Here Are The Factors Underlying Our $93 PT On Alibaba’s Stock

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Alibaba Group

Alibaba’s (NYSE:BABA) stock price has risen by an impressive rate of more than 50% since its IPO only a few months ago, creating tremendous euphoria on the Wall Street. Its stock currently trades at around $105, which represents over 10% premium to our $93 price target. In this article, we assess the key factors underlying our valuation, and the scenarios under which our price estimate could swing around 10-20% both upside and downside. We analyze the key financial metrics that affect free cash flows and thereby valuation, including revenue, margins and capital expenditure.

We estimate Alibaba’s top-line to expand rapidly at a CAGR of 25% over 2013 to 2020, driven by enormous growth on its Chinese retail marketplaces. The demand within the Chinese e-commerce market will increase tremendously over the coming years, fueled by rising Internet penetration and growing proportion of Internet users shopping online. The share of online retail sales in overall Chinese retail sales is expected to surpass 15% by 2017, and this will spur transactions on Alibaba’s Taobao and Tmall marketplaces. In addition, Alibaba’s foray into new geographies and businesses could also result in significant new revenue streams, bringing more upside for the stock. In the event, revenue grows more strongly at a CAGR of 28% during our forecast period, it would result in over 20% increase in our price estimate.

Our profitability outlook is also positive in the long-run. While investments in growth strategies fueled by the company’s grand ambitions will affect margins in the near-term — over the long-run, we expect sales to rise at a faster rate than expenses due to the company’s lean marketplace model, favorably impacting the margins. In addition, we think capital expenditure as a percent of revenue will trend downward over the coming years due to gain in operating leverage.

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See our complete analysis for Alibaba

Revenue Is Expected To Grow At A Stellar Pace

Metric

2013

2014F 2015F 2016F 2017F 2018F 2019F

2020F

Revenue (RMB Billion)

49 73 104 131 158 185 212

238

Annual Growth (%)

59%

48% 43% 26% 21% 17% 15%

12%

Alibaba’s top-line is expected to rise at a tremendous pace over the coming years, owing to huge growth in gross merchandise value (GMV) on its Chinese retail marketplaces. We expect GMV to increase at CAGR of 23% during 2013 to 2020, as the demand in the Chinese online retail market is forecast to grow rapidly in the coming years. Online retail sales in China, which have already surpassed sales in the U.S., are expected to grow from RMB 1.9 trillion in 2013 to RMB 5.6 trillion by 2017, according to iResearch. [1] [2] Alibaba accounts for around 80% share in this market, and in a previous article, we noted that it will continue to command a dominant share in the foreseeable future.

The proportion of online retail sales in the overall retail market of China was recorded at more than 10% in Q2 2014, and it is further forecast to cross 15% by 2017. [3] We estimate China’s Internet penetration rate to surge from around 50% currently to over 65% in the long-run. Additionally, we forecast the number of online shoppers in the country to expand from 302 million in 2013 to more than 700 million by the end of our forecast period. [1] This demand will be buoyed by ease of shopping online, heavy discounting, secure payment mechanisms, fast delivery methods, and an increase in disposable income in the country. We think Alibaba would also start flexing its growth muscles to expand in other Internet businesses within China. Its investments in Lyft (ride sharing mobile app) and Tango (messaging app) during 2014 gives the company access to new technology, which it could replicate in the Chinese market.

In addition to this, Alibaba is looking to aggressively invest in international expansion which could throw open additional revenue streams. There are indications that Alibaba will soon partner with one of the leading e-commerce players in India to enter the country’s rapidly growing e-commerce market. In addition, it is also eyeing growth in Europe, South America, North America and Middle East to gain a larger share in the global e-commerce space.

In the event, Alibaba’s revenue grows much faster at a CAGR of 28% over 2013-2020, as compared to our present estimate of 25% — due to faster than expected growth in China and successful investment in other expansion opportunities — then it would represent around 20% upside to our price estimate to $112.

Margins Should Expand In The Long-Run

Metric

2013

2014F 2015F 2016F 2017F 2018F 2019F

2020F

EBITDA Margin

59%

55% 54% 56% 58% 59% 60%

61%

We believe Alibaba’s EBITDA margins will see some decline in the near-term due to the acquisition of new businesses, investments in mobile, cloud computing and other growth initiatives, as well as rise in marketing expenses. The company’s grand ambitions means it will keep investing heavily in growth initiatives, and this will weigh on margins in the near-term.

However, over the long-run, we think that margins will stabilize as the company’s marketplace business model has low variable costs. Software platforms are scalable with low incremental costs of expansion, and Alibaba does not have to invest as heavily in warehousing and distribution centers unlike other pure-play online retailers which own inventory such as Amazon. Additionally, as online marketing is gaining traction with improved analytics and targeting capabilities, the company will continue to attract more advertising dollars. Thus, in all likelihood, profits will grow faster than revenue pushing up the margins.

In the event, margins rise much higher to 68% by the end of our forecast period, then it would represent around 10% upside to our price estimate. On the flipside, if EBITDA margin falls down to 56%, then it would lead to a downside of a similar order.

Capital Expenditure As A % Of Revenue Could See Leverage

Metric

2013 2014F 2015F 2016F 2017F 2018F 2019F

2020F

Capex as % of Net Revenues

9.9%

9.4%

8.4% 7.4% 6.9% 6.4% 5.9%

5.4%

We believe capital expenditure will grow in absolute terms over our forecast period, as Alibaba will invest in technology upgrades and growth strategies to expand its business throughout the globe. However, since the company’s business model is not capital intensive and does not require large investments in delivery centers and logistics, we expect gain in operating leverage will cause capital expenditure as a percentage of revenue to diminish during our forecast period.

We encourage our readers to tweak our estimates to see the impact on Alibaba’s valuation.

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Notes:
  1. China officially passes the U.S. in e-commerce, Internet Retailer, May 29, 2014 [] []
  2. China Online Shopping GMV Soars 47.1%, iResearch, August 11, 2014 []
  3. China Online Shopping GMV Soars 47.1%, iResearch, August 11, 2014 []