Initial Report: Alibaba Group Holding Limited (NYSE: BABA), 66% 5-yr Potential Upside (EIP, Team Prism)
Seems like the Z Club has great faith in Baba - here's the 3rd move forward on this stock!
LinkedIn | Joseph CHONG
Company Overview
Alibaba Group Holding Ltd (BABA) is a Chinese technology conglomerate that is primarily focused on e-commerce, retail, logistics and technology.
Business Segments
Cloud: A cloud computing company that provides a wide range of cloud computing services, including data storage, computing, and security solutions.
Digital Media and Entertainment: This segment operates content platforms that provide online videos, films, live events, news feeds, and literature and music.
Innovation Initiatives and Others: This segment offers a mobile digital map, navigation, and real-time traffic information; a digital collaboration workplace that provides various ways of working, sharing, and collaborating for enterprises and organizations; and an AI-powered smart speaker.
China Commerce: This segment operates platforms in retail and wholesale commerce. It also provides logistics and local consumer services.
International Commerce: This segment operates platforms in retail and wholesale commerce. It also provides logistics and local consumer services.
Local Consumer Services: This segment offers location-based services, such as Ele.me, Amap, Fliggy, and Taoxianda.
Cainiao: This segment offers one-stop-shop logistics services and supply chain management solutions.
Industry Overview
Market Size
In 2021, China became the largest market for eCommerce with a revenue of US$1,543 billion after growing at a CAGR of 17.7% from 2017 to 2021. This is expected to continue growing at a CAGR of 11.6% between 2021 and 2025 to reach CNY21.4 trillion (US$3.3 trillion) in 2025. Analysts expect this next leg of growth to be driven by an increase in Chinese user penetration from 71.9% in 2022 to 83.9% in 2025.
Growth Drivers
We believe the growth of the Chinese eCommerce market will be driven by these factors:
Post-Pandemic Macroeconomy Recovery
In the months of January and February, the total retail sales of consumer goods were 7,706.7 billion yuan, a year-on-year increase of 3.5%, and a month-on-month increase of 5.3%. Inflation has been maintained at low-level and consumer confidence has seen gradual increases. High-frequency essential goods grew by 9.0% YoY. High-frequency optional consumer goods grew by 5.4% YoY.
High growth of China’s B2B Cross-border E-commerce Market
China’s B2B cross-border e-commerce market is forecasted to grow by 160% between 2021 and 2025. As of March 1st, OpenAI, the developer of ChatGPT, announced the opening of its API (application programming interface), allowing third-party developers to integrate ChatGPT into their applications and services through the API. Several e-commerce-related companies have started to integrate ChatGPT's API interface to improve their operational efficiency. Cross-border e-commerce SaaS service provider Shopify (which belongs to Alibaba) was the first to integrate ChatGPT. ChatGPT can mainly improve operational efficiency in five aspects: Intelligent customer service, product recommendations, product descriptions, marketing strategy and data analysis.
Competitive Landscape
After years of development, the 2B/2C/local life fields have all undergone a round of online transformation, and the e-commerce retail field has formed a situation of four major players: Alibaba, JD.com, Pinduoduo, and Meituan. In 2021 (Alibaba's FY3/2022), the combined GMV of Alibaba, JD.com, and Pinduoduo reached approximately RMB 13.5 trillion. In terms of service transactions, as a leading company, Meituan's GMV in 2021 also reached about RMB 1 trillion.
In terms of the user base. Alibaba is leading, but the ceiling is becoming apparent. As a more comprehensive e-commerce platform, Alibaba's China-related businesses (Chinese retail + wholesale business, local life, Cainiao) had an MAU of 940 million in 2Q2021. From the perspective of AAC, as of the end of 1Q2022, Alibaba's AAC number reached 903 million, while Pinduoduo closely followed Alibaba with 880 million AACs. Meituan and JD ranked third and fourth with 690 million and 590 million AACs respectively, as of September 2022.
Each of the platforms is currently adopting different pricing and subsidy strategies. JD.com's strategy aims to offer subsidies to certain product categories, particularly home appliances, electronics, and mobile phones, to attract high-quality buyers in top-tier cities. Pinduoduo's "A Billion Subsidy" program offers discounts on a wide range of products, particularly 3C and home appliances, and has become an essential component of the platform's user experience, with over 170 million monthly active users. Alibaba's "Price Power" strategy includes designing marketing products, Taobao's direct-to-consumer business model, and the integration of the ‘Juhuasuan’ platform.
The competitive strategy of e-commerce platforms evolves over time. Driving traffic with a focus on core product categories is optimal in the short-run. In the medium term, platforms tend to focus on operational efficiency. In the long term, supply-side factors such as product variety and availability are essential for driving sales volume and achieving significant profits at scale.
Investment Thesis
Thesis 1: Alibaba & Taobao are strong and growing products
1.1 Household disposable income
A higher disposable income rate often relates to a higher consumption rate. As the population move forward, China saw a huge increase in their working population. People aged 30 and 39 are expected to account for 19.9% of online shopping customers who have a tendency of having less free time and are more price-conscious - a perfect formula for online shopping. On average, urban disposable income totalled an annual $7,349.8. Moreover, Morgan Stanley predicted that China’s private consumption is set to double in the next 10 years, reaching $12.7 trillion which is comparable to the amount that American consumers currently spend.
This disposable income trend ultimately brings a huge potential market to tap into for Alibaba. With Taobao holding more than 45% market share, Alibaba is well positioned in capturing the market share.
1.2 Competition from Substitutes (Other companies’ online platforms)
With a range of different segments, Alibaba provides a full range of diversified products and services. Although Alibaba will be challenged by different competitors such as Pinduoduo in the lower-end market and Douyin in other markets, Alibaba is still a competitor in the space.
Compared to Pinduoduo, Alibaba is more focused on mix of cheaper and full-quality items, giving an edge on the consumer that would like to explore the products that they buy. Moreover, Pinduoduo currently has a poorer reputation compared to Alibaba due to the prevalence of counterfeit items. Although Pinduoduo has an edge in the context of suburban and rural population penetration, China’s urban population is growing at a steady pace (reaching 65.2% in 2022 and is expected to reach around 80% by 2035) - hence giving Alibaba an edge in a longer run.
On the other side of the spectrum, Douyin, which is integrated to TikTok, is leaning towards social media marketing and ‘impulse’ buying as products are linked to TikTok influencers’ videos. Taobao has an edge compared Douyin in terms of customer retention, as customers with the intention to purchase are more likely to come back again to the platform for subsequent purchases. Although statistics show that impulse buying is dominating local spending, it is more prevalent in clothing and does not serve an excellent impression on the customer. A survey showed that more than 64% of impulse buyers regret their decisions, and this will not serve as a good way to retain buyers, leaving Alibaba in a better position
1.3 Aging Population
Across the globe, many countries are facing a significant rise in their ageing population, and China is not an exception. The country is now home to the largest population of elderly people in the world. In 2019, 254 million mainland Chinese were above 60 years old. By 2040, this number is expected to increase by 1.5 times to 402 million, which will constitute nearly 30% of the country’s population. This reality, however, presents bouts of opportunities for Alibaba, which aims to target the silver economy for continuous and sustainable growth via its various platforms.
In late August 2022, Taobao introduced a new voice search featuring catering to older users speaking in regional dialects rather than the official Mandarin language. Across the country, standard Mandarin is just one of the hundred over dialects that are being spoken. Older generations are generally more comfortable speaking their native dialects rather than the standard language (South China Morning Post, 9 Aug 2022). As such, through Taobao, Alibaba is aiming to focus on building and deepening the existing user relationship and boost user loyalty. According to the company’s latest figures, over 30 million Taobao users are over 50. By actively capitalizing on this user segmentation base, Taobao is likely to provide an improved user experience and customer value proposition to their customers. With this, we believe that the recurring purchases from the silver economy is likely to rise and jumpstart the growth in Taobao’s gross merchandising value (GMV).
1.4 Hema Xiansheng
In addition, while many businesses suffered due to the Covid-19 Pandemic, Alibaba’s e-grocery model, Hema Xiansheng managed to thrive during this crisis, and after 7 years, the business broke even. (Tech Node, 4 Jan 2023) This event is considered to be a significant milestone at a time where many other tech-funded grocery chains are finding means to break even in the ultra-competitive fresh grocery industry. The Covid lockdowns boosted online sales of fresh produce such as vegetables, seafood and meat, which placed the company on track to serve 1 billion customers with an estimated sales value of RMB 1 trillion (US$145 billion) over the next decade. This illustration further cements Alibaba’s ability to convert loss-making businesses to profitable ones over time, and the company’s vision to prioritize long-term sustainable growth over short term growth.
Thesis 2: Continued cloud computing growth
Despite the apparent view that China’s digital economy has already advanced and grew to RMB45.5b in 2021 as it has scaled up so quickly over the past 2 decades, China’s digital growth is still far from over, which is expected to drive Alibaba Cloud’s revenue and cash flow contribution to Alibaba.
For instance, China's public cloud is expected to more than double in size in the next few years, from $32 billion in 2021 to $90 billion by 2025. This will drive cloud infrastructure services spending by companies in China, which is expected to reach US$85 billion by 2026, with a CAGR of 25%.
Alibaba Cloud is poised to capture this growth as they currently still remains the leader with a 37% market share, ranking first in the cloud market in 2021 ahead of Huawei Cloud (18%), Tencent Cloud (16%), and Baidu AI cloud (9%).
For 2Q23, Alibaba Cloud accounted for 10% of total revenues. Although revenue for this segment slowed down by 6.0% this quarter, it is due to lockdowns and depressed sentiments during this quarter. Prior to this, there has been consistent growth at 41.5% y-o-y in 2Q22 and 68.8% y-o-y in 2Q21. In addition, despite slowing revenue, the cloud segment managed to achieve a positive adjusted EBITDA of US$61m, similar to 2Q22 despite lower revenues, reflecting better cost management. This is a significant achievement as for a number of years, this segment was unprofitable.
Alibaba Cloud is also continuing to invest in its infrastructure to cater to wider fields of cloud applications. For instance, they have created a new type of database that can handle a large amount of data in real-time and is using AI technology to improve the customer experience and make its business run more efficiently. All of these efforts and initiatives will help the company stay competitive in the market and continue to improve its services.
Catalyst
1. IPOs of business units
Alibaba announced on 28 March 2023 it will split its company into 6 business groups – Cloud Intelligence Group, Taobao Tmall Business Group, Local Services Group, Global Digital Business Group, Cainiao Smart Logistics and Digital Media and Entertainment Group.
This restructuring allows each business group company to pursue independent fundraising and IPOs as and when they are ready. We believe that upon IPO of its business units, it will unlock further shareholder value as investors begin valuing the company more accurately on a sum of the parts (SOTP) valuation.
Valuation
Given that Alibaba is in the process of spinning off its 6 business units, we used a sum-of-the-parts valuation model to value the business. Using conservative estimates of FY24 financials and valuation multiples, we were still able to derive an upside of 24.1%.
ESG Analysis
Environmental Risks: Alibaba's operations and supply chain have a significant impact on the environment, particularly in terms of energy consumption, waste generation, and greenhouse gas emissions. Investors should consider Alibaba's efforts to reduce its environmental impact, including initiatives to increase energy efficiency and reduce waste.
Energy Management- Hardware Infrastructure Energy & Water Management
A large part of the energy consumed by the E-Commerce industry is used to power critical hardware and IT infrastructure in data centers. Data centers need to be powered continuously, and disruptions to the energy supply can have a material impact on operations, depending on the magnitude and timing of the disruption. Companies also face a tradeoff when it comes to energy and water consumption for their data center cooling needs: Cooling data centers with water instead of chillers is a means of improving energy efficiency, but it can lead to dependence on significant local water resources. Companies that effectively manage this issue may benefit from cost savings and minimize reputational risks, as there is growing concern over energy and water use.
Product Design & Lifecycle Management - Product Packaging & Distribution
A significant part of the E-Commerce industry’s added value comes from firms’ ability to move a wide array of goods efficiently to consumers who would otherwise have to personally travel to collect the goods from brick-and-mortar stores. As the volume of packaging shipments increases, the industry may become more exposed to environmental externalities, such as carbon pricing and subsequent rising fuel costs that present risks associated with the shipping of products. While firms that outsource shipping and logistics have less control over the specific processes of shipping operations, they can still select suppliers with more energy-efficient business practices. As this is a highly competitive and low-margin industry, the ability to shave off shipping costs through fuel reduction and more efficient routing can allow firms to pass those savings on to their customers. Additionally, e-commerce firms have an incentive to minimize the use of packaging. Efficient packaging can lead to cost savings from reducing the amount of material that needs to be purchased, as well as saving on logistics costs, as more products can fit into a single shipping load.
Social Risks: Alibaba is a major player in the collection and use of customer data, which creates privacy risks for its users. Investors should assess the company's data protection policies and practices, particularly in light of increasing regulatory scrutiny around data privacy.
Customer Privacy - Data Privacy & Advertising Standards
E-commerce companies have access to consumer information, including financial information, purchase history, and basic demographic data. Companies in this industry must carefully manage two separate and often conflicting priorities. On one hand, companies compete on their ability to leverage data to provide users with relevant services and target advertising or product recommendations based on consumers’ preferences and behavior patterns. On the other hand, the fact that companies have access to a wide range of user data, such as personal, demographic, and behavioral data, raises privacy concerns among users and the public at large, and is leading to increased regulatory scrutiny from authorities in the U.S., Europe, and other jurisdictions. Failure to manage the issue can result in costs associated with regulatory oversight and reputational risks. Furthermore, effective management in this area can have financial implications through increased user confidence and loyalty, which are particularly important to maintain market share
Data Security
The business model of companies in the E-Commerce industry depend on a firm’s ability to securely process electronic payments. As consumers become more educated about the threats of cybercrime, particularly in the wake of continued high-profile attacks, having a reputation as a secure company will become increasingly important to maintain or gain market share. There is an opportunity for the most trusted brands to position themselves favorably in the eyes of consumers and gain a significant competitive advantage. This makes user loyalty, which is highly influenced by the perception of the safety of the user’s valuable financial and personal information, particularly important to maintaining market share
Employee Recruitment, Inclusion & Performance
Employees are key contributors to value creation in the E-Commerce industry. While the number of job openings in the industry continues to grow, companies are finding it difficult to recruit qualified employees to fill these positions. In key markets, a shortage of technically skilled domestic workers has created intense competition to acquire such employees, contributing to high turnover rates. This competition for talent and the search for innovation opportunities presents several interrelated sustainability challenges regarding human capital that companies must manage. Hiring foreign nationals to compensate for shortages in local talent can create risks related to perceived social implications in the host and home countries of workers. Companies offer significant monetary and non-monetary benefits to improve employee engagement and, therefore, retention and productivity. Initiatives to improve employee engagement and work-life balance might influence the recruitment and retention of a diverse workforce. As the industry is characterized by relatively low representation from women and minority groups, efforts to recruit from and develop diverse talent pools can serve to address the talent shortage and generally to improve the value of company offerings. Greater workforce diversity is important for innovation, and it helps companies understand the needs of their diverse and global customer base.
Governance Risks: Alibaba has faced criticism over its governance structure, particularly the concentration of power in the hands of founder Jack Ma and the lack of independent board members. Investors should evaluate the company's governance practices, including its policies around executive compensation, board diversity, and shareholder rights.
Other risks:
Regulatory Risks: Alibaba operates in a heavily regulated industry and is subject to a range of regulatory risks, particularly in China.
*Do note that all of this is for information only and should not be taken as investment advice. If you should choose to invest in any of the stocks, you do so at your own risk.