Summary
The new plan of Alibaba will benefit long-term investors.
There could also be interesting opportunities for investors who do not hold Alibaba stock, acquiring the shares of its different business units separately.
Some institutional investors might divest the shares of some of the business units creating pressure in their prices and opening new opportunities for retail investors.
We calculate Alibaba's intrinsic value using the SOTP method with projections for 2026.
We discuss briefly the business units that might experience a hypothetical sell off after their IPOs.
China International Import Expo (CIIE) - Day One
We rate Alibaba (NYSE:BABA $Alibaba(BABA)$ ) as a "buy" as the new plan of the company, which is being split into six units, will enable the market to unlock value of the different business units that might be launched through an IPO. However, there would be shares of some of the Alibaba's units that might be sold by institutional investors generating pressure on their stock prices creating opportunities for "outsiders" or, in other words, those investors who are not holding Alibaba stock. Therefore, after each IPO, we should expect an increase in the valuation of some of the units and a decrease in others as there would be more interest in those units with the best growth prospects. We will discuss the different incentives triggered by this new reorganizational plan in our own particular view. Also, we calculate our intrinsic value using the sum of the parts (SOTP) method making projections toward 2026 in which we find that Alibaba stock could reach $176 per share assuming very conservative assumptions.
Context
The Chinese economy is prepared to recover as it was struggling in the last two years due to the Covid's effects while the crackdown against the tech sector seems to have smoothed out despite recent news about its AI generative bot. Alibaba's management wants to be prepared to reduce the possibility of future punishments by the regulator while recovering its pre-pandemic performance.
Under this scenario, Daniel Zhang, CEO of Alibaba, has stated that the company will split into six different business units, each with the ability to raise capital through an IPO. This huge reorganization might bring two benefits: i) it could ease scrutiny by regulators as smaller companies would target acquisitions independently, and ii) better focus of each business unit. The six business units are the following: Cloud Intelligence Group, Taobao Tmall Commerce Group, Local Services Group, Cainiao Smart Logistics Group, Global Digital Commerce Group and Digital Media and Entertainment Group.
Taobao Tmall Commerce is the only business unit that will be wholly own by Alibaba while the rest will be launched as spin-offs; Alibaba will retain the majority of shares in each of them.
The real benefits of a Spinoff for Alibaba
Alibaba not only wants its six business units to work independently and make their own decisions, which has been discussed deeply in other articles, but also the company is planning to launch most of these units into the stock markets triggering incentives that will reinforce the initial plan of the company of unlocking shareholder value and fostering market competitiveness.
The first benefit of these spinoffs is to have the possibility of separating unrelated businesses so each of them will be better appreciated by the market. Indeed, the new shares of these business units will be launched with information about the business that right now is unknown such as their own financial statements and growth opportunities which might help us to get a way better picture about each business unit's worth.
A second benefit is that Alibaba's CEO will be more focused on the Alibaba's core businesses or those that have the most promising future. For example, according to the new reorganization, Daniel Zhang will lead the Taboao Tmall Commerce group and the Cloud Intelligent group being both the most profitable business units with the best growth prospects. This new scenario will enable Mr. Zhang to focus on developing and expanding both businesses rather than using his time to develop six different businesses as before the plan.
Third, spinoffs open the possibility to Alibaba of selling any of its underperforming or unprofitable subsidiaries in the future in a more liquid market like the stock markets. In addition, spinoffs might help Alibaba to make future acquisitions without calling the attention of regulators as much as these business units would be seen as more independent.
Last but not least, the split into six business units would enable managers to be more focused on their respective businesses not only because they will take their own decisions and would be supervised by their own respective board, but also because Alibaba would have the chance to establish a strong "skin in the game" program, taking advantage of each spinoff. In this sense, if Alibaba sets out an adequate stock based compensation to each CEO, enabling them to have a vested interest in each company, those managers would have stronger incentives to perform better than before the reorganization.
Pay attention to the incentives triggered by the IPOs
There are several institutional investors who are holding the Alibaba shares as part of their portfolios. Most of them would not be interested in the shares traded in other stock markets than NYSE. The problem is that some or all the business units that would be launched through IPOs might make it through stock markets outside the US like the case of Cainiao Network Technology that is looking at the Hong Kong stock exchange for its IPO.
Also, I believe most of these institutional investors would not be interested in some of the business units like the Digital Media or Local Consumer Services because they'd want to focus only on, for example, more profitable business units with better growth prospects. This is important to understand since these institutional investors would have all the incentives to provoke a sell off of all those undesirable shares that they would receive from the IPOs.
We are not even mentioning that institutional investors use to consider the company's size in an IPO as other important factors to decide if that new stock could be held or not in their portfolios. Therefore, we should not be surprised of the high volatility that would come after each IPO creating so much opportunities for new investors who do not hold Alibaba but who want to buy those new shares of the business units by separate. According to the book of Joel Greenblatt, "You can be an stock market genius", this high volatility of the stock price of those new IPOs that are massively divested by institutional investors might last between 1 and 2 years, but they end up delivering significant returns if those shares are acquired at a very cheap price since we should not forget that those business units would have stronger incentives to deliver value.
Outsiders should look at how big is the compensation package for the CEOs in each IPO, couple with the growth prospects of the business unit and the feasibility of the management's strategy to deliver value.
Valuation
We make projections in each business unit to estimate an intrinsic value considering an investment until 2026. In addition, we assume the following:
assumptions
It is clear that our discount rate is considering the country risk in order to add more margin of safety to our final calculation. For the calculation of this intrinsic value, we are using very conservative assumptions that could be considered our margin of safety too. Let's dive in the calculation of each business unit's intrinsic value:
The Taobao Tmall Commerce Group
The Taobao Tmall Commerce Group business unit will not be launched through an IPO, so it'll keep being wholly own by Alibaba. The IPOs of other business units might trigger a higher demand for Alibaba stock as the market would know that it will include the Chinese e-commerce and the cloud business units which will receive a higher focus from the CEO Daniel Zhang.
For the Chinese e-commerce business unit, we are making projections using the Gross Merchandise Value (GMV) which is an important metric that gauges all the products and services sold in the Alibaba's platforms in China. We are assuming an annual growth of 5% in line with the expectations of the Chinese economy's growth of 5% for the next years, even when its expected GMV's growth for China is 12.4% for 2023-2027.
ecommerce
Dividing the enterprise value (EV) by GMV, we assume a very conservative EV/GMV ratio of 0.3x for Alibaba since other similar companies like MercadoLibre (MELI) or Etsy (ETSY) have ratios of 2.1x and 1.4x respectively. We finally get an intrinsic value taking our target price of $168.29 in 2026 and calculating the present value using the discount rate of 15% for 2023. For this unit, we get an intrinsic value of $96.22 per share. CEO Daniel Zhang will be more focused on expanding the GMV per user. If an investor bought Alibaba's shares at a price of $96 or lower, he is getting for free the rest of the business units.
The Cloud
The Cloud business unit will receive a higher attention of Daniel Zhang to expand its services. Around 90% of the companies surveyed by McKinsey in June 2022 require more private cloud services than public cloud services. Within the same study, it has been found that several economic sectors in China will demand more of these private cloud services.
cloud
Despite its poor performance as of September 2022, the Cloud business unit of Alibaba is able to offer a high-value proposition for its clients like its high performance services through the 5nm-chip Yitian 710 which improves the cost performance ratio by 30% among other advantages.
Given its leadership in market share in China, the reopening of the Chinese economy, the better focus of Mr. Zhang reinforced by his stronger incentives to deliver value thanks to an eventual IPO and more independence as a business unit, the Cloud business unit of Alibaba might achieve an annual revenue growth of 10% in the next years. These shares could be very attractive not only for institutional investors who will receive their shares given their holding of Alibaba stock in their portfolios, but also for "outside" investors who might be interested only in the cloud business unit.
We assume EV/Sales of 5x, in line with other cloud businesses like Salesforce (CRM) and Veeva Systems (VEEV) with EV/Sales of 5x and 10x respectively. We get a valuation for this business unit of $8.80 per share.
Global Digital Commerce
This business unit includes Alibaba's international e-commerce platforms such as Lazada and AliExpress. Lazada has an important presence in Southeast Asia but it faces an strong competition from Shopee in several markets within that region. The new CEO Jian Fan will have all the incentives to strengthen the Lazada's market position and focus his efforts on Indonesia as this country offers the highest growth prospects among all the countries in that region.
lazada
We assume a EV/sales of 3x, considering that companies like Mercado Libre has a ratio of around 5x. We get an estimated intrinsic value for this segment of $8.58 per share.
Local Consumer Services
This business unit includes Ele.me, which is an online-to-offline platform of catering and food delivery; it also includes local services and on-demand delivery platforms. Some companies that are part of this unit is Taoxianda, Amap, which is a provider of mobile digital map, navigation and real-time traffic information in China, Fliggy, which is an online travel platform, and Koubei, which is a restaurant and local services guide platform for in-store consumption.
Some institutional investors might not be interested in this business unit, so there might be a sell off of these shares after the IPO. There are some reasons that could support this hypothetical scenario like the fact that the business is unprofitable involving physical stores in sectors whose nature are low net margins with a moderate growth prospects.
Local
Nonetheless, retail investors might find the shares of this unit very attractive if a massive sell off happen as the new CEO, Yu Yongfu, will have the incentives to turn this business into a profitable one. It'd be very important to look at his share based compensation and the long-term strategy of the business; this information will be available once the IPO is released. We assume EV/Sales of 3X getting an intrinsic value of $5.46 per share.
Cainiao Smart Logistics
Cainiao has developed a strong network in China, offering tailor-made solutions in logistics. In foreign markets, Cainiao has developed a network of assets and partners to support its international retail platforms such as AliExpress, Tmall Global and Lazada. The CEO Wan Lin will keep leading this unit, but now, with more independence in his decisions. It would not be a surprise that the shares of this unit would be strongly demanded by investors once its IPO is released as this unit is close to breakeven and its growth prospects is very interesting.
Cainiao
We assume EV/sales of 5x and we get an intrinsic value of $11.62 per share.
Digital Media and Entertainment
This might be another business that institutional investors would be willing to sell once they receive their shares in an IPO. The business is currently unprofitable and does not reveal a clear path for future growth; however, it could be an interesting bet if the share price drops significantly as investors could assess better the strategy and growth prospects of the business once the information is released with the IPO, and how much "skin in the game" will have the new CEO Fan Luyuan to deliver value.
Digital
Intrinsic Value
Adding the intrinsic value of all the business units through the SOTP method plus the cash and subtracting the debt we get the following:
intrinsic value
In our previous article "Alibaba stock: Ant Group still a good long-term driver" we've used a DCF method, reaching an intrinsic value of $151.23 even when our assumptions were very conservative. Our intrinsic value using the SOTP method gives us a higher intrinsic value of $176.49 per share including Ant Group from which more detailed information can be found in that article.
Risks
Any Alibaba's investor must consider that Chinese stocks, particularly those related to the tech sector, might be subject of unexpected new regulations that could trigger a higher volatility of the stock in the short term. In addition, other risk is that each business unit, according to the last reorganization, do not perform as expected which could strongly disappoint the market.
Nevertheless, we may find mitigations for both risks; more regulations could be expected in the future but we know that the most important ones were already implemented and Alibaba is taking important steps to fulfill those regulations and, at the same time, deliver long-term value for the shareholders. This new reorganization announced recently by the company will give it a better focus and more aligned incentives with the management while adjusting better its organization to reduce future scrutiny.
Final Thoughts
The new reorganization of Alibaba is positive for investors who are currently holding the stock for the long term as their shares might experience a capital appreciation given the better focus of each business unit and the more aligned incentives of their CEOs. Furthermore, this reorganization could represent an interesting opportunity as well for outsiders or investors who are not interested in Alibaba stock as a whole but in some of its business units once they are traded in stock markets through IPOs.
These IPOs might trigger incentives of institutional investors to sell off the shares of those business units that do not fulfill with their preferences or requirements, causing a decline in those stock prices artificially. Thus, those outsiders could buy those cheaper stocks from those business units and benefit from their future recovery as those units will be led by CEOs with more independence and probably with stock compensation packages that will align the CEO's efforts with the stock performance.
Source: seeking alpha
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