Alibaba Earnings Preview: Acquisitions To Help Drive Revenue Growth, Compress Margins In The Near Term

Alibaba (NYSE:BABA) is scheduled to announce its fiscal Q3 2017 earnings on January 24. ^[1] The company reported 40-50% growth in revenues in each of the first three quarters of 2016, with significant growth coming from its cloud computing and Digital Media businesses. In the most recent quarter, Digital Media and entertainment, which includes revenues from online video streaming Youku Tudou and mobile Internet services revenue from UCWeb, were up by over 300% to RMB 3.6 billion. This was primarily attributable to the Youku Tudou acquisition, which was completed in the first half of the year. Additionally, cloud computing and other ventures revenues were up by a massive 110% to RMB 2.2 billion.

On the other hand, Alibaba’s core commerce businesses has continued to post strong revenue growth over the last few years. This trend continued through 2016 with over 40% revenue growth in combined core commerce revenue streams. Growth in Alibaba’s international e-commerce business was further boosted by the $1 billion acquisition of the Singaporean e-commerce giant Lazada in April last year. ^[2]

Alibaba’s largest division is the online retail business in China, which includes websites Taobao, Tmall and Juhuasuan. This segment has provided consistent growth for the company over the last few years, with revenues growing from RMB 24 billion in 2012 to RMB 75 billion in 2015. The growth spree has continued in 2016, with revenues growing by 35-40% through the March, June and September quarters.

For the full year we forecast Alibaba’s China retail revenues to grow by 32% to just under RMB 100 billion, driven by a corresponding increase in the total gross merchandise volume (GMV) handled by Alibaba. Alibaba’s China domestic GMV could increase by over 25% to RMB 3.7 trillion for the full year. GMV for Alibaba is calculated as the multiplier of total number of buyers (or monthly active users) and the average spend per buyer. Alibaba has witnessed strong growth in monthly active users, especially in lower-tier cities across China due to the growing smartphone and internet penetration in these regions. ^[3] As a result, the number of buyers is expected to continue to increase over the next few years.

Comparatively, we forecast Alibaba’s cloud computing and other revenues combined to grow at almost 100% year-over-year to RMB 16.1 billion. As mentioned earlier, much of the growth in Digital Media is attributable to the acquisition of Youku Tudou. Additionally, cloud computing revenues have grown as a result of an increase in the number of paying customers. The total number of paying customers in the June quarter more than doubled over the previous year quarter to 651,000. ^[4]

We forecast the company’s adjusted EBITDA to grow at 27% through 2016, which is actually a slightly slower rate than its forecast revenue growth. The resulting EBITDA margin could compress by almost 4 percentage points to around 48%. This is mainly due to the fact that Alibaba is currently operating at a loss on all its non-commerce divisions. Alibaba is investing heavily on developing platforms for cloud computing, acquiring traffic for the online video and music segments, and investing in content and production with a longer term view. As a result, Alibaba’s operating profit margin has declined on a year-over-year basis in each of the previous two years as the company has acquired new businesses and invested in developing newer platforms. This trend could continue over the next couple of years since the near-term pressure on EBITDA margins is expected to sustain due to increased investments. However, the company has a marketplaces model and has a huge potential to scale up its cloud offerings. This could help the company maintain relatively low variable costs in the long run, which would imply that its operating leverage will remain high in the long run.

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1. Alibaba Group Will Announce December Quarter 2016 Results on January 24, 2017, Alibaba Press Release, January 2017 [↩]
2. Alibaba Expands in Southeast Asia With $1 Billion Lazada Deal, Bloomberg, April 2016 [↩]
3. Alibaba Q4’16 6-K Filings, SEC, May 2016 [↩]
4. Alibaba Q2 FY 2017 Earnings Call Transcript, Seeking Alpha, November 2016 [↩]