What kind of business is Vipshop, the company Tencent just bought into?

You have almost certainly heard of it, but you probably don't use it much.

Three years after selling off its own e-commerce business, Tencent bought into China's third-largest e-commerce company on Monday.

On the morning of December 18, Tencent and JD.com announced they were taking stakes in Vipshop, subscribing to Vipshop shares in cash for $604 million and $259 million respectively. Counting the 2.5% JD.com already held, once the deal closes Tencent and JD.com will own 7% and 5.5% of Vipshop. Tencent is now the second-largest shareholder, behind only Vipshop founder Shen Ya.

Vipshop has been calling itself undervalued for a while now, and Tencent and JD.com clearly agree: the price of this investment is a 54.6% premium over Vipshop's closing price on the previous trading day.

Two trading days later, shares in this e-commerce company — the one that has placed its products in two seasons of Ode to Joy and in a pile of variety shows — were up nearly 40%. Vipshop has now turned a profit for 20 quarters straight, and the whole company is worth $7.09 billion. But it sits far behind the top two: that is 1.6% of Alibaba's market value and one-tenth of JD.com's.

Tencent's reason for buying in is obvious. It is investing in every e-commerce company outside Alibaba, using the enormous traffic of WeChat and QQ to help them fight Tmall and Taobao. Tencent and its affiliates now hold more JD.com stock than Richard Liu does. The other e-commerce companies Tencent has backed include Mogujie and Meilishuo, MissFresh, Pinduoduo and Xiaohongshu. Just last week it bought 5% of Yonghui Superstores.

So, after all those investments, what kind of company is the one Tencent has just paid a 55% premium for?

Vipshop is basically an online second- or third-tier department store

On the home page of the Vipshop app, the categories that stand out are women's clothing, shoes and bags, beauty, maternity and baby, and underwear. Click into any one of them and the goods are laid out much the same way: everything on the page is telling you that you can buy branded merchandise at 20% or 30% of the original price.

Apparel — the category JD.com has spent heavily on, expects a lot from, and still finds hard going — is Vipshop's strength.

Vipshop's 2016 annual report shows that apparel, shoes and bags, and cosmetics together made up 70.2% of revenue that year.

Open the Vipshop app and, by category and by customer, it looks a lot like Taobao's women's clothing channel. By brand, though, the difference between the two comes down to whether there is a brand behind the product at all.

We looked at the top ten real-time best-sellers in women's clothing on JD.com, Vipshop and Taobao. On Vipshop we found Taobao-bred labels such as Liebo and Yipin Tiancheng that have already pulled out of JD.com; on Taobao, the best-sellers were all shop-made goods and copies of what internet celebrities wear.

Browsing Vipshop today, those Taobao-bred labels aside, feels more like walking through a department store in a second- or third-tier city. You will see international brands such as Under Armour and UGG, but more often you will see the brands a first-tier city mall would never give a counter on its first or second floor.

In the statement announcing the partnership, Tencent stressed that users' "demand to search for, discuss and buy branded apparel" inside WeChat and QQ "is rising." Vipshop said it would further strengthen its "leading position in fashion and wearable categories (including clothing, shoes, bags and accessories) and in beauty," along with its advantage among female users. JD.com said the two companies have "a similar operating model, a high share of self-operated business, and both attach great importance to expanding in fashion."

More than 6,000 brands from around the world now sell on Vipshop. In the most recent quarter, Vipshop added a luxury channel, worked with independent designers, went to Milan Fashion Week, and brought in Giorgio Armani, Versace, Guess, Marc Jacobs, Sergio Rossi and Shanghai Tang.

This is a business built on women, and more of its users come from third- and fourth-tier cities than JD.com's or Taobao's

By Vipshop's own account, 80% of its 300 million users are women.

Figures from Aurora Mobile's iApp monitoring platform show that 68.9% of Vipshop app users are women, far above JD.com's 39.2% and above Taobao's 59.5%. One caveat: this counts only the JD.com app itself, not people who reach JD.com through the shopping entry inside WeChat.

Back in 2014, Shen Ya told an earnings call that transaction value from first- and second-tier city users had overtaken the value from third- and fourth-tier cities. Since last year, though, Vipshop's earnings calls have gone back to telling a third- and fourth-tier city story, saying that building its own logistics network has prepared it to "move down into third- and fourth-tier cities."

Recent numbers from Aurora Mobile's iApp platform show third- and fourth-tier city users at 42.6% of JD.com's user base, 50.9% of Taobao's and 52.9% of Vipshop's.

JD.com has lately been busy pushing its growth channels into the countryside and offline. In this partnership, besides filling each other's gaps in fashion and apparel brands, Vipshop could also help JD.com reach third- and fourth-tier city users.

It is the difference between shopping in a mall and shopping at the Sijiqing wholesale market: plenty of the brands on Vipshop are not the ones a mall would put in a prime spot, but the unfamiliar labels you drift past on a mall's third, fourth and fifth floors still bring in orders worth real money.

In the most recent quarter, 23.8 million users opened Vipshop at least once a month, and each of them spent an average of 643.2 yuan on it over the quarter. Add up per-person spending over the past year and it comes to more than 2,500 yuan, roughly the same as JD.com's figure; annual spending per active buyer on Alibaba's platforms is only around 250 yuan.

It has not skimped on advertising, but delivery is Vipshop's biggest cost

Vipshop's ads are everywhere.

Since 2013 it has never stopped sponsoring variety shows and putting its name on them, and spotting a Vipshop plug — smooth or clumsy — in a popular urban drama or film is nothing new.

Come promotion season, plenty of people who never buy anything on Vipshop still cannot escape its ads on video sites, buses and subway platforms. Since last year, Vipshop has also had Jay Chou as its "chief surprise officer."

Over a year, Vipshop spends well over a billion yuan on advertising.

Even so, marketing is not its biggest cost, and marketing's share of revenue has been falling year by year.

In the most recent quarter, Vipshop spent 478 million yuan on marketing, only 3.1% of its revenue for the quarter and the lowest level in 15 quarters.

Vipshop president Yang Donghao said the company had started using a personalized recommendation platform that quarter. The bigger reason, though, is that Vipshop moved part of its third-quarter marketing budget into the fourth. "In July, August and early September the weather tends to be very hot, and people tend not to buy much clothing."

The fourth quarter is in fact Vipshop's heaviest marketing quarter: there is Double 11, and Vipshop's anniversary sale falls in it too.

Because Vipshop builds its own logistics and warehousing and has to cover third- and fourth-tier cities, its biggest cost is delivery. In the most recent quarter it swallowed half of gross profit.

That half of gross profit came to 1.7 billion yuan. Over the coming year, Vipshop expects to put another 3 billion yuan into logistics.

Vipshop set up its logistics company in 2013. This July, its courier arm, Pinjun Express, received a courier business license from the State Post Bureau.

In the first nine months of this year Vipshop added more than 7,000 employees, mainly to handle "last-mile" delivery. It also opened 1,000 more delivery stations to support its domestic and overseas warehouse centers.

Today Vipshop's own logistics company delivers 95% of its orders, and 68% of returns are collected at the customer's door by Vipshop's own couriers. That makes the experience steadier than Taobao's.

On the first-quarter earnings call this year, Vipshop chief financial officer Yang Donghao said the company would restructure the logistics business, partly to improve cash flow. JD.com said late last year that it would open up its logistics; Vipshop made a similar decision this May. Yang said Vipshop's warehouses are running at about 80-85% utilization, and that opening the service to more third-party merchants would also spread the delivery cost of each order.

Nine years in, Vipshop has tried plenty of new things and still lives off its core business

Vipshop was founded in Guangzhou in December 2008. It began with flash sales of luxury goods — designer clothes, shoes and hats — modeled on the French site Vente Privee.

The luxury model soon proved unworkable, and Vipshop switched to flash sales of second- and third-tier brands. From then on its slogan was "a website that does flash sales."

With two rounds of money from Sequoia Capital and DCM, Vipshop listed on the New York Stock Exchange three years after it was founded.

Chinese stocks were out of favor in the U.S. market at the time, and American investors did not like Vipshop's. It broke its offering price on day one and closed 15% below it.

The stock only turned after Vipshop reported a profitable quarter, and for a while it was even called a "monster stock." In 2015, on the back of one profitable quarter after another, its market value rose as much as 60-fold at the peak.

In the years after Vipshop went public, the apparel industry happened to have huge piles of leftover stock to clear, and Vipshop's model got copied. Under the banner of "capped at 30% of list price, name-brand flash sales," Vancl, Yihaodian and Tmall all launched flash-sale sections or name-brand flash-sale channels on their sites in 2013, and Dangdang simply called its channel "Clearance Mart," devoted to flash sales of branded clothing, shoes and bags.

In 2014 Vipshop bought 75% of the beauty e-commerce site Lefeng.com. In 2015, with maternity-and-baby and cross-border e-commerce both hot, Vipshop joined in on both. In the first half of 2015 alone it invested in four maternity-and-baby e-commerce companies: Mailegou, Lamabang, Beilian Technology and Hehua Qinzi.

It also got into overseas shopping. On that year's first-quarter earnings call, Shen Ya said: "The categories Vipshop runs now are also very well suited to cross-border e-commerce. Vipshop's overseas shopping business has a lot of room to grow." In 2015, 2016 and 2017, Vipshop ran a "Pink Friday" shopping festival alongside Black Friday.

From 2015 to 2016, though, cross-border stayed at about 5% of Vipshop's gross merchandise value (GMV), with little progress.

On the most recent earnings call, Yang Donghao said Vipshop buys from some overseas suppliers but mostly sells standardized goods, such as cosmetics, household items and baby products.

Neither maternity-and-baby nor cross-border turned into a strong new business. But Vipshop's core — apparel, shoes and bags — has kept growing.

Vipshop also built its phone app early: it went live in 2009. That gave it far better odds of survival than the e-commerce companies that were half a beat slow moving from PC to mobile.

Worries about the quality of goods on the platform, and reports of Vipshop selling fakes, have never stopped.

At the end of 2015, Moutai sold during Vipshop's anniversary promotion was found to be counterfeit, and Kweichow Moutai said it had never had any partnership with Vipshop. On December 31, Vipshop issued a statement promising to advance tenfold compensation, but stopped short of admitting it had sold fakes. Early the next year, the China Consumers Association sent Vipshop a public letter of admonishment, saying the company had admitted only that some goods did not come from the Moutai Group's own factory while dodging the question of quality. Vipshop eventually apologized in public and acknowledged that it had not handled the matter sincerely enough.

This year, Vipshop began telling a new story: quality e-commerce.

On May 31, its official Weibo account, which has 7 million followers, wiped 30,000 old posts about flash sales.

Two days later, Vipshop vice president Feng Jialu published an open letter, Not Just a Full Stop, announcing a new advertising line and an upgrade of the brand into a quality-of-life platform built on "global curation, genuine goods, flash prices."

In Ode to Joy 2, which aired in July, the placement deal even had one of the leads make a point of saying she shops on Vipshop because "it's genuine, and you can return things."

Vipshop is number three, but in China today no e-commerce company other than Alibaba and JD.com is very big

Before JD.com and Alibaba went public, Vipshop was one of the few Chinese e-commerce companies to list successfully. Jumei, which listed around the same time as JD.com, is now worth a quarter of what it was.

Mecox Lane and Dangdang, both of which listed before Vipshop, left the U.S. market in 2016.

The gap between JD.com and Alibaba is already wide. The gap for Vipshop, in third place, is far wider.

Vipshop holds only 3.7% of China's e-commerce market, and that still makes it the biggest player outside Alibaba and JD.com. As of this November, an average of 199 million users opened Taobao once a day; JD.com and Vipshop came second and third, but at a different order of magnitude — 35.99 million and 22.59 million.

Every e-commerce company of any size today belongs either to Tencent or to Alibaba

Rumors that Tencent would invest in Vipshop date back to 2015. This July there were also reports that JD.com might buy Vipshop; at the time, the two had jointly issued a public statement against Tmall's practice of forcing brands to "pick one of two" platforms.

Both denied the merger reports then.

A few months later the answer arrived: Tencent and JD.com investing together, and at such a high premium — which says Tencent and JD.com were the more anxious parties.

Fair enough. Had Vipshop tipped toward Alibaba, apparel would have become almost entirely Alibaba's business. Apparel is still what drives e-commerce, and while Vipshop might not have added that much to Alibaba, Vipshop sitting outside JD.com's camp would have been a serious problem for JD.com.

For Vipshop, working with JD.com helps directly with logistics. The two run similar logistics models: both have poured enormous sums into cutting delivery times and covering as many first-, second-, third- and fourth-tier cities as they can.

On a recent earnings call, an analyst asked for an update on warehouse utilization and on whether the logistics business makes money. Even though Vipshop's warehouses hit 80-90% utilization at peak times, it still needs more orders to spread the logistics cost of each one.

What Tencent can give Vipshop is, of course, traffic.

Once the deal closes, Vipshop will keep operating independently. Tencent president Martin Lau said in the announcement that "Tencent users' demand to search for, discuss and buy branded apparel in our apps is rising," and that Tencent would work with Vipshop on "user traffic, marketing and payment solutions."

A Vipshop entry will appear in the grid of icons in WeChat Wallet, next to Didi, Meituan food delivery, Dianping and Mogujie's women's clothing. JD.com will add Vipshop entries in WeChat's "Discover-Shopping" section and on the home page of the JD.com app. In the announcement, JD.com also promised to help Vipshop hit certain sales targets on the JD.com platform.

On the November earnings call, Vipshop said it was "looking at social platforms, including WeChat," and that its mini program had only just started. Asked how well WeChat traffic works, Yang Donghao said it "could become one of the effective ways to acquire traffic."

E-commerce is ultimately a business of scale, and all the e-commerce companies Tencent backs, added together, are still far smaller than Tmall and Taobao. Sooner or later they have to settle things with Tmall and Taobao.

On the strength of its traffic infrastructure, Tencent has taken stakes in a whole crowd of e-commerce companies, big and small. It sounds as though putting on the "Tencent camp" hat hands these companies every privilege WeChat and QQ can offer. Only, cooperation across companies has never been easy.

Charts by Feng Xiuxia

Cover image from the TV drama Ode to Joy, STIL on Unsplash