4 Years, 73.5 Billion Yuan: How Alibaba Bought Its Way Into China's Biggest Offline Retail Business

Alibaba, Amazon, Walmart, JD.com — the biggest retailers are all doing online and offline at once

73.5 billion yuan: that is how much Alibaba has now put into offline retail, a sum equal to its combined operating profit over the past six quarters.

The latest piece of it came on November 20, when Alibaba announced it would take a 36.16% stake in Sun Art Retail Group for HK$22.4 billion (about 19 billion yuan).

Sun Art runs the Auchan and RT-Mart hypermarket chains, with 446 stores across mainland China. Jack Ma's e-commerce company is now Sun Art's second-largest shareholder, trailing the largest, Auchan, by 0.01 percentage points.

Alibaba CEO Zhang Yong called the arrangement between the two companies a marriage: "Today is the wedding ceremony. We've always said the marriage itself is what matters — but before the wedding, we'd already worked out, in a lot of detail, how we'd live together afterward."

Nine months earlier, at the press conference where Alibaba announced its partnership with Bailian, Zhang Yong used the same figure of speech: "I think today is a brand-new starting point, the first stop in year one of New Retail. Today our wedding ceremony has been held successfully."

This is Alibaba's third investment of more than 10 billion yuan in offline retail, after its stake in Suning and its purchase of Intime.

As China's Largest Offline Retailer, Sun Art Sold Its Shares to Alibaba at a 25% Discount

The RT-Mart and Auchan supermarkets Sun Art runs are concentrated in East China; Jiangsu, Zhejiang, Shanghai, Anhui and Shandong account for more than 50% of its stores, with total retail floor space above 5.2 million square meters. Its 446 stores outnumber Walmart China's 439, making it China's largest offline retailer.

Growth in China's offline retail has slowed year over year for six straight years; in 2015 and 2016 sales fell 0.1% and 0.5%.

Sun Art, which owns Auchan and RT-Mart, has kept growing both revenue and profit over that period, if more slowly than before — still better than offline retail as a whole.

Sun Art's ownership structure is complicated, with several shareholders holding stakes in one another. Alibaba's deal breaks down into three parts.

1. A share transfer inside Jixin, Sun Art's controlling shareholder. Jixin holds 51% of Sun Art and was set up by Auchan and Ruentex, which contributed capital in a 51:49 ratio. Under this deal, Ruentex transferred 19.9% of its Jixin shares to Auchan in exchange for the 9.71% of Sun Art that Auchan held directly.

2. Alibaba, through Taobao China, bought 26.02% of Sun Art outright for HK$16.1 billion. The sellers were Ruentex Group and Auchan — the stake sold includes the 9.71% Auchan had transferred to Ruentex.

3. At the same per-share price, Alibaba bought 19.9% of Jixin, Sun Art's controlling shareholder, for HK$6.3 billion. Since Jixin holds 51% of Sun Art, that works out to Alibaba acquiring 36.16% of Sun Art in total, at a combined cost of HK$22.4 billion.

Along with the stake, Alibaba made a privatization offer to Sun Art: the deal is to close within three months. If no further shareholding changes occur in that window, Alibaba will have to buy the remaining outstanding Sun Art shares at HK$6.5 apiece — roughly another HK$13.4 billion.

That does not mean Alibaba intends to buy Sun Art outright. Its cumulative stake has passed 35%, and it has become a concert party with Auchan and Jixin. Under Hong Kong Stock Exchange rules, it must make a general offer whether or not it ever wanted to take the company fully private.

Sun Art's other shareholders, though, seem unlikely to accept a price this low. Over the past 1,551 trading days, Sun Art's shares have averaged HK$8.37.

The strangest part of the deal is the price. Sun Art's former largest shareholder, Ruentex Group, together with Auchan, accepted Alibaba's offer of HK$6.5 a share — a 25% discount to Friday's closing price of HK$8.60.

Acquisition prices are usually above the market price, especially for a company like this one: profitable, and first in its industry. A 2016 report from CICC found that Hong Kong-listed companies taken private go for an average of 43% more than their share price.

Wang Zeyu, a former private-equity investment manager, told QDaily that traditional hypermarkets do face industry-wide headwinds, which keeps valuations low even for profitable supermarket chains — but buying in at a 25% discount is still rare. "The parties may have other side agreements," Wang said. None of them explained why the price was set so low.

The low offer set off a sell-off in Hong Kong. After trading resumed on the 20th, Sun Art's shares fell 9% in two days, erasing HK$10 billion in market value.

On Ruentex's decision to sell down, one Taiwanese analyst argued that China's offline retail is performing badly across the board: last year's closure of RT-Mart's Shandong stores was read as another sign of decline in traditional Chinese retail, and Feiniu.com, the e-commerce site RT-Mart invested in, is still losing money. Ruentex, the analyst said, may be using the deal to exit the Chinese market.

Four Years, 73.5 Billion Yuan: Alibaba Has Become China's Largest Offline Retailer

From shopping malls to supermarkets to neighborhood convenience stores, the physical businesses e-commerce once set out to replace have not disappeared. Some have become e-commerce companies' partners; some have become their subsidiaries.

Bernstein analyst Bhavtosh Vajpayee wrote in a note to clients: "China is undergoing a revolution, in the course of which offline retail is, more often than not, becoming a partner to e-commerce rather than a resister, a victim or a loser."

But it is usually not a partnership between equals. It is a partnership in which Alibaba takes a stake in the other side, or buys it.

In March 2014, Alibaba — then still preparing to list on the New York Stock Exchange — proposed a strategic investment of HK$5.37 billion in Intime, and set out to link the two sides' membership, payment and merchandise systems. That is one of the stories now told under the banner of New Retail.

It was probably the first time Intime became widely known outside Zhejiang Province. It now runs 29 department stores and 17 shopping malls in Hangzhou, Beijing and other cities.

In 2015, Alibaba spent 28.3 billion yuan on a stake in Suning, becoming its second-largest shareholder.

Suning, in turn, spent 14 billion yuan subscribing to newly issued Alibaba shares — less than 0.5% of Alibaba's nearly $500 billion market value, and no say at all in how Alibaba is run.

Suning then opened a flagship store on Tmall, which also addressed Taobao and Tmall's weaker reputation and logistics in home appliances compared with JD.com, and the uneven quality of the consumer electronics sold there. Investors liked the deal at the time: Alibaba's stock rose 2% after the two companies announced it.

In 2016, Alibaba invested in or bought a string of offline shopping centers and supermarket chains:

• 2016.1 Led Hema (Freshippo)'s Series A round with $150 million
• 2016.3 Invested in Yiguo Fresh, amount undisclosed
• 2016.11 Paid 2.15 billion yuan for 32% of Sanjiang Shopping Club
• 2016.12 Paid 237 million yuan for 21.17% of Lianhua Supermarket

In January this year, Alibaba raised the stakes offline again: with a consortium formed with Intime founder Shen Guojun, it proposed taking Intime private at HK$10 a share, for as much as HK$19.8 billion.

Once that deal, at a 50% premium, closes, Alibaba's stake will rise to 74% and give it control. Intime will delist from the Hong Kong Stock Exchange.

But Intime performs worse than Sun Art. And revenue in the department-store business Intime belongs to grew just 1.3% in 2016, less than a fifth of the rate for supermarkets.

Deal by deal, investment by investment, Alibaba has become China's largest offline retailer.

The World's Three Biggest Retailers Are All Doing Online and Offline at Once

The world's three most valuable retailers today are Amazon, Alibaba and Walmart. All three are listed in the United States, worth $547.7 billion, $486.2 billion and $289.4 billion respectively.

The three run their businesses in very different ways, but all of them are now in both online and offline retail.

Over the past few years Amazon has tried same-day delivery, one-hour delivery and warehousing inside city centers, trying to use ordinary e-commerce delivery to get into fresh groceries. The progress has been slow.

In July, Amazon bought Whole Foods for $17.7 billion — its largest acquisition ever, and the fourth-largest deal in the history of American retail. With Whole Foods' more than 460 stores, Amazon became the fifth-largest grocery retailer in the United States.

Amazon has also gone into physical bookstores, opening 12 so far, most of them this year. Only one national bookstore chain is still standing in the United States.

Beyond groceries and books, Amazon spent $27 million in September on a stake in Shoppers Stop, an Indian offline retailer with 83 stores in 38 cities. Amazon plans to put retail experience centers inside Shoppers Stop's malls to push its online fashion merchandise; Shoppers Stop will put the more than 400 brands it carries on sale on Amazon's site.

Amazon's rise has come almost in step with Walmart's decline.

By market value Walmart is the world's third-largest retailer; by sales, its nearly $500 billion makes it first. Through the superstores it opened across the United States, it once changed a country's shopping habits and way of life.

Walmart's first move into e-commerce came in 2011, when it bought a company in Silicon Valley and set up WalmartLabs, staffed with early executives from eBay and Amazon.

But Walmart's e-commerce progress was slow, and the company at one point paused its online investment. On May 19, 2015, Walmart reported falling revenue and profit, with e-commerce revenue growth down to 17% — the stock fell more than 4% that day.

After the second half of 2016, Walmart spent more on e-commerce again, tying the online business to its own share price.

It paid $3 billion for Jet.com and put Jet.com founder Marc Lore in charge of Walmart's e-commerce business. Lore had founded the baby-products site Diapers.com in 2005 and forced Amazon into a price war that ended with Amazon buying the company for $540 million.

Jet.com was Walmart's largest single e-commerce purchase. It went on to spend $70 million on the shoe site Shoebuy, $51 million on the outdoor-apparel site Moosejaw, $80 million on the women's apparel site ModCloth and $310 million on the online menswear brand Bonobos.

The deals were packed into 2016 and 2017.

Walmart's e-commerce business in China began in 2011, when it took control of Yihaodian. It then invested $4 billion in JD.com in June 2016 and, this February, raised its stake to 12.1%, making it JD.com's third-largest shareholder.

Sam's Club, Walmart's membership warehouse brand, now has an official flagship store on JD.com, and Walmart supermarkets have plugged into JD Daojia, JD.com's two-hour supermarket delivery service.

They May Not Have Figured Out How to Merge Online and Offline, But They All Have to Try

The biggest retailers are buying and investing on a large scale, and all of them have tried some way of joining online and offline.

Amazon's cashier-less convenience store, Amazon Go, has customers check out through the Amazon app and uses artificial intelligence in place of clerks to hold down operating costs.

Its bookstores pick their titles from the data on Amazon's website, and the prices in the store match the prices online.

New technology aside, the one convenience store and 12 bookstores it has opened all sit in busy shopping districts with foot traffic already there. Most of the bookstores only opened this year, and it isn't yet clear whether prices as low as the website's can justify what the storefronts cost.

As for the newly bought Whole Foods, it has run some promotions, but it is too early to tell anything.

Walmart has opened more Neighborhood Markets — small stores selling toothpaste, toilet paper and other daily necessities — and has been closing the big supermarkets that sit far from customers and require a car and a bulk shopping trip, because the business those big stores used to do has gone to its e-commerce division.

Matching prices online and offline and offering in-store pickup are both things Walmart has tried.

These ideas sound reasonable: identical prices online and offline should keep customers in the store, where they can swipe a card and walk out with the goods. In practice they are hard to run. Walmart has now given up on price parity. This month it began raising the online prices of certain products — toothbrushes, dog food, macaroni — to push people into stores, because these goods are cheap and light, and shipping them costs more than Walmart makes selling them.

Alibaba has done more. Its fresh-food supermarkets are both stores and warehouses for its fresh-grocery delivery service. Customers who come in are encouraged to download the app, so that later they can order from home and get delivery within an hour.

Intime, which Alibaba bought, charges the same price online and offline, but its sales keep falling. Same-store sales nationwide grew just 0.5% in fiscal 2015, then turned to -4.1% in the first half of 2016. Of the 43 stores open more than a year, more than half saw sales decline.

Suning, two years into its partnership with Alibaba, still cannot guarantee the same price online and offline: sales staff in the store will encourage you to haggle, then quote a price that "might even be cheaper than online."

None of this has slowed Alibaba's spending on remaking physical stores. During Double 11, Alibaba, which keeps pressing the idea of "New Retail," tried out nearly every new retail technology in China and abroad, from cashier-less shopping to facial-recognition payment to magic-mirror makeup try-ons.

Behind all of it is the pressure to grow. For every one of these e-commerce and brick-and-mortar giants, the markets they started in are close to saturated, and growth keeps slowing.

E-commerce has taken a large piece of the offline market, but clearly the offline market is not going to vanish.

Data from China's Ministry of Commerce and the Ministry of Industry and Information Technology shows growth in the number of Chinese online shoppers slowing for four straight years. As of June this year, 500 million Chinese internet users had bought something online, with year-over-year growth down from 20% four years ago to 10%.

In 2016, 5.5 trillion yuan of online sales made up only 19% of China's retail market. Growth in China's total online retail sales has now slowed three years running.

The contrast is sharper in the United States. Between 2013 and 2017, online sales as a share of total retail rose only from 8% to 9%. A separate survey by the consumer-products research firm TABS Analytics found that despite the heavy investment by companies like Amazon, only 4.5% of shoppers buy groceries online often — barely above the 4.2% of four years earlier.

Not every acquisition adds up to 1+1=2; in most cases the combined market comes out to less than 2. But in search of a bigger market and future growth, the retail giants can no longer pick just one of "online" and "offline."

Cover image/BuzzOrange, Chasing Corners