VIPSHOP (VIPS) IS GROSSLY OVERVALUED

Currently VIPShop is trading at $72, an increase of over 161%% in the past 6 months. This is a bit ridiculous as there are really not much changes in basic company fundamentals for this company.

The current share price already reflects the most optimal scenario this company will ever have. At this price level, it has really very limited upside. However, the downside risks are significant for this company.

From my extensive knowledge of the Internet space in China, VIPShop is close to its maximum growth potential. Past explosive historical growth is actually due to its low base, which is a mathematical fact for almost all early-stage growth companies. It is as simple as that, an increase from $1 to $10 commands 900% growth rate. Nevertheless, I will analyze its business in several parts as follows:

1. Revenue Potential
VIPShop is close to reaching its full scale. I expect 20-30% further expansion at maximum in the coming few years based on current quarter revenue annualized. The revenue may expand to about $2 billion at some point by around 2016. I don't see much further growth potential beyond that and its revenue may even start declining due to increasing competition from big players. The current website is already too crowded, gradually damaging user experience.

2. Margin Contraction
As with all e-retailers these days, most players are having decreasing margins due to ever keener competitions. VIPShop will not be an exception. VIPShop will have decreasingly bargain power with suppliers and may have to incur more marketing costs due to ever increasing competition. Many e-retailers are having negative net margins these days!

3. Possible Future Inventory Writedown
Just like many Chinese shoes and apparel manufacturers/retailers,  many of their past profits are lacking quality.  For those companies, a shipment to distributors count as sales but eventually many of them have to be bought back as excess inventories from distributors. The consequence of this is to create large profit in early years and then follow big some large inventory writedowns. Similar thing may happen for VIPShop if VIPShop cannot send the unsold stocks back to the supplier in the future, which is possible.

4. Competition
VIPShop is just a simple website that costs fewer than $1K to replicate in China. It has very low entry barriers. There are tons of sites like this in China, such as Shangpin, Jiapin, etc. I think the biggest competition will come from existing huge incumbent players such as 360Buy, TMall and Tencent. They may just tweak their existing platform to conduct similar flash sales function.

5. Industry Trends
The current hype of VIPShop is partly due to the industry inventory glut of the shoes and apparel industry in China. But the industry is already near the bottom and some segments such as Sports apparel and shoes are already experiencing a slight recovering after some painful destocking activities. It will likely be more difficult for VIPShop to source the products in the future.

6. Consumer Reaction
VIPShop sells a few premium brands, but most items listed are actually crappy brands that trying to sell at a high price. Chinese consumers may not be aware of this at first. But gradually I believe they will find out about it and stay away from VIPShop.

I think in the long run, VIPShop may generate $50 million net profit per year, which is not a bad figure for a website. Applying a 10x muliple, I think it's fair value stands at $500 million, which is about $9 dollars per share, in line with IPO pricing. There is substantial downside risk for this stock!!!