Will Alibaba Acquire JD.com

1 Will Alibaba Acquire JD.com Founded in 1999, Alibaba Group is a Chinese multinational corporation whose founded is known Jack Ma. It is a multinational technology company that specializes in facilitating consumer-to-consumer (C2C) services through Taobao, business to business trade (B2B) services through Alibaba, and business-to-consumer (B2C) services through Tmall. It operates in a wide array of sectors, including e-commerce, technology, retail, and internet. Alibaba became a publicly listed company in September 2014 and generated $25 billion from its initial public offering (IPO) (Akdeniz, 2014). The company is highly successful; it is the 59th largest public company in the world and is listed as one of the top 10 most valuable corporations. In addition, it is also the largest e-commerce platform in the world and is considered to be among the most valuable artificial intelligence and internet companies in the world. Since 2015, it generates significantly higher income than Walmart, Amazon and eBay combined.

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2 JD.com, formerly known as 360buy is also referred to as Jingdong. Founded in 1998, it is an e-commerce platform whose headquarters are based in Beijing, China. It a huge player in the B2C online retail industry in China and a member of the Fortune Global 500. It is also one of the major competitors of the Alibaba owned B2C marketplace, Tmall. The company has invested significantly in drone delivery systems, infrastructure and capability. Additionally, it is currently constructing drone delivery airports and testing the concept of offering delivery services through robots. Tencent has a 20% stake in JD.com. Essentially, JD.com is a successful company with great future prospects, and Alibaba would benefit from acquiring it.

Is JD.com a perfect fit for Alibaba?

Since its inception, the revenues and growth of JD.com have increased at a rapid rate.

The company also invests significantly in developing its technologies and infrastructure in order to continue to generate high revenues.

Alibaba and JD.com command the largest market share of the e-commerce industry in China. Alibaba commands a 59% stake and JD.com is its closest rival with a 17% share of the market (Charles, 2014). Both companies are listed in the stock market and value of their shares have steadily risen since they went public. Despite the fact that they operate in the same industry, their business models are strikingly different. Alibaba provides a platform for buyers and sellers to transact, and does not take on any inventory. It earns revenues in the form of listing fees and commissions from providing logistics services as a third-party. JD.com, conversely, purchases inventory, storing it in warehouses, and therefore has a more complex supply chain. As a result, it generates revenue from direct sales. It therefore has lower margins than Alibaba. According to JD, this strategy gives it a better control of the market and also gives it better control of the quality of products it supplies (Kumar, 2016). Alibaba’s CEO, Jack Ma considers JD’s business

3 model to pose a great risk, and said that it is likely to end in tragedy. If Alibaba acquires JD, it would be able to dictate its business model Alibaba’s e-commerce platforms are also more varied than JD’s. It provides B2B, B2C and C2C services, whereas JD only operates in the B2C sector. Despite the differences in their business models and the type of customers they serve, JD has a large customer base. Its annual active customers are approximately 330 million. JD is a worthwhile investment because it has high potential for growth. Despite only doing B2C business, it still commands a large market share PESTEL Analysis of E-Commerce E-commerce continues to experience immense growth and advancements in technology continue to provide a favorable environment for further growth. While China and US are the greatest players in the industry, China will continue to dominate the United States into the foreseeable future.

Political Factors There are various political and legal factors affecting advancements in e-commerce. For instance, the growth of global e-commerce corporations such as Amazon and Walmart in Asia is curtailed by government imposed trade restrictions. In retaliation, the United States also imposes trade barriers (Ibrahimi, 2018). Political and legal issues also extend to the level of political stability and bureaucracy in a country. E-commerce thrives when there is high political stability and low bureaucracy.

Economic Factors Economic factors play a major role in the development of the industry. During periods of high economic growth, spending increases, therefore enhancing the advancement of e-

4 commerce. However, during periods of recession, the economy shrinks, and people have lower spending power. This slows down the growth of e-commerce.

Social factors Social and cultural factors have a significant impact on Alibaba and JD. They are both successful and widely accepted in China. However, their growth in foreign markets may not be as rapid due to differences in social and cultural factors. For instance, some countries have not yet fully adopted mobile technology for shopping, preferring to use more traditional approaches.

Social and cultural factors also affect how these corporations market themselves, and how different marketplaces around the globe perceive these advertisements.

Technological Factors The development of e-commerce can be attributed to the advancements in technology.

Both JD.com and Alibaba have invested significant amounts of capital in developing advanced technologies and creating infrastructure that facilitates continued economic growth. JD, for instance, is the world leader in drone delivery and is currently exploring robot deliveries and the construction of a drone airport.

Environmental Factors In recent years there has been increasing focus on the environmental impact that businesses have due to the realization of the adverse effects of environmental degradation such as global warming. E-commerce has a very low direct impact on the environment. Investing in sustainability also helps to improve the image of the organization. JD.com should reduce its supply chain to make it more sustainable. Other ways of improving sustainability include using sustainable packaging, investing in renewal energy and implementing waste reduction measures (de Kluyver, 2013).

5 Legal Factors JD.com and Alibaba are required to be compliant with the laws of various countries around the world. It is important to hire legal teams that can provide accurate advice on compliance issues. It is important to note the negative impact of non-compliance on the organization, and take the appropriate measures to ensure it is compliant.

The Financial Ratios of Alibaba and JD.com Working Capital Current Asset - Current Liabilities

312

132.49

Current Ratio 0.9 Current Asset / Current Liabilities

1.8

9

Acid-Test Ratio (Cash + Account receivable) / Current Liability

1.5 2.67 7

Margin 14.

Net Income / Sales

28.4 42

Turnover 6.9 Sales / Average Assets

9.62 4

ROE Net Income / Average Equity

24

17.

6 24 P/E Ratio 101 Market Price / EPS

148

.88

Dividend Payout Ratio 1.1 Annual Dividend per Share / EPS

1.21 9

Dividend Yield Annual Dividend per Share / Market Price per Share

4.20 %

3%

Debt Ratio 52.2 Total Liability / Total Assets

5%

61.

26%

Debt to Equity Ratio 21.1 Total Liability / Total Equity

3%

31.

52%

("JD Financial Statements 2012-2020 | JD", 2020) Alibaba has a healthy working capital which indicates that it has sufficient capital to effectively run the business. JD.com, on the other hand, has a negative value working capital, which means that its current liabilities are higher than its current assets ("JD Financial Statements 2012-2020 | JD", 2020). The working capital deficiency is not significant enough for Alibaba not to acquire JD. However, JD should work on improving its working capital position by generating more revenues through increasing its sales. If Alibaba acquires JD.com, it can

7 correct the working capital issue by changing its business model to reduce the amount of inventory it carries and focus on acting as a third party between buyers and sellers.

Both companies have a positive current ratio, showing that they are able to meet their obligations as they arise. Investors are more willing to acquire companies whose current assets exceed the current liabilities. Therefore, JD.com is a viable investment for Alibaba.

JD.com has fairly low acid-test ratio, which shows that it manages it should better manage its cash flow. The financial statements and ratios of JD.com show that it is a healthy company that would earn its investor. The financial statements also reveal that Alibaba has enough free cash flows to acquire JD. These ratios also reveal that JD is a good fit for purchase.

SWOT Analysis if the Merger Succeeds Strength JD has several strengths that would be of benefit to Alibaba. Firstly, JD is committed to offering good-quality products and customer service. As a result, it has good brand equity, and has a high number of loyal customers. Secondly, JD.com generates billions of dollars in revenues every year from sales, and it has the potential to make its market share even larger (Charles, 2014). Thirdly, JD.com is a highly innovative company that has developed the art of adapting new technologies promptly. It has well-developed infrastructure, some of which Alibaba does not own. Alibaba will therefore benefit from its acquisition of JD.com. Fourthly, JD.com has been in the e-commerce industry for over two decades, and has therefore garnered significant experience, skills and knowledge in the industry. It has invested huge resources in training its workforce to ensure continued growth and learning. It therefore has the potential to continue growing and becoming more successful. Fifth, JD.com has developed a robust distribution network over the years, which enables it to deliver goods to its market effectively.

8 Weaknesses Despite its numerous strengths, JD.com also has weaknesses that it can improve on. The company needs to market itself more aggressively to increase its market share. Currently, it allocates only a small proportion of its revenues to marketing. Secondly, JD.com’s investment in Research and Development is also below the industry average. If it invested more of its resources on R & D, it would be able to develop a higher competitive advantage. JD.com also has poor demand forecasting, causing it to end up with high inventory levels, which negatively affect its profitability. Fourthly, the business model of JD.com where it stocks products in its warehouse increases its risks of losses due to high storage costs, risk of product damage, and obsolescence.

To eliminate this risk and also increase its profits, the company should minimize on retailing and focus on acting as a third party between buyers and sellers.

Opportunities JD.com currently serves only the B2C segment yet it generates earnings worth billions of dollars. Its success in this segment gives it an opportunity to expand to B2B and C2C. JD also has the opportunity to convert its business model from being a retailer to acting as a third-party between buyers and sellers. This model will enable it to reduce the risk of losses, earn higher revenues and increase its potential to reach a wider market. The company also has a variety of new technologies to adapt that could make it even more effective. The e-commerce industry is continually growing and evolving, and there are several new revenue streams that are available to companies that are prompt to learn the new trends in the industry.

Threats The global economy is currently in a state of recession, therefore it is not the right time for Alibaba to acquire JD.com. The best time for an acquisition is when the economy is stable.

9 Secondly, there is increasing rivalry in the industry from multinational corporations such as Walmart, eBay and Amazon. The increasing competitiveness in e-commerce poses a threat to the profitability of JD.com. This might cause it to lose its investment viability. It is important for Alibaba to develop effective strategies as it considers acquiring JD.com to ensure that it retains its market share. JD.com’s profitability is also threatened by the rising material and operational costs, which are likely to continue increasing due to the turbulent economic environment.

Additionally, Alibaba and JD.com have varying business models and the founder of Alibaba believes that the business model of JD.com is fundamentally wrong. If Alibaba acquires JD.com, these differences could expose it to the threat of a company whose revenues might become unstable (Zhu, 2018). It is therefore important for Alibaba to determine whether it is best to let JD.com retain its business model or to make changes to it.

What is the Maximum Purchase Price of the Acquisition?

To determine the acquisition price, it is crucial to study the financial statements of JD.com. A DCF analysis will be used to forecast the company’s free cash flows for the next five years. The formula used to calculate the discount rate is k – rf + b(rm – rf) (Husby, 2017). To find the purchase price of the acquisition, the company’s growth is divided into two stages, In the first period, JD.com is assumed to grow at a higher rate, and in the second period, the growth rate is assumed to have stabilized. In this case, we shall assume the company’s cash flows for the next ten years based on the current cash flows. The discounted cash flow (DCF) is based on the idea that the value of money depreciates over time, therefore, the value of a dollar today is higher than the value of the same dollar in the future.

Present Value of 10-year Cash Flow = CN ¥243b (Husby, 2017).

10 The present value of future cash flows for the 10-year period should be followed with the terminal value. The terminal value helps to determine the price at which Alibaba will purchase JD.com. The terminal value is determined through the Gordon Growth Formula. The growth rate should be equal to the 10-year government bond rate of 1.7%. The terminal cash flows will be discounted to the current value at a rate of 11%. This rate represents the cost of equity.

Terminal Value (TV)= FCF2029 × (1 + g) ÷ (r – g) = CN¥58b× (1 + 1.7%) ÷ 11%– 1.7%) = CN¥655b ("JD Financial Statements 2012-2020 | JD", 2020) Present Value of Terminal Value (PVTV)= TV / (1 + r)10 = CN¥655b÷ ( 1 + 11%)10= CN¥236b ("JD Financial Statements 2012-2020 | JD", 2020) Alibaba would therefore acquire JD.com at CN¥240 billion.

How the deal would be financed and the risks At the end of the first quarter of 2020, Alibaba had $53 billion in cash, which if converted to Chinese Yuan is approximately CN¥378 billion ("Alibaba - Stock Price History | BABA", 2020). This shows that it can easily afford to purchase JD.com using its cash and cash reserves. Alibaba could use some of this cash to finance the acquisition. JD.com is a worthwhile investment, therefore, buying it cash would still guarantee returns. Alibaba’s share holder equity is valued at $122,945 million, which translated to Chinese Yuan is CN¥866 billion ("Alibaba Stock Price History | BABA", 2020). Alibaba, therefore, has sufficient finances to acquire JD.com through a combination of both cash and shareholder’s equity.

Recommendation for Alibaba The above calculations show that Alibaba would benefit from acquiring JD.com. The acquisition would help to accelerate JD.com’s growth because it would have access to a wider

11 pool of capital, a more effective business model, as well as better growth and marketing strategies. JD.com has the potential to become a larger company than it already is by opening itself up to serving all the e-commerce segments instead of focusing solely on B2C.

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