Long Alibaba – Plenty of Upside on This One

Alibaba logo

Long Alibaba @ $155/ADS (July 2017)

Target Price: $300+ (by CY2020 or before)

Summary: Recommend long BABA stock at $157, with 2 year price target of $250-300, further upside even after 2 years. 25% IRR from one of the world’s leading tech companies.

Introduction: Alibaba needs no introduction. The world’s largest e-commerce business by GMV ($580B USD), this company has revolutionary leadership in Jack Ma, who is insanely focused on the long-term. BABA’s ecosystem will get stronger over next two years as core retail, advertisements, video, cloud, payments, and investments all ramp up growth and deepen their moats. We forecast BABA to compound revenue, operating income, and FCF at 30% CAGR to 2021 and beyond, making BABA possibly a trillion dollar valuation in a few years, with stock price well over $300/share and market cap over $700B. Stock has run up recently (up 80% YTD) but is still far from fair value.

Core Assumptions:

  • China retail growth of 5-7% p.a. for next 6-8 years, driven by increase per capital income (mid-teens growth)
  • E-com retail penetration increase from 12% in 2016 to 33% in 2023, CAGR of 25-35%
  • # of T-mall users to grow in the high-single digits to mid-teens from 480 million in 2016 to over 800 million by 2024
    • Driven by increased penetration in Tier 1-3 cities and rural expansion
  • # of Taobao users to grow in the mid-single digits from 480 million in 2016 to ~600 million in 2024.
    • Lots of upside in rural areas
    • I don’t think accusations of Taobao selling “fake products” are accurate. Many Chinese prefer to purchase lower quality products knowing full well they could be fake, so clearly it’s not to deceive the customer, but because unique cultural differences indicate demand. Many US investors don’t really understand nuances of Chinese culture, but have slowly become more aware of these nuances.
  • T-Mall GMV growing at 20-25% p.a. for next 6 years at the very least (mobile contribution increasing to 85%)
    • Average spending per user increasing in the mid-teens (equivalent to 5-10% of annual income, which is itself growing at 10-15% per annum). No evidence BABA is reporting “fake” numbers, as short-sellers like to insinuate from time to time.
    • T-mall take rate growing from 2.6% in 2016 to possibly 4-5% by 2024 (with significant upside here if T-mall take rate approaches 8-15% seen in competitors, including AMZN, JD, Mercadolibre, etc….)
      • I see take-rate improvement, especially on mobile, being source of significant upside
    • Taobao GMV growing high-single digits:
      • Average spending per user increasing low-single digits
      • Taobao will see growth decelerate because of C2C shifting to B2C, but will still be key source of advertisement revenue and traffic source for T-Mall
    • My estimates are consistent with BABA reaching about USD 1 trillion in total US GMV by 2021, as Ma has said many times
    • Advertising revenue will be key source of upside, should increase at 25%+ rates for many years
      • China online advertising is $50B market, currently BABA has about 20% market share. Entire online advertising market will grow at 15-20% for next 8 years, I expect BABA to take incremental share and possibly increase to 30%+ market share of online ads in 5 years
      • BABA has massive user metrics that allow for personal, targeted advertising => increased ROI for advertisers. Similar to trends seen in the USA, Chinese ad budgets are moving very fast to digital
    • Cloud revenue should increase at very fast (triple digits) or high double-digits for many years, could increase from 4% of total revenues (2016) to over 20% by 2024.
      • AliCloud is #1 in China by a huge margin, we expect that to continue
      • LT operating margins could approach AWS standards (20-30%), we forecast 20% to be conservative
    • Revenue from international, cross border commerce should increase at 15-25% p.a. (at least) for several more years given BABA’s investments in promoting cross border consumption / trade / contribution from Lazada
    • Revenue from digital media / entertainment (Youku-Tudou, UCWeb, YunOS, AutoNavi, etc…) should increase at 10-15% clip for next 10 years, but won’t contribute much to overall revenues (only 2%)
    • BABA enjoys 50% EBITDA margins but margins could dip below 45% for many years due to LT investments (5-7 year time horizon). EBITDA (including and ex-SBC expense) should compound at 25%+ rates for next 5 years at least.
    • I think there is significant additional upside if BABA somehow finds a way to work with offline retailers in China to monetize a portion of the massive offline retail spend. BABA is currently working on unmanned supermarket concept stores similar to AMZN’s Go.

Equity Investments:

BABA investments

BABA has a ton of equity investments made over the years, summarized in the chart above. Core holdings include a 33% stake in Ant Financial, 30% stake in Weibo, and 47% in logistics network operator Cainiao.

Given it’s 50%+ market share in the fast growing mobile payments space, Ant Financial could be worth significantly more than $65B in a few years. Ant Fin currently has 50% market share in China’s rapidly growing 3P mobile payments space, and over 450 million annual active users and 150 million daily average users (much larger than the 200 million annual users for Paypal globally). Tenpay is #2 at 38% market share and should catch up a bit, but I believe the mobile payment space has enough runway for both BABA and Tencent to grow and take share. Ant Financial is currently the biggest contributor to value in BABA’s investment portfolio, worth currently about $8/share. I believe this will be conservative in a few years.

Alipay Tenpay share

BABA was also smart enough to invest in Didi rather than Uber a few years ago, the latter eventually retreating from China a-la Google fashion.

Based on latest fund-raising figures, the sum total of these investments equates to about $47 billion, or $18 USD / share.

BABA also has about $8B USD of net cash, or $3.1/share.

BABA’s capital allocation track record is phenomenal, as evidenced by this slide during BABA’s June 2017 investor day in Hangzhou. These guys really know how to create value and reinforce the ecosystem. Much better track record than JD.com, for instance.

The slide below says it all:

BABA investments track record.png

BABA has the best information and data insights into consumer spending in China (more commercial intent than Wechat), and will be able to effectively monetize this at 25% growth rates in the many years ahead.

Valuation:

  • 2573 million ADS outstanding.
  • Core biz (advertisements and retail) business should be valued on EV/EBITDA basis
    • My CY2020 EBITDA is RMB 285B, 13% higher than consensus. I expect BABA to surprise on take-rate and ad monetization upside
    • BABA will be compounding EBITDA at 20-30% p.a. for the next 5 years at least.
    • I used 18x EV/EBITDA on CY2020 EBITDA, minus net cash, minority interest / mezz equity => $750B equity value / 2,573M TSO = $290/share
    • Per share value of equity investments will probably increase from $18/share to $20+ by 2020. So $20/share (investments) + $290/share (core biz) = $310/share
    • Compared to $155/share today, assuming price is achieved in 3 years (market is forward looking so could achieve target before 3 years), yields 25% IRR at a minimum
    • If I’m a bit more aggressive, applying 25x EV/EBITDA on 2020 forecasts yields a $420/share valuation, or a 40% 3-year IRR. BABA would break a $1 trillion valuation, but it’s possible given the growth and market size.
  • Not surprisingly, given BABA’s vision, its execution, and size of China’s market, BABA could be one of the most valuable business on earth in 3-5 years.
  • Ma owns about 7% of BABA

Competition with JD.com:

The China e-com market is big enough for both BABA and JD to increase at comfortable rates over the next 5-10 years. BABA has around 80% of all China online GMV in 2016 (~98% in C2C and around 50% in B2C) and that will come down over time due to law of large numbers. But that doesn’t mean BABA can’t sustain 20-25% growth in GMV, with revenue upside from take-rate improvement and advertisements.

I don’t buy the argument that JD’s logistics service are definitely superior to BABA’s in any way. BABA has made significant improvements to its Cainiao logistics network and the historical service gap between Cainiao and JD’s own logistics is closing. Plus, a difference of 1 day in delivery doesn’t make or break the purchase decision for many consumers. Most Chinese still cite T-mall or Taobao as their preferred e-com site of choice in China.

BABA’s Ant Financial / Alipay will also make its retail, entertainment, and cloud platforms very sticky, another advantage over JD.com. The big data insights gleaned from having such a crucial pulse on payments will be very valuable for BABA over time.

Overall, I think there is room for both BABA and JD.com (and even VIPS) to grow over time. I think BABA’s focus on monetization of its user-base has huge upside and will cause the stock to re-rate over time.

Risks:

There are lots of risks with investing in BABA, but I don’t believe any should keep an investor away from investing in one of the world’s greatest tech companies. Stock has run up recently (up 80% YTD) but is still far from fair value. Several risks also apply for all Chinese companies, so not much specific to BABA.

  1. Political risk
  2. RMB devaluation risk
  3. Integration risk
  4. Key man risk with Jack Ma
  5. Accounting risk – no hard evidence presented whatsoever by SEC or short-sellers
  6. Competitive risk – but I believe BABA will continue to deepen its moats and execute

 

 

 

 

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Author: goldenharborinvesting

Global investing across the capital markets.

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