Alibaba is a Chinese e-commerce company. Over recent years, it has also been building its capability in cloud computing and the fintech space, with the most prominent one being Ant Group.
Alibaba’s stock price has risen steadily since its first public offering, thanks to its increasing revenue and promising future prospects.
However, things changed in October 2020, when the government cracked down on these Chinese tech behemoths.
Alibaba was hit with a slew of penalties and warnings as a result of the Chinese government’s crackdown. Ant Financial was forced to restructure, and Alibaba received a record $2.8 billion fine from antitrust authorities in April.
Since then, Alibaba’s stock price has fallen by more than 30% and has yet to recover:
Investors must be regretting right now because not only has Alibaba’s share price dropped, but its peers have outperformed it.
Despite the unfavourable news, Warren Buffett’s long-time partner and Berkshire Hathaway vice chairman, Charlie Munger, invested in Alibaba in April. His actions could indicate that the market is overreacting and that Alibaba is a good buy right now.
Nonetheless, Alibaba’s problems aren’t over yet, so let’s weigh the risks and rewards of investing in this firm before making a decision.
Heads up: Alibaba is a behemoth, this will be a long article. Here’s a table of contents for easy navigation:
Alibaba’s Business – what do they do?
Alibaba Group was founded in 1999 by Jack Ma. Today, it is one of the biggest e-commerce companies in the world, with over 50% of China’s e-commerce market share.
In total, Alibaba’s core commerce business makes up 87% of the total company revenue from its range of sub business like Taobao, Tmall, AliExpress, Lazada, Cainiao and many more.
Other than e-commerce, Alibaba has been investing heavily in its Cloud Computing business. As of FY2021, its cloud computing segment makes up 8% of the companies total revenue.
The remaining 5% comes from:
- its Digital media and entertainment segment,
- Innovation initiatives and
The stages of each segment are seen in the diagram below. As depicted on the image, the larger the size of the tree shows, the more profitable the segment is.
You can probably tell that Alibaba is a huge company with many different business segments. Overall, it can be categorised into four business segments and another two investment segments. These are:
- Core Commerce,
- Cloud Computing,
- Digital Media & Entertainment,
- Innovation Initiatives & others,
- Ant Group and,
- Strategic investments.
Let us break it down and learn more about each segment.
Core Commerce (Taobao, Tmall, AliExpress, Lazada, 1688.com and many more)
Making up the bulk of Alibaba revenue and profit is its core commerce, which comprises TaoBao, TMall, AliExpress and many more. This segment has many subsegments:
- TaoBao (C2C)
TaoBao is a Consumer to Consumer e-commerce platform which allows small business and individuals to sell their products to consumers in mainland China, Hong Kong, Macau and Taiwan.
- Tmall (B2C)
Tmall is made up of two parts: Tmall China and Tmall Global.
Tmall China was launched in 2008 as a business to consumer (B2C) e-commerce platform. It mainly allows businesses with an offline presence in China to sell their products to Chinese consumers. This is a stark contrast from TaoBao, as only recognized companies like Nike can sell their products here.
Tmall Global, on the other hand, was launched in 2014 and also functioned like Tmall China. The only difference is that foreign brands without a physical presence in China can list their products. Currently, it is the largest Chinese cross border e-commerce platform with over one-third of the market shares.
Acquired in 2019, Kaola.com primarily serves as an online marketplace for Chinese consumers to buy imported products. We can see Kaola.com as an extension to Tmall.
Formed in 2013 through a partnership with six other Chinese logistics companies, Cainiao primarily serves as Alibaba’s logistics arm.
With its logistics infrastructure globally, Cainao is increasingly being adopted by Alibaba’s merchants across its various e-commerce platforms. For FY2021, Cainiao has achieved revenue growth of 68% year on year and represented 5% of Alibaba’s total revenue and has turned cash flow positive this year.
- Ele.me & Koubei
Acquired in 2018, ele.me is an on-demand delivery platform in China that allows consumers to order food and groceries online. In addition, it also provides last-mile logistics services, which include delivery services for Freshippo and Alibaba Health.
Meituan is still the market leader in food delivery services with over 65% of China market share. Nonetheless, ele.me still has a commanding 27.4% market share, putting it in second place.
Kuobei, on the other hand, is one of China’s leading restaurant and local services guide platforms for in-store consumption.
Known as ‘Hema’ in Chinese, it is a chain of self-operated retail shops (Similar to Amazon Go) that offers zero human touch shopping experience. As of March 31, 2021, 257 Freshippo stores are running, which are primarily located in tier one and tier two cities across China.
Acquired in 2016, Lazada primarily serves the South East Asian market and is currently one of the largest e-commerce players in SEA. While Lazada has had triple-digit year-on-year order growth, it is worth noting that it has recently lost ground to SEA group‘s shoppee, which has done exceptionally well thanks to its localized marketing efforts.
Nonetheless, Lazada is still in second place, ahead of Tokopedia, with over 100 million monthly active users.
AliExpress, launched in 2010, is a global marketplace enabling consumers to buy directly from manufacturers and distributors, primarily in China.
- Alibaba Cloud
Alibaba Cloud offers a suite of cloud services to its customers globally. These services include data storage, large-scale computing, security, big data analytics, machine learning platform and IoT services.
In terms of market share, Alibaba Cloud comes in at fourth place with a market share of 6%, just below Amazon, Microsoft and Google. In its home market, Alibaba cloud takes to lead with over 39.8% market share.
Alibaba Cloud’s revenue increased by 50% year over year to US$9,176 million in FY2021, and the company became cashflow positive for the first time. This increase can be ascribed to the Covid-19 pandemic as well as general digitization tendencies. Moving forward, with the Chinese government’s strategic priority in cloud computing, I believe Alibaba Cloud will grow immensely.
Digital Media & Entertainment
- Youku, Alisports, AliGame, UC etc.
This segment makes up a small part of Alibaba’s revenue.
Acquired in 2016, Youku is the third-largest online long-form video platform, which has over 500 million monthly active users. Apart from providing digital media and entertainment content to its users, Youku serves to complement Alibaba’s e-commerce business through its membership program and also as a medium for live streaming of major events of its core commerce like the 11.11 global shopping festival.
Its main competitors are iQIYI and Tencent Video.
- Amap, DingTalk, etc.
This segment is like a ‘startup’ arm of Alibaba, and most if not all initiatives are still unprofitable. Nonetheless, if Alibaba manages to find 1 or 2 gems, it could potentially be a 10x bagger.
Currently, Alibaba is working on initiatives like Amap and DingTalk. Amap is a mobile digital map that provides navigation and real-time traffic information in China. Its big data-enabled technology helps power major mobile apps across different industries, including ride-hailing and social networking.
DingTalk is a digital collaboration workplace that offers new ways of working, sharing and collaborating in schools and offices. It allows users to stay connected while working remotely, which is crucial given the pandemic now.
Ant Group is a fintech company that provides a range of financial services like its payment services, Alipay, which is well integrated into its e-commerce platform. To put its size into perspective, Ant group’s active user is about two times that of of Paypal’s, with a global annual active users of 1.3 billion.
Due to regulatory issues, Ant Group had to split from its parent company. As such, it now forms the investment part of Alibaba where it holds a 33% equity stake in the company.
Other than that, Ant Group also partners with financial institutions to offer wealth management products, micro-financing and insurance products.
While Ant Group has taken a massive hit after its IPO was halted, there is still a lot of growth coming from this segment. With the growing middle income and its investment in the commercial applications of blockchain, AntGroup has a long runway ahead for it.
- Didi, Bilibili, etc.
Apart from its own business, Alibaba has also invested in other companies, with the two most notable ones being Bilibili (8% ownership) and Didi Chuxing.
Key Financials – is the business healthy?
So how has Alibaba performed over the years?
I’d say it’s very impressive. Alibaba’s revenue has been steadily increasing for the past ten years.
The company’s revenue in FY2021 was RMB717,289 million (US$109,480 million), up 41% from RMB509,711 million in FY2020.
The high revenue growth was mainly due to Sun Art’s consolidation beginning in October 2020, together with the excellent performance of its cloud computing segment and Cainiao logistics services businesses.
Even without the Sun Art merger, its revenue would have still increased by 32% year on year.
Here’s a breakdown of its revenue contributed by the different segments:
Making up the vast chunk of the pie is its core commerce segment. Overall, Alibaba’s e-commerce segment did well in 2020, probably with the boost from the pandemic. Its revenue for its China commerce retail business, China commerce wholesale business, International commerce retail business and International commerce wholesale business were up 42%, 15%, 42% and 50%, respectively
Cainiao, Alibaba logistics arms, has also seen its first year of positive cash flow after a 68% growth in its revenue compared to FY2020, primarily due to the increase in the volume of orders from its e-commerce business.
Local consumer services, including its on-demand delivery platform Ele.me, have also seen a 24% increase in revenue as delivery surged in 2020.
Its Cloud Computing segment is its rising star with a 50% increase in its revenue compared to the previous year. Like Cainiao, Alibaba Cloud has also started turning cash flow positive and is now a cash cow for Alibaba.
I won’t dive too much into the last two segments, Digital media and entertainment and Innovation initiatives and others, but likewise, their revenue has grown in FY2021.
Increasing Net Income
So, Alibaba’s top line has done tremendously well. What about its bottom line?
Similarly, for the past ten years, its net profit has been increasing.
The company’s net income for FY2021 was RMB143,284 million (US$21,869 million), up 2% from RMB140,350 million in FY2020.
Yes, this is low compared to the company’s revenue growth, owing to the anti-monopoly fee imposed on Alibaba. If all of these one-time losses and profits are excluded, Alibaba’s non-GAAP net profit would have risen to RMB171,985 million (US$26,250 million), up 30% from RMB132,479 million in FY2020.
Alibaba’s cash and cash equivalents were RMB473,638 million (US$72,291 million) as of March 31, 2021, compared to RMB358,981 million a year ago.
The rise was primarily due to RMB172,662 million (US$26,353 million) in free cash flow from operations.
In a nutshell, Alibaba is one of the rare breeds of high-growth companies that are already profitable. As you can see from the chart above, Alibaba has already been a cash cow.
Healthy Debt levels
With a current ratio of 1.91 in FY2021, it is safe to say that Alibaba has the means to pay its short term obligations without problems.
A low Debt to Equity ratio also suggests that Alibaba shouldn’t be running into any financing problems anytime soon.
Operating Margins are high
Unlike Amazon or J.D., which handles the product and storage cost themselves, Alibaba is primarily a platform provider and does not handle the parcels themselves.
As a result of this business model, we can see that Alibaba’s operating margin is significantly higher than the industry average.
This not only results in larger net profits but also makes the company more resilient in the long run.
Should there be a drop in margins for the whole industry (A possible scenario as a result of the Anti Monopoly crackdown), Alibaba would undoubtedly be able to handle it better than a company like J.D., which is barely profitable.
Alibaba’s Growth potential
Alibaba’s China retail marketplaces have more than 811 million annual active consumers as of March 2021, with an annual net gain of 85 million.
Overall, the company’s e-commerce platforms have witnessed higher average yearly spending per consumer (China retail marketplaces reached over US$1,404 per consumer) and a higher retention rate, both of which are encouraging signs for the future.
Moving forward, the business expects to generate over RMB930 billion (US$144 billion) in revenue in 2022, which represents a 30% increase from above FY2021 revenue.
Well, 30% seems like a lot for such a large corporation, so let’s see whether it’s achievable.
Huge market potential
With a population size three times the U.S., the e-commerce market in China is the biggest globally, accounting for 56% of global online sales in 2019.
It is interesting to note that the Chinese are much comfortable shopping online, as seen from its online sales which accounted for about 52.1% of retail sales in China, compared to only 15% in the United States.
With the growing middle class that can spend more on consumer goods and an increasing number of new users from the rural cities, Alibaba core commerce will undoubtedly continue to grow.
This is backed up by data from GlobalData, which forecasts that the Chinese e-commerce market would expand at a CAGR of 12.4% from CNY13.8 trillion (US$2.1 trillion) in 2021 to CNY19.6 trillion (US$3.0 trillion) in 2024.
Other segments benefiting from core commerce growth
Apart from its core commerce growth, infrastructure and services that go hand in hand with e-commerce shopping are likely to grow. With the integration and convenience of the payment solution on Alibaba e-commerce sites, Ant group’s Alipay would see a growth in its transactions, and hence revenue moving forward.
With the rise of ‘buy now pay later’ payment models, Alipay is also offering a similar service called Huabei. As of today, Alipay and WeChat Pay are both the largest payment tool in China.
Alibaba logistic arm is the other company that would benefit from the boost in e-commerce sales too.
Data is the new gold
The pandemic has shown the importance of digitalization for businesses to stay relevant. As a result of this and the general digitalization trend, there will be more data being produced.
According to IDC research, China had generated 13.1 ZB of data in 2020, accounting for 21.4% of world data. Over the next five years, this data volume would like to increase at a CAGR of 24.4%.
As these data needs to be processed and stored somewhere, cloud infrastructure like Alibaba Cloud has is essential and will be required by many businesses.
China’s cloud computing market will likely increase in the next few years. According to CAICT, it will reach 375.42 billion RMB by 2023 with a CAGR of 29.5%.
4 Risks of investing in Alibaba
I have painted such a rosy picture for Alibaba, but there must be reasons why it remained undervalued right? Here are some risks when we are investing in Alibaba.
1 – Uncertainty of the Chinese regulators
As a result of the crackdown, they were a lot of market fears.
We will never know what the Chinese government is going to slap Alibaba with next. Will it be another Antitrust fine? Will Alibaba be forced to divest some of its investments? We do not know, and this is the uncertainty that could be why Alibaba has been trading at such a low price.
2 – VIE structure
If you haven’t heard, the Chinese regulator is attempting to close the VIE structure’s loophole.
A Variable Interest Entity (VIE), for those unfamiliar with the acronym, is a sort of legal entity that allows investors to profit from a company’s economic activity without actually owning it.
This structure was created to circumvent the Chinese government’s regulations on foreign investment in sensitive areas, allowing Chinese enterprises to obtain capital without first seeking authorization from the authorities.
Moving ahead, Alibaba, which is listed on the U.S. market through the VIE structure, may be needed to acquire further permission from the market if they require additional capital, which can be a hassle.
3 – Delisting Risk
The talks of delisting have been around for many years. This was further intensified after the tension between U.S. and China escalated. In March, the U.S. Securities and Exchange Commission adopted the Holding Foreign Companies Accountable Act, which states that any companies listed on the U.S. exchange must be audited by the U.S. watchdog. Failure to comply would result in the company being delisted.
In addition to this, the Chinese government has also been ‘nudging’ its company to list on the home exchanges.
While this is a risk, such risk can be avoided by buying Alibaba shares from the Hong Kong exchange instead of the U.S. one. So I do not see much issue with this. In addition, Alibaba shares are fungible. Meaning we can exchange easily exchange our BABA share for 9988.
4 – Growing competitions
While Alibaba takes up most of the market shares at 69% in terms of online retail profit, its competitors J.D. and Pinduoduo, are not cutting any slacks.
JD.com is currently China’s second-biggest e-commerce retailer, with about 12% of the market share. To make things worse, Tencent is also J.D.’s major stakeholder, allowing J.D. products to be shown on its messaging platform WeChat.
Pinduoduo is also another big e-commerce retailer in china with around 8% market share. This e-commerce company has also been growing very rapidly due to its group buying business model where customers are invited to form groups with others interested in the same product.
Here is another diagram that shows the breakdown of the B2C online retail market share in China for the first quarter of 2021:
Tmall accounts for 63% of all transactions, for now.
Valuation of Alibaba – can buy?
There are many ways we can value Alibaba. For this article, I will simply use the DCF model from Finbox and its P/E ratio.
Nonetheless, you can also break down its business segment and assign a valuation to each base on its competitors market cap. From there, you can estimate the overall potential value of Alibaba. Well, I can give you a ballpark value which is around $250 to $300 per share.
Based on Finbox’s discounted cash flow method with an estimated revenue of 5 year CAGR of 19.7%, its fair value is around $276.55 USD which signals a 28.8% upside from the current price.
Based on Alibaba’s historical P/E, its current P/E of 26 is roughly at its historical average, which could signal that it is fairly valued at this point.
However, if we compare with it with Amazon, which has a P/E of 68, Alibaba is way undervalued. Of course, I do not think it will be able to hit the same P/E as Amazon due to the risk associated with the CCP.
When I was doing my research on Alibaba, I could sense a lot of fear and uncertainty from investors. Looking at the comment sections, many were sceptical of the CCP actions and how it was out to kill Alibaba.
That being said, Alibaba is definitely a buy for me. I believe, like many Chinese stocks, the market is overly discounting Alibaba. There is indeed some real risk due to the uncertainty of the Chinese government, and the market should discount this from its share price. However, this discount may have been too much.
Nonetheless, I believe Alibaba will continue to grow with a strong growth tailwind in its e-commerce and cloud computing segment. For investors holding on to Alibaba, there is no guarantee when the share price would go up as the market can remain irrational for as long as it likes.
However, this high growth company has a lot of upside potential in the long run, which makes the risk to reward simply too compelling for me not to miss.
What about you, what are your thoughts on Alibaba?
Disclosure: I have a position in Alibaba at the time of writing.
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