fe5dd2d0-c208-4bd7-8d85-d9b1caa0d308_Alibaba-Premium-Analysis_2019.pdf
Alibaba Premium Analysis 2019
Introduction:
Alibaba is situated between two of the major growth drivers in tech: cloud infrastructure and B2B eCommerce. China is the world’s leader in manufacturing, and this country has the widest gap between the current cloud IaaS and future cloud IaaS market.
Alibaba would be a breakaway stock if not for the trade war and China’s slowing economy. The second-largest economy in the world grew 6.2% in the second quarter of 2019, a drop from 6.4% in the first quarter. This is the slowest growth since 1992. Industrial output growth slowed to 4.8% in July, which is the weakest pace since February 2002.
This analysis will outline the major industry verticals that Alibaba is uniquely positioned to benefit from along with technical analysis to help guide entry in a choppy geo-political environment.
SECTION 1: Fundamentals
Alibaba trades at 25x forward earnings and 21x cash flow, while growing revenue at 40% with long-term earnings growth projected at 26% and a PEG of 1.1. Amazon trades at a forward PE of 45 and MercadoLibre at 111.
Alibaba’s projected earnings growth is higher than its mega-cap peers at 26%, including Facebook at 21.6%, Apple at 4.53%, Amazon at 18.9%, Microsoft at 11.1%, or Alphabet at 17.6%, placing its implied share price at a minimum of $231 when comparing P/S ratios to forward growth. Based on P/E ratios to forward growth, Alibaba is also undervalued relative to its peers.
According to MarketBeat, analysts have a consensus price target of $221.64, representing 33% price target upside. Analysts have had a BABA price target above $200 since early 2018. Since the last earnings report, HSBC, Morgan Stanley, Raymond James, Goldman Sachs, Bank of America and a few others have either set price targets above $200 or boosted their price target.
• Revenue last quarter rose 42% year-over-year to $16.8 billion compared to 51% growth YoY in the last quarter
• Operating income grew 27% year-over-year excluding stock-based compensation from Ant Financial. Adjusted EBITDA increased 35% year-over-year to $5.7 billion
• Net income was $2.79 billion with non-GAAP net income of $4.05 billion, with an increase of 54% yearover-year
• Diluted earnings were $1.17 and non-GAAP of $1.83, or an increase of 56% YoY.
Core commerce revenue was up 44% and “other revenue” was up 134%, consisting of new retail and direct sales businesses. The company reported strong growth in Southeast Asia, with orders growing over 100% for the third consecutive quarter. Cloud computing was up 66%.
The most recent earnings report called attention to the fast-growing Taobao, the world’s biggest eCommerce site, and Tmall, a spinoff of Taobao. These platforms grew 44% and 34%, respectively. Taobao has 730 million active buyers across its marketplaces, representing about 50% of the Chinese population.
The last earnings report also highlighted additional revenue drivers such as the grocery retail chain Freshippo, and the Cainiao Network, which offers cross-border fulfillment and last-mile solutions. As of June 30th, 2019, there were over 150 self-operated Freshippo stores.
Alibaba may hold a separate listing in Hong Kong for as much as $20 billion this year.
SECTION 2: B2B eCommerce
The B2B eCommerce opportunity is tremendous with estimates the market will reach $12.2 trillion in 2019 compared to $2 trillion for the B2C market. Of this, Asia Pacific contributes 80% to the market with North America and Europe’s share being 12% and 3%, respectively. The four largest markets are China, Japan, South Korea and the United States.
According to Gartner, spending on B2B eCommerce platforms is expected to grow at a CAGR of over 15% during 2015-2020. The Asia Pacific B2B eCommerce market will be worth an estimated $9.8 trillion in 2019, up from $4.7 trillion in 2013. Compare this to the North American market, valued at $1.4 trillion in 2019.
According to Accenture, 50% of B2B companies around the world began to implement a digital strategy in the last three years, rather than rely on a salesperson’s personal relationship with the client. B2B eCommerce follows either a direct model that allows companies to sell directly to buyers, or a marketplace model where products are sold alongside competitors. The marketplace model has gained the most traction due to the ability for wholesalers, distributors, and manufacturers to test new geographic markets.
Alibaba claims 30% of the Chinese B2B market and is expanding its operational base into India, Europe and the United States. Due to a vast network of low-cost suppliers, Alibaba is able to dominate the market. Alibaba’s main strategies include adopting an online to offline (O2O) approach and collaborating with local finance and logistics companies in international markets.
China is the largest B2B eCommerce market in the world and is expected to grow from $1.3 trillion in 2013 to an estimated $3.5 trillion in 2019, at a CAGR of 17%. China’s market is bigger than both North America and Europe combined.
In 2018, the top three B2B platforms in terms of revenue were: Alibaba, HC350 and Cogobuy. Together, these three companies make up 57% of the Chinese market. Alibaba is now focused on the Indian market, where the company competes with Amazon.
SECTION 3: Ant Financial
Ant Financial is the Alibaba affiliate that operates the Alipay payment service. Operating income tripled in the most recent earnings report. Alibaba’s share was $237 million, representing 7% of operating income, which was the highest in two years. In the past, Ant Financial has run at a loss or provided zero earnings.
Ant Financial is worth about $150 billion and serves about 1.2 billion users with 300 million users outside of China. The company is considered one of the most valuable private sector FinTech companies in the world. Due to a recent restructuring deal, Ant Financial is eligible for an IPO in the coming years.
SECTION 4: China’s Cloud IaaS Market
China has been more than fashionably late to cloud infrastructure with a total market size of $1.2 billion in 2018 compared to the United States’ $40 billion in 2018, which affords a window of opportunity. The majority of the 20x growth of this segment in China will funnel into Alibaba with the company already owning 90% of the market.
China’s enterprise IT market is five to seven years behind the United States and Western European markets. Once fully mature, China’s need for cloud infrastructure will rival the United States with 3x the population and a bottomless appetite for smart cities, artificial intelligence and machine learning plus manufacturing IoT automation.
The reversal of where China is today with cloud IaaS, and where China will be in five years, could be a bigger story than the B2B marketplace as the growth is closely tied to China’s position as a global leader.
In 2017, China published a roadmap on how it seeks to become a global powerhouse in AI. According to the report entitled “Next Generation Artificial Intelligence Development Plan,” the domestic AI market will be worth a total of $150 billion. Today, China’s AI market is worth $6.2 billion.
Artificial intelligence and machine learning require private cloud and public cloud infrastructure-as-a-service (or a hybrid mix with on-premise servers) as storing data in separate silos weakens AI and ML capabilities, reduces training performance and lowers accuracy. Artificial intelligence and machine learning require speed with most AI solutions split between 40/60 with private/public cloud or 60/40 if you’re a regulated industry. The United States CIA describes moving to the cloud in 2013 the “best decision we’ve ever made” as what used to take 180 days to provision a server improved to 60 days, and now takes minutes.
At roughly fifty percent year-over-year growth, China’s AI market will reach approximately $60 billion by 20232024, which is in line with China’s Development Plan. This is also in line with the global market forecast which puts the AI market at $190 billion by 2025. The overall Chinese AI industry is growing at a rate of 67 percent and the country is now producing more AI patents than the United States. On that note, Alibaba’s cloud growth is currently at 66% year-over-year with $1.13 billion in quarterly revenue.
4B. Alibaba Cloud
Amazon is the perfect example of how profits from a cloud economy can outpace eCommerce income. The parallels between Alibaba and Amazon are easy to see. Both are e-commerce companies that are pioneers in cloud infrastructure as a vast number of servers had to be built to handle traffic spikes and large work-loads on peak days, such as Black Friday and Singles Day.
In the most recent quarter, AWS accounted for 13% of Amazon’s overall revenue and 52% of Amazon’s $3.1 billion operating income and is growing at 37% year-over-year. Microsoft’s cloud IaaS is growing at 64% YoY.
As stated previously, China has been late to adopt IaaS cloud, and this likely contributed to Alibaba’s delay as the first serious investment by the company was made in 2015, six years after the launch in 2009. Since 2015, it has taken Alibaba only three years to reach a $1 billion run rate compared to Amazon’s six years (2006-2012).
In addition, tech developers are responding to Alibaba with over 120,000 people attending its cloud conference compared to the AWS conference, which attracts 50,000 attendees. This is important intel that financial statements don’t reveal.
Alibaba Cloud reported 66% year-over-year growth in Q2 2019, primarily driven by enterprise customers. During the June 2019 quarter, Alibaba Cloud announced the SaaS accelerator plus over 300 new products and features. This is what the current YoY cloud growth trajectory looks like when modeled.
The law of large numbers could slow the trajectory depicted on the chart, although China’s late entry to the cloud IaaS market is likely to do the opposite and accelerate (or at least sustain) the YoY growth in the nearterm.
Today, AWS reports about 40% growth YoY more than a decade after it launched. Microsoft’s Azure reported 300% growth between 2015-2016 and 90-100% growth for the following years.
Globally, Alibaba has quietly become the number four cloud services provider worldwide, behind Amazon, Microsoft and Google when Synergy Research Group placed Alibaba ahead of IBM. Note, Gartner places Alibaba as the number public cloud provider. Across Asia-Pacific, Alibaba is the number two cloud services provider.
Alibaba Cloud was launched in 2009, however, the company did not take the IaaS revenue segment seriously until 2015, when Alibaba made its first investment of $1 billion. As stated in previous analysis, China has been late to adopt IaaS cloud, and this likely contributed to Alibaba’s delay. When adjusting Alibaba Cloud to 2015, we see it took 3 years to reach $1 billion run-rate (2015-2018) while it took Amazon 6 years to reach a $1 billion run-rate on AWS (2006-2012).
4C. Capex for Cloud IaaS
For the most recent quarter, adjusted EBITDA margin for Alibaba Cloud was -5% compared to -10% and -4% in previous quarters. According to the company, infrastructure and capacity investments triggered the quarterly loss.
Alibaba’s quarterly free cash flow in Q2 2019 was $3.8 billion with net cash of $5 billion. Therefore, like Amazon, the e-commerce business is able to carry the capex requirements for the cloud business. With that said, investors should be aware that building modern cloud computing services requires billions every quarter. For historical. comparison, Google spent $5.6 billion in accrued capex in Q3 of 2018 and Microsoft spent $4.3 billion on capex during the same period for “ongoing investment to meet demand for our cloud services,” as pointed out by Amy Hood, Microsoft’s CFO.
Please keep in mind, there will be opportunities for an attractive entry as Alibaba Cloud will not command AWSlevel and Azure-level percentages of revenue until H1 2020/H2 2020 and onward.
However, once AWS and Azure reached $5 billion in revenue, stock prices were around $300 and $70, respectively so entering Alibaba before the Cloud revenue reaches $2-$4 billion in quarterly revenue is important. While IaaS did not account for all of the increase in revenue (obviously) from the $300 and $70 stock price mark for AMZN and MSFT, I want to emphasize that cloud IaaS is Amazon’s top growth driver still today and Microsoft’s fastest growth driver for many years is Cloud IaaS.
The capex costs will affect free cash flow at times, however, this is not a concern long-term as typical cloud profit margins are around 58 percent and typical operating margins are at 22 to 32 percent.
Time Machine: Time Machine:
I wanted to leave you with a fun, little blurb from Amazon’s earnings in 2011 on AWS when it was at $1 billion in revenue (it’s now at $25 billion in annual revenue in 2018). Alibaba Cloud is at the $1 billion barrier right now.
“The speculation that Amazon's cloud is breaking the $1 billion barrier in the very near future comes as the cloud giant prepares to announce its 2011 second quarter earnings Tuesday.
"While still very small for Amazon (likely about $750 million revenue run rate), given the size of the market opportunity and Amazon's strong competitive positioning, we believe that this could soon be a $1 billion revenue segment," Citigroup Internet analyst Mark Mahaney said in a note to investors last week.
And Mahaney isn't alone in his lofty Amazon cloud expectations. In fact, his estimate could be seen as conservative. JPMorgan Chase's Dough Anmuth told Reuters that he expects Amazon's AWS to generate a whopping $2.6 in revenue come 2015.”
SECTION 5: TECHNICAL ANALYSIS
By Knox Ridley
5A. Overview – Weekly Chart
Looking at the weekly price action, along with the weekly Relative Strength Index (RSI), provides us a with a view of the overall health of a trend. Providing this history helps to also filter out any short term moves that are based on emotions. The above chart is Alibaba’s (BABA) weekly chart going back to 2016.
Long-Term Trend Lines
The dark blue trend lines highlight the long-term trends in play. The uptrend line started with the 2016 bull market. The price has tested this trendline 4 times on the weekly chart, going back approximately three years. It’s worth noting, the more a stock tests a support/resistance region, the weaker it becomes.
There is also a downtrend line, highlighted in blue that has been pushing the price of BABA down since the June high in 2018. These 2 trend lines are converging into a triangle pattern. The price of BABA is being forced to a decision soon, and we will know rather soon if the bottom is in for BABA, and the uptrend will continue, or if we could get a retest of the December lows.
5B. Moving Averages
The 50-Day Moving Average is in orange. The price of BABA is trading just below the 50-day. This average is acting as resistance, and is sandwiched between the 50-day, above, and the blue long-term trend line below. The pressure is currently down, but what BABA does in the next few days will determine the next move in the trend.
The 200-Day Moving Average is in green. The 200-day is commonly looked at as the final stand for a bull pattern. It’s worth noting that the 200-day is currently just below the $130 region, which coincides with the December 2018 bottom and 39.2% retrace level. Any pull back from here, and the 200-day will be major support to follow.
5C. Intermediate Trend Lines and RSI Warnings
The two dotted lines are lower time frame trendlines. Note how the price trends coincide with the RSI trendlines below. This is always a sign of a healthy trend. When I see a trend like this – both down and up – I follow the RSI to get a clue as to when the trend may be over.
The red X indicates the point where the price and RSI both broke their trends. As usual, this happens in unison, and is a major warning for anyone long the position. Leading up to this trend break, the RSI started making lower highs, warning of a momentum slow down. These valuable tools that Technical Analysis can offer help to manage risk.
Conversely, we have the opposite scenario on the downside. The price and RSI followed a downtrend into the December low 2018, which is shown by the second dotted line. Just after this moment, both the RSI and the price broke their downtrends. The RSI made higher highs as the price made its final low. All of these signs indicate a reverse of trend to the upside.
I’m pointing this out because we have a similar pattern unfolding today. The RSI and the price are hovering just above their respective trendlines. If they both break, I would take that as a warning of further down side to prepare for.
In conclusion, because we are trading at the end of a triangle pattern, BABA is about to give us an indication as to the direction of the next move. Below, I outlined the bear and the bull cases.
5D. Elliot Wave – Bear Count
The bear count has us currently in a larger degree Wave 4, which are the numbers #1-#3 highlighted with the blue count. The extensions of this count are in blue on the far right. These extensions act as guides for moves higher and lower and they are important for determining the likely target of any additional pullback.
If we look one degree lower, you’ll see the red 5 count, which is the internal waves of the blue count.
Remember, the pattern of 5 waves in the primary direction and 3 waves in a corrective direction is occurring on
All levels – larger degree and smaller degree. So, the larger degree Blue count, has its own internal count, which can give us clues as to where the market may be leaning.
So, we have a clear 5 waves up in red, which completes wave 3 in the blue count. The retrace levels of this count, are shown in red on the right. We touched the 38.2% retrace level, which acted as final support for the previous pullback.
I put the 50% retrace level on the chart as well, which is the bottom of the bearish target box in green. I don’t see BABA going lower than this level, even in a worst-case scenario. Furthermore, I believe you have to have a “good enough” price tag for a solid long-term investment in a downtrend. Baba at or below $130 is a steal, even if it goes lower.
A pattern that keeps showing up within this pullback is a classic A,B,C correction, where the C wave extends with 5 waves to at least the 138.2% extension. This can be seen with the first drawdown move with the orange A,B,C count, and with the 5 wave count of the final C wave revealed in teal roman numerals. This pattern is a clue to
the likely path of the larger degree pattern, and I am expecting this pattern to unfold to the downside in my primary count. The extension to this final C wave down is shown in pink.
If we break the $146 support region, I will consider this count in play, and suggest preparing accordingly. I will consider this count to be invalidated if we break the triangle pattern to the upside and close above $185. At this point, we will likely be in the bull count, which is listed in the next section.
5E. Elliot Wave – Bull Count
The Bull Count has the larger degree wave 4 ending at the December low. We have all the waves and the proper structure in place to justify this; also, the time frame works to justify this count as well. If this count is where we are, then we are in the final 5th Wave push, and just about to begin the heart of this move, which I calculate will take us well beyond the all-time highs. This count will be invalidated if we move beyond the $146 support region. If this happens, we will likely revisit the $130 support region and possibly beyond.
Because of the fundamental story in BABA, we have a high conviction on the company, yet naturally, are unsure of the geo-political environment. For now, we favor the bull case absent any news around the trade war, the delisting of Chinese companies, etcetera. At minimum, I’d place a stop just below $146. If you want further confirmation, wait for $185.