2023-05-18 10:00:17 ET
Summary
- Alibaba Group Holding Limited's growth slowed to 2% in the March quarter, underperforming consensus revenue estimates.
- Alibaba full-year growth was the slowest in almost a decade, underscoring the weight of ongoing macroeconomic, regulatory, and geopolitical pressures on the underlying business.
- Alibaba management has confirmed plans to pursue capital-raising activities for its cloud, logistics, international commerce, and retail grocery businesses, which the market had speculated about in recent weeks.
- But the market's muted response post-earnings implies there is much work left to be done at Alibaba to restore its battered credibility and investor confidence in the stock.
Alibaba Group Holding Limited (BABA) finished the March quarter (fiscal Q4 2023) with mediocre results , with the company's tepid revenue growth of just 2% y/y during the period making it the latest Chinese private big tech to join peers on exhibiting modest recovery prospects, consistent with mixed economic data that points to a reopening narrative that could be losing momentum.
Investors remain focused on the company's prospective IPO plans following the announcement of a new organizational structure earlier this year, which is expected to unlock incremental value. While investors' excitement over the new organizational structure priced into the stock earlier this year has largely fizzled due to the lack of follow through on proposed IPO plans for its fastest growing logistics , cloud and global e-commerce units, management's commentary at the March quarter earnings call, pointing to board approvals for the speculated carve-outs, at least adds clarity on progress pertaining to related efforts.
We are taking concrete steps towards unlocking value from our businesses and are pleased to announce that our board has approved a full spin-off of the Cloud Intelligence Group via a stock dividend distribution to shareholders, with intention for it to become an independent publicly listed company…We are delighted to share that our board has approved the process to start external financing for Alibaba International Digital Commerce Business Group; exploration of IPO for Cainiao Smart Logistics Group; and execution of IPO for Freshippo.
Source: Alibaba F4Q23 Earnings Press Release .
Looking ahead, as Alibaba proceeds with its first full quarter of business under the new organizational and governance structure while also grappling with a mixed reopening outlook in China, investors will likely continue to demand consistent positive progress and follow-through on levers pulled by management in recent quarters promising renewed growth and value accretion - including the successful listing of proposed IPOs and spinoffs within the foreseeable future. In the meantime, ongoing uncertainties over economic recovery, regulatory and geopolitical concerns are likely to remain a lingering overhang on the Alibaba stock's prospects as investors' confidence remains fragile.
Weak Recovery Momentum
China's reopening play and lingering regulatory and geopolitical risks remain headwinds for Alibaba. On the economic recovery front, Alibaba's tepid first quarter results and modest outlook commentary for the current quarter remains in line with conservative improvements observed at peers like JD.com, Inc. ( JD ) earlier this week, as well as mixed economic data on China's recovery.
Specifically, continued weakness in Alibaba's core commerce operations in China continue to highlight a muted pace of consumption recovery in the region. The gross merchandise value ("GMV") for its core domestic e-commerce apps Taobao and Tmall, which measures total transactions completed via the platforms, fell by "mid-single-digit year-over-year," consistent with the 2% y/y decline in China commerce sales. Although management had already previously reported of weakness observed in January through early February, in line with seasonal trends due to the Lunar New Year holiday, with the pace of completed transactions picking back up exiting the March quarter, the tepid results remain consistent with recent economic data that suggest a mixed outlook on China's reopening play.
From January to early February of this year, overall sales of online physical goods remained weak, and our China commerce continues to be highly impacted due to COVID cases as well as people traveling home or to other places during the spring festival holidays.
Source: Alibaba F3Q23 Earnings Call Transcript .
In the month of March, online physical goods GMV growth on Taobao and Tmall, excluding unpaid orders, turned positive, driven by strong growth of fashion and accessories and healthcare categories.
Source: Alibaba F4Q23 Earnings Press Release.
While China had finished the first quarter of calendar 2023 with GDP expansion of 4.5% , helped primarily by improved consumption following the removal of years-long COVID restrictions that have hampered the country's economy, markets have remained cautiously optimistic at best given other core economic driving factors remain in contraction. This is further corroborated by a weaker-than-expected pace of retail sales growth in April, despite an easy prior year comparison due to COVID lockdowns in Shanghai at the time, which indicate fizzling momentum in consumption-driven growth. China's April CPI also remained at a "two-year low of 0.1% " which suggests nominal "demand-driven inflation in the economy." Meanwhile, imports declined by almost 8% y/y in April, implying waning momentum in China's demand environment and increasing risks of a stalled recovery.
The results reflect a swift shift to slow the taps on consumer spending, as unemployment remained near record high levels beyond 5% (the figure surges above 20% for the 16-24 age group), threatening to derail the release of record high cash piles in household savings accumulated over the past two years critical to reviving the economy. Other drivers of China's recovery, including the property sector which accounts for about a fifth of GDP, also remain weak, with growth in home prices slowing in April while purchases also decelerated, despite loose property policies aimed at shoring up the sector's demand.
China's mixed recovery prospects this year remain an acute challenge for Alibaba's core commerce unit, which is looking to "regain momentum after years of punishing COVID Zero restrictions." The segment's prospects of returning to its previous double-digit growth trajectory are also becoming further out of reach considering the mixed domestic economic recovery outlook, and shifting consumer preferences with rising competition. Despite Alibaba's recent vow to reimagine its Taobao shopping experience with incremental investments into bolstering short-form video and live-streamed shopping capabilities for merchants, as well as more price competitive offerings to users, related efforts are not expected to drive material growth to core domestic commerce operations, but instead help preserve its leading market share from further losses to competition.
Lingering Risk Overhang
Meanwhile, on the regulatory and geopolitical front, although Beijing's campaign on reining in big tech influence appears to have eased, its agenda for the private sector continues to lack transparency and predictability. This is consistent with the latest development pertaining to Beijing's curtailment of "access by overseas firms to Chinese data sources," citing national security concerns. Despite Beijing's shift in focus towards bolstering foreign investments to support the country's growth aspirations for the current year, its policy outlook continues to say otherwise. Net foreign direct investments have been extending declines observed in the second half of 2022, while interest in both Chinese equities and bonds have also plummeted for the majority of the last 12 months.
Specifically, U.S. businesses with operations in China have become " increasingly pessimistic about the relationship between Washington and Beijing as geopolitical tensions escalate," compounding concerns over existing regulatory uncertainties. VC funding from the West into China have also dried up , as confidence wanes given the "evolving risks of doing business in China."
Meanwhile, the U.S. has also recently stepped up efforts in countering related risks, further exacerbating the risk sentiment over Chinese investments. In addition to the existing Committee of Foreign Direct Investment in the United States, or "CFIUS," which reviews "foreign investments in or acquisitions of U.S. businesses," the Biden administration has been contemplating the enactment of a " reverse CFIUS ," which would review outbound American investments - particularly in China given escalating national security concerns.
In reports provided to lawmakers Friday on Capitol Hill, the Treasury and Commerce departments said they were considering a new regulatory system to address U.S. investment in advanced technologies abroad that could pose national security risks...People familiar with the work on the new program expect it to cover private-equity and venture-capital investments in advanced semiconductors, quantum computing and some forms of artificial intelligence. U.S. officials want to prevent American investors from providing funding and expertise to Chinese companies that could improve the speed and accuracy of Beijing's military decisions, for example.
Source: The Wall Street Journal .
Related developments risk exacerbating an already distorted growth trajectory for Alibaba following an aggressive overhaul of private sector regulations over the past two years. This includes slowed growth at Alibaba's core commerce operations following Beijing's tightening of anti-trust rules that have heightened competition, as well as limitations to its cloud unit's growth ambitions due to the Chinese government's preference for state-backed hyperscalers due to national security concerns. This is in line with Alibaba's diminishing market share in the Chinese cloud-computing market to the mid-30% range in 2022, down from 37% in 2021 and 46% in 2019, as well as management's acknowledgement of declining demand from the public sector:
[Cloud] revenue growth from non-Internet industries was 9% and contributed 53% of overall car revenue. The non-Internet revenue growth was mainly driven by solid growth of financial services education, automobile industries, which was partially offset by the decline in public services industry.
Source: Alibaba F3Q23 Earnings Call Transcript.
The stiffening regulatory headwinds gating Alibaba's growth aspirations have also added to its customer acquisition costs. In order to bolster penetration into China's expanding cloud TAM and preserve its market leadership in the region, Alibaba has recently announced price cuts of up to 50% for its cloud services.
According to Alibaba Cloud's website, prices for elastic computing services - the ability to quickly expand or decrease processing - using Arm and Intel-based chips will drop by 15% to 20%, while services using Nvidia's (NVDA) V100 and T4 graphics processing units will drop between 41% to 47%.
Source: Reuters .
Peers are also starting to follow suit, precipitating a price war ahead that could weigh further on Alibaba's cloud profitability and, inadvertently, the unit's valuation prospects ahead of the planned spinoff - especially as investors' enthusiasm dulls on the unit's first y/y decline during the March quarter, highlighting ongoing impacts from the aftermath of COVID restrictions among other business challenges.
And just this week, the WeChat operator [Tencent] (TCEHY) announced a price cut of some of its core cloud products by as much as 40%, following a similar move by nemesis Alibaba.
Source: Bloomberg News .
Taken together, the regulatory and geopolitical environment facing Alibaba remains fraught, which coupled with China's uncertain reopening trajectory represents continued multiple compressions risk to the stock as investors' confidence remains limited.
Any Sliver of Hope Has Only Gotten Slimmer
Despite recent market interest in generative AI, the technology's exuberance has done little to overshadow the precedence of aforementioned risk overhangs. The company's announcement of its aspirations in the budding subfield of AI, starting with the roll-out of its large language model " Tongyi Qianwen " introduced in early April, has not garnered nearly as much momentum as its U.S. counterparts have over the past six months. The stock has even extended declines of more than 10% since the announcement of the new generative AI solution, which Alibaba plans to implement "across all sectors" of its business, starting with its workplace collaboration tool DingTalk and smart home assistant Tmall Genie. Similar to large language model marketplace offerings that American hyperscalers - spanning Microsoft Corporation's ( MSFT ) Azure, Amazon Web Services of Amazon.com, Inc. ( AMZN ), Google Cloud Platform of Alphabet Inc. ( GOOG / GOOGL ), and Meta Platforms , Inc. ( META ) - have introduced on a rolling basis in recent months to facilitate faster and more cost-conscious development and deployment of generative AI tools, Alibaba also has plans for similar offerings, starting by providing its cloud customers with "access to Tongyi Qianwen [and] help them build customized large language models." While the new service has garnered positive reception across a "broad range of [enterprise] sectors" during the beta tasting phase, it will likely play a nominal role in alleviating growth headwinds in Alibaba's cloud unit within the immediate term, which is corroborated by the segment's unprecedented y/y decline during the March quarter.
Meanwhile, the lack of follow through on levers Alibaba has sought to pull in hopes of shoring up investors' confidence in the stock - including the business' new organizational structure and impending IPOs - have also smothered the nascent recovery momentum earlier this year. Although management's latest commentary during the March quarter earnings call indicate continued commitment to drive incremental shareholder value through the revamped corporate strategy, with spinoff and IPO plans targeted for completion within the next six to 18 months, it remains insufficient to assuage core concerns over the immediate impact of economic deterioration on fundamentals and longer-term impact of regulatory and geopolitical risks on its broader business prospects.
Fundamental Analysis
Adjusting our fundamental forecast for Alibaba based on its latest March quarter results, as well as management's cautiously optimistic commentary on the company's forward growth and cost prospects consider ongoing company-specific and macro factors, the company is expected to achieve modest acceleration in fiscal 2024, with the pace of recovery looking more optimistic approaching the December quarter, helped by seasonality tailwinds (e.g., Single's Day Shopping Festival; holiday season demand) as well as a weak PY comp considering COVID-related impacts during fiscal 2023's December quarter.
Over the longer-term, international commerce and Cainiao are expected to remain Alibaba's fastest-growing consumer-facing units. Meanwhile, Alibaba's cloud unit will indubitably take precedent on the enterprise-facing front, considering expectations for the ramp-up in deployment of its new generative AI offerings that will help to partially neutralize regulatory limitations.
Continued improvements to Alibaba's operational efficiency and cost structure, paired with expectations for an increased revenue mix shift towards higher-margin cloud sales will likely bolster the company's profitability.
Alibaba_-_Forecasted_Financial_Information.pdf .
Valuation Analysis
We believe Alibaba's estimated intrinsic value based on the steady-state valuation method outlined in our previous coverage on the stock remains a reasonable reflection of its base case. Recall that the steady-state value reflects the worth of company cash flows that can be sustained indefinitely regardless of whether incremental investments are made. The steady-state firm value can be denoted by a forward P/E ratio equivalent to one divided by the company's cost of capital:
A company can continue to grow earnings as it invests at the cost of capital. It will just fail to create value, and hence should trade at its steady-state worth. We can readily translate from the steady-state value to a steady-state price-earnings multiple, which is the reciprocal of the cost of [capital].
Source: Credit Suisse .
We have computed a WACC of 11% for Alibaba, which is consistent with its current risk profile and capital structure. This would translate into a steady-state P/E of about 9.1x. Applying this to Alibaba's estimated earnings in conjunction with our fundamental forecast discussed in the earlier section, the company yields an estimated steady-state value of about $172.8 billion, or $67 per share.
We view the near-$70 range as a reasonable reflection of Alibaba's base case valuation, as it does not consider any incremental premium attributable to the company's projected cash flows and representative of its most conservative growth prospect. The scenario is consistent with considerations over substantial macroeconomic headwinds that could weigh on whether the anticipated capital raising functions for its cloud, logistics, international commerce, and retail grocery businesses can garner sufficient momentum and favorable terms to restore investors' confidence in the stock's prospects. It also reflects the lingering geopolitical and regulatory risks that remain gating factors to Alibaba's ability in executing its value accretive efforts. The base case price target of about $70 is also consistent with the level in which the Alibaba stock has continued to find support in recent months whenever rallies fizzle on the lack of sustainable momentum.
Meanwhile, under the best-case scenario, we see the stock potentially rising to the $130-range. The bull case price target is determined based on company fundamentals under the discounted cash flow method. The analysis considers Alibaba's projected cash flows in conjunction with the fundamental forecast discussed in earlier sections, as well as the 11% WACC computed earlier, and an implied growth rate of 2%, in line with the long-term growth rate of the company's core operating regions (i.e., China, SEA, and Europe).
However, as discussed in the foregoing analysis, Alibaba's market valuation discount to its broader tech and internet peers largely stems from China- and company-specific risks that have swayed the stock to trade predominantly on sentiment rather than solely on the underlying business' fundamental prospects. As such, we believe the bull case would only be sustainably achievable if there is consistent positive progress on Alibaba's delivery of its value accretive promises, including the proposed completion of planned spinoffs, IPOs, and capital raising activities within the next six to 18 months, in addition to ongoing realization of internal growth and optimization efforts.
The Bottom Line
Investor sentiment over the macroeconomic, geopolitical and regulatory environment surrounding Alibaba Group Holding Limited's underlying business remains the driving factor for the stock, rather than company-specifics right now. Given the little durability in market confidence over Chinese equities, especially after the lack of follow through on government policy support and company-specific promises time and again, it will likely take the realization of Alibaba's IPO plans - with Freshippo likely being first out of the gates - to drive sufficient tangible evidence in restoring credibility to the stock. This is consistent with the stock's muted response in pre-market trading May 18 following the release of Alibaba's March quarter results.
Despite management's reaffirmed commitment on completing planned capital raising activities within the next six to 18 months, Alibaba Group Holding Limited's muted March quarter results - particularly on the unprecedented y/y decline in its prized cloud unit - is bringing immediate macroeconomic, geopolitical and regulatory considerations right back to the helm again.
For further details see:
Alibaba Fiscal Q4 2023: Boom Or Bust Depends On FY 2024