To The Moon

Alibaba: Sum-Of-The-Parts Valuation Reveals Deep Value Opportunity

Summary

• Alibaba will be reorganized into six business groups and other investments, which will help unlock shareholder value and foster market competitiveness.

• These six business groups will be managed by its own CEO and board of directors and have the ability to pursue independent fundraising and IPOs when they are ready.

• This reorganization will enable each business group to be more agile, enhance decision-making, and enable faster responses to market changes.

• This could bring efficiency improvements to Alibaba Group as each unit is now in charge of their own performance and costs.

• My SOTP price target for Alibaba is $145, which implies 42% upside from current levels.

• This idea was discussed in more depth with members of my private investing community, Outperforming the Market. Learn More »

Andrea Verdelli/Getty Images News

The announcement of the reorganization of $Alibaba(BABA)$ Alibaba (NYSE:BABA) came as a major surprise to the markets and presents a strong positive catalyst for Alibaba investors.

I highlighted to members of Outperforming the Market this change in valuation the market will give Alibaba as a result of this reorganization.

In my previous article, I was arguing that the regulatory and political winds have been changing in recent months as the Chinese government looks to focus on growth of the economy after its pivot away from its zero Covid policies. Furthermore, I argued that Alibaba's China e-commerce business will likely deliver strong growth in 2023 as the economy opens up and due to a low base in 2022. Furthermore, the company has seen the benefits of its cost optimization efforts as the company's margins continue to improve while losses continue to narrow. Lastly, Alibaba's cloud computing segment will see greater traction as the Chinese economy improves and the internet companies recover from a tough technology clampdown period.

In this article, I aim to explain to you the main benefits of the reorganization of Alibaba that was announced earlier, what it means to the company, and more importantly, what it means to you as a shareholder. I will end by sharing with you my sum-of-the-parts ("SOTP") valuation for Alibaba. The SOTP valuation gives investors an idea about the value of Alibaba's six business units when they are separately valued and provides investors with the shareholder value that could be unlocked as a result of the reorganization.

The great reorganization

Alibaba announced on March 28, 2023 that it will be reorganized into six business groups and other investments.

These six business groups are the Cloud Intelligence Group, Taobao Tmall Commerce Group, Local Services Group, Cainiao Smart Logistics, Global Digital Commerce Group, and the Digital Media and Entertainment Group.

This reorganization is aimed at unlocking shareholder value and fostering market competitiveness.

After the reorganization, Mr. Daniel Zhang will continue to serve as Chairman and CEO of the Alibaba Group, and each of the six business groups will be managed by its own CEO and board of directors.

This essentially gives each business group and company the ability to pursue independent fundraising and IPOs when they are ready. The only exception is for the Taobao Tmall Commerce Group, which will remain as wholly-owned unit of Alibaba Group.

More on the individual groups

As mentioned, there will be six business groups after this reorganization.

First, there is the Cloud Intelligence Group. This Group will include all cloud, artificial intelligence activities, and businesses like DingTalk. Mr. Daniel Zhang will serve as the CEO of this Group.

Second, there is the Taobao Tmall Commerce Group. This group will include China commerce activities such as Taobao, Tmall, Taobao Deals, Taocaicai, 1688 and other businesses. Ms. Trudy Dai will be the CEO of this group.

Third, there is also the Local Services Group. This includes Amap, Ele.me and other businesses. The CEO of the Local Services Group will be Mr. Yu Yongfu.

Fourth, there is the Cainiao Smart Logistics, of which Mr. Wan Lin will continue as the CEO.

Fifth, there is the Global Digital Commerce Group, which will see Mr. Jiang Fan as CEO. This Group will include Lazada, AliExpress, Trendyol, Daraz, and Alibaba.com.

Last but not least, we have the Digital Media and Entertainment Group. This Group includes Youku, Alibaba Pictures and other businesses and it will be led by Mr. Fan Luyuan.

Effects of the reorganization

Needless to say, this is the largest reorganization effort that Alibaba has undergone. That said, I do think that this is beneficial for Alibaba in the long term given the size it has grown to and the current regulatory environment. At the end of the day, with the entire Alibaba Group at such a large size, the splitting of the Group into six units will empower each of its business units to become more agile, enhance decision-making, and enable faster responses to market changes.

I think that this could be a potential game changer for Alibaba given that the size that it has grown to makes it difficult to adapt quickly to changing trends and technologies. At the end of the day, as a nimbler business group, each business can then pivot and change with the times more quickly, potentially bringing better innovation to the market.

Also, this restructuring will be beneficial for shareholders given that it helps to unlock the value within the entire Alibaba Group. For a long time, Alibaba has been seen only as an e-commerce player but as can be seen in its different business groups, there are many other business segments, geographies in which it could expand to and eventually become a substantial part of its business.

With tailored incentive plans for each management team of the respective business groups, they could then help bring greater value to shareholders. In addition, at the Alibaba Group level, we will likely see more efficiency gains as there is a chance to reduce the middle and back-office functions at the Alibaba Group level. There are even opportunities for the middle and back-office capabilities that have been built over the years to transition into relevant business groups and companies.

Nimbler organization

As a result of the reorganization, this will make Alibaba's business more nimble and agile. In fact, I think that Alibaba has been affected by the slow decision-making process as a result of its size, while its pure play competitors are able to move much faster. This is a result of the complex organizational structure of the company.

I am of the view that many of Alibaba's business units can be better off as a separate individual business without the complex organizational structure of the Alibaba Group.

Examples of Alibaba's business losing out to pure play competitors include the competition between Lazada and Shopee, Youku's competition with iQiyi, Eleme's competition with Meituan, amongst others.

As a result of the splitting into six business units, Alibaba will be able to enable and empower its individual business units to make faster decisions and improve operating efficiency of each unit.

Efficiency improvement

As a result of Alibaba's scale, this reorganization will likely bring solid efficiency improvement. This is because at the current large scale that Alibaba operates at, there are principal agent problems existing within the organization. As a result of the reorganization and splitting the group into six individual units, this will help to make the entire group more cost-efficient. Also, each individual business unit will then become accountable for their own performance and costs. This is due to the ability for each of these groups to eventually raise their own funds and independently IPO.

As a result, I think that we will see consistent margin improvement from the reorganization efforts on a group level.

Valuation

I think that the reorganization announcement will lead to changes in the way Alibaba is valued. When the Alibaba Group is valued as a whole, a P/E multiple is applied onto the company and this P/E multiple is more often than not tied to its China e-commerce business.

That said, by valuing Alibaba based on a SOTP valuation model, this will bring out the value of the individual business units within Alibaba. For example, using my forecasts for Alibaba in 2024, I applied a 10x P/E to Alibaba's core commerce business, 3x P/S for its local services business, 3x P/S for its Cainiao business, 3x P/S for its international commerce business, 5x P/S for its cloud computing business, amongst others.

This led to a SOTP price target of $145 after taking into account a 20% holding company discount for the Alibaba Group. This implies 42% upside from current levels.

Alibaba SOTP Valuation (Author generated)

Risks

Competitive pressures

There is no lack of competition for Alibaba's businesses. Within its local services business, there could be a threat from other large internet companies like $Tencent Holding Ltd.(TCEHY)$ and $Baidu(BIDU)$ . Furthermore, there are strong competitive pressures within its core e-commerce business in China as $JD.com(JD)$ is offering a substantial amount of subsidies to compete with $Pinduoduo Inc.(PDD)$ as they both wage a price war and compete on prices.

Regulatory and political risks

Despite regulatory headwinds basically clearing up after the split up of the Alibaba Group into six business units and with Jack Ma's return to China, I think we need to be wary of the continued risks that regulatory and political headwinds may bring.

Conclusion

From the perspective of an investor, the reorganization of Alibaba, although a surprise to the markets, has been a positive catalyst for unlocking of shareholder value for Alibaba shareholders. This is also a clear sign that the company, and its founder Jack Ma, is increasingly aligning with the Chinese authorities and thus, reducing the company's regulatory and political risks while improving the company's reputation. Importantly, it also erases Alibaba's label as the icon for the technology sector clampdown, potentially showing signs once again that the technology sector clampdown is over.

In the longer term, I expect that Alibaba will be valued in a different manner and this will help unlock value for the group. At the end of the day, I also expect each individual business unit to be more agile and nimble, and better aligned to improve their performance and costs individually. As a result, this reorganization will have a significant implication to Alibaba's business fundamentals and valuations in the longer term.

As mentioned above, my SOTP price target for Alibaba is $145, which implies 42% upside from current levels.

Source: tradingview