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Several years experience as an analyst in the hedge fund world. Investment knowledge includes long/short equities, credit, macro, arbitrage, distressed debt, and special situations. Previous research publication experience includes Japanese small cap research distributed to institutional investors. Education credentials include BS in Computer Science, MBA in Finance, and CFA Charter. Follow on Twitter @ChinaStockRsrch Follow on StockTwits @ChinaStockResearch

Alibaba Q3 FY2015 Results

Arguably this week’s most-anticipated earnings release, for investors in US-listed China stocks anyway, was Alibaba’s (NYSE:BABA). The company reported a solid beat on EPS ($0.81 vs. $0.75 est.), but revenue that fell short of consensus ($4.2 vs. $4.5 billion est.), which sent the stock tanking, closing lower nearly 9% on volume three times heavier than average.

Here’s a quick recap of the quarter’s performance:

  • Revenue hit 26 billion RMB ($4.2 billion), up +56% QoQ, +40% YoY
  • Operating profit reached 9.3 billion RMB ($1.5 billion), up +115% QoQ, +6% YoY
  • Operating profit margin was 36% vs. 26% last quarter and 47% in Q3 last year
  • Net income was 5.9 billion RMB ($964 million), up +97% QoQ, -28% YoY
  • Net profit margin was 32% vs. 18% last quarter and 45% Q3 last year

Fixed expenses were up on an absolute basis vs. earlier quarters, and as a percentage of sales were 36%, down vs. last quarter’s 41% but higher than earlier quarters. Alibaba increased spending in product development during Q3, and also boosted sales and marketing, items which could provide longer-term payoffs. The near-term increase in costs, however, was one of the reasons for the Q3 earnings miss.

There were some bright spots in the earnings release, like growth in mobile, which contributed a larger portion of total gross merchandise volume than prior quarters. Ironically, the changing mix to more mobile business was one of the factors impacting revenue – non-mobile sales are relatively more lucrative for the company than mobile sales. Monthly active mobile users (those users who made a purchase during the period) hit 265 million in the quarter, growing +22% QoQ and nearly doubling YoY. Although there were clearly some effects on the top line from the growing mobile business, operating metrics are demonstrating clear progress in growth, and achieving an enviable scale.

But the elephant in the room was undoubtedly the potential impact from recent reports that the State Administration for Industry and Commerce (SAIC) specifically identified Alibaba as conducting or abetting a host of illegal activities on its platforms. Specifically, the SAIC identified some unfair business practices (bullying merchants), turning a blind eye to counterfeit products and shady online merchants, accepting bribes for favorable search rankings, allowing misleading advertisements, and rigged merchant feedback (here’s more detail).

The bombshell in the SAIC report was that publication was delayed so as to not disrupt Alibaba’s IPO process. Whether or not that is true, or just how much Alibaba knew beforehand, is the question of much debate. The SAIC has apparently taken steps to backpedal a bit, deleting the main link to the report; however, it is still available online.

Management did address this issue on the earnings conference call (excerpt here), remarking that it had no prior knowledge of the report, and also pointed out that fake products are available from offline retailers also (very true). Additionally, the company took the bold move of pointing out what it saw were flaws, and said that it would file a formal complaint against the SAIC.

What will happen next is anyone’s guess. The fact that Alibaba decided to publicly challenge the government’s accusations is a somewhat unusual approach. Chinese companies usually tacitly acknowledge the supreme power of the government by taking a humble and remorseful approach when accused of any misdeeds, but Alibaba seems to be taking the challenge head-on.

Taken in a broader context, it seems that this event may herald increased scrutiny of China’s Internet, both in terms of content and e-commerce. For some investors not considering the potential impact of a regulatory crackdown,there could be some more surprises ahead.

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