion.......................................................................................8 Focal points for key e-commerce stocks in 2019..............14 Profit margin trend to stabilize in 2019E; signs of a rising marg......................14 Driver of profit margin #1: User acquisition cost.............................................16 Driver of profit margin #2: Compare unit economics among merchant .......... 16 Valuations.........................................................................18 Valuation framework ....................................................................................... 18 Valuation details..............................................................................................18 Valuation comparisons....................................................................................19 Alibaba.............................................................................23 JD.com.............................................................................25 Outlook and financial forecasts........................................27 Valuation and key risks.....................................................33 Valuation..........................................................................................................33 Key risks...........................................................................................................33 Company profile...............................................................34 Shareholding structure....................................................................................34 Management profile........................................................................................35 Pinduoduo........................................................................36 Outlook and financial forecast..........................................38 Marketing cost is the key variable in turning profitable...................................39 Financial forecasts...........................................................................................40 Valuation and key risks.....................................................45 Valuation framework ....................................................................................... 45 Key risks...........................................................................................................45 Company profile...............................................................46 Shareholding structure....................................................................................46 Management profile........................................................................................47 Vipshop............................................................................48 Outlook and financial forecasts........................................50 Deutsche Bank AG/Hong Kong Page 3 27 May 2019 Software & Services China E-commerce Table Of Contents Valuation and key risks.....................................................55 Valuation framework ....................................................................................... 55 Earnings sensitivity..........................................................................................55 Key downside risks..........................................................................................56 Company profile...............................................................57 Shareholding structure....................................................................................57 Management profile........................................................................................58 Page 4 Deutsche Bank AG/Hong Kong 27 May 2019 Software & Services China E-commerce Industry overview We see two main industry trends driving the corporate strategy of major e-com- merce players in China: 1) a category shift towards FMCG and a repositioning of core expertise, and 2) diverse demographic and geographic segmentation, which encourages companies to seek a larger user base. Focus on New Retail for growth Key growth focus in underpenetrated FMCG segment One of the key underlying themes in e-commerce continues to be the push towards FMCG (fast-moving consumer goods) segment penetration, as e-commerce evolves from standardized products