Alibaba Update: Lowering Our Fair Value Estimate Due to Cloud Unit Disclosures and Increased Uncertainty
Operating Results Overshadowed by Canceled Spin-Off Plans
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September Quarter 2023 Financial Highlights (Figures converted from $RMB to $USD)
Revenue: $30.8B (+9% y/y)
EBITDA: $5.9B (+18% y/y)
EBITDA Margin: 19%
Free Cash Flow: $6.2B (+27%)
FCF Margin: 20%
Earnings Review
Alibaba’s shares fell roughly 10% after the company released its September quarterly results last week. The operating results came in solid, with the company growing both revenue and profits above analysts estimates. One major highlight was the strong growth in their international commerce segment, which grew revenues 53% YoY. Free cash flow grew 27% to approximately $6.2B USD for the quarter and $11.6B over the last 6 months. The solid operating results ultimately were overshadowed by management canceling plans to spin-off its Cloud business unit, a move that was intended to unlock significant shareholder value. This decision comes after the company previously halted its Freshippo IPO, due to low valuations in the market.
“The recent expansion of U.S. restrictions on export of advanced computing chips has created uncertainties for the prospects of Cloud Intelligence Group. We believe that a full spin-off of Cloud Intelligence Group may not achieve the intended effect of shareholder value enhancement. Accordingly, we have decided to not proceed with a full spin-off, and instead we will focus on developing a sustainable growth model for Cloud Intelligence Group under the fluid circumstances.”
We believe that the decision for management to cancel its previous spin-off plans indicate a few things about the current state of the company and the greater market; Firstly, the company will not be able to enhance shareholder value through financial engineering in the near term due to poor market conditions in China. This may change in the future but is dependent on market conditions improving significantly. Secondly, management strategy has become inconsistent over the past year as it relates to restructuring plans and returning capital to shareholders. The market does not like change and uncertainty, evidenced by the continued weakness in Alibaba’s shares. Finally, management has not laid out a convincing plan to unlock shareholder value in the near future.
The company’s capital allocation strategy appears to involve using a portion of their excessive cash to compete in a long term price-war with the likes of JD.com, PDD, and Bytedance, a move that ultimately lowers returns for all players in the space. Price-wars become apparent when either the market has become saturated or there is a significant economic downturn, causing consumers to cut back on discretionary spending. Until the Chinese economy improves materially, we see this cash drain as a negative for Alibaba. This problem has become magnified with managements latest disclosure related to their Cloud Intelligence Group, as this unit was to become the core profit driver for the decades ahead:
“We believe that these new restrictions may materially and adversely affect Cloud Intelligence Group’s ability to offer products and services and to perform under existing contracts, thereby negatively affecting our results of operations and financial condition. These new restrictions may also affect our businesses more generally by limiting our ability to upgrade our technological capabilities.”
Upon review, we have decided to lower our fair value estimate of Alibaba from $177 to $130.84 per share.
Valuation Update:
Alibaba’s Net Asset Valuation = $135B or $53.05 per share. This would indicate that 67% of the company’s current market cap is protected by net assets alone. We use this net asset value as a floor liquidation value for the business, and to analyze the strength of the company’s balance sheet. As some accounting values are more reliable than others, we accept or adjust the stated numbers on the financial statements. This process leads to an ultra-conservative estimate of Alibaba’s stated net-asset value.
Alibaba’s EPV Valuation= $268B or $105.52 per share. Earnings Power Value is a technique for valuing businesses by assuming the sustainability of current earnings and cost of capital, but assuming no future growth. At the time of writing Alibaba is trading under our EPV Valuation.
Alibaba’s DCF Valuation= $332B or $130.84 per share. This valuation assumes a 10-year CAGR of 5.27% over the next 10 years and an average EBIT margin of 16.64% over the same time period. At the time of writing, Alibaba is currently valued at $79.10 per share. This would indicate that the company is still significantly undervalued.
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Sincerely,
Jack Beiro, MBA
JB Global Capital
BABA 0.00%↑ PDD 0.00%↑ JD 0.00%↑
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