Will Alibaba’s growth accelerate?

Investment Recommendation: Buy

Current Price ($US): 183.68

Target Price ($US): 220

Market Cap ($US bn): 470.4

52-week price range ($USD): 173.3-204.3

Company Overview

Alibaba Group is a Chinese multinational public company specialising in e-commerce, internet infrastructure, online financial services and technology. Founded in 1999 in Hangzhou, it currently dominates internet retailing and B2B sales services in China. Today, Alibaba Group is one of the largest companies in the world by both revenue and market capitalisation, owning several subsidiary companies including Alibaba.com, Alipay, Taobao.com, Aliexpress.com.

Investment Thesis and Catalysts

I recommend a buy for Alibaba due to strong company fundamentals and significant scope for expansion across Asia and Western markets. Currently leading the Chinese e-commerce market, Alibaba’s earnings outperformed estimates by nearly 20% in 2017 and keep rising at a faster rate than the US’s and Europe’s GDP growth rates combined. As of 18th February, shares closed at $183.68 with a P/E of 52.16 and a market cap valued at $470.4 billion.

1). Diversification through investments

Initially established purely as an e-commerce platform, Alibaba is now actively investing in various markets including cloud computing and entertainment where returns increased by 103% and 234% respectively. The benefits of being the first mover in the market of platforms connecting businesses (B2B) also justifies its significant scope for rapid growth; so far, no other company seems to be able to compete with the B2B giant in this business area. Alibaba’s campaign in achieving higher prominence in other markets has led to success in Southeast Asian countries. For example, the company has led a US $1.1 billion investment in one of Indonesia’s biggest online marketplaces, Tokopedia, further accelerating the Chinese giant’s expansion into Southeast Asia. Furthermore, Jack Ma’s conglomerate has stakes in several e-commerce and payment companies in India and is very likely to continue expanding its activities in the region.

2). Success in growing outside of China

According to Alibaba Group’s Chairman Jack Ma, the company has very promising long-term strategies and goals for the next 10-20 years, including its aims to achieve a strong consumer base of more than 2 billion people all over the globe. Even though its dominance in the Chinese market seems to be indisputable, the holding is relentlessly trying to expand its business into new geographies. One of the Alibaba Group’s subsidiaries, Alipay, has already penetrated into the US and Europe which allows Chinese travelers to carry out cashless transactions. However, there is still a serious amount of work to accomplish in terms of strengthening the payment tool in those countries. The holding is now actively trying to establish itself in the Western markets through acquisitions of companies in these areas.

3). Increasing internet access in developing markets

Another significant factor that might considerably boost earnings of Alibaba’s subsidiaries such as Alipay and Alibaba.com is the ease of access to the World Web by the public, which is very strongly correlated with a country’s GDP per capita. Today, China has one of the highest levels of income inequality with the richest 1% of households owning a third of the country’s wealth whilst the poorest quintile owns only one percent of total wealth. According to TechInAsia’s research, only 53% of the Chinese population have Internet access, yet based on how quickly these figures have changed in our decade, we can expect Web access to accelerate in the near future. Chinese income inequality as measured by the Gini coefficient has risen from 0.35 to nearly 0.5 in the last 20 years and the total number of internet users experienced a growth by 7 times rising from 100 million users in 2007 to 700 million today. If the Chinese economy maintains the trend of reducing income inequality and improving living standards, Alibaba Group will be the first to benefit.

Investment Risks

A key problem faced by Jack Ma’s Alibaba Group is worldwide suspicion of counterfeits sold on the platform that severely inhibits its growth in Western countries. One of Alibaba’s subsidiaries, Taobao, which specialises in customer-to-customer sales services has been blacklisted by the U.S. Trade Representative on accusations of spreading pirated and counterfeit goods. This issue has to be seriously considered by Alibaba’s chairman Jack Ma as any hopes of settling the business in the U.S. and Europe might shatter in the blink of an eye.

E-commerce is one of the most rapidly developing industries populated by giants like Amazon and eBay as well as domestic competitor JD.com, with the former undertaking a very similar growth strategy to Alibaba in terms of further business expansion. These firms risk becoming straight rivals in industries such as original content and cloud services, especially in Europe and the Americas. Amazon first announced Amazon Drive storage service on March 29, 2011 whereas Alibaba introduced its Alibaba Cloud two years earlier. The rivals are also acquiring dominance in media and entertainment with Amazon’s Audible and Alibaba Music rising to prominence in their respective markets. However, similar products might not always imply that the firms are following the same path, so more global and significant developments have to be considered. Amazon is eager to break into the Chinese market, but it faces a lot more difficulties than the firm expected. It has also advertised positions in Chinese digital content production, although an expansion into local TV and entertainment would appear difficult given China's strict media regulations. So we are now able to witness a dramatic race of two straight rivals competing in many markets and if one firm underperforms in any of these business segments another firm might take the lead in this race.

Recommendation

Given the risks, Alibaba Group’s shares are “on fire” and remain undervalued (against target $220 per share) amid claims of not being able to successfully expand its e-commerce business to new geographies. Many still believe the stock has been overvalued since its record high IPO of $25 billion but the vast majority of these claims are supported by little or no evidence. The company’s long-term goals gradually seem to be more achievable and performance in the near future will be strongly determined by their ability to gain prominence in other parts of the globe yet maintain their dominance in the Asian market. The announcement of being one of the major sponsors at the 2018 Winter Olympics is a huge leap towards global recognition of the brand that will only accelerate its growth along with the catalysts mentioned above. Therefore, I recommend a buy for Alibaba.

References

1. https://www.reuters.com/article/us-alibaba-ipo-value/alibaba-ipo-ranks-as-worlds-biggest-after-additional-shares-sold-idUSKCN0HH0A620140922

2. http://www.businessinsider.com/amazon-is-ramping-up-its-china-based-hiring-as-part-of-asian-expansion-strategy-2017-9?IR=T

3. https://www.ft.com/content/53c8ce56-0300-11e7-ace0-1ce02ef0def9

4. http://fortune.com/2018/01/12/alibaba-taobao-blacklist-counterfeit-products/

5. https://www.dealstreetasia.com/stories/alibaba-to-invest-nearly-450m-in-two-new-vc-funds-targetting-hong-kong-taiwan-20562/

6. https://www.forbes.com/sites/michaelzakkour/2017/10/31/singles-day-alibabas-vision-for-the-future-of-retail/#45258a0768e0

7. https://www.opengovasia.com/articles/philippines-government-exploring-alibabas-technology-solutions

8. https://www.forbes.com/sites/greatspeculations/2016/10/13/a-closer-look-at-alibabas-long-term-strategy/#4d261d852bc0

9. https://www.nasdaq.com/symbol/baba/analyst-research

10. https://hackernoon.com/a-brief-overview-of-alibaba-5c5ae9aa2d34