Alibaba Group’s (NYSE:BABA) recent strategic shift to a “1+6+N” governance structure marks a pivotal turning point in its 24-year journey. This groundbreaking move will evolve Alibaba from a monolithic entity into a holding company supervising six key business segments and a myriad of other enterprises. This innovative model is designed to foster enhanced autonomy, innovation, and agility, whilst mitigating regulatory pressures. This article delves into the intricate details of this transformation, its potential impact on stakeholders, and how it positions Alibaba in the rapidly evolving digital landscape.
Alibaba Reborn: A Move to Unlock Shareholder Value, Reduce Regulatory Pressures
Alibaba’s decision to switch to a new “1+6+N” governance structure is a critical milestone in the company’s 24-year trajectory. This transformation will morph Alibaba from a solitary unit into a holding company (“1”) supervising six primary business segments (“6”) and an assortment of other businesses (“N”).
These six principal segments encompass Cloud Intelligence, Taobao and Tmall, Local Services, Alibaba International Digital Commerce (AIDC), Cainiao Smart Logistics Network, and Digital Media and Entertainment. The “N” denotes various other businesses such as Alibaba Health, Sun Art Retail, and Freshippo.
Every entity within the “6+N” structure will form its own board of directors to provide guidance and support to the respective business CEOs. This decentralization is projected to spur increased autonomy, innovation, and nimbleness within each segment. Meanwhile, Alibaba Group, as the holding company, will concentrate on capital management, fostering the growth of these diverse entities, and promoting the inception of innovative new businesses.
These units are permitted to raise external capital with a possibility of future initial public offerings. Only the China e-commerce unit, Taobao Tmall Commerce Group, will stay entirely within Alibaba’s ownership.
We believe that Alibaba’s strategy to potentially fragment the company into several entities might alleviate government apprehensions about the consolidation of power and influence among China’s internet giants.
The market responded positively to the announcement, as Alibaba’s U.S.-listed shares saw a surge of over 14 percent post-announcement.
Business Strategy Analysis
From our perspective, Alibaba’s strategic roadmap highlights its progressive stance in leveraging the opportunities emerging from the rapidly growing digital transformation. The corporation is capitalizing on the fast-paced trend of online shopping, the integration of revolutionary technologies like generative AI, and a restructuring of its organizational and governance framework to stimulate ingenuity, adaptability, and amplify shareholder value.
The firm’s three strategic cornerstones – consumption, cloud, and globalization – outline a holistic strategy to capture market opportunities. Alibaba’s concentration on the growing consumption power, in China and across the globe, signifies its commitment to expanding its consumer base. In our opinion, for example, the improvements to its supply chain capabilities and the reshaping of the Taobao app from a transaction-focused platform to a center for shopping exploration are unmistakable signs of Alibaba’s quest to elevate customer experiences.
Furthermore, Alibaba’s focus on its Cloud Intelligence division, a substantial player in the worldwide cloud computing market, exhibits its determination to solidify its standing in this crucial sector and stimulate additional growth. The emphasis on global expansion, especially in the e-commerce sector, represents a strategic maneuver to exploit the vast potential of international markets.
Significantly, Alibaba’s investment in Cainiao to create a diversified delivery network is a key move towards bolstering its service capabilities. This focus on logistics and delivery highlights the company’s commitment to delivering a dependable and efficient shopping journey for its customers.
Risks: The “China Situation”
For anyone unfamiliar with the situation, a quick search for “Alibaba China troubles” on Google will provide a multitude of results detailing the company and its founder, Jack Ma’s, challenges in China. While we won’t delve into the specifics here, the crux of the matter appears to have originated from Jack Ma’s criticism of the Chinese government, leading to his declining favor. This, coupled with a less robust recovery of China’s economy from the COVID lockdowns than anticipated and the country’s rising geopolitical conflicts with the U.S., encapsulates the situation.
In our view, the company’s significantly discounted valuation can largely be attributed to the above-mentioned factors. However, we believe sentiment has swung so firmly into negative territory that the market has been slow to respond to favorable developments on all three fronts.
We believe the previously discussed company restructuring is a move that indicates the normalization of regulatory support for China’s tech industry and private businesses after an extended period of strict control. The restructuring news coincided with co-founder Jack Ma’s return to mainland China, a move that many interpret as a planned media event to lift market sentiment. Ma’s presence is often seen as a gauge of the Chinese government’s backing for private business.
The Chinese government is now keen to boost growth and restore confidence in the tech sector and the broader economy following three years of rigorous COVID-19 controls. Chinese leader Xi Jinping has urged the government to support private businesses and called on entrepreneurs to enhance growth and tech innovation. Premier Li Qiang, a close ally of Xi, has initiated a series of measures to mend relations between the government and the private sector.
We understand that despite evident indicators suggesting an improvement in the regulatory and macroeconomic landscape, this issue continues to be a primary concern for investors. However, we are cautiously optimistic that these headwinds will lift, resulting in multiple expansions for Alibaba.
Financial & Valuation
Note: All historical data in this section comes from the company’s filings, and all consensus numbers come from FactSet.
Our analysis of Alibaba’s latest earnings and financial trends reveals a company that has weathered a difficult period but is now showing signs of a potential turnaround. BABA posted a stellar Q1 earnings report, with a 6.8% y/y revenue growth to $32.5 billion, surpassing consensus estimates by 4.1%. The stock responded positively, climbing 4.6% the day after earnings were announced. Elevated gross and operating margins of 39.2% and 18.2%, respectively, coupled with a 39% y/y rise in EPS to $2.41, signals strong operational efficiency and profitability.
While it’s true that BABA’s revenue CAGR of 20.1% over the past three years outpaced its EPS growth CAGR of 1.5%, this is not necessarily a red flag. Rather, it could suggest the company is investing in future growth. Consensus forecasts are also favorable, predicting an upward trend with revenue growth of 6.9% and 9.7% for the next two fiscal years, reaching $132.1 billion and $144.9 billion, respectively.
Yes, the EBIT margin has seen a decrease from 18.0% to 11.6% over the past three years. However, it’s important to note that the street is forecasting a significant bounce back, with margin expansion to 14.1% and 14.5% for the next two fiscal years. This indicates the belief in BABA’s ability to improve profitability. With capex as a percentage of revenue averaging 7.3%, BABA is certainly investing in its infrastructure, which could underpin future growth.
Although the free cash flow margin has decreased from 29.6% four fiscal years ago to a forecasted 16.1% this current fiscal year, BABA still produced an average FCF margin of 21.5% over the past four fiscal years, showcasing its cash-generating capability. With a solid net cash position of $50,172 million, BABA’s balance sheet remains sturdy.
While BABA underperformed the S&P 500 by 16 percentage points over the past year, it’s noteworthy that the stock is trading 2.1% above its 200-day moving average and 62% above its 52-week low. This could indicate a turning point and the beginning of a positive trend.
In terms of valuation, BABA presents an attractive proposition. It trades at a significant discount to the S&P 500, with an EV/Sales discount of 47.8%, an EV/EBIT discount of 49.1%, a P/E discount of 44.5%, and an FCF discount of 53.7%. Additionally, BABA’s P/E multiple of 10.3 is historically low compared to its 5-year mean of 20.7. This offers a compelling entry point for investors.
When we consider its peers, BABA appears even more enticing. JD.com (JD) and Amazon (AMZN) are trading at forward 12-month P/E of 10.6 and 48.0, respectively, making BABA’s multiple seem particularly appealing.
Alibaba’s strategic transformation is a testament to its forward-thinking approach and responsiveness to changing market dynamics and regulatory landscapes. It highlights the company’s commitment to enhancing shareholder value while fostering innovation and business agility. Alibaba’s strategic roadmap is not just about restructuring its governance model; it is about reimagining its business to better leverage the opportunities of the digital age.
While regulatory concerns and geopolitical tensions remain a significant hurdle, the company’s restructuring efforts and the Chinese government’s renewed focus on supporting private businesses suggest a possible easing of these headwinds. This, coupled with the company’s robust financial performance and undervalued proposition, makes Alibaba a compelling investment proposition.