Baozun: Investing in the Shopify of China

Introduction

The company started by providing brand e-commerce solutions in China in August 2007 through Shanghai Baozun, a PRC limited liability company founded by Mr. Vincent Wenbin Qiu (CEO), Mr. Junhua Wu (CGO), Mr. Michael Qingyu Zhang and several other individual investors.

As they began to expand their business outside of mainland China, the group established Baozun Hongkong Limited in September 2013, which currently still serves as the operation center in Hong Kong. In December 2013, they incorporated the holding company, Baozun Cayman Inc., under the laws of the Cayman Islands.

In 2015, Boazun offered its shares to the broader public with its IPO on the Nasdaq Stock Exchange raising 110 million USD, which was somewhat less than investors had initially expected. Its valuation at the time was around the 600 – 700 million USD region.

Since 2018, the company has pivoted technology as its primary focus. Baozun expects technology to significantly influence the retail industry going forward, as illustrated by its slogan “Technology empowers future success”.

The industry

The Brand E-commerce Industry is a very fragmented market. In 2019, a research firm reported Baozun as the market leader with a 7.9% market share. Moreover, the top five players in China have a combined market share of 14.1% (Baozun, 2020).

Of course, a lot depends on how you define the industry and its scope. We can assume the scope includes (partner product) sales where Baozun takes care of the entire supply chain from inventory to delivery and customer service, but do you add “placeholders” on online platforms or in physical stores through consignment deals? And what if a foreign brand only relies on Baozun for a specific marketing tool, or merely for IT support?

The customization that Baozun offers is obviously valuable to its partners, but it’s hard to tell what part of its business can be categorized as part of a broader industry, and to what extent Baozun is unique in its offering within this industry. We’ll take a closer look at Baozun’s different segments in section 2.2 and section 3.1.

Recent news: Partnership with iClick

Recently (January 26th), Baozun announced a strategic cooperation with iClick, an independent online marketing and enterprise data solutions provider in China. As a result of this news, the stock rose about 35% on one day, likely following somewhat of a short squeeze with trading volume six times its normal level. A significant 20% of its shares where sold short around the time of the announcement. Currently, short interest stands at around 14%.

Baozun obtained a significant portion (around 4%) of iClick’s capital, representing approximately 10% total voting equity. As part of the transactions, Baozun and iClick have entered into a strategic cooperation framework agreement, pursuant to which both parties will collaborate in developing a full-cycle, closed-loop e-commerce service model, covering areas such as system development, IT services, digital marketing, store operation, customer services and warehousing and fulfillment services to better serve potential brand partners CITATION Glo21 \l 2067  (GlobeNewswire, 2021).

Also key in the deal is that both companies will develop a private domain traffic platform for Tencent, the tech giant and owner of WeChat. Private domain traffic is a way of grouping customers with similar buying habits or interests with the objective of triggering sequential purchases.

iClick is an established (Platinum) Tencent partner, co-developing SaaS-based retail solutions and relying on its cloud, chatbot and facial recognition technology CITATION PRN20 \l 2067 (PR Newswire, 2020).

To our view, this partnership makes sense as its gives both companies a way to integrate its services and provide an improved offering for its partner brands. It might also lead to increased cooperation with Tencent in the future.

Recent news II: Acquisition of Full Jet

The news didn’t stop there! On February 3^rd, Baozun announced the acquisition of Full Jet Limited, a luxury-focused brand-management company in China. It did not disclose any price, but said it was paying 12.5 times Full Jet’s 2020 EBITDA. As 2020 wasn’t a regular year with the pandemic, we believe Baozun did not overpay for this acquisition based on this multiple. Payment was done 50% in cash and 50% in deferred payments in cash or equity over the following three years.

Baozun management said the combination would help the company unlock 20 bln RMB (around 3 bln USD) in new GMV over the next three to five years. The full Jet Management is kept on board, subject to annual performance targets over the next three years

During the week of the announcement, Baozun jumped another 20% after losing some of the previous gains following the iClick Deal. It’s currently trading at the highest level since September 2019. 

Both moves illustrate Baozun’s vision to consolidate its lead in the fragmented brand e-commerce industry. The coming years will provide more insights into whether Baozun is able to successfully merge the different businesses.

Baozun senior management

The company has an established executive team, with the co-founders still actively involved in the daily operations.

Partner brands

Chinese E-commerce service providers often reach news headlines when they are able to attract well-known foreign brands. Some examples are listed below:

• Ikea choosing to partner with Tmall (Alibaba) as its first third-party marketplace in China
• Farfetch, a luxury good marketplace, partnering with Alibaba with Baozun providing the logistic support
• LG International deciding to partner with JD.com

Baozun has a network of over 260 partners including 15 out of the top 50 most valuable global brands ^[1]. Partner brands include Nike, Philips, Starbucks and Microsoft.

In Q3 of 2020, it reported that it was able to attract an additional 10 brands, without disclosing any specific names. The ability in which Baozun can continue to team up with global, well-known brands is essential for company’s future.

Baozun is also one of the primary TP’s (Tmall partners), which are third-parties certified by Tmall (Taobao Mall) to help local and foreign sellers with their marketing, logistics, IP protection, technology development and more. In April 2020, Baozun was rewarded the “TMG Partner Award of FY2020”. In November, its management disclosed that about 70% to 75% of its revenue is gained through its partnering with Tmall, and that it is looking for other platforms to partner with (as illustrated by the recent deal with iClick).

Business model

Baozun separates its revenue by distinguishing “Product Sales” and “Services”. They respectively account for around 45 and 55 percent of revenue. Revenue from product sales is considered all the revenue it captures from foreign and domestic brands where Baozun operates either as intermediary or end-to-end seller. Revenue from services includes specific offerings in areas like fulfillment, IT, marketing, etc.

An important metric for any party involved with E-commerce its GMV, or Gross Merchandise Volume. Baozun defines its GMV as the sum of:

• the full value of all purchases transacted and settled on stores operated by Baozun
• the full value of purchases for which customers have placed orders and paid deposits (through Baozun)
• excluding any costs related to shipping, non-VAT taxes, returned goods and non-settled deposits

It further separates GMV into distribution GMV and non-distribution GMV, the latter either through fees or in the form of a consignment business model (more on this in section 3). Baozun’s GMV has been increasing at a rate of over 50% the last 2 years, indicating Baozun is quite successful in selling partner brands through its different channels, which in turn can convince more brands to join the Boazun network.   

As for its product sales, its revenues ultimately depend on (brand partner) product mix, which affect revenues and profitability. It seems that the company is rather flexible in determining what product area it wants to focus on. Currently, Baozun’s main categories (> 10% of GMV) include apparel, electronics, and FMCG. 

During the previous earnings call, management indicated it is particularly interested in the rise of E-commerce of FMCG ^[3] in China. Although low value, these high-volume goods might be an area that can grow at a higher rate than other segments. Recent financial results from Alibaba Group, published on February 2^nd, confirmed this view with their management indicating rapid growth in the FMCG segment.

Takeover target

One of the reasons why this stock has been on our radar for so long, is that we considered it a likely takeover target for Alibaba Group. The latter already owns 16.5% of the Baozun share capital and 9% of the voting shares.

However, with the recent anti-trust headwinds, we consider this option as less likely to play out in the near future. Despite this, the regulatory pressures on Alibaba might force it to rely more on third parties such as Baozun instead of asserting its dominance on the market through its own subsidiaries.

Its partnership with iClick and the recently acquired company “Full Jet” indicates Boazun is certain of its ability to continue its path as a standalone company.

[1] Most Valuable Global Brands as defined by Brandz in 2019.

[2] Brand partners are defined as companies for which the company operates or have entered into agreements to operate official brand stores, official marketplace stores, or official stores on other channels under their brand names.

[3] FMCG – Fast Moving Consumer Goods

Key Performance Indicators (KPI’s)

As previously mentioned, Baozun receives over half of its revenue from direct sales. GMV generated through Baozun currently stands at 10,8 bln RMB (around 1,7 bln USD), an increase of 19% year-year.

Financial KPI’s – Operations

Revenues in Q3 grew at a considerable rate of 21.7%, although operating expenses were also higher. Cost of products incurred under the distribution model rose 27.22 %, likely related to inventory build for the Chinese shopping holidays in the last three months of the year. Revenue from services is accelerating at a faster pace than revenue from product sales, which indicates Baozun’s ability to capture value in the supporting areas of E-commerce such as IT, marketing and fulfillment.

Other KPI’s

GMV stood at around 1.627 million USD for Q3 of 2020, with the largest amount coming from its non-distribution GMV. Non-distribution means merchants are shipping their products to consumers directly, without Baozun having to buy the inventory beforehand (as is the case under the distribution model).

As previously mentioned, non-distribution GMV is derived from 2 business models: the service fee business model in which the seller pays a portion for every sale they make through a Baozun (affiliate) platform and the consignment business model, in which Baozun provides a place for a brand to sell its products and in return receives a percentage of the sales price.

We notice non-distribution GMV growing at a faster pace than distribution GMV, which we consider a positive evolution. The more Baozun can rely on the non-distribution model, the less it has to occur expenses for buying and holding inventory of brand partner products.

Valuations metrics

Let’s look at how the company is currently priced. We do not offer a comparison with competitors, as the company is mainly in competition with either brands themselves (who choose not to rely on a foreign partner) or large tech giants which are active in multiple other areas. A comparison would provide readers with limited knowledge on the relative valuation of Baozun. Prices are obtained on the 4^th February, 2021.

Peter Lynch’s 6 categories of stocks: Baozun, the fast grower

Under the Peter Lynch categorization, we consider Baozun as a fast grower. The key for investments in fast growers is figuring out to what extent future growth is reflected in current prices. Eventually, revenue growth will slow down as the industry becomes further consolidated. The key for these kinds of companies is 1) deciding how much are you willing to pay for the future growth and 2) deciding whether the future potential for the stock is worth the volatility and risk of lower prices for a prolonged period of time. 

Interest rates also come into play, as higher interest rates increase discount rates of future cashflows. If inflation would pick up and central banks would start to increase interest rates again, high-growth companies are the first to decline. In periods of higher interest rates, value names are preferred over high growth/cyclical companies.

As we saw in the previous segment (valuation metrics), Baozun’s growth is very much priced in at current stock levels. The potential upside for investors might not outweigh the risk any serious declines going forward.

What is the market telling us?

Currently, investors hold a considerable 14% short interest in the company. The put/call ratio is around 2, indicating there are 2 outstanding puts for every call. This indicates some investors have a negative outlook on the stock.

Risk 1: Competition & offerings

With Baozun relying ever more on revenue from services, there is a risk that Chinese tech giants like Alibaba and Tencent might improve the offerings in which Baozun is currently active. This includes areas like marketing, IT and fulfillment. These platforms might also decide to compete more vigorously with Baozun in an effort to capture more value from the growing industry. Note that around 70% of Baozun’s revenue is derived from its partnership with Alibaba Group (including Tmall, Cianiao…). This in itself is a considerable risk that investors should keep in mind. With the rising Chinese brand E-commerce industry, other parties might also enter the market, putting pressure on margins for the industry as a whole. 

We also see a risk in the increased reliance on the non-distribution GMV model for its direct sales. This model might be interesting as investments in PPE are reduced, but it can also lower customer (brand partner) loyalty as inventory is not directly held by Baozun.

Additionally, brand partners may choose to continue using or developing applications or building e-commerce teams or infrastructures in-house, rather than paying Baozun for its solutions and services.

Risk 2: Valuation Risk

At current levels, the stock is definitely not cheap. High price to book value, while operating margins are on the lower end. Although the market capitalization is relatively small (compared to other Chinese E-commerce players) and the stock is quite unknown, investors are still pricing in a considerable amount of growth at current prices. Over the last few months, the company has risen over 50% from its December lows which might mean the stock is ready for a pullback. Should revenues be disappointing in the coming quarter(s), the stock might underperform the broader market. Alternatively, if the company is able to attract even more partners and increase its GMV and revenue, we might see the stock continuing its current upward path.

We believe Baozun will continue to strengthen its position in the brand e-commerce space over the coming years, a market ripe for further consolidation.

China’s per capita disposable income has been increasing at an impressive rate, especially in urban areas. This provides a foundation for the E-commerce sector as a whole, with brand E-commerce especially profiting from consumer spending on luxury items.

The company has been in our portfolio for some months because of its fundamentals and relative underperformance when comparing to the broader E-commerce sector. However, with the stock price adding over one third in recent weeks, we expect to see some short-term reversal in the coming year.

Baozun’s management team will likely need some months to fully consolidate the recently acquired “Full Jet”: it might also take a while before this acquisition and its partnership with iClick is reflected in its financial results and more specifically, its bottom line. Despite this negative 1 year outlook, we remain positive on the next earnings results, expected on 17 march of 2021.

Analyst expectations were revised downwards in the recent months, providing a potential catalyst for the stock if results are better than expected. We might see the FMCG segment outperforming the other segments, like in the case of Alibaba.

Should we be wrong in this regard, we still believe a substantial drop in the stock price is unlikely. Management will give more information on the recent partnerships and acquisition, something that will withhold long-term investors from selling. We might instead see the reversal starting to happen some weeks after the March earnings announcement, after which we reassess our position.

To conclude, we keep most of our position until the next earnings reports, capitalizing on any positive surprises along the way. 

How to take on a position in Baozun?

Baozun is trading on both US (ADR) and Hong Kong markets. Its ticker is NASDAQ:BZUN and HKG: 9991. We advise international investors to buy shares on the US listing, as liquidity is higher for these markets.

Investors who want to add leverage to their portfolio can use the options market. Buying the April calls before the earnings report of March can provide investors with considerable gains if results are better than expected.

Buying “in the money” calls can be an expensive endeavor.  Investors can limit the cost of a long trade idea using a vertical bull spread strategy. One uses this strategy this by buying calls at a specific strike price while also selling the same number of calls at a higher strike price (at the same expiration date). This limits your potential gains, but reduces the net premium paid for the call option.

We illustrated this with an example at current option chain prices:

At current option prices, this might mean buying the $44 call option for a price of $8,40 and selling the $55 call option for a price of $4,15. Both options expire on April, 16^th of 2021.

The net costs of this investment strategy is $4,25. Should the stock rally to $53 at expiration, your long call option returns $9 per contract and the net gain would be $4,75 ($9 –  $4,25). For 1 contract of 100 shares, this would be a profit of $475 on a net investment of $415, illustrating the leveraged gain of 114%, while the stock price “only” increased by 20%. Note that in this case, the maximum gain is capped at $6,75 and the maximum loss at $4,25 per share.

Baozun. (2020). Baozun Corporate Presentation Dec 2020. Baozun.

GlobeNewswire. (2021, 01 26). Baozun and iClick Announce Equity Investment and Strategic Business Cooperation. Opgehaald van GlobeNewswire: https://www.globenewswire.com/news-release/2021/01/26/2164038/0/en/Baozun-and-iClick-Announce-Equity-Investment-and-Strategic-Business-Cooperation.html

PR Newswire. (2020, 10 6). iClick Interactive and Tencent International Business Group Announce Strategic Collaboration on Smart Solutions in Key APAC Markets. Opgehaald van en.prnasia.com: https://en.prnasia.com/releases/apac/iclick-interactive-and-tencent-international-business-group-announce-strategic-collaboration-on-smart-solutions-in-key-apac-markets-293979.shtml