|Shares Out. (in M):||2,599||P/E||0||0|
|Market Cap (in $M):||462,622||P/FCF||0||0|
|Net Debt (in $M):||-10,933||EBIT||11,383||15,791|
I was a bit surprised that no one on VIC had done a write-up on Alibaba yet. Perhaps this is understandable with the business trading at 16.5x trailing revenues and >40x EBITDA. Even so, as I will discuss below, I think that BABA is one of the most compelling long-term opportunities and still has room for significant capital appreciation despite the major run-up in its stock over the past year. At the very least, submitting this write-up may provide a discussion forum for this well-known yet misunderstood name. Even if you are not swayed to invest, it is still helpful to better understand Alibaba given its major impact on a huge swathe of the modern Chinese economy.
At a high level, the investment thesis here is pretty straightforward:
Alibaba is a tollbooth on middle class Chinese consumption which has a long tailwind of growth ahead after only being “unshackled” recently through major policy reforms and the achievement of smartphone ubiquity in China since 2013.
Alibaba’s business/financial model exhibits tremendous operating leverage; one of the most attractive I’ve come across. The majority of each incremental dollar of revenue it captures can either fall to the bottom line or be invested in initiatives that widen its moat or capture new business opportunities. This is primarily a function of how far ahead Alibaba is compared to the competition in China.
Alibaba generates a tremendous amount of proprietary transactional data that is valuable both as a key component in its economic moat and in allowing Alibaba to invest in new business areas on an advantaged basis.
Alibaba is in pole position to apply its core business models (commerce, fintech and possibly cloud) to the majority of the developing world and we are already starting to see this play out in the battle for Southeast Asia.
Even as Jack Ma re-iterates that Alibaba is different from Amazon (most recently two weeks ago in an interview on Bloomberg), the comparison is nonetheless still valid and enlightening. The two companies may look very different from a financial perspective and in the way they do business but there are some interesting insights that investors can draw by seeing where they are similar and where they differ. The key conclusions I drew from the comparison are that (i) the economics of Alibaba’s business model are superior to Amazon’s, (ii) Alibaba’s e-commerce business is already larger than Amazon’s and still growing significantly faster and (iii) Alibaba’s e-commerce business should arguably be valued significantly higher than Amazon’s.
To gain comfort with the long thesis, one must also be familiar with some key elements of the short thesis:
Alibaba’s business model is inferior to JD and will lose in the long run.
But first let’s go through the long thesis.
We are still in the early innings of the Chinese middle class moving to a consumption-centric society.
There were two major enabling factors here that have both taken place over the last five years.
The first factor was a series of major reforms that were largely initiated during the Third Plenary Session in November 2013, particularly those impacting banking and consumer finance. Prior to this, Chinese fiscal and economic policy can best be summarized as “financial repression” where the household sector effectively subsidized capital-intensive economic activity. This resulted in remarkably high proportion of GDP and economic activity focused on investment at the expense of consumption. The key enabling policy tool was the suppression of interest rates on bank deposits (often below the rate of inflation, so negative in real terms), strict capital and investment controls (so savers had no other alternatives) and subsidized loan rates for state-owned enterprises. These policies were systematically dismantled following the Third Plenary session, which featured deep reforms in the banking and consumer finance sectors. In simple terms I think of it as a major tax on consumption that has finally been lifted. It is also still quite early in seeing the full effects of this play out.
The other big factor was the introduction of the smartphone in China and mobile broadband. Both the iPhone and 3G arrived in China in late 2009. By 2014, smartphone penetration reached over 60% with near-universal adoption in urban areas. Having largely skipped the PC / web browser phase, China was able to swiftly introduce a number of leapfrogging innovations that were designed for a digital and mobile-centric world. An example of this was skipping credit cards and moving straight to digital/mobile-centric payments – a story where Alibaba played a starring role of course. Moving to a digital and mobile-centric economy has massively reduced the friction costs of doing business and enabled new business models, many of which help Chinese consumers find creative new ways to consume products and services.
Now I stress “middle class” to differentiate from the “first” boom in Chinese consumption, one that was primarily driven by the top 1% and largely focused on luxury consumption goods. Emerging in the mid-2000s, this boom was driven by China’s old economic model where corruption and luxury consumption often went hand in hand. The current middle class-driven consumption boom is built on a stronger foundation and thus more sustainable, and its scale will be many times larger than what we saw in the previous boom.
Alibaba is a tollbooth on broad Chinese consumption.
With its scale and broad reach into transactions of all types, Alibaba is well-positioned to collect a small piece of most types of consumption in China.
For physical products, its two major platforms have dominant market share in both of their respective “segments” (Taobao for smaller merchants and P2P transactions, Tmall for bigger brands). It has the largest wholesale commerce platforms both domestically focused (1688.com) and internationally focused (the original Alibaba.com). It holds a 51% stake in a logistics company it co-founded that directs the majority of e-commerce-related fulfillment and logistics in China.
For services-type consumption, Alibaba owns or holds major stakes in many of the leading O2O companies including media and entertainment (Youku, Alibaba Pictures), transportation (Didi Chuxing), and restaurants/delivery (Koubei/Ele.me).
And last but certainly not least, Alibaba’s economic stake in and close relationship with Ant Financial / Alipay means that it gets a small piece of almost any type of transaction imaginable – from taxi rides to fruit vendors to mobile phone top-ups.
Essentially, Alibaba captures a small piece of most types of “modern consumption” (smartphone or otherwise digitally enabled) in China. And because it is digital and relatively low-friction, the type of modern consumption it specializes in will only continue to take market share from more traditional forms of consumption, even as the overall consumption pie grows in China.
Alibaba’s business model is extremely cash-generative and exhibits tremendous financial and operating leverage.
Let’s take a look at how each incremental dollar of revenue translates into operating income in its Core Commerce division: