This article is a follow-up to that which appeared in the Sydney Wealth Management update – winter 2021. Since that article was published, the share price of Alibaba Group Holding Limited has declined significantly, from levels north of US$200 to a recent low of US$110. The uncertainty around the company has intensified and revolves around a ramping up in competition, as well as increased regulatory scrutiny, which continues to lead to adverse rulings impacting many big-tech companies, not in the least Alibaba. In light of the increased news flow over the past few months, it is appropriate that we revisit the investment case for Alibaba.
Alibaba is the world’s largest online and mobile commerce company. It operates China’s online marketplaces, including Taobao (a consumer-to-consumer e-commerce platform) and Tmall (a business to consumer e-commerce platform for brands and retailers). These platforms have the largest number of merchants and the highest gross merchandise value per user in China. This provides Alibaba with an unparalleled source of data that it can use to help merchants and consumer brands develop personalised mobile marketing and content strategies to expand their target audiences, increase both click-through rates and physical store transactions, and bolster return on investment. Whilst the bulk (85%) of Alibaba’s revenues come from e-commerce, 10% is derived from the cloud computing division and this division is growing at an annual rate of 33%. The divisions of digital media/entertainment and innovation initiatives contribute to the remainder of revenues.
Alibaba’s performance is leveraged to globalisation, rising disposable incomes and consumption trends, living standards, and continued e-commerce penetration. Despite its phenomenal success since its establishment over two decades ago, which has resulted in an impressive business in many aspects (quality assets, a solid business model and attractive growth prospects), there are several headwinds which could hamper Alibaba’s performance over the short to medium term. Firstly, concerns about corporate governance (anti-competitive measures) at the company have resulted in the company being fined 18.2 billion Chinese Yuan (US$2.8 billion) in April this year as a result of Alibaba forcing merchants to choose its platform exclusively, thereby suppressing competition. Secondly, recent regulatory changes potentially threaten to reduce the company’s profitability. Thirdly, Alibaba continues to face increasingly intense competition in the e-commerce space, chiefly from rivals Pinduoduo and JD.com, the former recently overtaking Alibaba in the number of active users. The net effect of these concerns has led to the company losing more than half its market value in the past year in an otherwise strongly rising market and continues to deter many potential shareholders from investing in the company.
Alibaba has been caught up in China’s crackdown on companies the Authorities believe have too much market power. A timeline of events that have impacted Alibaba and other Chinese technology giants in recent months includes the following:
- August 10 – the Communist Party’s Central Committee issued a new five-year plan that calls for greater regulation across a broad scope of businesses and the economy.
- August 17 – the Ministry of Industry and Information Technology (MIIT) issued a set of draft rules governing competition among online platform operators.
- August 20 – China approves new data-privacy laws, raising concerns of further crackdowns on internet firms and companies that rely heavily on consumer data.
- August 27 – China issued draft guidelines on regulating the algorithms used by internet firms to make recommendations to users, with the stated goal of protecting users’ privacy and data security.
- September 13 – speculation increased that regulators have pushed to break up Alipay, the super app owned by Jack Ma’s Ant Group, with the lending business moving to a separate app.
- October 26 – The Chinese Ministry of Commerce, the Cyberspace Administration of China (CAC) and the National Development and Reform Commission (NDRC) released a draft of China’s 14th five-year plan for e-commerce. It forecast a slowdown in the country’s e-commerce growth rate, but expected the sector to remain a key lever to pursue “high-quality” growth in the next five years, especially in terms of narrowing the development gap between urban and rural areas.
- November 5 – the Guangdong Administration for Market Regulation (GAMR) accused 16 e-commerce platform operators of various irregularities including selling fake products, false advertising and poor after-sales service. The GAMR issued a set of guidelines for the offending platforms, including requiring them to establish a compliance management system to handle consumer complaints in a timely manner, protect consumers’ personal information, and refrain from false or illegal advertising.
- November 20 – Alibaba, along with a raft of tech giants, was fined for failing to report corporate acquisitions that occurred up to eight years ago under rules on “operating concentration”.
The speed and voracity of these regulatory actions have caught markets by surprise. For decades, China has pursued common prosperity via the trickle-down effect, allowing and indeed encouraging businesses to be successful, which in turn has created jobs and incomes for the population. The recent change in reducing inequality is more in line with old school communist principles and represents a highly concerning marked shift in rhetoric. Analysts are continuing to grapple with how far the Authorities and state agencies will go, acutely aware that this is a very dangerous strategy that is likely to backfire. Instead of redistributing wealth as intended, it is more likely to reduce prosperity for the population as a whole.
The table below shows that Alibaba is currently trading on a multiple of 17.8 TTM Earnings.
|Alibaba Group Holding Limited1|
|Share price 7 Dec. 2021: US$126.50||FY19||FY20||FY21||TTM2|
|Net Income (CNY)||87.6b||149.3b||150.3b||124.5b|
|Diluted Earnings Per Share (EPS) (CNY)||33.4||55.9||54.7||45.3|
|Price to Earnings (PE)||25.6||23.3||19.3||17.8|
|Price to Book Value||6.6||5.1||2.5||2.3|
|Net Income Growth||36.9%||70.4%||0.7%||-17.2%|
1 All figures in Chinese Yuan (CNY) unless denoted.
2 Trailing Twelve Months
At the release of its second quarter results, Alibaba slashed FY22 revenue guidance from 30% growth to between 20% and 23% growth, citing slower growth in Chinese consumer spending. The growth at the profit level is likely to be weak as the company is investing heavily in new business activities (mostly within its e-commerce business) amid strong competition from rivals.
Notwithstanding the headwinds facing the company from both a regulatory and competitive perspective, which continue unabated, there are positives for current shareholders of the company:
- The company is trading at a current TTM Price to Earnings (PE) ratio of around 20 times. This is the lowest PE ratio the company has been trading at for the past five years.
- Whilst Chinese retail sales growth slumped to 2.5% year-on-year in August, it has regained momentum to show a 4.9% yearly rise through to October. This is a positive for e-commerce retailers like Alibaba who are leveraged to stronger retail sales.
- Alibaba’s market share in Europe is small, but even if it retains this market share, it stands to benefit significantly as Europe’s e-commerce market is expected to expand strongly in coming years, providing another growth driver.
- A strong network effect allows leading e-commerce players to extend into other growth avenues, and this is especially evident with Alibaba. An example of this, in the case of Alibaba, is financial services where Alibaba’s Alipay payments app can be used to pay for day-to-day expenses and can also be used to invest in a money-market fund.
Alibaba’s “ecosystem” is made up of the twin pillars: Taobao Marketplace and Tmall, China’s two most popular online shopping marketplaces. As Alibaba’s various online marketplaces are interconnected, it compounds the company’s network effect, which then breeds other competitive advantages and growth opportunities. Unfortunately, the company has been besotted by problems in the past few months. The significant correction in Baba’s share price due, primarily, to continuing regulatory concerns may provide an attractive entry point into an outstanding company should the numerous headwinds buffeting the e-commerce giant abate.