If you haven’t reviewed Alibaba stock before, then you may think that the company’s presence is tied mainly to alibaba.com. However, as we shall see later, this international wholesale business is not the key driver of its business.
Alibaba stock price has gone through some huge swings in the past year. From the correction during the first Covid-19 outbreak, it climbed rapidly surpassing $300 a share in Oct 2020.
Thereafter, news on its Ant Group IPO suspension and the subsequent antitrust probe from the Chinese regulators has sent its share price to near pre-Covid levels. Does it represent a window of opportunity or the beginning of the further decline? In order to make that assessment, we have to have a complete understanding of Alibaba’s business. So, let’s check it out.
Alibaba Stock Business Overview
Business Segment Breakdown
Source: Alibaba Group FY2020 Annual Report Business Segments
Alibaba is a huge business with footprints in many technologically related sectors. Its business is segmented into below four main categories (Core Commerce, Cloud Computing, Digital Media & Entertainment, and Innovation Initiatives & Others) . Its related subcategories and some of the key brands are summarized below as well.
Retail Commerce – China
- Taobao marketplace: China’s largest mobile commerce destination in terms of Gross Merchandise Value (GMV) for the twelve months ended March 31, 2020, according to Analysys.
- Tmall: Largest third-party online and mobile commerce platform for brands and retailers in the world in terms of GMV for the twelve months ended March 31, 2020, according to Analysys.
- Freshippo (known as “Hema” in Chinese): Proprietary grocery retail chain.
- Taoxianda: Online-offline retail integration service solution for fast-moving consumer goods (FMCG) and grocery retail partners with physical stores.
- Tmall Supermarket: Utilizes both marketplace and retail model to offer consumers a broad range of high-quality daily necessities.
Wholesale Commerce – China
- 1688.com: China’s leading integrated domestic wholesale marketplace in 2019 by revenue, according to Analysys. Connects manufacturers and wholesale sellers to wholesale buyers in China.
- Lingshoutong: Helps FMCG brands and their distributors connect directly with small retailers, primarily mom-and-pop stores, in China.
Retail Commerce – Cross-Border and Global
- Lazada: Leading and fast-growing e-commerce platform in Southeast Asia for SMEs, regional and global brands.
- Trendyol: Largest e-commerce platform in Turkey.
- Daraz: Leading online marketplace in South Asia, empowering tens of thousands of sellers to connect with millions of customers.
- Aliexpress (China export commerce): Global marketplace targeting consumers from around the world and enabling them to buy directly from manufacturers and distributors in China and around the world.
- Tmall Taobao World (China export commerce): Chinese-language e-commerce platform, allowing overseas Chinese consumers to conveniently shop for products from China.
- Tmall Global (China import commerce): Largest import e-commerce platform in China, in terms of GMV for the twelve months ended March 31, 2020, according to Analysys. Addresses increasing Chinese consumer demand for international products and brands.
- Kaola (China import commerce): Operating as an independent app, it offers high-quality imported products and premium services to consumers.
Wholesale Commerce – Cross-Border and Global
- Alibaba.com: China’s largest integrated international online wholesale marketplace in 2019 by revenue, according to Analysys. It connects Chinese and overseas suppliers to overseas wholesale buyers.
- Cainiao network: Operates a global fulfillment network together with its logistics partners, by providing domestic and international one-stop-shop logistics services and supply chain management solutions. It addresses various logistics needs of merchants and consumers at scale.
- Ele.me: Leading on-demand and local services platform in China, enabling the ordering of meals, snacks, beverages, fresh food and groceries online.
- Koubei: One of China’s leading restaurant and local services guide platforms, integrated closely to Ele.me.
- Fliggy: Leading online travel platform in China, providing comprehensive reservation services for airline tickets, train tickets, accommodation, car retinal, package tours, and local attractions.
- Alibaba Health: Engages in pharmaceutical and healthcare product sales business, establishes internet healthcare platforms and explores digital health using cloud computing and big data technologies.
- Cloud Computing: World’s third largest and Asia Pacific’s largest Infrastructure as a Service (IaaS) provider by revenue in U.S. dollars, according to Gartner’s April 2020 report. In addition, Alibaba Cloud is China’s largest provider of public cloud services by revenue in 2019, including IaaS and PaaS (platform-as-a-service) according to IDC (Source: IDC Semiannual Public Cloud Services Tracker, 2019).
Digital Media & Entertainment
- Key distribution platform
- Youku: Third largest online long-form video platform in China in terms of monthly active users in March 2020, according to QuestMobile.
- Key content platforms
- Alibaba Pictures: Internet-driven integrated platform that covers content production, promotion and distribution, intellectual property licensing and integrated management, cinema ticketing management, and data services for the entertainment industry.
- Damai: Leading online ticketing platform for live events, including popular concerts, plays, and sporting events, in China.
- Shuqi: Online literature distribution and reading platform and it offers content for use in derivative works or tie-in entertainment.
Innovation Initiatives & Others
- Amap: Largest provider of mobile digital map, navigation, and real-time traffic information in China by monthly active users in March 2020, according to QuestMobile.
- DingTalk: Digital collaboration workplace that offers new ways of working, sharing and collaboration for modern enterprises and organizations, including schools and education institutions.
- Tmall Genie: AI-powered smart speaker. No. 1 smart speaker in China by shipments in 2019 according to IDC (Source: IDC China Quarterly Smart Home Device Tracker, 2019). It links customers with new services and experiences to be generated by IoT and smart home appliances.
Ant Group – Financial Technology Services
Alibaba stock price has been affected negatively due to the news on its failed IPO attempt of its Ant Group.
Understand that Ant Group primarily deals with digital payment services and digital financial services through its Alipay app.
In its digital payment services segment, Ant Group helps to facilitate online and offline transactions between customers and merchants. On the other hand, its digital financial services arm, through partnerships with third-party financial institutions, the group provides services consisting mainly of wealth management, micro-financing and insurance.
Meanwhile, the group expanded its footprint beyond China through strategic partnerships with nice local partners in Bangladesh, Hong Kong S.A.R, India, Indonesia, Korea, Malaysia, Pakistan, the Philippines and Thailand.
At the technology frontier, the company pioneered various services such as the commercial application of blockchain. Its proprietary blockchain technology had been applied to many cases such as supply chain financing, product provenance, electronic bill issuance and circulations.
With the spinoff of Ant Financial from Alibaba, Alibaba will hold a 33% stake in Ant Financial. As a result, earnings will be reported under equity investment method upon the completion of the transaction in September 2019.
Alibaba Stock Financial Overview
Alibaba Stock Revenue By Segment
Source: Alibaba Group FY2020 Results Presentation
You can see that Alibaba’s core commerce contributes 86% of the group’s total revenue in FY2020. In fact, 65% of the revenue comes directly from China’s commerce retail subsegment. This tells us that the key business driving the group is mainly attributed to its Taobao and Tmall ecommerce platforms. And they are focused on the China consumer market.
The company generates its revenue in the China commerce retail subsegment through customer management, commission and others.
- Customer management involves merchants paying for online marketing services to advertise their products to potential customers.
- At the same time, merchants also pay a small percentage of commission. They are associated with transaction value generated on Tmall and certain other marketplaces.
- Other revenue from the China commerce retail subsegment is primarily generated from New Retail and direct sales businesses. They are derived mainly from Freshippo, Tmall Supermarkets, direct import and Intime.
The international whole commerce business coming from Alibaba.com contributed a mere 2% to the group’s revenue. In fact, its wholesale commerce business within China contributes more to its revenue than the international counterpart.
Compared to the previous year, FY2020 saw a 35% increase in revenue in its core commerce segment. China commerce retail sub-segment continues to show strong growth of 34%. On the other hand, Cainiao logistics services and local consumer services saw much faster growth at 49% and 41% respectively.
We want to highlight the strong growth in its cloud computing business, with a 62% YOY revenue growth for FY2020. Also, this is a growing market with the potential to allow Alibaba to turn a good profit, just like Amazon.
However, before we get all too excited about its growth story, let’s check the earnings for each of the segments.
Alibaba Stock Earnings By Segment
Source: Alibaba Group FY2020 Results Presentation
Observe that the group’s core commerce business is very profitable, with a EBITA (Earnings Before Interest, Tax and Amortization) margin of 38% for FY2020. Such high profit margin is an indication of strong competitive advantage that the company enjoys.
However, other than its core commerce segment, the rest of the segments are not so profitable. They have negative EBITA values. That being said, we are not downplaying the importance of these other segments. Moreover, Alibaba group prides to be at the forefront of technological advancement. Hence, it is no surprise that they continue to invest heavily in many areas, albeit unprofitable in the short term.
For instance, there was an increase of RMB8,302 million in depreciation expenses and bandwidth and co-location fees as a result of the group’s investments in their cloud computing and core commerce businesses. It is difficult to segregate expenses in maintaining its business and the expenses associated with expanding the business. However, we are positive in terms of its eventual profitability, based on the economics of cloud players in the U.S.
While other business segment still seem far to turn a profit, its Cloud Computing segment is a promising candidate.
Rapid Growth In Cloud Computing Business
Drawing from established cloud computing giants, like Amazon in the U.S, we can expect substantially favorable economics and profitability in Alibaba’s cloud business eventually as well.
Source: China Internet Watch / Cloud complying market share: China vs Global
In fact, Alibaba holds a dominant market share of about 40.1% for the China cloud market as of Q2 2020. Moreover, China’s public cloud market continues to expand rapidly.
The IaaS and PaaS combined market grew at 58.7% year-on-year as of Q1 2020. As such, we believe that Alibaba’s Cloud Computing business has huge potential to generate substantial earnings. It will be a boost to Alibaba stock price in the future.
FY2020 Financial Results Adjustment
Source: Alibaba Group FY2020 Annual Report / Consolidated Income Statement
Observe that for the whole period of FY2020, net income attributable to ordinary shareholders was US21,080 million. But if you examine higher up the income statement, income from operations only contributed US$12,912 million. Whereas interest and investment income, net, contributed a substantial US$10,303 million.
Apparently, this US$10,303 million was mainly attributed to a one-time gain of US$10.1 billion in relation to the receipt of 33% equity interest in Ant Group. As such, we should discount this off to derive the actual sustainable earnings of the business.
For simplicity, we will take US10.303 billion off the reported net income of US21.080 billion, leaving us with US10.8 billion. Divide the figure by the number of outstanding shares of about 2.7 billion ordinary shares. Thus, we will arrive at a full year earnings per share (EPS) of US$4.
However, understand that for FY2020, which ended 31 Mar 2020, it was impacted by the outbreak of the coronavirus. The pandemic had affected the group’s earnings for the first few months of 2020. Therefore, the computed earnings of US$4 a share is understating the actual earnings. The trailing twelve months earnings already amounted to US$6.2 a share. It also accounts for the negative impact during the first quarter of 2020.
Let’s do some quick adjustment:
- Add US$0.5 earnings a share to account for the negative impact sustained during Q1 2020 due to the coronavirus outbreak.
- For simplicity, assume if the group spinoff or terminate all it’s currently unprofitable businesses, we can shave off about US$3 billion in adjusted EBITA losses. Hence, we can add back about US$1.11 earnings per share to the group’s bottomline.
- Alibaba group derives profit from its 33% stake in Ant Group. Assuming conservative estimates of Ant Group’s full year earnings at US$3billion, Alibaba will have its share of US$1billion earnings. We can add back an equivalent of about US$0.37 earnings a share to Alibaba’s earnings.
Therefore, Alibaba’s sustainable earnings can be worked out to be about US$8.18 (6.2+0.5+1.11+0.37) a share.
Assume Alibaba is an established company that has slowed down its growth. Hence, for a quick estimate, we can use a P/E multiple of 20 to value its share price. This will result in a fair value of US$163.6 a share.
However, this is obviously not the case as the group continues to grow rapidly. Thus, the market has already priced in part of its growth story into the current market price. The stock price is hovering around US$220 – US$240 a share. The question is whether the growth element has been fully priced in or if the current negative news pertaining to regulatory probes and the failed Ant IPO attempt have actually discounted Alibaba stock’s growth prospect. We will discuss more later.
Alibaba Stock Strategic Analysis
Source: Alibaba Group FY2020 Annual Report / Alibaba in Numbers
In the earlier sections we discussed the key businesses of Alibaba. We saw that the company dominated China’s retail commerce market, in terms of GMV, mainly through Taobao marketplace and Tmall. In fact, Alibaba owns 53.3% of ecommerce sales in China. This gives the group the economies of scale to be competitive in terms of its service offerings.
In addition, through its rapid branching into areas such as New Retail, consumer services and content creation, distribution and consumption, the digital economy that Alibaba is creating has strong self-reinforcing network effects benefitting its various participants, who are in turn invested in the digital economy’s growth and success.
The large number of consumers on the marketplaces attracts a large number of merchants. The latter in turn become paying customers for the marketing services provided by the company. In turn, they provide vast selections of products at competitive prices which attracts more consumers to the platform.
Not only that such a strong network effect is difficult to replicate, Alibaba’s business model provides significant operating leverage. As a result, its digital economy enables the group to realise structural cost savings. For instance, Taobao marketplace drives significant traffic to Tmall and vice versa, allowing cross-selling opportunities.
One example is that consumer services provided by Ele.me and digital entertainment, including Youku, can be promoted to consumers in the various marketplaces. These interlinked network effects reinforce each other, allowing for lower traffic acquisition costs. Also, it creates synergies across the different business segments.
Return On Equity
Source: Stockrow / Alibaba Group Holdings Limited Return On Equity
Alibaba’s return on equity (ROE) has been hovering above 12% in the past so far. This indicates the presence of competitive advantage that we have discussed above.
In addition, its EBITA margin of 38% for the group’s core commerce business validates that indeed the company enjoys strong barriers to entry, especially from its China retail commerce category.
Therefore, we believe that Alibaba has created a strong economic moat around its businesses especially in its core commerce segment.
Valuing Growth og Alibaba Stock
We saw that group grew its revenue by 35% for FY2020 that ended 31 Mar 2020. However, for conservative estimation, we will look at the growth elements below when assessing Alibaba stock.
Total Retail Sales In China
Source: eMarketer / China to Surpass US in Total Retail Sales
With the rising incomes of consumers in China, moving them into the new middle class, we observe the growth rate in China’s total retail sales to be about 5 – 7% annually. We expect such growth to continue in the next few years. This will be one key natural growth rate that Alibaba group’s core commerce segment will enjoy in the coming years.
China Ecommerce Penetration
Source: Statista / E-commerce share of total retail sales in China from 2014 to 2019
Statista shows that China’s ecommerce penetration has been increasing over the past years at around 2% annually. We expect this to continue and will be another element of natural growth rate for Alibaba, especially since it’s a dominant ecommerce player in the country.
Growth Returns From Investment
Source: Stockrow / Alibaba Group Holdings Limited Return On Equity
Alibaba’s return on invested capital (ROIC) has been hovering above 8% over the past years. But the group is still investing heavily to grow its businesses. We will take it as 8% to be conservative.
We will not dwell into the details of breaking down the respective ROIC segment by segment to derive the overall growth rate that resulted from the invested capital.
For a quick understanding, we saw Alibaba group spent about US$8.032 billion in acquisitions and US$6.41 billion in capital expenditures namely in the purchases of computer equipment and licensed copyrights, expansion of corporate campuses, as well as investments in infrastructure of logistics and New Retail businesses and data centers. This total up to about US$14.442 billion
According to the FY2020 financial report, depreciation of property and equipment, and operating lease cost relating to land use rights work out to be US$2.899 billion. Also, amortization of intangible assets and licensed copyrights works out to be US$3.093 billion. That equates to a total of US$5.992 billion.
Thus, capital expenditures (capex) used for growth can be estimated to be about US$8.45 billion (US$14.442 billion – US$5.992 billion).
To derive its net operating profit after tax (NOPAT), we will apply a tax rate of 15% to the operating income of US$12.912 billion. Thus, NOPAT will work out to be US10.98 billion.
Returns from growth related investments = Growth Capex / NOPAT x ROIC = 6.2%
Summing All Growth Components
From the above three key growth components, we can add up and derive a conservative growth rate of 13.2%
- Growth related to total retails in China: 5%
- China’s ecommerce penetration growth out of total retail sales: 2%
- Returns from capital investment by Alibaba to grow the business: 6.2%
This is a quick estimate of Alibaba’s growth rate, without emphasis on Ant Group’s progress nor the rapid growth from its Cloud Computing business. At the current P/E of around 25, we feel that there is low risk of multiple compression that can cause substantial capital loss to investors. The base case conservative growth rate of 13.2% is still quite substantial to consider investing in Alibaba stock.
Alibaba group is a dominant player in the ecommerce market in China, while expanding its presence in Asia and branching aggressively into other segments like digital media. The most promising segment is its Cloud Computing business, albeit making a slight loss in FY2020.
While the fate of Ant Group financial technology services is still a question mark, Alibaba’s core businesses in commerce already makes it a great company to consider for investment. Strong barriers to entry brought about by the strong network effects in its digital economy creates the economic moat that can withstand the fight with key competitors like JD.com.
While it is difficult to examine the regulatory risk, we don’t think that it makes sense for the authority to break up such a great company. Perhaps there will be fines and warnings. Destroying such a prominent business will only harm its own thriving business community. Furthermore, it will dampen the confidence of global investors to invest in chinese companies in the future.
Therefore, we believe the failed attempt in its Ant Group’s IPO, as well as the antitrust probe from regulation provides a good entry for investors to grab a share in this still-growing-fast business. Moreover, Alibaba group’s financial health is very strong with a negative net debt position. In another word, they have more cash than debt in their balance sheet.
So, do consider adding Alibaba stock to your watchlist or even adding some to your portfolio.
Keep learning and happy investing!