Alibaba Group Research Report

Alibaba Group

Middle Kingdom Merchant

Alibaba is the world’s largest online and mobile commerce company, as measured by gross merchandise volume (GMV). Through its Tmall and Taobao brands, Alibaba dominates the Chinese e-commerce landscape. The sheer size and scale of its marketplaces, leveraged to the fastest growing, second largest global economy, gives the company a strong moat and ensures its leading competitive position for the foreseeable future. Alibaba is poised for broader growth outside China. We are positive on the company and set our valuation at $166 billion, $67 per share. We believe our valuation is aggressive but justified.

 

KEY POINTS:

  • On Deck for an IPO. Alibaba Group is scheduled to price its initial public offering on September 18. With a business model that can be described as a cross between eBay, Amazon, and Google, Alibaba is the largest online and mobile commerce company in the world, in terms of gross merchandise volume (GMV). Alibaba enjoys market dominance in excess of 80% of Chinese ecommerce traffic.
  • Perfect Confluence of Factors. Chinese e-commerce benefits from a confluence of factors: a growing economy, the rise of personal consumption, underdeveloped offline retail, need for logistics and payments infrastructure, improving broadband connectivity/mobile penetration, and a consumer culture disposed toward C2C platforms. China is on track to become the largest private consumption location on earth. The physical infrastructure for mass retail does not exist, particularly in smaller cities and ex-urban areas. China is already the largest mobile market and we expect 200 million new smartphone customers within the next 4 years.
  • A Play on China, Private Consumption and Mobile Commerce. China’s real GDP of US$9.5 trillion in 2013 is projected to grow at a CAGR of 7.0% from 2013 to 2016. Real consumption is about 35.8% of total GDP, a rate significantly lower than that of other countries. US consumption contribution to GDP ran at 67.1% in 2013. China must and is pivoting to an economy based on considerably higher domestic consumption.
  • Long Runway Ahead. Alibaba presently controls the dominant brands, traffic and payments systems used for online and mobile commerce. Dominating C2C and B2C marketplaces will ensure a leading competitive position and operating leverage, translating to strong revenue and FCF growth.
  • Buyer Beware. The history of US listed Chinese companies is littered with regulatory and financial irregularity. Longtop Financial and Sino Forest examples, cast a shadow. Fairly or not, Alibaba will be viewed with greater suspicion. The VIE corporate structure raises some real concerns. Jack Ma’s Alipay conduct, although long settled, raises issues. The rapid multi-billion dollar acquisition spree the company has been on and the opaque corporate governance structure will rattle some. Alibaba is a one country, China, story. Until revenue and profit are diversified, there is concentrated country risk.
  • Fairly Valued at $166 billion. Our blended valuation analysis pegs Alibaba’s fair valuation at $166 billion, or 9.0x our calendar 2015 revenue estimate. This is justifiable, in our view, given the company’s strong growth trajectory, and its competitive position, tempered modestly by risk factors. We believe there is room for additional valuation upside if the company can show stronger than expected revenue growth on the back of mobile e-commerce growth and international expansion.

 

Equity Valuation: $166 Billion

Price/Share: $67

screen-shot-2016-10-25-at-10-44-17-am screen-shot-2016-10-25-at-10-43-07-am

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Executive Summary

Alibaba Group, a China-focused e-commerce powerhouse, is scheduled to price its initial public offering on September 18. Ahead of the offering, this report provides an overview of the company and highlights the investment merits and risks along with a valuation analysis based on a blend of discounted cash flow and comparative market multiple methodologies.

Positive Investment Thesis. We believe the company is benefitting from an auspicious confluence of factors that should ensure its moat and sustain its market-leading competitive position in a nascent Chinese e-commerce market. While there are some significant risk factors – as with most Chinese companies – we believe the risk/reward is positively balanced in the case of Alibaba.

Largest Online and Mobile Commerce Company. With a business model that has elements of eBay, Amazon and Google, Alibaba is the largest online and mobile commerce company in the world in terms of gross merchandise volume. Furthermore, the company’s ecommerce transactions on its mobile platform are on an upward trajectory, with June 2014 quarter mobile GMV at 32.8% of total GMV compared to 27.4% in the prior quarter and 12% in the prior year. This is significant in the face of a secular shift in China – as in the rest of the world – to mobile devices from desktops.

Leading Chinese Online Retailing Platforms: Taobao, China’s largest online C2C shopping site; Tmall, China’s largest third-party B2C platform for branded goods; and Juhuasuan, China’s most popular group buying marketplace by monthly active users. These three marketplaces accounted for 81.6% of Alibaba’s revenue in fiscal 2014, with the remainder coming from China wholesale sites, international commerce, cloud computing, and other services. Furthermore, these marketplaces combined generated $296 billion in annual GMV through June 2014, or roughly 84% of China’s total online GMV, from a staggering 279 million annual active buyers, averaging 52 average orders annually from 8.5 million active sellers.

A Perfect Confluence of Factors Underlies Alibaba’s Dominance: These include a booming Chinese economy (7% CAGR), rising personal consumption (36% of GDP vs 67% in the US),  minimal offline retail presence in non-urban cities (0.6 square meters per capita vs 2.6 in the USA), underdeveloped logistics infrastructure, and weak payments mechanisms for the unbanked and/or underbanked slice of the population. Furthermore, China’s broadband penetration (~46%) and mobile penetration (~37%) remain relatively low. All these factors combined have made C2C marketplaces the first stop for consumers, and B2C the next frontier for consumers moving up the value chain to high-quality brand named goods and services from established businesses – both in Alibaba’s sweet spot.

Biggest Risks.  Questionable governance practices and margin compression are two significant risks that need to be flagged in our opinion. The effective control of the company is concentrated around Jack Ma and a few early cofounders, which could potentially work against the best interests of the shareholder. Additionally, given the Cayman Island-based VIE classification of Alibaba, investors will be buying a stake in an entity that is under contract to receive the profit from Alibaba’s lucrative Chinese assets but will not actually own them – only Jack Ma and Simon Xie will own them – limiting legal recourse for aggrieved parties from outside China. Margin compression is a looming threat for Alibaba. The company has an 87% market share and commands an EBITDA margin of 59%. This is an attractive margin for any business and could be unsustainable in the face of new competitors in the B2C marketplace and a faster than expected shift to mobile e-commerce, which inherently commands lower conversion rates compared to online e-commerce rates.

Fair Value is $166 billion. We approached the valuation from two angles: DCF analysis and Public Market Multiples (EV/Rev) of comparable companies. Additionally, we layered on Alibaba’s equity stake in publicly traded companies. Accordingly, we peg the blended fair valuation at $166 billion, or 9.0x our calendar 2015 revenue estimate. This is justifiable, in our view, given the company’s strong growth trajectory and competitive position, and discounting the risk factors. We believe there is room for additional valuation upside if the company can show stronger than expected revenue growth on the back of mobile e-commerce growth and international expansion.

Investment Positives

Alibaba – An Ecommerce Juggernaut

China’s explosive e-commerce growth within the business-to-consumer (B2C) and consumer-to-consumer (C2C) arenas have catapulted the country to the global top. In 2013 China surpassed the United States in e-commerce sales, and sales are projected to grow 45.8% in 2014 to $446.6 billion, according to market data from iResearch. Alibaba has been the key driver in this race to the top.

 

Figure 1: E-Commerce Sales in China vs the US: 2010-2013 ($B)

picture1

 

 

 

 

 

 

 

Source: U.S. Department of Commerce, iResearch

With a business model that has elements of eBay, Amazon, and Google, Alibaba has a strong presence across the e-commerce spectrum in China. In particular, the company’s C2C marketplace is highly popular with small and medium businesses and is the first stop for many consumers looking for wide variety and good deals. The scale and scope of the company’s e-commerce business are reflected in the following metrics:

  • Roughly 90% of China’s retail e-commerce flows through Alibaba’s marketplaces – Taobao, Tmall, and Juhuasuan;
  • 87% of China’s mobile commerce flows through Alibaba. Additionally, mobile GMV accounted for 32.8% of Alibaba’s total GMV compared to 27.4% in the prior quarter and 12% in the prior year quarter, suggesting an impressive upward trajectory. This is significant in the face of a secular shift in China – as in the rest of the world – to mobile from desktops;
  • Alibaba’s marketplaces had 279 million annual active buyers and 8.5 million annual active sellers as of June 2014, well above Amazon and eBay’s participants;
  • Alibaba received 14.5 billion annual orders, generated 6.1 billion packages, and processed over 2.78 billion transactions with a total value exceeding $148 billion. For comparison, United Parcel Service delivered 4.3 billion packages and PayPal processed $50 billion of transaction value.

Robust Marketplaces

Alibaba’s strong retail and wholesale marketplaces, complemented by an efficient payment processing and third-party logistics business, has proven to be a winning strategy.

  • Retail Marketplaces: Taobao, Alibaba’s customer-to-customer (C2C) platform, is China’s largest online shopping destination in gross merchandise volume (GMV). Tmall, the company’s business-to-customer (B2C) platform, is China’s largest third-party platform for brands and retailers in gross merchandise volume. Juhuasuan, Alibaba’s third retail platform, is China’s most popular group buying marketplace by monthly active users. These three marketplaces accounted for 81.6% of Alibaba’s revenue in fiscal 2014, with the remainder coming from China wholesale sites, international commerce, cloud computing, and other services.
  • Wholesale Marketplaces: Alibaba.com and 1688.com are marketplaces where Chinese wholesalers and manufacturers supply retail merchants in China on 1688.com and global wholesale buyers on Alibaba.com. Through AliExpress, global consumers are able to purchase goods from retail or wholesale sellers.
  • Alipay Payments Service. Alibaba, through service agreements, uses Alipay to process transactions. Alipay, also known as Zhejiang Alibaba E-Commerce Ltd, runs a PayPal-like Internet-payment service that is already the most used processor of mobile payments in the world. Over the years, the company earned the trust and business of many Chinese customers, many of whom did not have credit cards and other modern forms of payments. Alipay Wallet has been downloaded more than 100 million times, according to iResearch. Alipay is essentially an all-in-one banking mobile application consisting of a savings bank, wire service, and investment house. Controlled by Jack Ma (46%) and other Alibaba executives, processed $519 billion worth of digital payments in 2013, well above PayPal’s $50 billion.
  • China Smart Logistics. China’s poor distribution infrastructure and consumer demand for overnight deliveries require a very efficient logistics process. Alibaba has established a distributed and scalable logistics system that links a network of logistics providers to its proprietary information platform, which is operated by China Smart Logistics. Alibaba does not own the physical infrastructure but instead works with a variety of logistics partners to ensure the ability to connect buyers and sellers throughout China. The logistics platform provides real-time access to information for both buyers and sellers, as well as information that allows delivery service providers to improve the efficiency and effectiveness of their services.

 

Figure 2: Alibaba Ecosystem

picture1

 

 

 

 

 

 

 

 

 

Source: Alibaba, Manhattan Venture Partners (MVP) Research

Powerful Network Effect

The interactions between buyers and sellers in Alibaba’s marketplaces and the interconnection between the marketplaces generates a powerful network effect. This, in turn, has proven to be a strong and sustainable competitive moat and has solidified the company’s position in the nascent Chinese e-commerce market.

The key factor underlying the network effect is the unique nature of the Chinese market. Unlike other developed countries where the e-commerce market is dominated by business-to-consumer players like Amazon in the U.S, Flipkart in India, Tesco in the U.K, and Rakuten in Japan, consumer-to-consumer marketplaces accounted for almost 64% of China’s total online shopping GMV in 2013, according to data from iResearch. We expect a secular shift to B2C e-commerce in the years to come as other large domestic and foreign B2C platforms establish their presence. Over the next decade in China, traditional retailers will roll-out online platforms and Chinese consumers demand higher-quality and branded goods. This will drive C2C buyers toward B2C platforms.

Alibaba’s various online marketplaces are interconnected, compounding the company’s network effect, which then breeds other competitive advantages. Buyers on Tmall’s marketplace could also go to Taobao for a broader product selection, while Taobao users with a strong appetite for branded products could switch to Tmall for a better shopping experience and higher quality assurance. Ultimately more buyers attract more sellers and vice versa, raising a strong moat around the ecosystem.

 

Figure 3: Classic Network Effect

picture1

 

 

 

 

 

 

 

Source: MVP Research

The network effect and moat factor are apparent from the user metrics across the company’s marketplaces. Millions of consumers in China consider Taobao and Tmall as their default, go-to options when seeking products and services online – roughly 70% of online shoppers according to CNNIC’s 2013 online shopping survey. Additionally, a 2011 survey from iResearch suggests that more than 30% of Taobao users started their online purchase by directly going to Taobao’s site, compared with about 1% who started with a search engine, suggesting that Alibaba’s marketplaces are increasingly becoming the starting point for online purchases in China.

A Triple Play on China, Private Consumption, and Mobile Commerce

China GDP is expected to grow at a 7.0% CAGR through 2016, rising from $10.1 trillion in 2014 to $11.6 trillion by 2016, according to data from Euromonitor International.

 

Figure 4: China GDP ($Trillions)

picture1

 

 

 

 

 

 

 

Source: Euromonitor International

In step with the rising GDP, China’s real consumption in 2013 was 35.8% of total GDP, which is a rate that is significantly lower than that of other countries, such as the United States, which had a consumption penetration rate of 67.1% in 2013, and most other developed countries, according to data from Euromonitor International.

 

Figure 5: China Consumption as % of GDP

picture1

 

 

 

 

 

 

 

Source: Euromonitor International

China has the highest number of Internet users, 618 million, but only 49% or 302 million shop online. This compares with 277 million internet users in the US and 87% penetration, according to data from Alibaba and the U.S. Department of Commerce. Overall, online shopping, which represented 8.0% of total China consumption in 2013, is projected to grow at a compound annual growth rate, or CAGR, of 36.1% from 2013 to 2016, according to iResearch, as more consumers shop online and e-commerce spending per consumer increases.

We believe that the increased usage of mobile devices will make access to the Internet even more convenient, drive higher online shopper engagement and enable new applications. As for broadband networks, lower 3G tariffs in the future will facilitate the penetration of 3G networks while extended coverage of 4G networks will greatly improve wireless network service. China is early in the twin transitions to smartphones and to 4G wireless service. Each of these developments separately, and both together, will accelerate the transition of the emerging consumer class onto Alibaba’s networks. China currently has the world’s largest mobile Internet user base with 500 million users (~37% penetration) as of June 2014, and mobile usage is expected to increase, driven by the growing adoption of mobile devices.

 

Figure 6: Alibaba’s Mobile GMV Rising as a % of Total Retail GMV

picture1

 

 

 

 

 

 

 

Source: Alibaba

Alibaba is the leader in mobile commerce in China in terms of mobile retail GMV, with mobile GMV transacted on its China retail marketplaces accounting for 87.2% of total mobile retail GMV in China. Mobile transactions accounted for 27.4% of Alibaba’s total transactions in the three months ended March, up from 19.7% in the previous quarter. The company’s mobile Taobao App has been the most popular mobile commerce app in China by MAUs every month since August 2012 and recorded 188 million mobile MAUs on its China retail marketplaces in June 2014.

 

Figure 7: Mobile Shopping GMV – China vs. USA: 2011-2017

picture1

 

 

 

 

 

 

 

 

Source: iResearch

To increase e-commerce, mobile-commerce, participants are trying multiple approaches to diverting traffic to mobile. For instance, several companies have launched various marketing activities on mobile while improving the functions of their products on mobile devices. Alipay enhanced mobile payment security to make mobile shopping safer and more convenient, thus increasing the penetration of mobile shopping.

Under Developed Retail Infrastructure beyond Tier 1 Cities

China’s offline retail infrastructure is underdeveloped. China had only 0.6 square meters per capita of retail space in 2013. This compares with 2.6 square meters in the USA, 1.3 in the U.K. and Japan, and 1.5 square meters in Germany. The underdevelopment of consumption infrastructure is an artifact of lower average income, a low consumption culture and a heavy concentration of the middle and upper classes in larger coastal cities. All of these limiting factors are changing more rapidly than the built environment. Thus, the virtual environment offers China’s emerging consumers an ecosystem moving at their speed and catering to all their emerging spending tastes. Tomorrow’s largest middle class will be digital native to Alibaba’s system.

Given favorable consumer demographic trends, an underdeveloped supply chain, and logistics infrastructure, we believe China’s retail industry will bypass the traditional consolidation stage that most developed countries experienced. We see Chinese consumers leapfrogging the traditional channel diversification stage, including online commerce and specialty stores. These massive crowds are migrating into mobile commerce, using Alipay and buying on Taobao and Tmall. As a result, we believe vendors will continue to depend on Taobao and Alibaba’s other marketplaces, driving increased consumer engagement levels. Users generate GMV and advertising revenues and attract merchants.

International Expansion – Potential Growth Driver

International expansion is an imperative for Alibaba. As the preferred marketplaces shift from C2C to B2C, we expect the competitive landscape to get crowded with domestic retail establishments increasing their online presence and global online companies offering branded, high-quality goods. Amazon, Flipkart, and others will be increasingly relevant as Alibaba branches out and others fight their way into the Chinese market.

Against this backdrop, Alibaba has embarked on an aggressive expansion strategy. The company has made or entered into agreements to make, strategic investments, acquisitions, and alliances in a number of countries. From 2010 to 2014, for instance, Alibaba has invested approximately $10 billion in enhancing user engagement, improving customer experience and expanding products and services.

Interestingly, Alibaba has created an investment arm in the United States focused on building up its social and mobile offerings. Alibaba’s US Team is led by Michael Zeisser, a former Liberty Media executive. The unit has made a number of high-profile investments, including Lyft, a peer-to-peer ride-sharing company that competes with Uber; a $215 million investment in Tango, a mobile messaging platform that competes with Tencent Holdings’ highly popular WeChat messaging platform; ShopRunner, a subscription service similar to Amazon Prime; a $50 million investment in Quixey, a search engine for mobile apps, and most recently, in July 2014, Kabam received around $120MM, a leader in free to play mobile gaming.

 

Figure 8: Acquisitions & Partnerships: 2010 to 2014 – By Business Category

picture1

 

 

 

 

 

 

 

 

 

 

 

Source: Alibaba, MVP Research

High Margins and Strong FCF to Fund Growth

Alibaba’s ecosystem and the resulting network effect of its marketplaces have distinct advantages over full-service e-commerce companies such as Amazon and JD.com. Alibaba does not source merchandise or hold inventory, as Amazon and JD.com do. Alibaba is charging for its platforms, serving ads and making money on payments. A lower capital expenditure and more rapid roll out model have contributed to a creative, nimble and high margin focus. This model eliminates the associated costs, risks and capital requirements many competitors face. Network effect assists in keeping the customer acquisition costs low and keeping the sales force headcount low.

Alibaba had a healthy EBITDA margin of 59% in fiscal 2014, up from 36% in fiscal 2013, and should remain strong over the next 24 months on the back of strong operating leverage in the business model. We expect the company to generate about $6.7 billion in adjusted EBITDA in fiscal 2015, an increase of 36% over the prior year, and a margin of 55%. Similarly, we expect FCF of $4.3 billion in fiscal 2015, an increase of 24% over the prior year and an FCF margin of 35%.

 

Figure 9: Alibaba – Adjusted EBITDA & Margin: 2010-2016E

picture1

 

 

 

 

 

 

 

 

 

Source: Alibaba, MVP Research

 

Investment Concerns

Governance Issues

The history of Chinese companies listed in the US is littered with regulatory and financial irregularities. Companies such as Longtop Financial and Sino-Forest, among others, were delisted because of financial fraud. Against this backdrop, the fact that Alibaba’s Alipay scandal was eventually settled with the aggrieved parties does not rule out the possibility of similar scandals in the future. Fairly or not, Alibaba will be viewed by some as risky by virtue of its nation of origin and operation. There exists a fair amount of mystery regarding the founding group and internal deliberation at Alibaba. This contributes to a general sense of powerful figures and machinations behind the scenes at the company.

The effective control of the company is centered around Jack Ma and a cadre of early co-founders, which could potentially work against the best interests of shareholders. The Cayman Island-based VIE classification of Alibaba means that investors will be buying a stake in an entity that is under contract to receive the profit from Alibaba’s actual Chinese business/assets but, will not actually own them. Only a separate entity controlled by Jack Ma and Simon Xie will own the underlying revenue and profit stream directly. This ownership structure is required given China’s legal structure but adds a possible incremental risk element for investors. VIE structures can limit direct legal recourse for aggrieved parties from outside China.

Mobile Monetization Gap Needs to Close

The shift to mobile devices is irreversible. Inability to manage the transition from online commerce to mobile commerce can have a material impact on a company’s top and bottom lines. Accordingly, all consumer-facing companies need to constantly redevelop and improve their mobile monetization technologies. Leadership changes very quickly and once lost, leadership is very hard to get back.

Alibaba has done an impressive job in managing the transition to mobile. Mobile MAUs increased to 188 million in the June 2014 quarter from 136 million in the December 2013 quarter. That translated to 32.8% of total GMV from mobile devices in the June quarter, up from 19.7% in the December quarter.  The advertisement is far less profitable to serve on mobile devices and that is where existing Alibaba customers are moving and where new customers will be found. Retailers can and will fight back against mobile commerce by tying offline and online together with apps and in-store digital tie-ins.

The monetization rates of desktops and mobile devices are still far apart. In the most recent June quarter, Alibaba’s total monetization rate (total retail marketplace revenue/total retail marketplace GMV) was 2.52%, well above the mobile monetization rate (mobile revenue/total mobile GMV) of 1.49%. While the gap has closed significantly from the December quarter (3.05% vs 1.12%) and the prior year quarter (2.51% vs 0.58%), we believe Alibaba needs constantly to improve its mobile marketing services to provide engaging content and drive higher GMV.  As with all dominant software providers that evolved in the desktop, there are challenges and risks as the majority of users come from mobile devices. Additionally, mobile ad rates are lower and mobile e-commerce abandonment rates are higher than the comparable rates on desktops.

 

Figure 10: Bridging the Monetization Gap

picture1

 

 

 

 

 

 

 

 

Source: Alibaba, MVP Research

Margin Compression

Margin compression is a looming threat for Alibaba, given its dominant market share in the retail e-commerce space. The company has over 80% market share and commands an EBITDA margin of 59%. It is an attractive margin by any standard. Is it sustainable? That is the $64,000 question in the face of an expected shift to B2C e-commerce in the years to come. Alibaba will face enhanced competition domestically and international. Tencent, Baidu, and JD are in or entering the Chinese home market and large foreign B2C platforms plan to bolster their presence in China. Additionally, traditional retailers will be increasingly rolling out online e-commerce platforms. We expect there to be change as Chinese consumers demand higher-quality and branded goods.

We believe the operating leverage from network effects In Alibaba’s ecosystem will sustain the margins in the near future. Specifically, as long as the company’s C2C Taobao marketplace remains the gateway to the company’s entire ecosystem, providing low-cost organic traffic for other B2C marketplaces like Tmall and Juhuasuan, and reducing Alibaba’s reliance on a sales force for marketing services, the margins remain sustainable. Conversely, inability to do so could pose a significant risk to driving growth, and profitability. Consumer tastes and habits are always plastic and change can be sudden and very difficult to predict.

Valuation

We approach the valuation of Alibaba from three angles: DCF analysis; public market multiples (EV/Rev) of comparable companies; and Alibaba’s equity stake in publicly traded companies.

Accordingly, we peg Alibaba’s blended market value at $166 billion, or $67 per share. This translates to 9.0x our calendar 2015 revenue estimate, 14.4x our forward EBITDA estimate and 20.3x forward earnings. This is justifiable, in our view, given the company’s strong growth trajectory, and its competitive position tempered modestly by the risk factors. We believe there is room for additional valuation upside if the company can show stronger than expected revenue growth on the back of mobile e-commerce growth and international expansion.

 

Figure 11: Valuation Summary

picture1

 

 

 

 

 

Source: MVP Research

Below we highlight the three components of our valuation analysis:

1. Discounted Cash Flow

Using a WACC of 19%, which assumes a risk-free rate of 2.5%, a beta of 2.5 and a market premium 6.5%, a terminal FCF growth rate of 0% after 20 years, our discounted cash flow analysis supports a valuation of $165 billion, or $67 per share. The relatively elevated WACC due to a high beta of 2.5 is justified in our opinion given our belief that Alibaba is over twice as risky as the overall market for a series of reasons reviewed above.

Below, we show our DCF calculation and the sensitivity analysis using a range of WACC from 18-20%. The resulting range is $153 billion to $178 billion, or $165 billion, $67 per share, at the midpoint.

 

Figure 12: Alibaba – Discounted Cash Flow Analysis

picture1Source: MVP Research

2. Public Company Multiples

We looked at three groups of companies in our analysis: Internet companies with primarily advertising-based revenue models, China-based pure e-commerce companies, and US-based e-commerce and auction companies.

  • Internet Ad-Based Revenue Models. This group comprises Baidu, Tencent and Google. All three are diversified companies but at the core, they have advertising-based revenue models and constitute the best group for a comparative analysis. The group is trading at 8.0x calendar 2015E consensus revenue estimate and 27.5x 2015E earnings. Alibaba has comparable margins but has faster-projected growth in 2014 and 2015.
  • Pure-play China-based ecommerce companies. This group comprises JD.com, 58.com, Dangdang, Jumei International and Vipshop Holdings. These e-commerce companies, while similar to Alibaba in terms of facilitating e-commerce transactions, take on inventory risk and fulfill orders, which Alibaba does not. This group is trading at 3.3x 2015E consensus revenue estimate and 40.4x 2015E earnings estimate. 
  • US-based ecommerce/auction companies. This group is comprised of Amazon and EBAY. These ecommerce companies are pioneers in the C2C and B2C segments and have defined the space.

While both these companies fall under the catch-all category of ecommerce, they take on inventory risk and fulfill orders, neither of which are Alibaba’s focus. This group is trading at 2.3x 2015E revenue and 95.4x 2015E earnings.

Of the three groups discussed above, we believe the pure-play advertising-based Internet companies – Baidu, Tencent, and Google – are the most relevant group for comparative multiple analysis given their revenue model, their exposure to a growing list of Internet services. Additionally, we believe EV/Rev is the most reasonable multiple to apply for the comparative analysis, underscoring the importance of capturing the incremental market share and growing the revenue base, in the face of increased competition.

Accordingly, applying the mean 8.0x CY2015E EV/Revenue multiple of the group to Alibaba’s calendar 2015 revenue estimate, we arrive at an equity value of $150 billion, or $60.83 per share.

 

Figure 13: Comparative Analysis using Public Company Multiples

picture1

 

 

 

 

 

 

 

 

 

Notes: Dollars in millions except per share price;

FX rates: RMB/$ = 6.15335; HK$/US$ = 7.75

Stock prices as of September 05, 2014 closing

Source: Yahoo Finance, Thompson Reuters, MVP Research

 

Figure 14: Alibaba – Implied Equity Value

picture1

 

 

 

 

 

 

 

Source: Yahoo Finance, MVP Research

3. Aggregate Value of Investment Portfolio (public companies only)

Alibaba has been making strategic investments across multiple verticals and geographies. Since the start of 2012, for instance, the company announced 26 deals worth $16 billion, expanding into everything from finance to soccer to media entertainment and taxi booking services. In 2014, the company agreed in June to acquire the rest of UCWeb Inc. to add Internet browsers and an application store to its services for mobile devices and in May bought a 10% stake in Singapore Post Ltd. It also invested in Youku Tudou, Intime Retail Group Co., and TangoMe, and on July 15 announced plans for a video streaming service in China with Lions Gate Entertainment Corp.

More recently, and closer to home, Alibaba has invested in Lyft, TangoMe, ShopRunner, Quixey, and Kabam, aiming to increase its presence in the fastest growing market, and taking early positions in emerging early stage growth companies. Unlike Google or Facebook, Alibaba has acquired minority stakes in these companies.

We believe Alibaba’s share of the market value of public companies in its investment portfolio should be added to the overall valuation of the company. As the following chart indicates, we have compiled a list of public companies and arrived at total valuation of $8.9 billion.

 

Figure 15: Alibaba’s Equity Stake in Public Companies

picture1

 

 

 

 

 

 

Notes: FX Rates: USD/HKD = 7.75; USD/CNY = 6.15; USD/SGD = 1.25

Stock prices as of September 5, 2014 close

Source: Bloomberg, MVP Research

 

Revenue Model

The company’s revenue model is primarily driven by advertising and marketing revenue. In all the company has five revenue buckets: online marketing services (via Alimama), commissions on transactions and fees for online services, membership fees, value-added services and cloud services.

 

Figure 16: Alibaba Monetization Segments

picture1

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Source: Alibaba, MVP Research

 

A Typical Transaction

Sellers on Taobao Marketplace and Tmall pay commissions based on the percentage of GMV for transactions settled through Alipay from users sourced from third-party marketing affiliates. In addition to purchasing online marketing services, sellers on Tmall and Juhuasuan also pay a commission based on a percentage of GMV for the transaction. The vast majority of transactions flow through Alipay. Transactions settled through Alipay partially flow revenue back to Alibaba. Commission percentages typically range from 0.3% to 5% of GMV depending on the product category.

 

Figure 17: An Example of a Transaction

picture1

 

 

 

 

 

 

 

 

Source: Alibaba, MVP Research

 

Market Opportunity

With over 85% of the Chinese ecommerce market in Alibaba’s control, the next leg up for Alibaba will be a function of the Chinese consumption pie getting bigger. Strong GDP growth, combined with higher Internet penetration and mobile adoption, should drive consumer spending higher and provide a strong tailwind to the ecommerce sector. Alongside this Alibaba is poised to grow its export wholesaling business, Alibaba.com. We see Alibaba expanding beyond China and facing greater upfront costs and competition in these geographies.

According to data from Euromonitor International, China’s real GDP of S$9.5 trillion in 2013 is projected to grow at a CAGR of 7.0% from 2013 to 2016, to $11.6 trillion in 2016. Similarly, real consumption in China is projected to grow at a CAGR of 8.3% during the same period, thus becoming an increasingly important contributor to the Chinese economy. More importantly, the proportion of GDP accounted for by consumption in China was 35.8% in 2013, a level which was significantly lower than the United States, the United Kingdom, Japan, and Germany, suggesting a compelling market opportunity for e-commerce companies such as Alibaba.

 

Figure 18: China GDP & Consumption Projections ($Trillions)

picture1

 

 

 

 

 

 

 

 

Source: Euromonitor International

 

Competitive Landscape

As we noted above, Alibaba competes with three sets of companies: Internet companies with advertising-based revenue models, China-based pure ecommerce companies and US-based ecommerce/auction companies. Additionally, Alibaba will see increasing competition from the traditional retail chains as they beef up their online presence.

The closest competitors are Baidu and Tencent and, to some extent, Google. All three are diversified companies but at the core, they have advertising-based revenue models. Alibaba has followed Tencent and

Baidu and is engaged in or moving toward involvement in nearly every area of consumer facing online life in China. Pure-play China-based e-commerce companies such as JD.com, 58.com, Dangdang, Jumei International and Vipshop Holdings compete with Alibaba in certain end markets and product categories. These e-commerce companies, while similar to Alibaba in terms of facilitating e-commerce transactions, take on inventory risk and fulfill orders, which Alibaba does not.

The recent and aggressive acquisition spree has seen Alibaba acquire into multiple geographies and sectors. This suggests the firm will continue to try to engage new areas and locations over the next several years.

 

Figure 19: Competitive Landscape

screen-shot-2016-10-25-at-11-41-28-am

 

 

 

 

 

 

 

 

 

 

Source: Alibaba, MVP Research

 

Financial Review & Estimates

Revenue

Alibaba posted revenues of $8.4 billion in fiscal 2014 (ending March), up 52.1% over the prior year. Sequential revenue growth has averaged 72% over the last five years on the back of robust growth in the core China commerce segment. Looking ahead, we expect revenue growth to continue its upward trajectory, in step with the growing economy and the resulting rise in the consumer spending power. We expected revenue to grow at a decelerating rate. We expect $12.27 billion in fiscal 2015 (+45.2% Y/Y) and $17.95 (+46.3% Y/Y) in fiscal 2016).

 

Figure 20: Alibaba – Revenue Trend ($Bil): 2010-2016E

picture1

 

 

 

 

 

 

 

 

 

Source: Alibaba, MVP Research

Gross Profit & Margin

Alibaba posted a strong gross margin of 75% in fiscal 2014, up 300 bps from the prior year. The business model benefits from a very reasonable cost of revenue, which is primarily payment processing fees paid to Alipay or other financial institutions and traffic acquisition costs paid to third party affiliates. We expect the company to maintain its gross margin in the 70%+ range in the foreseeable future.  Alibaba has been able to seize the dominance in the most profitable portions of the ecommerce process without the higher costs risks and entanglements faced by firms like JD in China and Amazon in the US.

 

Figure 21: Alibaba – Gross Profit & Margin: 2010-2016E

picture1

 

 

 

 

 

 

 

 

 

Source: Alibaba, MVP Research

Adjusted EBITDA Margin

Alibaba had a healthy EBITDA margin of 59% in fiscal 2014, up from 36% in fiscal 2013. We expect margins to remain strong in the foreseeable future on the back of strong operating leverage in the business model.

 

Figure 22: Alibaba – Adjusted EBITDA & Margin: 2010-2016E

picture1

 

 

 

 

 

 

 

 

Source: Alibaba, Manhattan Venture Partners

Net Income & Margin

Alibaba turned net income positive in 2011 and has remained consistently profitable since then. In fiscal 2014, the company earned $3.8 billion on a net margin of 45%, or $1.61 per share. We expect continued profitability with steady margins, as competitive pressures partially offsetting the operating leverage in the model. For fiscal 2015, we are projecting $4.9 billion in earnings on a 40% net margin, or $2.24 per share.

 

Figure 23: Alibaba – Net Income & Margin: 2010-2016E

picture1

 

 

 

 

 

 

 

 

 

 

Source: Alibaba, MVP Research

 

Management Team

Alibaba management team has adopted a partnership approach to manage the company. The partnership currently has 27 members comprising 22 member of management, four members of management of Small and Micro Financial Services Company and one member of management of China Smart Logistics. The partnership will have the exclusive right to nominate up to a simple majority of the members of the board of directors. Accordingly, the company increased the number of directors appointed by the partnership to 11 from the previous agreement of nine.

Jack Yun Ma, Lead Founder and Executive Chairman.  The lead founder and, since May 2013, the executive chairman. Prior to that, from 1999 till May 2013, Mr. Ma served as chairman and chief executive officer. Mr. Ma currently serves on the board of SoftBank Corp, and is a director of Huayi Brothers Media Corporation, an entertainment group in China as well as the chair of The Nature Conservancy’s China board of directors and a director of its global board of directors. Mr. Ma graduated from Hangzhou Teacher’s Institute with a major in English language education.

Joseph Tsai – Executive Vice-chairman. Mr. Tsai was a member of the Alibaba founding team and has served as executive vice-chairman since May 2013. Mr. Tsai was previously chief financial officer and has been a member of the board of directors since inception. Prior to Alibaba, Mr. Tsai worked in Hong Kong with Investor AB, the main investment vehicle of Sweden’s Wallenberg family, where he was responsible for Asian private equity investments. He received his bachelor’s degree in Economics and East Asian Studies from Yale College and a juris doctor degree from Yale Law School.

Masayoshi Son – Director. Mr. Son is the founder, chairman and chief executive officer of SoftBank Corp. Mr. Son founded SoftBank Corp in 1981 and served as chairman and chief executive officer of several other SoftBank subsidiaries and affiliates, including Softbank Mobile Corp, SoftBank BB Corp as well as serving as chairman of Yahoo Japan Corporation since 1996, and of Sprint Corporations since 2013. Mr. Son has been Alibaba’s director since December 2012 and received his bachelor’s degree in Economics from the University of California, Berkeley.

Jonathan Zhaoxi Lu – Chief Executive Officer, Director. Mr.  Lu succeeded Jack Ma as chief executive officer in May 2013 and has at different points served as the top executive officer of almost of all key business units in Alibaba. Prior to his current role, he served as chief data officer and also oversaw Yun OS division. Before that, he served as chief executive officer of ALibaba.com from February 2011 until its privatization in 2012. He joined Taobao in January 2008 and served as its chief executive officer from January 2010 to June 2011. In September 2004, he led a dedicated team to establish Alipay and became Alipay’s first president. From 2000 to 2004, Mr. Lu held several leadership roles at Alibaba.com and managed its South China sales region. Before joining Alibaba Group, Mr. Lu was co-founder of a network communications company. Mr. Lu received a graduate certificate in hotel management from Guangzhou University and a master’s degree in business administration from China Europe International Business School. Since May 2014, Mr. Lu has served on the board of directors of Youku Tudou.

Daniel Yong Zhang – Chief Operating Officer, Director. Mr. Zhang has been chief operating officer since September 2013. He was appointed president of Tmall.com in June 2011, when Tmall.com became an independent platform. He was chief financial officer of Taobao from the time he joined in August 2007 until June 2011 and also served as general manager of Tmall during the latter three years in this period. Before joining Alibaba Group, Mr. Zhang served as chief financial officer of Shanda Interactive Entertainment Limited, an online game developer and operator. Mr. Zhang received a bachelor’s degree in finance from Shanghai University of Finance and Economics. He is a member of the Chinese Institute of Certified Public Accountants.

Maggie Wei Wu – Chief Financial Officer. Ms. Wu has been chief financial officer since May 2013 and served as deputy chief financial officer from October 2011 to May 2013. Ms. Wu joined Alibaba in July 2007 as chief financial officer of Alibaba.com and was responsible for instituting Alibaba.com’s financial systems and organization leading up to its initial public offering in Hong Kong in November of that year, as well as co-leading the privatization of Alibaba.com in 2012. Ms. Wu is a member of the Association of Chartered Certified Accountants (ACCA) and a member of the Chinese Institute of Certified Public Accountants. She received a bachelor’s degree in accounting from Capital University of Economics and Business.

Jian Wang – Chief Technology Officer. Mr. Wang has been chief technology officer since August 2012. Prior to his current position, he was chief architect from the time he joined in September 2008. He also served as president of Alibaba Cloud Computing from its inception in September 2009 until September 2013. Before joining Alibaba, Mr. Wang was assistant managing director at Microsoft Research Asia, where he had served since 1999. Before that, he worked at Zhejiang University in Hangzhou, China as a professor and head of the psychology department. Jian serves on the board of directors of CITIC 21. He received a bachelor’s degree in psychology and a Ph.D in engineering from Hangzhou University.

Models


Figure 24: Alibaba Income Statement

($in millions except per share data)

picture1

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Source: Alibaba, MVP Research

 

Figure 25: Alibaba Balance Sheet

picture1

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Source: Alibaba, MVP Research

 

Figure 26: Alibaba Statement of Cash Flow: Fiscal Year Ending March 31

picture1Source: Alibaba, MVP Research

 

Appendix

Appendix 1: Timeline of Alibaba Group

The Alibaba group is a family of Internet-based businesses based in Hangzhou. Since its inception in 1999, it has developed leading businesses that includes the largest online and mobile commerce in the world in terms of gross merchandise volume in 2013 (IDC GMV report), cloud computing, Business-to-business (B2B) marketplaces, online payment, mobile apps and expanding further into new areas such as Internet TV and mobile operating systems. It has offices located in the United States, United Kingdom, India, Korea, Taiwan, and Hong Kong and with 22,072 employees, it has more people working for Alibaba than Facebook and Yahoo combined.

 

Figure 27: Timeline of Alibaba Group

picture1

 

 

 

 

 

 

 

 

 

 

 

 

Source: Alibaba, Manhattan Venture Partners

 

Appendix 2: Revenue Components

Online Marketing Services – Pay-for-performance, or P4P, marketing services, where sellers bid for keywords that match products or service listings appearing in search or browser results on a cost-per-click, or CPC, basis at prices established by Alibaba’s online auction system.

  • Display Positions – sellers are able to bid for display positions at fixed prices or prices established by real-time bidding system on a cost-per-thousand impression. Similarly, sellers pay placement fees to purchase promotional slots on Juhuasuan marketplaces for a specific period of time.
  • Commissions Transactions – In addition to purchasing online marketing services, sellers on Tmall and Juhuasuan also pay a commission based on a percentage of GMV for transactions settled through Alipay. Commission percentages typically range from 0.3% to 5% depending on product category.
  • Membership fees and Value-added Services – China TrustPass memberships are sold to allow wholesalers to host premium storefronts with access to basic data analytic applications and upgraded storefront management tools.
  • Online Market Services – Keyboard bidding and P4P marketing services.

International Commerce – Accounting for nearly 10% of total revenues in fiscal year 2014 are primarily from AliExpress, through commissions, which are 5% of GMV for transactions settled through Alipay.

Membership fees and Value-added Services – Sellers purchase Gold Supplier memberships on Alibaba.com which allow wholesalers to host premium storefronts with product listings on the

  • Value-added services such as custom clearance, value-added tax, and product showcase as well as import/export business solutions.
  • Online Marketing Services – Revenue primarily derived from P4P marketing services.

Cloud Computing and Internet Infrastructure Services – Users pay for services such as elastic computing, database services and large-scale computing services, web-hosting and domain name registration. Other sources of revenue include micro-finance services through SME loan business. As of March 31, 2014, there were over 365,000 borrowers with roughly $82 billion in outstanding balance.

Appendix 3: Alipay – A Key Enabler

Alipay, also known as Zhejiang Alibaba E-Commerce Ltd, is a PayPal-like Internet-payment service, and an all-in-one banking mobile application consisting of a savings bank, wire service and investment house. A key enabler in the evolution of Alibaba, Alipay is indirectly controlled by Jack Ma and other Alibaba executives. Alipay processed $519 billion worth of digital payments in 2013, making it the largest processor in the world, and roughly three times PayPal’s processing volume of $180 billion. Alipay Wallet has been downloaded more than 100 million times, and its transaction volume and active user base are superior to all its competitors.

 

Figure 28: Alipay’s Ownership Structure

picture1

 

 

 

 

 

 

 

 

 

 

 

Source: Alibaba, MVP Research

 

Appendix 4: Strategic Investments and Partnerships

Figure 29: List of Investments from 2010 to 2014

picture1

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Source: Alibaba, MVP Research

 

About Manhattan Venture Partners

Our Research Methodology

Manhattan Venture Partners provides clients with accurate, timely and innovative research into the companies and sectors we cover. To that end we established an experienced team of analysts, researchers, economists and industry veterans that focus exclusively on private companies with a proven track record of success. Producing quality research on a private company is uniquely challenging. Our analysts communicate with employees, ex-employees, early investors, VCs, competitors, suppliers and others to gather valuable information about the company under coverage. This information enables us to create unique financial models that value the underlying company and provide insight to our clients and industry experts, leveraging years of experience working for bulge bracket firms.

Manhattan Venture Partners reports include business and financial aspects of late-stage companies. These reports include but are not limited to industry overviews, competitor analyses, SWOT analysis, products (existing and in development), management and key directors, risks and concerns, other propriety channels, historical financials, revenue projections, valuations (using various matrices and valuation recommendation), waterfall analysis, and a capitalization table.

About the Analysts

Santosh Rao

Santosh Rao has over 15 years of experience in equity research, primarily within the technology and telecommunications space. He started his equity research career at Prudential Securities and later served as a Vice President and Senior Equity Analyst at Broadpoint Capital (Broadpoint Gleacher), where he specialized in the telecommunications equipment and services sectors. Prior to joining Manhattan Venture Partners, he was Managing Director and Head of Research at Greencrest Capital, focusing on private market TMT research, and prior to that at Evercore Partners’ Institutional Equities Group, focusing on telecom and data services companies. Prior to moving to equity research, Mr. Rao worked as a Senior Financial Analyst in the Financial Analysis & Reporting Group at PaineWebber and Prudential Securities. Mr. Rao earned his Bachelor of Arts in Economics and Accounting from Rutgers University and an MBA in Finance from Rutgers Business School.

Max Wolff

Max Wolff is an economist specializing in international finance and macroeconomics. Before joining Manhattan Venture Partners, he was Chief Economist at Greencrest Capital, and prior to that spent four years as the senior hedge fund analyst at the Beryl Consulting Group LLC. Mr. Wolff teaches finance and statistical research methods in the New School University’s Graduate Program in International Affairs. Max’s financial markets and Macro-Economics work appears regularly in Seeking Alpha, The WSJ, Reuters, Bloomberg, The BBC, Russia Today TV, and Al Jazeera English.

Disclaimer
I, Santosh Rao, certify that the views expressed in this report accurately reflect my personal views about the subject, securities, instruments, or issuers, and that no part of my compensation was, is, or will be directly or indirectly related to the specific views or recommendations contained herein.

I, Max Wolff, certify that the views expressed in this report accurately reflect my personal views about the subject, securities, instruments, or issuers, and that no part of my compensation was, is, or will be directly or indirectly related to the specific views or recommendations contained herein.

Manhattan Venture Partners LLC (Hereafter “Manhattan Venture Partners”) does and seeks to do business with companies covered in this research report. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. This document does not contain all the information needed to make an investment decision, including but not limited to, the risks and costs.

Additional information is available upon request. Information has been obtained from sources believed to be reliable but Manhattan Venture Partners or its affiliates and/or subsidiaries do not warrant its completeness or accuracy. All pricing information for the securities discussed is derived from public information, unless otherwise stated. Opinions and estimates constitute our judgment as of the date of this material and are subject to change without notice. Past performance is not indicative of future results. Manhattan Venture Partners does not engage in any proprietary trading.  The user is responsible for verifying the accuracy of the data received.  This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. Manhattan Venture Partners does not have ownership of the subject company’s securities. Manhattan Venture Partners does not have any market making activities in the subject company’s securities.   The opinions and recommendations herein do not take into account individual client circumstances, objectives, or needs and are not intended as recommendations of particular securities, financial instruments or strategies to particular clients. The recipient of this report must make its own independent decisions regarding any securities or financial instruments mentioned herein. Periodic updates may be provided on companies/industries based on company specific developments or announcements, market conditions or any other publicly available information.

Copyright 2014 Manhattan Venture Partners LLC. All rights reserved. This report or any portion hereof may not be reprinted, sold or redistributed, in whole or in part, without the written consent of Manhattan Venture Partners.

Information Access Level Classification System (IALCS)

Manhattan Venture Partners uses an Information Access Level Classification System (IALCS) to make clear the degree of access offered by the company(s) covered in all research reports.

Each research report is classified into one of three categories depending on its classification. The categories are:

I++: The company covered by the research report provided substantial disclosures to Manhattan Venture Partners.

I+: The report was prepared following partial disclosure by the company, including publicly available financial statements, and/or is based on conversations with past or present company employees.

I: All reports are prepared using a mosaic research approach. Not all companies are willing and able to provide substantive access to management and information. In I reports no direct access was granted.