Vipshop:  The More I Drink, The Better She Looks

​          Price Target $8.00

Link to News Story
  
June 2, 2016

In July of 1987, the British rock group Engine released a vinyl-only album entitled “Well Oiled,” which was recorded live in front of a studio audience.  This album can only be listened to on a turntable.  (Millennials may not be too familiar with vinyl albums and turntables.)  There’s a very memorable track on that vinyl album called, “The More I Drink, The Better She Looks.”  That more or less sums up our sentiment towards Vipshop Holdings Ltd – ADR (NYSE:VIPS).  You might have to be a wee bit tipsy to be bullish on this company.

Last November, the investment research firm Morgan Stanly Capital International (MSCI) announced that it would include American Depositary Receipts (ADRs) of Chinese companies in its Emerging Market Index.  At the time, approximately $1.6 trillion of investments tracked the Emerging Market Index, including $234 billion in the iShares MSCI Emerging Market EFT.  MSCI included Vipshop and 13 other companies in its Emerging Market Index:  Alibaba (NYSE:BABA), Baidu (NASDAQ:BIDU), Ctrip (NASDAQ:CTRP), JD.com (NASDAQ:JD), Netease (NASDAQ:NTES), New Oriental Education (NYSE:EDU), Qihoo (NYSE:QIHU), Qunar Cayman Islands (NASDAQ:QUNR), Soufun (NYSE:SFUN), Tal Education (NYSE:XRS), Youku (NYSE:YOKU), YY (NASDAQ:YY), and 58.com (NYSE:WUBA).

MSCI indexing is important because index funds, ETFs, and active managers index over $9 trillion to MSCI indexes worldwide.  Goldman Sachs estimated that as much as 94 billion would need to be bought for this particular MSCI rebalancing.  To break up the impact, MSCI split the inclusion of the stocks in two, half on December 1st of last year, and the remaining half yesterday.

On December 1st of last year, VIPS stock price closed at $16.24.  Six months later on June 1st the stock closed at $11.36, a 30% decline!  Clearly the first half of the MSCI rebalancing didn’t help Vipshop.  If that trend continues, six months from now the shares will be trading below $8.00.  One really doesn’t have to be tipsy to understand those numbers.

Another issue we have with Vipshop is its “unnamed logistics companies.”  Vipshop priced its initial public offering of 11 million US shares at US $6.50 in March of 2012, well below the expected $8.50 to $10.50 range.  Two months later, it was trading in the $5.50 range.  The stock price fell 15% below the issue price on the day of the IPO and remained flat for the next six months.  Investors were turned off by the company’s string of losses and tight cash flow.  The company became profitable for the first time during the last quarter of 2012 when gross margins improved from 9.8% to an estimated 23.7%.  The company’s stock price skyrocketed from then on, reaching a high last year of $30.72 last April.  However, the Wall Street Journal brings up a valid contention of short sellers that the company has taken minority interests in “unnamed logistics companies…(which) could be a way to push fulfillment costs off the official books.”  Vipshop specifically failed to address this particular issue when it refuted the short sellers’ allegations last year.  Additionally, Vipshop is overstating revenues by claiming to buy inventory that is actually on consignment.  This really shouldn’t affect the bottom line, so we won’t make much of that particular issue.  What we will say is that Vipshop’s PE ratio is oftentimes twice that of Alibaba’s.

Speaking of Alibaba, last week the market drubbed its stock price when Reuters reported that the SEC is investigating its accounting practices to determine whether they violated federal law.  A few days later, Japan’s Softbank Group announced a minimum $7.9 billion monetization of its Alibaba stake.  The press release was worded very kindly:  “All of the transactions announced today were initiated by SoftBank Group in order to generate proceeds that will be used to increase SoftBank’s liquidity cushion, improve its leverage ratio and enable flexible and prudent financial management for SoftBank.”  The Japanese are known to be very polite, so we will put it in our own terms: SoftBank is dumping Alibaba and not for the purpose of jumping into the Yahoo fracas.

Accounting fraud is something that should be considered with Chinese internet retailers, but a new scam came to our attention a couple days ago.  Chinese delivery companies are selling empty packages to boost e-commerce sales.  According to Eva Xiao, a tech reporter in Shanghai, “An investigative report by The Beijing News, a Chinese media company, was published yesterday, revealing China’s illegal market of “empty package scalping” whereby shop owners on Taobao and Tmall inflate their sales statistics though fake package deliveries by using ‘empty package’ service websites and delivery services.”  While we cannot say if Vipshop engages in this type of behavior, we do know that numerous customers complain that Vipshop is no real bargain.  Many shoppers go to cheaper websites or buy directly from American retailers.  According to one government employee in Shanghai, “Vipshop is sort of at an awkward place in my opinion – it’s neither cheap enough nor high-end enough.”

Our final reason for being bearish on Vipshop is that short interest is at a major high since last year’s $5 trillion rout.  According to Bloomberg, “Short interest in one of the largest Hong Kong exchange-traded funds tracking domestic Chinese stocks has surged fivefold this month to its highest level in a year…The last time bearish bets were so elevated, such pessimism proved well-founded as China’s bull market turned into a $5 trillion rout.”  Short interest in the CSOP FTSE China A50 ETF climbed to 6.1% on May 25th, the highest level since April 2015, two months before Chinese equities peaked, and up 1.3% from a month earlier.  Bearish bets in the US traded iShares China Large-Cap ETF jumped to a two year high of 18% of outstanding shares, up from 3% a month ago, according to data compiled by Bloomberg and Markit.  The rout in China spread to many US listed Chinese stocks last summer, and it looks like we may be heading that way again.

Disclosure:  We are short VIPS.  We do not have a financial relationship with the company.