Alibaba Earnings Review
Inflection Point for BABA and Broader Chinese Tech
December Quarter 2024 Financial Highlights (Figures converted from RMB to USD)
Revenue: $38.38B (+8% YoY)
Operating Income: $5.65 (+83% YoY)
OI Margin: 15%
Free Cash Flow: $5.35B
FCF Margin: 14%
Impressive Results from Top to Bottom
Alibaba’s most recent earnings surpassed analysts expectations for both top and bottom line, sending shares higher by 16% since the announcement. The company has returned to a more normalized growth rate in their core business (TTG) while re-accelerating growth in their international retail and cloud computing business units. Management attributed this growth to investments in user experience and higher monetization methods through software service and payment processing fees. Growth at Alibaba Cloud has been backed by triple-digit growth of A.I. related product revenue for the sixth consecutive quarter. We find that this is indicative of the growing adoption of A.I. in China and the leadership of Alibaba’s cloud business. (36% Market Share as of Q3 2024)
Operating margins improved significantly, with scaling effects improving retail and cloud margins while losses continued to narrow in their smaller business segments. (Cainiao, Local Services, Digital Media). In our original Investment Case for Alibaba, we highlighted the potential of loss making units to scale toward profitability, leading to a market re-assessment of the company’s total earnings power:
“We see [Alibaba’s cash flow] growing significantly as economic conditions normalize in China, cloud adoption accelerates in Asia, and their loss-making divisions continue to scale and trend toward break even margins. - Investment Case
The company has committed to spend aggressively over the next 3 years in capital expenditures to build out capacity for their cloud computing network. While this will put temporary pressure of FCF generation moving forward, we agree that the demand opportunity and Alibaba’s current edge in integrating cloud and A.I. is worth the heavy capex spend. Alibaba is one of the few companies globally with capabilities in both cloud and A.I, and with the financial resources required to build a long-term competitive advantage. For instance, as of the latest quarterly filing, the company has $83.6B in cash equivalents and structural free cash flow generation. This combination makes Alibaba a top pick for the leader in Cloud and A.I. in China and potentially throughout Asia.
Ant Group, of which Alibaba owns one-third, saw its quarterly profit surge more than 50-fold after it benefited from an investment gain. As Alibaba and Ant Group have significant investment exposure to the Chinese market, both companies would reap the benefits of a broader market rally. Marketable securities held by Alibaba grew from $4,659B in 2020 to $48,090B in 2023, increasing ~10-fold during a time when the Hang Sang Index (HSI) fell roughly 40%. Furthermore, a market rally would benefit Ant Group, which saw its valuation plummet from $280B in 2020 to $80B in 2023— We expect Alibaba to revive it’s IPO of Ant when market sentiment improves.
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A.I., Chips, and Capital Returns to Shareholders
Much of the earnings call was dedicated (not surprisingly) to A.I. To summarize the overall discussion, here are some of our key takeaways:
Artificial general intelligence, a theoretical type of AI that could match or exceed human intelligence, is predicted to achieve 80% of human capabilities. As 50% of Global GDP is represented by mental and physical labor that can be optimized or replaced by AGI, the value creation opportunity is comparable to the invention of the internet.
High-quality A.I. models are becoming more ubiquitous at lower costs, leading to faster and wider adoption by businesses and consumers. Cloud network providers like Alibaba are the current beneficiaries of this increasing demand, as models need to be hosted on a cloud computing network. As an analogy, management explained how A.I. is like electricity and the cloud computing network is like the power grid.
A.I. is currently being implemented throughout the business to increase efficiency and user experience. Even at this early stage, the results are promising.
The company has optimized its chip procurement in response to export controls from the United States, claiming that they have designed their cloud network deliberately to be compatible with a range of chips— domestic and international.
The company will continue to return capital to shareholders through a combination of buybacks and dividends. As of the latest quarter, Alibaba has $20.7 billion dollars (7% yield) remaining in their share buyback program which runs through March 2027. Management stated that they would be opportunistic in their use of buybacks, considering market prices.
A Reflexive Shift in Narrative - From Retail to Technology
Alibaba’s shares have risen ~71% year to date. This surge has been underpinned by a reflexive shift in narrative that we first discussed in our Q3 Investor Letter,
“We believe that we are at the beginning of a reflexive shift in narrative for Chinese equities. The shift in narrative that we are witnessing has the potential to start the next bull market, provided that monetary and fiscal policies take effect and kickstart economic activity.” -
Reflexivity is a concept developed by George Soros to explain the phenomenon of psychology that leads to boom/bust cycles in markets. Essentially, the concept boils down to diminishing the distinction between subject (thinking participant/investor) and object (market prices/company fundamentals). The object is affected by the subject’s thinking/behavior which then reinforces the subject’s thinking/behavior, (i.e. a feedback loop). A reflexive change in narrative ultimately leads to bull markets as investor sentiment improves, leading to higher capital flows, which businesses can then exploit through equity and debt markets to generate higher returns. Pretty cool huh!
The shift in narrative that we have witnessed over the past few years relates to Alibaba being discounted as a retail business losing share to competitors such as Pinduoduo (Temu) and Bytedance (Tik-Tok). The discount in value was further exacerbated by geopolitical factors and an economic crises in China, leading to institutional banks such as J.P. Morgan calling China “uninvestable”. What appears to have been overlooked was the technological capability of Alibaba in particular relative to ecommerce competitors. Furthermore, U.S exceptionalism in A.I. was undercut by the release of open-source Deepseek, which matched top A.I. models in performance at a fraction of the cost.
*We plan to discuss this more in depth in our upcoming letter, expected in early April. Stay tuned!
Valuation
Upon review, we have increased our base case fair value estimate for Alibaba Group from $120.00 per share to ~$210 per share which would equate to a ~45% increase from today’s prices. This increase in fair value is based on faster breakeven for most segments and increased cloud growth related to A.I adoption. The valuation also assumes a recovery in China over the next 5 years, leading to higher revenue growth in TTG than previously anticipated. Our updated DCF model makes the following assumptions:
10-YR Revenue CAGR: 8.10%
Average Operating Margin: 15.08%
Average FCF Margin: 10.92%
WACC: 7.30%
TGR: 3.00%
BABA 0.00%↑ PDD 0.00%↑ JD 0.00%↑ BIDU 0.00%↑
Thank you all for reading! Please feel free to share our work with friends and colleagues interested in all things investing and finance. Until next time.
Sincerely,
Jack Beiro, MBA
JB Global Capital
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