Here’s Why We Continue To Remain Bullish On Alibaba

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Alibaba Group

In a recent update, we had revised down our price estimate for Alibaba (NYSE:BABA) to $82, based on slowdown in the Chinese economy, coupled with downward revision of gross merchandise volume forecast for the third quarter of 2015. Our current price estimate, which has been modeled assuming a more base-case scenario for the Chinese economy, represents a bullish outlook of around 30% upside to the current market price. This is as we believe the market could be currently overplaying the risks related to Chinese economy and increased competition.

While a hard landing for the Chinese economy will indeed take our price estimate lower by around 30% — but under a more favorable scenario we think the company’s stock is considerably undervalued. The key factors underlying our valuation. For one, Alibaba’s top-line is pegged to increase at over-15% CAGR over our forecast period. In addition, while its EBITDA margin is forecast to decrease in the near-term, we think it could rise to over 60% by the end of our forecast horizon. Plus, we expect the company to lower its capital expenditure investments (as a % of revenue) in the long-term, due to increasing maturity in the business model. We encourage our readers to tweak our estimates, to see the impact on the company’s valuation.

See our complete analysis for Alibaba

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Here Are The Key Factors Underlying Our $82 Price Estimate

Top-Line Could Rise At Over-15% CAGR To More Than RMB 260 Billion By 2022

We forecast Alibaba’s top-line to increase from RMB 70.8 billion in 2014 to RMB 262.6 billion by 2022 (at a compound annual growth of 17.8%). We have arrived at these estimates, based on the following factors:

  • We expect Alibaba’s Chinese retail marketplaces (Taobao and Tmall) to continue to account for around 80% of the company’s overall revenues over our review period. However, we forecast the mix of retail commission revenue to increase over this period, due to faster growth in the Tmall platform.
  • The gross merchandise volume transacted on Alibaba’s Chinese retail marketplaces is forecast to grow at an almost 15% CAGR over our forecast period. This is as we expect both active buyers and average spending by active buyers to go up in the coming years, owing to increasing Internet penetration in China coupled with rising popularity of online shopping.
  • Though the market share of Alibaba in the Chinese e-commerce market is expected to come down in the coming years, we believe it will continue to remain the dominant player in the industry.
  • Further, we expect revenue from Alibaba’s international and cloud-services businesses to expand at a significant rate over the coming years. This is because the company is making heavy investments in these business areas, where the market potential also looks strong.
  • Additionally, investments in online-to-offline (O2O) markets and parallel Internet markets could further propel revenue growth over the next 5-10 years.

EBITDA Margin Could Reach Cross 60% By 2022

Though Alibaba’s EBITDA margin came in at 58.8% and 55.1% in 2013 and 2014 respectively, it is expected to deteriorate in the near-term, due to: 1) increased investments in the acquisition of new businesses; 2) the development of mobile and cloud computing businesses;  and,growth in marketing and other growth initiatives. However, we believe the EBITDA margin could recover to over-60% by the end of our forecast period. This is as we expect the company’s business model to become more mature and realize economies of scale over the next five years. Additionally, the returns from new businesses could accelerate over the coming years, which would further support growth in margins.

Capex (As A % of Net Revenue) Could Come Down Over The Long-Run

While Alibaba’s capital expenditure as a % of net revenue was seen at around 9.9% over the last two years, we believe this ratio could drop to 6-7% by the end of our forecast horizon, as the company’s marketplaces business model is not capital intensive. Though Alibaba will continue to improve its logistics infrastructure over our forecast period, we believe such investments could come from either joint ventures or technological support. Hence, maturity in the business will result in less capex requirement (as a % of top-line) over the long-run, in our view.

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