Alibaba

Alibaba announced a new HKD 80 billion ordinary share placement at HKD 112.70 per share, a 3.6% discount to the US close price on Friday, to fund artificial intelligence investment. Shares fell 9% in Monday's Hong Kong session.

Why it matters: Although Alibaba is placing shares below our fair value estimate, it is not materially destroying value at this price. The share sales alone would cut our fair value estimate by 1.4%. The equity raise improves Alibaba's funding mix and lowers balance sheet risk. Alibaba already tapped debt for the AI buildout, and debt has to be repaid whether the spending pays off or not. But risk management doesn't mean doubt about AI returns—if so, it wouldn't raise capital to invest. Long-term investors and insiders find the shares attractive. The book was oversubscribed nearly three times within one hour of launch at a small discount, with 40% going to long-only and sovereign funds. Chairman Tsai and CEO Wu bought HKD 120 million of stock after the shares slumped.

The bottom line: We trimmed our fair value estimate for wide-moat Alibaba by 3% to HKD 201 per share and USD 207 per ADS, as we no longer assume share buybacks below the fair value estimate amid rising cash needs to fund AI capex. We continue to view Alibaba's shares as undervalued. We still think the market is underestimating Alibaba's long-term opportunities in AI cloud. We think the market is more focused on near-term earnings, which are pressured by losses in the on-demand delivery business. As Alibaba demonstrates its ability to reduce losses during fiscal 2027-28 and turn this business profitable in fiscal 2029, we think the share price will rise toward our fair value estimate.

We trimmed our fair value estimate for wide-moat Alibaba by 3% to HKD 201 per share and USD 207 per ADS, as we no longer assume share buybacks below the fair value estimate amid rising cash needs to fund AI capital expenditure.

We expect Alibaba’s ratio of China retail marketplace gross merchandise volume to China’s retail sales of consumer goods to continue to decline in the next decade. Considering intensive competition, we assume monetization of the China retail marketplace to be flattish after an increase due to the rollout of Quanzhantui, software fees, and quick commerce.

Our forecast 10-year compound annual growth rate for total revenue is 8%. We assume 10-year revenue CAGRs of 4% in the China e-commerce segment, 6% in international digital commerce, and 24% in cloud intelligence. Our 10-year adjusted EBITA CAGR estimate is 21% as we expect a turnaround of loss-making businesses and rising cloud margins to offset the negative impact from defending market share in China e-commerce.

Despite increasing competition, we're maintaining our wide economic moat rating based on Alibaba’s strong network effect, where the value of the platform to consumers increases with a greater number of sellers and vice versa. Alibaba is monetizing its network effect better than any other e-commerce platform in China. The short video platforms Douyin and Kuaishou have not proved they can monetize the physical goods e-commerce market with a durable profit margin, but Alibaba has been profitable for a decade, and we believe it will remain profitable for the next 20 years. In addition, we think that the livestreaming e-commerce that Kuaishou and Douyin offer is a supplement to e-commerce offerings, not a replacement of the mainstream e-commerce platforms. Livestreaming e-commerce tends to satisfy impulsive purchases instead of planned or urgent purchases. The return and refund ratio of livestreaming is high, which we think is inherent in its impulse purchase nature; this makes it difficult for brands to rely on this channel solely in the long term.

Even if these new competitors are successful in generating long-term durable profit, we still see Alibaba remaining as a key e-commerce marketplace for consumers due to its vast range of stock-keeping units, logistics infrastructure, operational expertise (governance of products and merchants, protection of consumers), and tools for merchants to manage full product lifecycles. It is the largest e-commerce platform that provides its merchants with predictability in sales and production volume, which leads to predictable production costs. There were over 124 million active consumers who spent over CNY 10,000 on Taobao and Tmall in fiscal 2022 (ended March) and fiscal 2023, respectively, while the retention rate of these consumers stayed at a similar level in fiscal 2023 as compared with the 98% in fiscal 2022. Alibaba has solutions for diversifying consumption scenarios like on-demand delivery, online-to-offline, offline, and content e-commerce. We think Alibaba will always have its place in China’s increasingly complex retail market.

Alibaba continues to most effectively monetize the network in terms of gross merchandise volume and margin, in our estimate. This should last for the next 20 years. According to Analysys, a data analytics company, Alibaba’s China commerce retail business was the largest in the world in terms of GMV in the 12 months ended March 2023. We estimate Alibaba’s Taobao and Tmall Group’s adjusted EBIT margin was 46% in the September quarter of 2023, higher than JD Retail’s 5.2% EBIT margin and PDD’s 26.3% non-GAAP EBIT margin during the same period. Even though we think there will be a decline in Alibaba’s adjusted EBIT margin in the marketplace businesses in the next five years due to reinvestment in the Taobao and Tmall business, we don’t think this will be significant enough to reduce Alibaba’s return on invested capital to below that of Pinduoduo and JD Retail.

We don’t see key competitors PDD and Douyin registering higher adjusted operating margins than Alibaba in the foreseeable future. PDD’s strategy has shifted to focus more on research and development—such as in technology and marketing tools—from a previous focus on sales and marketing in the first five years of the company’s history. It started its global e-commerce platform Temu to take on Shein. Management also reiterated the importance of investing in businesses such as Temu and in technology, while profitability is not the priority for now. These will offset the margin improvement from increasing the monetization rate of the Pinduoduo platform. These lead us to think that Pinduoduo’s adjusted EBIT margin is likely to be lower than 40% on a full-year basis in our next five-year forecast period. On the other hand, ByteDance is competing with many internet companies on many new fronts—cloud, business services, search, and e-commerce. There is no detail on its 2023 profit level as it is a private company. It is unclear if ByteDance’s China e-commerce segment will be able to register profit consistently, in our view. In addition, a successful e-commerce company cannot only rely on online traffic to succeed. Customer service; governance of e-commerce platforms to balance the interests of merchants and consumers, such as the management of issues like false advertisement and promises, and formulating return policies; the supply chain; logistics; and merchant support are critical as well.

We think the livestreaming e-commerce that Kuaishou and Douyin offer is a supplement to the e-commerce offerings, not a replacement of the mainstream e-commerce platforms. These newer platforms monetize their network of users mainly by content e-commerce—that is, content such as short videos or livestreaming—or interest e-commerce, which is selling products by understanding and predicting users’ interests. Key opinion leaders and livestreaming hosts on these short video platforms conduct livestreaming sessions to sell products online. Livestreaming e-commerce tends to satisfy impulse purchases instead of planned or urgent purchases. The return and refund ratio of livestreaming is higher, which we think is inherent in its impulse purchase nature, which makes it difficult for brands to rely on this channel solely in the long term. As per the 2020 livestreaming e-commerce white paper published by Xiaohulu, a livestreaming e-commerce service provider, the livestreaming industry’s return rate can be as high as 30%-40%, much higher than the traditional online sales return ratio of 10%-15%. The return rate of the leading livestreaming hosts is 10%-15%. We don’t think the return rate has improved significantly over the years. According to e-commerce insight provider DongGeJieDuDianShang, Douyin e-commerce’s 2022 Double 11 Shopping Festival return rate was at least 40%. Meanwhile, Kuaishou’s most famous key opinion leader, Xinba, who generated CNY 9.6 billion of paid GMV in the month of October 2023, disclosed that the return rate was 42% in the same month. We think the impulse purchase nature of livestreaming should keep the return rate higher than that of traditional e-commerce. The uncertainty in sales volume makes it difficult for established brands to plan production volume, which makes it difficult to achieve economies of scale. Such merchants wouldn’t rely on content e-commerce companies as their sole e-commerce channel. Thanks to the support of venture capitalists in China, new brands can spend generously on advertising dollars on the short video platforms to get brand exposure and sell their products, but maintaining the GMV of these brands is questionable if they reduce their advertising spending on these platforms.

Short-form video platforms Douyin and Kuaishou have entered the e-commerce arena with quick GMV growth, but we see less significant growth opportunities for livestreaming e-commerce in the future. Douyin’s GMV was up 80% year on year to CNY 2.1 trillion, and Kuaishou’s GMV rose 31% to CNY 1.2 trillion in 2023, based on our estimate. Livestreaming e-commerce GMV was estimated to be CNY 4.6 trillion in 2023 as per data analytics firm DianShuBao, about 31.9% of the China internet shopping market, which is already high in terms of penetration. Meanwhile, Double 11 Shopping Festival livestreaming GMV year-on-year growth in 2023 slowed to 19% from 146% in the same period in 2022, per data analytics firm Syntun. In our opinion, Douyin and Kuaishou will need to be successful in traditional search-based e-commerce in order to overtake the incumbents.

Anticompetitive exclusivity arrangements between merchants and Alibaba are a key environmental, social, and governance risk. We think the end of exclusive merchants on Alibaba’s platform has some but not significant impact on Alibaba’s wide moat, and we have accounted for the share loss in GMV to other platforms in our forecasts.

Alibaba is able to maintain or increase its gross merchandise volume share in China's e-commerce space, demonstrating its ability to execute its turnaround strategy.

Alibaba successfully increases key metrics such as customer retention, purchase frequency, and average order value, driving GMV growth to outperform the growth of China's online retail sales of physical goods.

Alibaba delivers better-than-expected adjusted EBITA margins despite competition and reinvestment.

Alibaba's GMV share in China decreases faster than we expect as competitors such as Douyin successfully enter the search-based e-commerce business.

Expansion into the nonphysical goods marketplace businesses and other regions leads to lower-than-expected margins, and the timing of profitability is delayed.

Alibaba fails in its globalization, public cloud, and artificial intelligence efforts and delivers slower-than-expected earnings growth.