Description

First of all, I want to give credit to milehigh, who wrote up Coupang back in 2021. The write-up gives great insight into Coupang’s business and provides a very good background. Since the last post, management’s execution has been stellar and the business has improved materially, although the stock is down 35%. The business currently trades for a market cap of $32.7 billion and an enterprise value of $30.2 billion. 

Business Overview

Coupang operates as the number one online commerce company in South Korea. At its core is the first-party (1P) retail business, where Coupang acts as the merchant, owning and holding inventory across different categories. In 2023, 1P retail accounted for 87% of the company's total sales.

More recently, Coupang's value proposition has grown beyond traditional e-commerce. The company has diversified into complementary services, including a third-party (3P) marketplace, expedited delivery, online grocery, restaurant order and delivery, streaming content, and fintech solutions like digital payments. Many of these offerings are bundled under the Rocket WOW membership program sold to customers for a monthly fee of 4990 won (approximately $3.69). Additionally, Coupang has started generating revenue through targeted advertising placements and providing fulfillment and logistics services.

Financial History

In 2023, Coupang had $24.4 billion in total net revenues, with $21.2 billion coming from 1P sales, and $3.2 billion from all other services. This was 18.5% growth YoY, up from 12% growth the year before.

Operating income was $473 million (1.9% margin) during 2023, up from -$112 million in 2022 and -$1.5 billion in 2021. 

Important to note is that the business runs on a negative cash conversion cycle, meaning working capital is used to fund a sizable portion of their operations. This is similar to most 1P online retailers. As of the end of 2023, Coupang had $5.1 billion in payables and held $1.7 billion in inventory with $314 million in receivables, producing a float of $3.1 billion. Days payables outstanding is 87 and days sales of inventory plus days sales outstanding is 29, so inventory is sold roughly two months quicker than when Coupang needs to repay its suppliers. 

Free cash flow for 2023 was $1.7 billion (OCF – capex), with a large portion attributable to the negative working capital and an increase in accounts payable. As long as the business keeps growing (and it should at least grow nominally with inflation), then this float will act as a permanent source of capital. Net income for the year was $1.36 billion, impacted by a benefit from a deferred tax asset of $776 million. In a normal year, the tax rate would be 27.5%. Because of this, normalized earnings were $423 million.

Another consideration for FCF if you wish to exclude the excess cash from working capital: use normalized earnings of $423mn + $275mn D&A – $896mn capex = -$198mn in “normalized” FCF. Breaking capex down further, 70% is spent on growth with 30% is going to maintenance. 

Two main factors that differentiate Coupang

1. Customer centric: Coupang puts the customer first in everything they do, and some of the services that illustrate this include delivery options, return policy, and product assortment. Founder Bom Kim has been quoted saying that Coupang’s goal is to “solve problems that the customer didn’t even know they had.” They strive to control every possible touchpoint, and are laser focused on providing the best possible customer experience as opposed to beating out the competition.

-- Delivery: Rocket delivery is provided to WOW members, and nearly every order (99%) is delivered within a day of making the purchase, no matter where a customer is. Bringing it a step further, Coupang now offers same day delivery and Dawn Delivery (order by 12AM for delivery by 7AM the next day).

-- Returns: if an order is incorrect or not satisfactory, the customer can arrange to return their item. What makes this process special is that customers are able to notify Coupang and then simply put the product back in the original packaging and leave it on their doorstep. A Coupang employee will come by and pick up the order, bringing it back to the warehouse.

2. Physical footprint/infrastructure: I believe this represents the most important competitive advantage. The business owns or leases 55 million square feet in warehouses and fulfillment centers, which is up from 30 million square feet at the time of IPO just 3 years ago. The S-1 stated that over 70% of the population lived within 7 miles of a fulfillment center as of 2021, but based on their expansion I assume this number is higher now. Coupang utilized funds during very low interest rate environments and expanded rapidly. Capital expenditures since going public total $2.4 billion, and the company raised $3.4 billion while private. Assuming that 85% of the privately raised funds went to building out the physical footprint, then it can be estimated that Coupang’s infrastructure is worth ~$5.3 billion. This makes it very difficult for competitors to catch up.

Management

-- Bom Kim is the founder and CEO. He is by far the most important person to the vision and operations of the business. He currently owns 10% of the company and his holdings make up nearly his entire net worth. 

-- Management’s top priority is customer satisfaction. They believe focusing on the customer will lead to optimal business performance and contribute to the best possible per share performance of the stock.

-- They understand value creation. On earnings calls, Bom Kim frequently highlights two main points: 1) Limiting dilution (1.3% YoY) and 2) maximizing free cash flow produced by the business. They also maintain a “high bar for investments” and only choose projects that provide high returns on capital. These factors give me confidence that management is being responsible when allocating capital and that they are making decisions that are in the best interest of shareholders.

Competition

-- Naver: largest search engine operator in South Korea that also runs an online marketplace. Currently holds a 17% share of the ecommerce market, which is second behind Coupang. Naver partnered with CJ Logistics to provide next day delivery in an attempt to challenge Coupang. Considering they already have a significant hold on the amount of screen time from mobile users, this would be the largest threat. 

-- Chinese competitors (Temu and AliExpress): These are different because their model is to spawn impulse purchases. Coupang has made an effort to be the exact opposite of this, instead selling what customers need. In 2023, Temu had 10mn app downloads and AliExpress had 5.3mn downloads, with 40mn total smartphone users. It will be difficult for these players to compete with Coupang on quality and delivery service, but the lower prices may prove to be a problem at some point.

-- 11street and Gmarket: both are online marketplace operators that hold <10% market share in South Korea. Coupang has taken significant share from both players over the last 5 years.

Market Opportunity

One of the most common questions related to Coupang is the size of their total addressable market and whether they are already approaching a ceiling. There are a few important considerations when looking at the market:

-- It is best to look at the total retail market of South Korea when considering Coupang’s potential. Management uses this as their benchmark, stating the size of this market is $483B, with online penetration rate at an estimated at 30%. Considering the lack of specialization across industries within the country, nearly all of this “total commerce” value is accessible to Coupang and other ecommerce providers. 

-- Coupang’s platform has current active customers of 21mn, which grew 16% YoY. Rocket WOW subscription members are at 14mn, which grew 27% YoY. The total population of South Korea is 51.3mn, and total households are 22.4mn. Active customers may start to reach an upper bound within the next couple of years, while Rocket WOW members will likely continue growing for longer.

-- Most growth will come as each group of customers increases spend. Every new year’s cohort of customers starts at a base higher than the previous year, with all cohorts still increasing spend by over 15% YoY. Coupang will act as a catalyst to move more commerce sales in South Korea online in the future.

-- Coupang has recently started to expand into Taiwan, which could potentially bring the size of the potential addressable market over $500 billion.

Valuation and potential returns

Consider the “Product Commerce” segment of the company:

This includes 1P as well as 3P services (such as merchant fees, advertising). As the addition of new users slows, most growth will come from the increase in spending by current customers. With each cohort increasing spending by 15%, this would represent the floor for gross merchandise value growth in the near future. As a reminder, most of Coupang’s sales currently come from the 1P business (where GMV translates to sales roughly 1 to 1), but they have been rapidly adding merchants onto their higher margin 3P marketplace. 

Third party merchant services contributed $2.6 billion in sales for 2023 (assume 90% is from merchant fees and 10% from ads, management seems to make an effort not to disclose specific numbers around ad sales but they state it is in “far early” stages). Using a statement from Coupang, they charge an average merchant commission fee of 10.9% on products sold. Using this take rate yields a projected GMV of $21.5B for 3P (($2.6B*0.9)/0.109). 

Based on growth trends, incremental GMV should flow to 3P and 1P in a 60% and 40% split, respectively. I believe this is conservative (the more money that flows to 3P, the better). If GMV grows at the projected 15% CAGR until the end of 2027, Coupang will have $75 billion in GMV, or about 13% share of the projected commerce industry in Korea. This will translate to $34B in 1P sales, and $4.9B in 3P services sales in 2027.

Considering that Coupang is not in steady state (and likely will not be in 2027), I have chosen to calculate potential earnings for the business. This is what it would likely earn if it were optimized for earnings and not making continued investments in growth. These total “steady state” earnings pencil out to $2.98B in 2027, and I assume cash conversion shifts closer to 100% as the business matures. Due to the growth, competitive advantages, and high persistence of earnings/cash flows, a 5% yield is reasonable. This produces a market value of $60B in 2028, implying a 19% IRR.

With these assumptions, the value of the Product Commerce segment essentially doubles over the next 3.5 years. I view the developing offerings category ($789mn in sales in 2023) as a basket of real options like expansion into Taiwan and Coupang Eats (restaurant delivery services) which provide massive potential upside that only improve the return further. For the sake of this valuation I have assigned these no value.

Risks

-- SoftBank is still the largest institutional owner holding over 20% of the equity. They have sold over $1.3 billion worth of stock over the last 5 months. This could continue to be a drag on performance if they keep liquidating. 

-- Country risk: Coupang operates in both South Korea and (more recently) Taiwan. Issues could arise if something were to happen with North Korea or China/Taiwan.

-- Bom Kim is essential to the company’s success. The investment would not be nearly as attractive if something were to happen to him or he decided to leave.

-- My margin assumptions may be generous and not come to fruition

-- The competitive advantages could deteriorate as other companies become more conscious of customer experience and improve quality and delivery.

-- Farfetch acquisition

      -- Coupang acquired Farfetch by committing to provide access to $500mn in capital. Offered via cash and bridge loan that will accrue paid-in-kind interest. This may end up being a sunk cost if the operations of Farfetch cannot be integrated successfully.

Catalyst

Growth, execution, and operating leverage

Management continues to allocate capital to high return investments