Alibaba: Valuing The 6 New Companies To Assess True Unlocked Value
Summary
The Chinese tech giant, announced the unexpected decision to split its operations into six different units, each of which will have its own CEO and the possibility to seek future.
With the new split, the management expects $Alibaba(BABA)$ to regain flexibility enabling the new six independent units to be completely focused on innovation and organic growth.
After the split, Alibaba's intrinsic value is equal to $542 billion, or $209 per share, a stunning 40% increase from the pre-split value.
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Investment Thesis
On March 28th $Alibaba(BABA)$ , the Chinese tech giant, announced the unexpected decision to split its operations into six different units, each of which will have its own CEO and the possibility to seek future IPO.
The management justified the drastic decision as a key strategy to unlock the hidden value of the already existing six different branches of Alibaba namely:
Taobao Tmall Commerce
Cloud Intelligence
Cainiao Smart Logistics
Digital Media & Entertainment
Global Digital Commerce
Local Services.
Over the 24 years since its foundation Alibaba became a colossal tech conglomerate that, despite maintaining a dominant market share, blocked the true growth potential of Alibaba while attracting the eyes of Chinese antitrust regulators that tackled its operations several times.
With the new split, the management expects Alibaba to regain flexibility in both decision-making and operations, enabling the new six independent units to be completely focused on innovation and organic growth.
In today’s analysis, we will assess how the split into six companies will unlock Alibaba’s true value making the company a good investment opportunity at today’s prices.
Operating Performance
Alibaba’s revenues grew at a compound annual growth rate (CAGR) of 45% from 2012 to 2022 reaching $134 billion in the latest fiscal year.
In the last five years, the median operating margin was 16.3% while the median return on invested capital (ROIC) was 9.73%, but both ratios were declining in recent years, especially after the outbreak of the Covid pandemic.
Despite that, Alibaba kept delivering strong free cash flows to the firm (FCFF) which grew from $737 million in 2012 to $5.3 billion in 2022.
In the nine-month ended in the 2023 fiscal year, Alibaba’s revenues declined 5.3% y-o-y in USD terms. The operating income was up 4.5% y-o-y and the operating margin improved from 12% to 13.3%.
Financially speaking Alibaba is very solid with a net cash position of $48 billion, a current ratio of 1.74, a debt-to-equity of 0.17, and an interest coverage ratio of 19.66.
Taobao Tmall Commerce
Looking at the single units’ operating performances, starting with Taobao Tmall Commerce, which comprises the e-commerce platforms that operate in mainland China, its revenues went from $544 million in 2010 to $92.3 billion in 2022, an astonishing CAGR of 53.4%.
The Chinese commerce unit is the only one with a positive operating income, equal to $26 billion in 2022, with a 5Y median operating margin of 33.8%. The management announced that this unit will remain a wholly owned subsidiary of the new Alibaba holding company that will be created.
Cloud Intelligence
The second unit by revenues is the Cloud Intelligence one, with $11.6 billion registered in 2022, growing at a CAGR of 69.21% since 2010.
The Cloud unit is the fastest growing one, and with no surprise, the current Alibaba CEO, Daniel Zhang, will serve as the CEO of the new unit to unlock its true potential and finally turn the -$805 million net loss into a positive operating profit galloping the ongoing trend of migration to cloud infrastructures.
Cainiao Smart Logistics
Following we have Cainiao Smart Logistics, a recent addition to Alibaba’s main operations, which since 2019 grew its revenues at a CAGR of 62.86% from $1 billion to $7 billion.
Despite not being yet profitable, the logistics unit represents a very interesting opportunity given the relevance that e-commerce platforms have in the Chinese market and the leading position of Cainiao in the logistics industry.
Global Digital Commerce
To conclude with the e-commerce related units, the Global Commerce unit, comprising the Southeast Asian e-commerce Lazada and AliExpress, grew its revenues at a CAGR of 30.68% since 2010, reaching $9.5 billion, but despite being active for such a long period, never managed to really conquer a significant market share and turn its operations profitable.
Local Services
Non-profitability is a particular signature mark also for the Local Services unit, which registered an operating margin of -70% in 2022. In this unit are included a bunch of platforms that offer local delivery services, like Ele.me, as well as Flaggy, an online travel agency.
Digital Media & Entertainment
Last but not least, the Digital Media & Entertainment unit totalized $5 billion in revenues in 2022 growing at a CAGR of 41.5% since 2016.
This unit mostly refers to Youku, the second-largest Chinese video platform owned by Alibaba and described as the Chinese YouTube. With no surprise, as most Chinese video platforms, it hasn’t yet reached profitability.
New six units operating performance (Bloomberg Terminal)
Growth Drivers
As the tech giant it is, Alibaba has to keep investing in R&D to continue developing its ecosystem adding new technologies and features to its various platforms in order to attract and retain more users which will in turn increase Alibaba’s revenues.
Another key growth drivers for the company are capital expenditures, which comprise all the investments made in both physical and digital infrastructures to support its various operations spanning from data servers to logistics networks.
Future growth can be determined by looking at how much and how well a company has invested in its growth drivers. The Reinvestment Margin shows what percentage of revenues has been reinvested into the company, while the Sales to Invested Capital ratio, shows how much revenues have been generated for each dollar invested by the company. If we multiply these two values and take the median value over the years, we obtain the expected growth rate in revenues based on how much and how well a company has invested in its growth drivers.
In our case, Alibaba’s expected growth rate is 13.12%.
Alibaba expected growth rate (Personal Data)
As regards the six new units instead, starting from the overall expected growth rate of 13.12%, we can adjust it by looking at how much the growth rate of each unit deviates from the overall company’s growth rate, using it as a proxy for the expected growth rate of each unit that will be created.
Comparing Alibaba’s 5-year revenues CAGR of 35.51% with the one of each unit, we obtain a delta that indicates the unit’s growth rate deviation from the company rate. Multiplying Alibaba’s expected growth rate of 13.12% by these deltas for each company we obtain a proxy for the expected growth rates for all the new companies created, with the Cloud and Logistic units having the higher expected growth rates of 20% and 23% respectively.
Six units expected growth rate (Personal Data )
Projections
Trying to project Alibaba’s future performances, before the split announcement, we could have expected Alibaba to reach $260 billion in revenues by 2032, maintaining good levels of efficiency and profitability despite being curbed by the non-profitable business lines, with an expected operating margin of 18% and a ROIC of 14% by 2032. We these assumptions Alibaba was expected to deliver FCFF in the range of $27 billion.
Alibaba future projections (Personal Data )
However, now that Alibaba will split into six new entities, we have to value each of them as a standalone company to assess Alibaba’s true value.
Taobao Tmall Commerce
Starting with the Taobao Tmall unit, we can expect its revenues to reach $183 billion by 2032 at a CAGR of 7.13%.
The true value here is unlocked by getting rid of the non-profitable business lines permitting the Chinese commerce unit to fully express its potential in terms of efficiency and profitability. We can expect the unit to have an operating margin of 30%, in line with its historical value, and a ROIC of 14% as the one we expected for Alibaba.
With this assumption Taobao Tmall is expected to generate $31 billion in FCFF, meaning that this unit alone can generate more cash flows than Alibaba as a single company.
Cloud Intelligence
Moving to the Cloud Intelligence unit, we can expect strong growth in revenues, expected to triple in 10 years reaching $35 billion.
Despite an initial struggle to turn profitable, we can assume the Cloud unit to reach profitability in the next 3/4 years, as cloud infrastructures enter the mass adoption phase, and reach levels of efficiency and profitability on par with its western rivals expecting an operating margin of 32% and ROIC of 16% which are derived from the average values of $Amazon.com(AMZN)$ , $Microsoft(MSFT)$ and $Alphabet(GOOG)$ cloud segments.
With these assumptions, the Cloud unit is expected to deliver FCFF of around $6.8 billion by 2032.
Cainiao Smart Logistics
Looking at Cainiao Smart Logistics, here again, we can expect revenues to grow strongly at a CAGR of 13.09% reaching $24 billion by 2032.
As regards future efficiency and profitability looking at Cainiao’s peers, the logistic industry is characterised by single-digit operating margins and ROIC. However, assuming Cainiao leveraging on the know-how developed by Alibaba’s e-commerce core operations, we can assume Cainiao’s future operating margins and ROIC to stay in the high tier of the logistics industry respectively at 9% and 14%.
With these assumptions, FCFF are expected to reach $1.2 billion by 2032.
If these free units so far are expected to significantly contribute to unlock Alibaba’s true value, the remaining three can best be described as deadweight rather than actual value enhancers.
Digital Media & Entertainment
The Digital Media & Entertainment unit registered the slowest growth rate among all others in the last 5 years, and given the cash-burning trend of Chinese video platforms, it can hardly be expected to turn profitable in the coming years.
Nevertheless, trying to be optimistic, as Youku is considered the Chinese YouTube, we can assume it will reach an operating margin of 16%, half of YouTube’s one, by 2032 and a ROIC of around 14% in line with Alibaba’s expected one before the split.
Therefore, in this very optimistic scenario, FCFF are expected to be around $700 million by 2032.
Local Services
Moving to another catastrophic unit, the Local Services one, which is an aggregate of different platforms that should ease the life of Chinese local communities and that can be compared to the more notorious DoorDash (DASH), Deliveroo (OTCPK:DROOF) and Yelp (YELP).
What these companies have in common is that they hardly make money, and we can expect the Local Services unit to keep burning cash for many years to come.
Hopefully assuming it will turn profitable in the next 5 years, we can expect Local Services to have a decent operating margin and ROIC, of around 15% and 14% respectively, as the business model of delivery companies is usually light on capital and very flexible.
Local Services' FCFF are expected to be $1.3 billion by 2032, assuming the company will survive that many years burning billions of dollars.
Global Digital Commerce
Finally, looking at the Global Commerce unit, it can be expected to grow at a modest rate, as it has done in the past, reaching $18 billion in revenues by 2032.
Despite being active since 2010 it still struggles to turn profitable, probably as a consequence of not being able to conquer a significant market share with AliExpress in relevant markets such as Europe.
However, as it has a decent grip on the Southeast Asian market with Lazada, and a leading position in Turkey with Trendyol, we can assume the Global Commerce unit to have an operating margin of 15% and a ROIC of 7% (half the value of the Taobao Tmall unit) by 2032.
With these assumptions, FCFF are expected to be around $1 billion.
Six units performance projections (Personal Data)
Valuation
Applying a discount rate of 8.01%, calculated using the WACC, the equity value of Alibaba pre-split was equal to $386 billion or $149 per share. However, after the split, the sum of the present equity value of each unit is equal to $542 billion or $209 per share, a stunning 40% increase.
Alibaba intrinsic value (Personal Data)
Units intrinsic value (Personal Data)
Definitely, the major contributors to this value enhancement are the Taobao Tmall Commerce and the Cloud Intelligence units, which respectively account for $423 billion and $70 billion.
The Taobao Tmall unit alone is worth more than Alibaba pre-split, as it will be able to unlock all its potential by getting rid of the other non-performing units. The Cloud Smart Intelligence unit is very interesting given the potential of the cloud sector and is considered the most plausible to seek for IPO in the future.
Among the other units, a worth mentioning goes to Cainiao Smart Logistics unit, which with a value of $7.2 billion can represent a good opportunity to enter the Chinese logistics industry.
The remaining three units, Digital Media, Global Commerce and Local Services have a relatively low impact on the total value unlocked by the split, contributing $5.5 billion, $3.9 billion and $1.4 billion respectively.
These units may seek IPOs to raise additional capital to support their cash-burning business models, but I hardly see them as a good investment opportunity without any significant future development.
Market & Risk
Despite the expected increase in value of 40%, Alibaba is definitely not a risk-free investment. First of all, the assumptions I’ve made must realize in the future, and talking about Digital Media & Entertainment, Global Digital Commerce, and Local Services, we have made pretty strong assumptions about their future profitability, which may not be achieved so soon given how much their peers are struggling to make that happen.
And of course, since we are talking about a Chinese company, we should always consider the impact that the policies implemented by the Chinese government might have on the company itself even if with the split Alibaba will reduce the threat of becoming a tech monopoly.
Conclusion
Given my analysis and assumptions, Alibaba’s stocks result to be strongly undervalued at today’s prices.
The unexpected announcement of the split changed forever the way we have to look at Alibaba. If before was a great company, definitely undervalued, with the split of its operations into six individual companies that will have a greater degree of flexibility in both decision-making and operability and the possibility to raise external capital, Alibaba surely represents a good investment opportunity at today’s prices.
Source: seeking Alpha
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